INTERNEURON PHARMACEUTICALS INC - 10-K Annual Report

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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the fiscal year ended September 30, 2001 or

[_] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the transition period from to

Commission File No. 0-18728

Interneuron Pharmaceuticals, Inc.

(Exact name of registrant as specified in its charter)

Delaware
(State or other
jurisdiction of 04-3047911
incorporation or (I.R.S. Employer
organization) Identification Number)
One Ledgemont Center 02421-7966
99 Hayden Avenue (Zip Code)
Lexington, MA
(Address of principal
executive offices)

Registrant's telephone number, including area code: (781) 861-8444

Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES [X] NO [_]

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [_]

The aggregate market value of the voting and non-voting common equity
(excluding preferred stock convertible into and having voting rights on certain
matters equivalent to 622,222 shares of Common Stock) held by non-affiliates of
the registrant was approximately $231,000,000, based on the last sales price of
the Common Stock as of December 5, 2001. Shares of Common Stock held by each
executive officer and director, by each person who beneficially owns 10% or
more of the outstanding Common Stock, and individuals or entities related to
such persons have been excluded. This determination of affiliate status may not
be conclusive for other purposes.

As of December 7, 2001, 43,283,016 shares of Common Stock, $.001 par value,
of the registrant were issued and outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

See Part III hereof with respect to incorporation by reference from the
registrant's definitive proxy statement for the fiscal year ended September 30,
2001 to be filed pursuant to Regulation 14A under the Securities Exchange Act
of 1934 and the Exhibit Index beginning on page number 46 hereto.

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PART I

Note Regarding Forward Looking Statements

Statements in this Form 10-K that are not statements or descriptions of
historical facts are "forward-looking" statements under Section 21E of the
Securities Exchange Act of 1934, as amended, and the Private Securities
Litigation Reform Act of 1995 and are subject to numerous risks and
uncertainties. These and other forward-looking statements made by the Company
in reports that we file with the Securities and Exchange Commission, press
releases, and public statements of our officers, corporate spokespersons or our
representatives are based on a number of assumptions and relate to, without
limitation: the Company's ability to successfully develop, obtain regulatory
approval for and commercialize any products; its ability to enter into
corporate collaborations or to obtain sufficient additional capital to fund
operations; and the Redux(TM)- related litigation. The words "believe,"
"expect," "anticipate," "intend," "plan," "estimate" or other expressions which
predict or indicate future events and trends and do not relate to historical
matters identify forward-looking statements. Readers are cautioned not to place
undue reliance on these forward-looking statements as they involve risks and
uncertainties and such forward looking statements may turn out to be wrong.
Actual results could differ materially from those currently anticipated due to
a number of factors, including those set forth under "Risk Factors" and
elsewhere in, or incorporated by reference into, this Form 10-K. These factors
include, but are not limited to: the early stage of products under development;
uncertainties relating to clinical trials, regulatory approval and
commercialization of the Company's products; dependence on third parties for
manufacturing and marketing; competition; need for additional funds and
corporate partners; history of operating losses and expectation of future
losses; product liability; risks relating to the Redux-related litigation;
government regulation; risks associated with contractual arrangements; limited
patents and proprietary rights; dependence on key personnel; uncertainty
regarding pharmaceutical pricing and reimbursement and other risks. The
forward-looking statements represent the Company's judgment and expectations as
of the date of this Report. The Company assumes no obligation to update any
such forward-looking statements. See "Risk Factors."

Unless the context indicates otherwise, "Interneuron" and the "Company"
refer to Interneuron Pharmaceuticals, Inc. and "Common Stock" refers to the
common stock, $.001 par value per share, of Interneuron.

ITEM 1. Business

(a) General Description of Business:

Interneuron is a biopharmaceutical company engaged in the development and
commercialization of a diversified portfolio of product candidates, including
multiple compounds in late stage clinical development. The Company is currently
developing or has certain rights to six compounds, listed in order of
development stage: pagoclone for panic and generalized anxiety disorders
("GAD"), trospium for overactive bladder, IP 501 for cirrhosis of the liver,
citicoline for ischemic stroke, PRO 2000 for the prevention of infection by the
human immunodeficiency virus ("HIV") and other sexually transmitted pathogens,
and dersalazine for inflammatory bowel disease ("IBD").

The Company seeks to acquire, develop and commercialize a portfolio of
pharmaceutical products for a range of therapeutic indications. The key
elements to Interneuron's business strategy include: 1) identifying products
with broad applications and large, unsatisfied markets, 2) acquiring clinical
and late pre-clinical stage compounds, including products with clinical data or
market experience outside the U.S., 3) defining pathways for these compounds
through the clinic and to market, 4) adding value to acquired products through
clinical testing and regulatory review activities and competencies, and 5)
commercializing products independently or through selective corporate
partnerships that will help ensure the timely penetration of target markets.
The Company's strategy is both systematic and opportunistic across a range of
products and therapeutic areas arising from a variety of partners including
biopharmaceutical, regional pharmaceutical, and multi-national pharmaceutical
firms, as well as academic and government institutions. Within these
relationships, Interneuron attempts to leverage its capabilities, expertise,
resources, and shared commitment to maximize the potential of each therapeutic
product.

2

Pagoclone, the Company's lead product, is a novel GABA (gamma amino butyric
acid) receptor agonist in development for the treatment of anxiety disorders.
In December 1999, the Company licensed worldwide development and
commercialization rights to Warner-Lambert Company, now Pfizer Inc. ("Pfizer")
in exchange for up-front, milestone, and royalty payments. Pfizer is currently
conducting a Phase III clinical trial in panic disorder and multiple Phase II
trials in generalized anxiety disorder with pagoclone. To date, preclinical and
clinical testing have shown pagoclone to have promise in the treatment of
anxiety disorders. Based on the mechanism of action of pagoclone as a potent
agonist of the GABA receptor, the compound has the potential for a rapid onset
of anxiolytic effect. Also, preclinical and clinical data suggest the potential
to avoid the side effects commonly seen with other drugs currently used to
treat anxiety disorders.

Trospium is a muscarinic receptor antagonist in Phase III development by the
Company as a treatment for overactive bladder. Trospium works by relaxing
smooth muscle tissue in the bladder, thus decreasing bladder contractions. The
Company's Phase III trial, a double-blind, placebo controlled study in
approximately 500 patients, is expected to conclude in the fall of 2002. If the
trial is successful, the Company plans to file a New Drug Application ("NDA")
shortly thereafter. The Company in-licensed rights to develop and commercialize
trospium in the United States from Madaus AG ("Madaus"), a German
pharmaceutical company. Trospium is currently marketed in Europe, where it is
one of the leading treatments for overactive bladder.

In December 2000, the Company exercised an option and licensed an orally
administered, anti-fibrotic compound known as IP 501 for the treatment and
prevention of cirrhosis of the liver. Data analysis of a Phase III trial with
IP 501 in alcoholic cirrhosis is ongoing by the Department of Veterans Affairs
(the "Veterans Administration"), and in January 2001, the National Institutes
of Health ("NIH") initiated a Phase III trial with this compound in Hepatitis
C-associated cirrhosis. The Company is awaiting results of the Veterans
Administration-sponsored study before beginning any further development of the
product.

Citicoline has been under development as a treatment for ischemic stroke.
Based on the data from three Phase III trials with citicoline conducted by the
Company, the Company believes that additional clinical testing is required
before an NDA can be submitted. In December 2000, the Company's development
partner, Takeda Chemical Industries, Ltd. ("Takeda"), notified the Company of
its decision not to participate in the further development of citicoline.
Therefore, the Company has reacquired all rights to this compound. The Company
does not intend to develop citicoline further by itself unless it is able to
find another partner to participate in such development.

PRO 2000 is a topical microbicide in development for the prevention of the
sexual transmission of HIV and other sexually-transmitted diseases ("STDs").
Government-sponsored Phase I and Phase I/II studies in both healthy and
HIV-positive women have shown PRO 2000 to be well-tolerated. Multiple
additional clinical trials in HIV prevention are expected to begin in 2002,
including a Phase II trial sponsored by the European Commission and a Phase
II/III trial to be conducted by the NIH in approximately 10,000 women in Africa
and India.

In September 2001, the Company acquired worldwide rights to dersalazine, an
anti-inflammatory compound in clinical development to treat IBD, which includes
ulcerative colitis and Crohn's disease. The Company believes that dersalazine,
a new chemical entity combining potent activity against several inflammatory
cytokines, such as TNF-alpha, with the standard first line therapy for IBD,
5-aminosalicylic acid ("5-ASA"), has the potential to be the next generation
first line therapy for mild to moderate IBD. The Company acquired dersalazine
from J. Uriach & Cia., S.A. ("Uriach"), a Spanish pharmaceutical company. The
Company expects to complete a multiple-dose Phase I clinical study for
dersalazine and initiate Phase II trials in ulcerative colitis in 2002.

Under an agreement with Eli Lilly and Company ("Lilly"), the Company
receives royalties on net sales in the U.S. of Sarafem(TM), a treatment for
premenstrual dysphoric disorder ("PMDD"), a severe form of premenstrual
syndrome ("PMS"). The Company expects to continue to receive royalties on the
net sales of Sarafem until March 2002.

3

On May 30, 2001, the Company entered into the Indemnity and Release
Agreement with American Home Products Corporation ("AHP") related to product
liability cases filed against the Company concerning Redux (the "AHP Indemnity
and Release Agreement"). Redux (dexfenfluramine hydrochloride capsules) C-IV, a
prescription weight loss medication, was launched by AHP in June 1996 and
withdrawn from the market in September 1997, following which the Company has
been named, together with other pharmaceutical companies, as a defendant in
approximately 3,200 product liability legal actions involving the use of Redux
and other weight loss drugs.

The AHP Indemnity and Release Agreement provides for indemnification and
funding by AHP as follows: (i) complete indemnification for plaintiffs who have
already opted out of AHP's national class action settlement of diet drug claims
and claimants alleging primary pulmonary hypertension, (ii) all future legal
costs related to the Company's defense of Redux-related product liability
cases, and (iii) additional insurance coverage to supplement the Company's
existing policies. In exchange, the Company agreed to dismiss its suit against
AHP filed in January 2000, its appeal from the order approving AHP's national
class action settlement of diet drug claims, and its cross-claims against AHP
related to Redux product liability legal actions. The Company believes that the
provisions of this agreement, combined with the Company's existing product
liability insurance, are sufficient to address the Company's potential
remaining Redux product liability exposure.

The Company was incorporated in Delaware in March 1990. The Company's
executive offices are located at One Ledgemont Center, 99 Hayden Avenue,
Lexington, Massachusetts 02421-7966.

(b) Financial Information about Industry Segments

The Company operates in only one business segment.

(c) Narrative Description of Business

PRODUCTS

The following table summarizes, in order of development stage, the products
under development by the Company or to which the Company has certain rights,
including product name, indication/use, regulatory status and commercial rights
held by the Company with respect to each product. For a more detailed
description of each product, see the product descriptions following the chart.

Product Name Indication/Use Regulatory Status * Commercial Rights
- ------------ -------------- ------------------- -----------------

Pagoclone Panic and Generalized Anxiety Phase III in panic disorder; Worldwide; licensed to Pfizer
Disorders Phase II in generalized anxiety
disorder
Trospium Overactive bladder Phase III U.S.
IP 501 Cirrhosis of the liver Phase III U.S., Canada, Japan and Korea
Citicoline Ischemic stroke Phase III U.S. and Canada
PRO 2000 Prevention of HIV and Phase II Worldwide
sexually transmitted diseases
Dersalazine Inflammatory bowel disease Phase I Worldwide

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* See "Government Regulation."

4

PAGOCLONE

General: Pagoclone is a compound under development to treat panic and
generalized anxiety disorders. Panic disorder is a severe anxiety condition
characterized by panic attacks, acute episodes of anxiety comprised of
distressing symptoms, such as breathing difficulty, sweating, heart
palpitations, dizziness or fainting, and fear of losing control. Generalized
anxiety disorder is characterized by excessive anxiety and worry most days for
at least six months about a variety of events or activities, such as work or
family. Patients with generalized anxiety disorder experience persistent
diffuse anxiety without the specific symptoms that characterize phobic
disorders, panic disorders or obsessive-compulsive disorders. There are
approximately 20 million people in the U.S. (Drug and Market Development,
October 2001) and 60 million worldwide with anxiety disorders (In Vivo,
September 2001).

Anxiety disorders, including panic disorder, are believed to be associated
with excessive neuronal activity resulting from a decrease in the function of
the major inhibitory neurotransmitter called GABA. The Company believes that
pagoclone, a novel GABA modulator and a member of the cyclopyrrolone class of
compounds, increases the action of GABA, thus alleviating symptoms of panic and
anxiety.

Current pharmacological treatments for panic and anxiety disorders generally
include benzodiazepines, serotonin agonists and selective serotonin reuptake
inhibitors. Traditional side effects seen with these classes of anti-anxiety
drugs include sedation, lack of mental acuity, withdrawal and rebound anxiety
related to the benzodiazepine class of drugs, and agitation, insomnia and
sexual dysfunction related to serotonin reuptake inhibitors. Pre-clinical and
early clinical data suggest that treatment with pagoclone may have advantages
over these treatments by limiting these common side effects.

Pfizer Agreement: In December 1999, the Company entered into an agreement
with Pfizer, subsequently amended, under which the Company licensed to Pfizer
exclusive, worldwide rights to develop and commercialize pagoclone (the "Pfizer
Agreement"). To date under the Pfizer Agreement, the Company has received
$16,750,000, including an up-front payment of $13,750,000, and is entitled to
receive up to an additional $62,000,000 in payments contingent upon the
achievement of clinical and regulatory milestones. Pfizer will also pay
Interneuron royalties on net sales if pagoclone is commercialized. Under the
Pfizer Agreement, Pfizer is responsible for conducting and funding all further
clinical development, regulatory review, manufacturing and marketing of
pagoclone on a worldwide basis. See "Agreements" and "Risk Factors--We will
depend on Pfizer to develop, manufacture and market pagoclone."

Ongoing Development: In August 2000, Pfizer initiated its clinical program
for pagoclone. Pfizer currently has ongoing a Phase III trial in panic
disorder, multiple Phase II trials in generalized anxiety disorder, and
multiple clinical pharmacology studies. Pending further evaluation, Pfizer may
initiate additional late-stage clinical trials in panic and generalized anxiety
disorders.

Phase II/III Clinical Trial: In August 1998, the Company announced results
of its Phase II/III trial showing that treatment with pagoclone statistically
significantly reduced the frequency of panic attacks among patients suffering
from panic disorder. In addition, pagoclone was well-tolerated by these
patients, with no evidence of sedation and no apparent withdrawal symptoms in
this study, which included a tapering-off period.

The double-blind, placebo-controlled, parallel group study involved 277
patients at six clinical sites in the United States. Patients were enrolled in
the study following confirmed diagnoses of panic disorder. The number of
attacks experienced by each patient during a two-week screening period prior to
enrollment represented the baseline for subsequent comparison of panic attack
frequency. Following the screening period, patients were randomized to receive
one of three doses of pagoclone orally (.15 milligrams/day, .30 milligrams/day
or .60 milligrams/day) or placebo for eight weeks. The primary outcome
measurement was the change from baseline in the number of panic attacks seen at
the eight week time point. This primary analysis, conducted on an LOCF (Last
Observation Carried Forward) basis, showed that patients in the .15
milligrams/day group experienced a 43% reduction in the number of panic attacks
relative to patients on placebo (p=0.141), that patients in the .30
milligrams/day group experienced a 70% reduction relative to patients on
placebo (p=0.021), and that patients in the .60 milligrams/day group
experienced a 52% reduction (p=0.098) relative to patients on placebo.

5

Pagoclone was well tolerated with a low incidence of side effects in all
dosage groups and no clinically significant differences from placebo. Sedation,
a major side effect of benzodiazepine drugs, was evaluated by use of the
Stanford Sleepiness Scale. There were no differences observed between pagoclone
and placebo using this scale. In addition, there were no evident withdrawal
effects seen at the end of the study as determined by the Rickels Withdrawal
Scale. Of note, other common side effects seen with existing classes of
anti-anxiety drugs were not significantly different between pagoclone patients
and patients receiving placebo in this trial. These traditional side effects
include sedation, lack of mental acuity, withdrawal and rebound anxiety related
to the benzodiazepine class of drugs, and agitation, insomnia and sexual
dysfunction related to selective serotonin reuptake inhibitors.

Pilot Study: In November 1997, the Company announced that data from a pilot
study among 16 patients suffering from panic attacks showed that those who were
treated with three doses per day, orally, of pagoclone experienced a marked
reduction in the number of their panic attacks compared to those who received
placebo. This double-blind, placebo controlled crossover study was conducted by
a team of researchers in the U.K. Pagoclone produced a significant reduction
(40%, p=0.012) in the total number of panic attacks over a two-week treatment
period and a reduction (40%, p=0.006) in the average number of panic attacks
per day compared to the pre-treatment period. No significant change in the
total number of panic attacks was observed during placebo treatment.

Licensing and Proprietary Rights: In February 1994, the Company licensed
from Rhone-Poulenc Rorer, S.A., now Aventis, S.A. ("Aventis") exclusive,
worldwide rights to pagoclone, subject to Aventis' option to obtain a
sublicense in France, in exchange for license fees, milestone payments and
royalties based on net sales. As a result of the Company's sublicense of
pagoclone to Pfizer, in lieu of milestone payments and royalties, Aventis will
receive a portion of payments received by the Company under the Pfizer
Agreement. A composition of matter patent and several process patents for
pagoclone have issued in the U.S. and Europe. See "Agreements" and "Patents and
Proprietary Rights."

TROSPIUM

General: Trospium is under development as a drug to treat overactive
bladder, the most common cause of urinary incontinence in the elderly.
Overactive bladder is defined as urge incontinence, urgency and frequency.
According to a recent report of the American Urological Association,
approximately 17 million Americans, 85 percent of whom are women, suffer from
bladder control problems, which can lead to overactive bladder. According to
the SCRIP Report dated September 2000, only 20 percent of overactive bladder
patients are currently treated with pharmacotherapy. Economic costs related to
diagnosis and treatment of overactive bladder are estimated to exceed $26
billion, as stated in the Journal of the American Medical Association report on
December 16, 1998.

Trospium belongs to the anticholinergic class of compounds and binds
specifically to the muscarinic receptors. These compounds relax smooth muscle,
or detrusor, tissue in the bladder, thus decreasing bladder contractions.
Overactive or unstable detrusor muscle function is believed to be the cause of
overactive bladder. Trospium is currently marketed in most European countries.

Current treatments for overactive bladder include compounds in the same
class as trospium, such as Detrol(TM) (tolterodine) and Ditropan(TM)
(oxybutynin). In contrast to trospium, these drugs are lipophilic and have been
shown to cross the blood-brain barrier. Based on the hydrophilic nature of
trospium and pre-clinical and clinical findings to date, the Company believes
that trospium does not cross the blood-brain barrier, thereby avoiding central
nervous system side effects. In addition, because trospium is not extensively
metabolized by the liver and is excreted primarily unchanged in the urine, the
Company believes that treatment with trospium may avoid many potential
drug-drug interactions seen in existing agents that are metabolized extensively
in the body by the cytochrome P-450 system, such as Detrol and Ditropan.
Finally, clinical data have shown that patients treated with trospium may have
a lower incidence of dry mouth relative to patients treated with other
compounds in the same pharmacological class. The side effects seen with other
treatments for overactive bladder have led to low satisfaction among physicians
and patients, and significant discontinuation rates among patients.

6

Development Program: In August 2001, the Company completed an
electrocardiographic study recommended by the U.S. Food and Drug Administration
(the "FDA") for drugs in the pharmacological class of trospium. Following the
successful completion of this study, the Company initiated a Phase III clinical
trial in September 2001 with trospium that will include over 500 patients
suffering from overactive bladder. This trial will compare both the reduction
in micturitions and incontinence episodes among trospium-treated patients
versus placebo-treated patients during a 12-week double-blind treatment period.
Based upon its discussions with the FDA, the Company believes that, in
combination with existing efficacy and safety data on trospium, a single,
successful Phase III trial of this scope will be necessary and sufficient for
submission of an NDA. Assuming patients are enrolled on a timely basis and
positive results are received from this trial, the Company expects to file an
NDA for trospium by the end of 2002. See "Risk Factors--We rely on the
favorable outcome of clinical trials of our products," and "--We will rely on
third parties to commercialize and manufacture our products."

Licensing and Proprietary Rights: In November 1999, the Company licensed
exclusive U.S. rights from Madaus to market trospium (the "Madaus Agreement").
In exchange, the Company agreed to pay Madaus regulatory milestone, royalty and
sales milestone payments. Interneuron is responsible for all clinical
development and regulatory activities and costs related to the compound and for
manufacturing and marketing the compound in the U.S. There are no existing U.S.
patents covering the use of orally-administered trospium to treat overactive
bladder. The Company expects to rely on the provisions of the Drug Price
Competition and Patent Term Restoration Act of 1984 ("Waxman-Hatch Act") to
obtain a period of market exclusivity in the U.S., if the FDA approves trospium
in the U.S. for the intended indication. The Madaus Agreement includes a
license of the know-how relating to the European clinical trials of trospium.
See "Agreements," "Patents and Proprietary Rights," and "Government Regulation."

Madaus Development: The current clinical database for trospium includes over
2,200 subjects and patients (over 1,300 treated with active drug). The database
comprises two double-blind, placebo-controlled dose-ranging studies, five
double-blind, placebo-controlled studies, one of which included an
active-controlled treatment arm, and several comparative trials, one of which
was a long-term comparative 52-week study on safety, tolerability, and
efficacy. Many of these studies assessed the relative efficacy of trospium on
urodynamic measurements such as bladder capacity and compliance, maximum
detrusor pressure, and residual urine, in addition to micturition frequency
diary data. In addition to this clinical database, over 10,000 patients have
been followed in post-marketing trials. To supplement the clinical database,
Interneuron will also utilize Madaus' extensive pharmacology, toxicology and
pharmacokinetic studies, including acute, subacute, chronic, carcinogenicity,
genotoxicity, and reproduction studies, as well as numerous pre-clinical and
clinical biopharmaceutical studies.

Madaus has conducted several trials comparing the safety and efficacy of
trospium with its two principal competitors in Europe, tolterodine and
oxybutynin. A double-blind, randomized efficacy trial, testing trospium and
oxybutynin, was conducted with 358 patients, 268 of whom were treated with
trospium (20 mg twice a day) and 90 with oxybutynin (5 mg twice a day) over a
52-week period. There was no significant difference between trospium and
oxybutynin in the primary outcome measures of the trial, reduction in
micturitions and urge incontinence episodes. Among key safety measures,
trospium had a statistically and clinically significantly lower incidence of
dry mouth (p(less than)0.01) and gastrointestinal adverse events (p=0.02) than
oxybutynin (Hofner et al., Neurourol Urodyn 19, 2000, 487-88).

A second double-blind, placebo-controlled randomized efficacy trial, testing
trospium and tolterodine, was conducted with 187 patients, 57 of whom were
treated with trospium (20 mg twice a day), 63 with tolterodine (2 mg twice a
day) and 60 with placebo over a three-week period. Trospium-treated patients
experienced a statistically significant (p(less than)0.01) reduction in
micturitions compared with placebo-treated patients, whereas the reduction in
micturitions among tolterodine-treated patients failed to reach statistical
significance over placebo patients, and there was no statistically significant
difference in side effects between trospium patients and tolterodine patients
(Junemann et al., Neurourol Urodyn 19, 2000, 488-90).

7

IP 501

General: IP 501 is under development for the treatment and prevention of
liver disease, including alcoholic cirrhosis and Hepatitis C cirrhosis. These
diseases lead to fibrosis, or scarring, of liver tissue, primarily through the
excessive accumulation of collagen.

Development Program: The Veterans Administration has completed an
800-patient Phase III clinical trial with IP 501 in patients with alcoholic
cirrhosis and is currently analyzing the results of this trial. In addition, a
250-patient Phase III trial in patients with cirrhosis caused by the Hepatitis
C virus has begun. Both trials have as their primary endpoint the comparison of
the reduction in the progression of cirrhosis among drug-treated pre-cirrhotic
patients compared with placebo patients, as measured by serial liver biopsies.
The Company is awaiting results of the Veterans Administration sponsored trial
before beginning any further development of this product.

Even if the results of this trial are positive, the Company would need to
conduct significant additional pre-clinical studies (including toxicology and
formulation) and extensive manufacturing development on this compound prior to
submission of an NDA. See "Risk Factors--We rely on the favorable outcome of
clinical trials of our products."

Licensing and Proprietary Rights: In December 2000, the Company exercised an
option and entered into an agreement to license IP 501 that includes rights to
develop and commercialize IP 501 in the U.S., Canada, Japan, Korea, and, under
certain circumstances, Europe and other markets. The Company is responsible for
all remaining clinical development, regulatory activities, manufacturing and
marketing of the compound. United States patent claims for IP 501 relate to
methods of preventing or treating liver cirrhosis. See "Agreements" and
"Patents and Proprietary Rights."

CITICOLINE

General: Citicoline has been under development as a treatment for ischemic
stroke. An ischemic stroke occurs when brain tissue dies or is severely damaged
as the result of interrupted blood flow caused by a clogged artery which
deprives an area of the brain of blood and oxygen, commonly known as an
infarct. This loss of blood flow and oxygen causes, among other events, a
breakdown of brain cell membranes, and places the surrounding tissue, the
penumbra, at risk for death, leading to an extension of the size of infarct.

Mechanism of Action: Citicoline is believed to have multiple acute and
longer-term mechanisms of action in diminishing the effects of stroke. On an
acute basis, citicoline appears to limit infarct size by preventing the
accumulation of fatty acids, which would otherwise yield toxic oxidation
products, by preventing their release. On a longer-term basis, citicoline is
believed to promote the formation of additional membrane elements needed by
damaged neurons to restore functional activity by raising blood levels of
choline, cytidine and other phospholipid precursors, which are substrates
believed to be essential for the formation of the nerve cell membrane.
Citicoline is thereby believed to help stabilize the cell membrane and, as a
result, decrease edema, or brain swelling, caused when blood flow to brain
cells is stopped, and help to re-establish normal neurochemical function in the
brain. Citicoline also appears to increase levels of acetylcholine, a
neurotransmitter believed to be associated with learning and memory functions.

Development Strategy: The Company has completed three Phase III clinical
trials and one Phase II/III trial with citicoline in North America. Based on
the results of these trials, the Company believes additional clinical testing
is required before an NDA for citicoline can be submitted for review by the
FDA. Following the termination of the Takeda Agreement (see "Takeda
Agreement"), the Company does not intend to develop citicoline further by
itself unless it is able to find another partner to participate in such
development.

8

Regulatory Review: The Company had submitted an NDA for citicoline to the
FDA in December 1997. Data in the NDA included the results of two Phase III
clinical trials conducted by the Company in the U.S., a Japanese Phase III
clinical trial conducted by Takeda and supportive clinical and post-marketing
data from more than 30 countries where citicoline has already been approved.
The NDA was accepted for filing and was assigned priority and fast-track review
status. However, based on the results of a subsequent 100-patient Phase III
trial which failed to meet its primary endpoint of reducing infarct size among
patients taking citicoline versus those taking placebo, the Company withdrew
its NDA in April 1998.

Takeda Agreement: In December 1999, the Company entered into an agreement,
subsequently amended, with Takeda (the "Takeda Agreement") under which the
Company licensed to Takeda exclusive rights to commercialize citicoline in the
U.S. and Canada. Under the Takeda Agreement, the Company received $13,000,000
in licensing and other payments and was entitled to receive up to $60,000,000
in payments contingent upon the achievement of regulatory milestones, as well
as royalties on net sales. Following analysis of a Phase III trial completed in
early 2000, Takeda notified the Company of its decision not to participate in
the further development of citicoline, thereby terminating the Takeda
Agreement. Therefore, the Company has reacquired all rights to this compound.
The Company does not intend to further develop citicoline unless it is able to
find another partner to participate in such development. Takeda's right under
the Takeda Agreement to negotiate a license of certain other products of the
Company expired September 30, 2001.

Licensing and Proprietary Rights: In January 1993, the Company licensed from
Ferrer Internacional, S.A. ("Ferrer") exclusive marketing and manufacturing
rights based on certain patent rights relating to the use of citicoline,
including certain patent and know-how rights in the U.S. and know-how rights in
Canada, in exchange for royalties based on sales (the "Ferrer Agreement"). In
June 1998, the Company amended the Ferrer Agreement to extend to January 31,
2002 the date upon which Ferrer may terminate the Ferrer Agreement if FDA
approval of citicoline is not obtained. The Ferrer Agreement provides for such
date to be extended for up to two years if the Company provides information to
Ferrer which tends to establish that the Company has carried out the steps for
obtaining such approval and that such approval has not been obtained for
reasons beyond the Company's control.

The Company has licensed both know-how and a use patent from Ferrer related
to citicoline. In addition, a U.S. composition of matter patent for a
"hyperhydrated" form of citicoline and three U.S. use patents have been issued
to the Company. In addition to these proprietary rights, the Company
anticipates that citicoline would be entitled to market exclusivity under
Waxman-Hatch Act.

PRO 2000

General: PRO 2000 is under development as a topical microbicide to prevent
the sexual transmission of HIV and certain other disease-causing viruses and
bacteria. HIV infection usually leads to AIDS, a life-threatening impairment of
the immune system. The World Health Organization estimates that 4.7 million new
adult HIV infections were acquired worldwide in 2000, the majority through
heterosexual intercourse. Heterosexual contact has also become the most common
route of HIV infection in U.S. women. Other STDs such as genital herpes,
chlamydia and gonorrhea can lead to serious complications, especially in women,
and can increase the risk of HIV infection. Based on estimates by the Kaiser
Family Foundation and the World Health Organization, there are 15 million new
STD cases each year in the U.S. and more than 340 million worldwide. Topical
microbicides represent a new class of protective substances that are designed
to be applied vaginally before sexual contact. Topical microbicides have the
potential to offer an appealing, female-controlled alternative to condoms, the
only products currently known to prevent HIV transmission.

The Company believes that PRO 2000's use as a topical microbicide is based
upon its ability to block infection by HIV and other sexually transmitted
disease pathogens by preventing their attachment and entry into cells.
Laboratory studies have shown that the drug is active against HIV, herpes
simplex virus, chlamydia and the bacteria that cause gonorrhea. Moreover, in
government-sponsored tests, vaginally applied PRO 2000 was shown to be
efficacious in a mouse model for genital herpes infection and a monkey model
for vaginal HIV infection.

9

The product is also highly stable, odorless and virtually colorless. PRO 2000
differs significantly from nonoxynol-9-containing spermicides, which have
failed to provide protection against HIV infection in previous human clinical
trials.

Development Program: A number of pre-clinical and early clinical studies
with PRO 2000 have been completed prior to planned Phase II and Phase III
trials. These include a European Commission-funded Phase II safety trial in
at-risk African women scheduled to begin in the first quarter of 2002. In
addition, an NIH-sponsored Phase II/III pivotal trial to determine the safety
and efficacy of PRO 2000 in blocking male to female HIV transmission is planned
to begin in 2002 in Africa and India. The study will involve approximately
10,000 HIV-uninfected women at risk for acquiring HIV by virtue of living in
countries where the risk of such infection is high. See "Risk Factors--We rely
on the favorable outcome of clinical trials of our products."

In October 2000, dosing and follow-up for a Phase I/II clinical trial of PRO
2000 vaginal gel was completed by the NIH at sites in the U.S. and South
Africa. This study was designed to assess safety and acceptability in healthy,
sexually active women and HIV-infected, sexually abstinent women. The results
were presented at the International Congress of Sexually Transmitted Infections
in June 2001 (Mayer et al., The Safety and Tolerability of PRO 2000 Gel, a
Novel Topical Microbicide, in Sexually Active HIV- and Abstinent HIV+ Women).
No serious side effects were reported, and the investigators concluded that PRO
2000 was safe and well tolerated in both groups of women. Previous Phase I
studies conducted in Europe with support from the Medical Research Council of
the United Kingdom showed a promising safety and acceptability profile for the
drug in healthy, sexually abstinent women. Phase I studies to evaluate the
safety of male exposure to PRO 2000 are ongoing.

In September 2001, the Company was awarded a grant by the Contraceptive
Research and Development ("CONRAD") Program under its Global Microbicide
Project to support two toxicity studies currently being performed by the
Company with PRO 2000. The Company expects these studies to be completed in
fiscal 2002.

Pre-clinical development with PRO 2000 included an NIH-funded study with 28
female macaque monkeys, divided equally into one control group and three
treatment groups that received gels with 0.5% PRO 2000, 2% PRO 2000, and 4% PRO
2000 concentrations. All of the control animals were infected within two weeks
after receiving the simian human immunodeficiency virus (SHIV), and went on to
develop AIDS symptoms. Of the treated animals, none in the 0.5% group, and only
one each in the 2% and 4% groups became infected and developed disease. Results
of this study were presented in February 2001 at the 8th Conference on
Retroviruses and Opportunistic Infections (Lewis et al., Efficacy of PRO 2000
Gel in a Macaque Model for Vaginal HIV Transmission).

Licensing and Proprietary Rights: In June 2000, the Company licensed
exclusive, worldwide rights from HeavenlyDoor.com, Inc., formerly Procept, Inc.
("HDCI"), to develop and market PRO 2000 in exchange for an up-front payment,
as well as potential future milestone payments and royalties on net sales. The
Company is responsible for all remaining development and commercialization
activities for PRO 2000. The Company holds an exclusive license to all
intellectual property relating to PRO 2000, including four issued U.S. patents:
one covering the composition of matter, two covering the use of PRO 2000 to
prevent or treat HIV infection, and one covering the use of PRO 2000 to prevent
pregnancy. A similar contraception patent has also issued in South Africa.
Composition and use claims are under review in several other territories,
including Europe, Canada, and Japan. See "Agreements" and "Patents and
Proprietary Rights."

DERSALAZINE

General: Dersalazine is a compound in early clinical development to treat
IBD, which includes ulcerative colitis and Crohn's disease. IBD results from an
abnormal immune system response to stimuli in the digestive tract. Several
types of cells, cytokines and other mediators are involved in the inflammatory
cascade initiated by the exacerbated immune response. Interfering with or
halting multiple stages of the inflammatory cascade may

10

provide an effective therapeutic approach to IBD. Ulcerative colitis is a
chronic disease that primarily affects the colon and causes inflammation in the
upper layers of the large intestine, while Crohn's disease usually occurs in
the small intestine and causes inflammation deeper within the wall of the
intestine. Up to one million people in the U.S. (Journal of the American
Medical Association, February 7, 2001) and two million worldwide
(Pharmaprojects 2001) suffer from these diseases. Fifty percent of these are
affected by ulcerative colitis and 50 percent by Crohn's disease (MEDACorp
Survey, 2001).

Dersalazine is a new chemical entity combining a novel potent
anti-inflammatory agent that inhibits key interleukin cytokines and acts as a
PAF (platelet activating factor) antagonist with a well-known anti-inflammatory
agent, 5-ASA (5-aminosalicylic acid). The chemical cleavage of dersalazine by
bacteria in the colon releases these two active components for the topical
treatment of inflammation in the colon.

The cytokines inhibited by dersalazine include TNF-alpha, IL-1 beta and
IL-8, all of which are believed to contribute significantly to the inflammatory
cascade leading to IBD. Dersalazine also appears to block the effects of
platelet activating factor, a naturally occurring mediator with
pro-inflammatory effects implicated in the pathogenesis of IBD. The 5-ASA
molecule contained within dersalazine has known anti-inflammatory and
antioxidant properties which may also ameliorate the deleterious inflammatory
effects ascribed to the overproduction of free radicals. The Company believes
that an agent with these multiple anti-inflammatory actions may offer
significant advantages over existing therapies.

Development Program: In various pre-clinical models of acute and chronic
colitis, dersalazine has ameliorated or prevented the inflammatory response
following the intracolonic administration of irritative agents, as measured by
tissue damage and biochemical inflammatory markers. Dersalazine appears to act
locally on the colon without the liability of unwanted systemic absorption. In
addition, the safety of single oral doses of dersalazine has been demonstrated
among healthy human volunteers, in whom the systemic absorption of the compound
and its two active components was very low.

Initial clinical trials are expected to focus on the effects of dersalazine
on acute flare-ups of ulcerative colitis, with follow-up studies to evaluate
its effects on remission and maintenance. Other parameters to be examined in
clinical trials include dosing strategies, comparator therapies, onset of
relief and reduction or prevention of need for other therapies, including
corticosteroids. Interneuron plans to complete a Phase I multi-dose clinical
study and initiate Phase II trials in ulcerative colitis with dersalazine in
2002. Future studies will also explore the utility of the drug in Crohn's
disease. In addition to its clinical trial program, the Company plans to
scale-up manufacturing processes and to conduct additional toxicology and
pharmacokinetic testing with dersalazine. See "Risk Factors--Our products are
early stage and may not be successful or achieve market acceptance."

Licensing and Proprietary Rights: In September 2001, the Company acquired
worldwide marketing rights to dersalazine from Uriach in exchange for an
up-front licensing payment, development milestones and royalty payments.
Interneuron will be responsible for the future clinical development, regulatory
activities and commercialization of dersalazine. The patents licensed by the
Company from Uriach cover compositions and processes for manufacturing
dersalazine and the cytokine inhibiting portion of the molecule following
bacterial cleavage. See "Agreements" and "Patents and Proprietary Rights."

SUBSIDIARIES

In the past, the Company had five subsidiaries: Progenitor, Inc.
("Progenitor"), Transcell Technologies, Inc. ("Transcell"), InterNutria, Inc.
("InterNutria"), Incara Pharmaceuticals Corporation, formerly Intercardia, Inc.
("Incara"), and CPEC LLC. Progenitor discontinued operations in December 1998
and InterNutria discontinued operations in September 1998. Transcell was merged
into Incara in May 1998. In July 1999, the Company reduced its ownership of
Incara and increased its ownership interest in CPEC LLC, previously a
majority-owned subsidiary of Incara. As of September 30, 1999, the Company
determined to discontinue the operations of CPEC LLC.

11

MANUFACTURING AND MARKETING

General: The Company's ability to conduct clinical trials on a timely basis,
to obtain regulatory approvals and to commercialize its products will depend in
part upon its ability to manufacture its products, either directly or through
third parties, at a competitive cost and in accordance with applicable FDA and
other regulatory requirements, including current U.S. Good Manufacturing
Practices ("cGMP") regulations. The Company has no manufacturing facilities or
marketing capabilities. In general, the Company intends to seek to contract
with third parties to manufacture and market products.

Development Strategy: The Company does not have sufficient funds to complete
regulatory testing or to commercialize its products under development. In
general, the Company intends to seek corporate collaborations in which a third
party assumes responsibility and funding for drug development, manufacturing
and marketing or to obtain additional financing to fund such development.

To the extent the Company enters into collaborative arrangements with
pharmaceutical and other companies for the manufacturing or marketing of
products, these collaborators are generally expected to be responsible for
funding or reimbursing all or a portion of the development costs, including the
costs of clinical testing necessary to obtain regulatory clearances, and for
commercial-scale manufacturing and marketing. These collaborators are expected
to be granted exclusive or semi-exclusive rights to sell specific products in
exchange for license fees, milestone payments, royalties, equity investments or
other financial consideration. Accordingly, the Company will be dependent on
such third parties for the manufacturing and marketing of products subject to
the collaboration. There can be no assurance the Company will be able to obtain
or retain third-party manufacturing and marketing collaborations on acceptable
terms, or at all, which may delay or prevent the commercialization of products
under development. Such collaborative arrangements could result in lower
revenues and profit margins than if the Company marketed a product itself. In
the event the Company determines to establish its own manufacturing or
marketing capabilities, it would require substantial additional funds. See
"Risk Factors--We will rely on third parties to commercialize our products,"
"--Our failure to acquire and develop additional product candidates will impair
our ability to grow," and "--We will need additional funds in the near future."

Pagoclone: Under the Pfizer Agreement, Pfizer is responsible for the
manufacturing and marketing of pagoclone. See "Risk Factors--We will depend on
Pfizer to develop, manufacture and market pagoclone."

Trospium: Under the Madaus Agreement, Interneuron is responsible for all
clinical development and regulatory activities and costs related to trospium in
the U.S. Interneuron anticipates that Madaus will manufacture the product,
provided that it can deliver acceptable product to satisfy the U.S. market
requirements. Interneuron has the option to seek a second source supplier to
satisfy these requirements in the event that Madaus is unable to do so.
Interneuron is responsible for the commercialization and marketing of trospium
in the U.S. either independently or through marketing partners.

Citicoline: As a result of Takeda's termination of the Takeda Agreement, and
in the event citicoline is further developed, the Company will be dependent
upon third party suppliers of citicoline bulk compound, finished product and
packaging for manufacturing and would be dependent on third parties for the
marketing and distribution of citicoline. Supplies of citicoline finished
product used for clinical purposes have been produced on a contract basis by
third party manufacturers. The Ferrer Agreement requires the purchase from
Ferrer of citicoline bulk compound for commercial purposes. If such conditions
permit the purchase of bulk compound from a third party, the Company entered
into an agreement with a manufacturer to supply citicoline bulk compound for
commercial purposes.

PRO 2000: The Company is responsible for providing adequate amounts of PRO
2000 for use in government-sponsored clinical trials. The Company will be
dependent upon third-party contractors for the manufacture and delivery of
these supplies. The Company intends to seek a partner for commercial
manufacture, marketing and distribution of the product.

12

Dersalazine: Under its agreement with Uriach, the Company anticipates that
Uriach will manufacture dersalazine through the completion of Phase II clinical
testing. Prior to the end of Phase II clinical trials, the Company and Uriach
shall jointly decide whether Uriach will manufacture dersalazine for additional
clinical trials and for commercial use.

COMPETITION

General: The pharmaceutical industry is characterized by rapidly evolving
technology and intense competition. Many companies, including major
pharmaceutical companies and specialized biotechnology companies, are engaged
in marketing or development of products and therapies similar to those being
pursued by the Company. Many of the Company's competitors have substantially
greater financial and other resources, larger research and development staffs
and significantly greater experience in conducting clinical trials and other
regulatory approval procedures, as well as in manufacturing and marketing
pharmaceutical products, than the Company. In the event the Company or its
licensees market any products, they will compete with companies with
well-established distribution networks and market position. Additional mergers
and acquisitions in the pharmaceutical industry may result in even more
resources being concentrated in the Company's competitors.

There can be no assurance that currently marketed products, or products
under development or introduced by others will not adversely affect sales of
any products developed by the Company, render the Company's products or
potential products obsolete or uneconomical, or result in treatments or cures
superior to any therapy developed by the Company, or that any therapy developed
by the Company will be preferred to any existing or newly developed products or
technologies. Other companies may succeed in developing and commercializing
competing products earlier than the Company or products which are safer and
more effective than those under development by the Company. Advances in current
treatment methods may also adversely affect the market for such products. The
approval and introduction of therapeutic or other products that compete with
products being developed by the Company could also adversely affect the
Company's ability to attract and maintain patients in clinical trials for the
same indication or otherwise to complete its clinical trials successfully or on
a timely basis. Further, certain of Interneuron's agreements provide for
reduced royalties in the event of generic competition.

Colleges, universities, governmental agencies and other public and private
research organizations continue to conduct research and are becoming more
active in seeking patent protection and licensing arrangements to collect
royalties for use of technology that they have developed, some of which may be
directly competitive with that of the Company. In addition, these institutions
may compete with the Company in recruiting qualified scientific personnel. The
Company expects technological developments in its fields of product development
to occur at a rapid rate and expects competition to intensify as advances in
these fields are made. See "Risk Factors--Our products may be unable to compete
successfully with other products."

Pagoclone: Current pharmacological treatments for anxiety and panic
disorders generally include benzodiazepines, such as Valium and Xanax,
serotonin agonists such as BuSpar, and selective serotonin reuptake inhibitors
such as Paxil, Zoloft, Prozac, and Effexor. Traditional side effects seen with
these classes of anti-anxiety drugs include sedation, lack of mental acuity,
withdrawal and rebound anxiety related to the benzodiazepine class of drugs,
and agitation, insomnia and sexual dysfunction related to serotonin reuptake
inhibitors. The results of the Company's 277 patient Phase II/III trial
indicated that pagoclone was well tolerated, with no evidence of sedation and
no apparent withdrawal symptoms. In addition, the Company is aware of
competitors which market certain prescription drugs for indications other than
anxiety and which are planning to seek an expansion of labeling to include
anxiety as an indication. The Company is aware that other companies are
developing compounds for anxiety that are in pre-clinical or clinical
development.

Trospium: Current therapy for overactive bladder includes anticholinergics,
such as Detrol and Detrol LA by Pharmacia Corporation and Ditropan and Ditropan
XL by Johnson & Johnson, Inc. Watson Pharmaceuticals has submitted an NDA for
an oxybutynin patch, Oxytrol Patch. The Company is aware of other companies

13

evaluating specific antimuscaranics and antispasmodics in pre-clinical and
clinical development for overactive bladder, including darifenacin by Pfizer.
Pre-clinical data with trospium suggests that it does not enter the central
nervous system and thus may have a side effect profile preferable to currently
available agents. In addition, clinical data and commercial experience reflect
favorable efficacy and safety profiles.

PRO 2000: No comparable product to prevent sexually transmitted infections
has been approved for use in the U.S., Europe or Japan. Marketed vaginal
spermicides containing the detergent nonoxynol-9 have been found to be
ineffective at reducing HIV transmission, and may actually increase the risk of
infection. Approximately 60 new substances are being evaluated for this
indication, but the Company believes only a few have reached the stage of
development of PRO 2000. These include BufferGel by Reprotect, LLC, Savvy by
Biosyn, Inc., Emmelle by ML Laboratories, PLC, Carraguard by The Population
Council, and cellulose sulfate gel by the Contraceptive Research and
Development Program.

Dersalazine: Various formulations of 5-ASA, which has long been used to
treat IBD, are available as oral preparations, suppositories and enemas. Often
used as first-line therapy for IBD, they include Asacol (mesalamine) tablets,
Dipentum (olsalazine) capsules, Pentasa (mesalamine) capsules and Colazal
(balsalazide) capsules. Corticosteroid therapy, such as prednisone or
hydrocortisone, is given when the 5-ASA products cannot control inflammation
and usually reserved for short-term use in moderate or severe cases. If the
patient does not respond to these treatments, anti-immune therapy is an option.
This therapy utilizes drugs that suppress the body's ability to make antibodies
against the disease and includes azathioprine and 6-mercaptopurine.
Investigational therapies include metronidazole, other antibiotics and
immunosuppressive agents, and monoclonal antibodies. A significant percentage
of those with ulcerative colitis and Crohn's disease will eventually require
surgery. New treatment options that induce and maintain remissions, minimize
side effects and improve quality of life are needed. The Company believes that
dersalazine has multiple anti-inflammatory mechanisms of action that might be
expected to have significant advantages over existing therapies.

AGREEMENTS

Pagoclone: In December 1999, the Company entered into the Pfizer Agreement,
under which the Company licensed to Pfizer exclusive, worldwide rights to
develop and commercialize pagoclone. To date under the Pfizer Agreement the
Company has received $16,750,000, including an up-front payment of $13,750,000,
and is entitled to receive up to an additional $62,000,000 in payments
contingent upon the achievement of clinical and regulatory milestones, as well
as royalties on net sales. Under the Pfizer Agreement, Pfizer is responsible
for conducting and funding all further clinical development, regulatory review,
manufacturing and marketing of pagoclone on a worldwide basis. Pfizer has the
right to terminate the Pfizer Agreement on not less than six months written
notice to Interneuron and in certain other circumstances. The parties have also
agreed to indemnify one another under certain circumstances.

In February 1994, the Company licensed from Aventis exclusive, worldwide
rights for the manufacture, use and sale of pagoclone under patent rights and
know-how related to the drug, except that Interneuron granted Aventis an option
to sublicense from Interneuron, under certain conditions, rights to market
pagoclone in France. In exchange, the Company paid Aventis a license fee and
agreed to make milestone payments based on clinical and regulatory
developments, and to pay royalties based on net sales or, if sublicensed by the
Company, the Company would pay to Aventis a portion of receipts from the
sublicensee in lieu of milestone and royalty payments. This license agreement
may be terminated in certain circumstances such as material breach or
insolvency. Unless earlier terminated, the license ends with respect to each
country in the territory upon the expiration of the last to expire applicable
patent in that country. The Company agreed to conduct at its expense and be
responsible for all clinical trials with respect to pagoclone and all related
products for use in clinical trials. In connection with the Pfizer Agreement,
Aventis consented to the sublicense to Pfizer, and Interneuron and Aventis
amended certain provisions of the agreement between Aventis and Interneuron. In
connection with Aventis' consent, Interneuron agreed that in the event Aventis
exercises its option to sublicense pagoclone in

14

France, Interneuron has an obligation to supply Aventis with all of its
requirements for pagoclone, and Pfizer has agreed to assume such obligation as
long as the Pfizer Agreement remains in effect. Interneuron agreed to indemnify
Aventis against claims and other damages resulting from the testing,
manufacture, use and sale of pagoclone and is required to maintain product
liability insurance.

Trospium: In November 1999, the Company entered into the Madaus Agreement
under which it licensed from Madaus exclusive U.S. rights to develop and market
trospium, an orally-administered prescription drug product currently marketed
as a treatment for overactive bladder in Europe. In exchange, the Company has
agreed to pay Madaus potential regulatory milestone, royalty and sales
milestone payments. Interneuron is responsible for all clinical development and
regulatory activities and costs related to the compound in the United States.
Pursuant to the Madaus Agreement, Madaus is required to manufacture the
product, provided certain conditions are met.

IP 501: In March 1997, the Company obtained an option from Dr. Charles S.
Lieber to negotiate an exclusive license to a compound (designated by the
Company as IP 501) for the treatment and prevention of cirrhosis of the liver
caused by alcohol and hepatitis viruses. In December 2000, the Company
exercised this option and entered into an agreement to license rights to
develop and commercialize IP 501 in several major markets, including the U.S.,
Japan, Korea and Canada. In exchange, the Company agreed to pay future
milestone payments and royalties on net sales. The Company is responsible for
all remaining development, manufacturing, and marketing of the compound.

Citicoline: In December 1999, the Company entered into the Takeda Agreement
under which the Company licensed to Takeda exclusive rights to commercialize
citicoline in the U.S. and Canada. Under the Takeda Agreement, the Company
received $13,000,000 in licensing and other payments, and was entitled to
receive up to $60,000,000 in payments contingent upon the achievement of
regulatory milestones in the U.S. and Canada, as well as royalties on net sales.

In December 2000, Takeda notified the Company of its decision not to
participate in the further development of citicoline, thereby terminating the
Takeda Agreement. Therefore, the Company has reacquired all rights to this
compound. In April 2001, Takeda exercised its option under the Takeda Agreement
to negotiate a license in the U.S. and Canada for a back-up compound from the
Company. Takeda designated IP 501 as such compound. Under this option, Takeda
had a six-month period during which the Company could not offer to another
party the compound selected by Takeda without first re-offering such compound
to Takeda on new terms. This option terminated on September 30, 2001, and
Takeda has no further rights to IP 501.

In January 1993, the Company entered into the Ferrer Agreement, subsequently
amended, granting the Company the exclusive right to make, use and sell any
products or processes developed under patent rights relating to certain uses of
citicoline in exchange for an up-front license fee and royalties based on
sales. The Company's license includes patent and know-how rights in the U.S.
and know-how rights in Canada, and is for a period co-extensive with Ferrer's
license from the Massachusetts Institute of Technology ("MIT"). The Ferrer
Agreement provides that Ferrer may terminate the agreement under certain
circumstances, including the insolvency or bankruptcy of Interneuron, in the
event more than 50% of the ownership of Interneuron is transferred to a
non-affiliated third party or in the event FDA approval of citicoline is not
obtained by January 31, 2002. The Ferrer Agreement provides for such date to be
extended for up to two years if the Company provides information to Ferrer
which tends to establish that the Company has carried out the steps for
obtaining such approval and if such approval has not been obtained for reasons
beyond the Company's control. The Ferrer Agreement requires Interneuron to use
diligent efforts to obtain regulatory approval.

In June 1998, the Company licensed to Ferrer worldwide rights, except in the
U.S. and Canada, to the Company's patent relating to the use of citicoline in
the protection of brain tissue from cerebral infarction following ischemic
stroke. In exchange, the Company will be entitled to royalties from Ferrer on
certain exports to, and sales of, the solid oral form of citicoline in certain
countries upon its approval in each country. See "Patents and Proprietary
Rights--Citicoline."

15

PRO 2000: In June 2000, the Company licensed exclusive, worldwide rights
from HDCI to develop and market PRO 2000, a candidate topical microbicide used
to prevent infection by HIV and other sexually transmitted pathogens, in
exchange for an up-front payment, future milestone payments, and royalties on
net sales. The Company is responsible for all remaining development and
commercialization activities for PRO 2000.

Dersalazine: In September 2001, the Company acquired worldwide rights to
dersalazine, a compound in early clinical development to treat IBD, from
Uriach, in exchange for an up-front licensing payment, and potential
development milestone and royalty payments. The Company will be responsible for
the future clinical development, regulatory activities and commercialization of
dersalazine. Under this agreement, the Company anticipates that Uriach will
manufacture dersalazine through the completion of Phase II clinical testing.
Uriach retains an option to co-market the product in Spain.

Sarafem: In June 1997, the Company entered into the Lilly Agreement, under
which it licensed to Lilly exclusive, worldwide rights to Interneuron's patents
for the use of fluoxetine to treat certain conditions and symptoms associated
with PMS (the "Lilly Agreement"). In July 2000, Lilly received approval for
fluoxetine to treat PMDD and is marketing the drug under the trade name
Sarafem. The Lilly Agreement provides for milestone payments and royalties
based on net sales in the United States up to a maximum limit. Royalties to the
Company will terminate at the end of the first two consecutive quarters in
which 70% or less of total Prozac prescriptions are "dispensed as written."
Lilly's composition of matter patent on fluoxetine expired in July 2001.
Potential royalty payments to the Company under the Lilly Agreement are
expected to expire in March 2002. The patent rights to the use of fluoxetine in
treating PMS are licensed by the Company from the Massachusetts Institute of
Technology ("MIT"), which is entitled to a portion of all payments, including
royalties, made to Interneuron by Lilly.

LidodexNS: In December 1996, the Company entered into an agreement with Endo
Pharmaceuticals Holdings Inc., formerly Algos Pharmaceutical Corporation
("Endo"), for the development and commercialization of a combination
pharmacological product known as LidodexNS, which may offer the potential for
relief of acute migraine headache through intranasal administration. The
agreement establishes a multi-stage development collaboration between Endo and
Interneuron and licenses to Interneuron rights, co-exclusive with Endo, to
manufacture and market the combined agent. The potential scope of this
collaboration includes certain pre-clinical studies, clinical trials and
regulatory review activities overseen by a joint steering committee. The
companies agreed to share in the marketing costs and profits generated by
LidodexNS.

PACAP: In April 1998, the Company licensed from Tulane University exclusive,
worldwide rights to a U.S. patent and U.S. and foreign patent applications
owned by Tulane relating to a novel neuropeptide, known as PACAP (pituitary
adenylate cyclase activating polypeptide). Limited pre-clinical data suggested
the potential of PACAP as a treatment for respiratory diseases, diabetes,
stroke and other neurodegenerative diseases. Under terms of the license, the
Company paid Tulane an up-front licensing fee, and agreed to fund research over
a two-year period, to make additional payments based on the achievement of
clinical and regulatory review milestones and to pay Tulane royalties on net
sales of any product developed from this program. Following an evaluation of
pre-clinical findings with PACAP, the Company terminated its PACAP agreements
with Tulane in September 2001.

Redux Agreements (See Redux Withdrawal and Item 3. Legal Proceedings)

AHP Indemnity and Release Agreement: In May 2001, the Company entered into
an agreement with AHP pursuant to which AHP agreed to indemnify the Company
against certain classes of product liability cases filed against the Company
related to Redux (dexfenfluramine), a prescription anti-obesity compound
withdrawn from the market in September 1997. This indemnification covers
existing plaintiffs who have already opted out of AHP's national class action
settlement of diet drug claims and claimants alleging primary pulmonary
hypertension. In addition, AHP has agreed to fund all future legal costs
related to the Company's defense of

16

Redux-related product liability cases. The agreement also provides for AHP to
fund additional insurance coverage to supplement the Company's existing product
liability insurance. The Company believes this total insurance coverage is
sufficient to address its potential remaining Redux product liability exposure.
However, there can be no assurance that uninsured or insufficiently insured
Redux-related claims or Redux-related claims for which the Company is not
otherwise indemnified or covered under the AHP Indemnity and Release Agreement
will not have a material adverse effect on the Company's future business,
results of operations or financial condition or that the potential of any such
claims would not adversely affect the Company's ability to obtain sufficient
financing to fund operations. Up to the date of the AHP Indemnity and Release
Agreement, the Company's defense costs were paid by, or subject to
reimbursement to the Company from, the Company's product liability insurers. To
date, there have been no Redux-related product liability settlements or
judgments paid by the Company or its insurers. In exchange for the
indemnification, defense costs, and insurance coverage provided to Interneuron
by AHP, the Company agreed to dismiss its suit against AHP filed in January
2000, its appeal from the order approving AHP's national class action
settlement of diet drug claims, and its cross-claims against AHP related to
Redux product liability legal actions.

Servier Agreements: In February 1990, the Company and Les Laboratoires
Servier ("Servier") entered into agreements, subsequently amended (the "Servier
Agreements"), granting the Company an exclusive right to market dexfenfluramine
in the U.S. to treat obesity associated with abnormal carbohydrate craving. The
Servier Agreements provide for royalties on net sales, with certain required
minimum royalties. Servier has the right to terminate the license agreement
upon the occurrence of certain events. Interneuron agreed to indemnify Servier
under certain circumstances and Interneuron was required to name Servier as an
additional insured on its product liability insurance policies which are
subject to ongoing claims by Servier.

AHP Agreements: In November 1992, the Company entered into a series of
agreements (the "AHP Agreements") which granted American Cyanamid Company the
exclusive right to manufacture and market dexfenfluramine in the U.S. for use
in treating obesity associated with abnormal carbohydrate craving, with the
Company retaining co-promotion rights. In 1994, AHP acquired American Cyanamid
Company. The AHP Agreements are for a term of 15 years commencing on the date
dexfenfluramine is first commercially introduced by AHP, subject to earlier
termination. AHP has the right to terminate the AHP Agreements upon 12 months
notice to the Company.

Effective June 1996, the Company entered into a three-year copromotion
agreement with Wyeth-Ayerst Laboratories ("Wyeth-Ayerst"), an AHP company (the
"Copromotion Agreement"). The Copromotion Agreement provided for Interneuron to
promote Redux to certain diabetologists, endocrinologists, bariatricians and
weight management specialists, subject to certain restrictions, and receive
payments from AHP for a portion of the Company's actual costs. Interneuron was
also entitled to varying percentages of profit derived from sales generated by
its sales force, after deducting certain costs.

Under the AHP Agreements, under certain circumstances, the Company was
required to indemnify AHP, and the Company was entitled to indemnification by
AHP against certain claims, damages or liabilities incurred in connection with
Redux. The cross indemnification between the Company and AHP generally related
to the activities and responsibilities of each company. The Company and AHP
mutually released each other from any rights to indemnification pursuant to the
AHP Agreements as part of the AHP Indemnity and Release Agreement described
above.

17

Boehringer: In November 1995, the Company entered into a manufacturing
agreement with Boehringer Ingelheim Pharmaceuticals, Inc. ("Boehringer") under
which Boehringer agreed to supply, and the Company agreed to purchase, all of
the Company's requirements for Redux capsules. The contract contained certain
minimum purchase, insurance and indemnification commitments by the Company and
required conformance by Boehringer to the FDA's cGMP regulations. Boehringer
has made certain claims on the Company related to the Company's cancellation of
the manufacturing agreement with Boehringer.

PATENTS AND PROPRIETARY RIGHTS

Pagoclone: The Company licensed from Aventis rights under U.S. and foreign
patents and patent applications covering compositions of matter, processes, and
metabolites of pagoclone. A U.S. composition of matter patent was issued in
October 1990 and four related U.S. patents were issued in February and March
1996 and February and October 1997. The Company sublicensed to Pfizer worldwide
rights to these patents.

Trospium: The compound trospium is not covered by a composition of matter
patent. Along with know how, the Company licensed from Madaus two U.S. patents,
one of which relates to a process for manufacturing trospium and the other
relates to the use of trospium to treat certain asthmatic conditions. These
patents were issued in August 1989 and October 1988, respectively. The
commercialization of trospium by the Company will not utilize these patents,
and the Company intends to rely on the provisions of the Waxman-Hatch Act to
obtain a period of market exclusivity in the U.S., if the FDA approves trospium
in the U.S. for the intended indication, although there is no assurance that
market exclusivity will be granted. The Waxman-Hatch Act establishes a period
of time from the date of FDA approval of certain new drug applications. The
applicable period is five years in the case of drugs containing an active
ingredient not previously approved.

IP 501: The Company exercised an option and entered into an agreement to
license a U.S. patent issued on February 8, 1994, relating to a phospholipid
found in lecithin (IP 501). Three claims of this patent relate to methods of
preventing or treating liver cirrhosis in mammals by administering an effective
amount of the compound. Japanese and Canadian counterparts are pending.

Citicoline: The compound citicoline is not covered by a composition of
matter patent. Pursuant to the Ferrer Agreement, the Company licensed from
Ferrer a U.S. patent covering the administration of citicoline to treat
patients afflicted with conditions associated with the inadequate release of
brain acetylcholine, which expires in 2003. As described in the licensed
patent, the inadequate release of acetylcholine may be associated with several
disorders, including the behavioral and neurological syndromes seen after brain
traumas and peripheral neuromuscular disorders and post-stroke rehabilitation.
Although the claim of the licensed patent is broadly directed to the treatment
of inadequate release of brain acetylcholine, there can be no assurance this
patent will afford protection against competitors of citicoline to treat
ischemic stroke.

U.S. patents were issued to the Company in September and October 1998 and in
February 1999 relating to use of citicoline in the protection of brain tissue
from cerebral infarction following ischemic stroke. The Company licensed
worldwide rights to these patents to Ferrer, except in the U.S. and Canada, in
exchange for which the Company will be entitled to royalties from Ferrer on
certain exports and sales of the solid oral form of citicoline in certain
countries upon its approval in each country. Additional domestic and
international patent applications have been filed by the Company.

In May 2000, the Company was awarded a U.S. patent, including claims
directed to a composition of matter, for a "hyperhydrated" form of citicoline.
It is believed that solid forms of citicoline, including tablets, have greater
stability when this hyperhydrated form of citicoline is present. The normal
term of this patent does not expire until 2018. The Company is also pursuing
foreign counterparts of this patent in Canada, China, all European countries
subscribing to the European Patent Convention, Hungary, Japan, Mexico and
Norway.

18

In addition to any proprietary rights provided by these patents, the Company
intends to rely on the provisions of the Waxman-Hatch Act to obtain a period of
marketing exclusivity in the U.S., if the FDA approves citicoline for marketing
in the U.S., although there is no assurance market exclusivity will be granted.
See "Risk Factors--We may depend on market exclusivity for trospium and other
products."

PRO 2000: The Company holds an exclusive license to all intellectual
property relating to PRO 2000, including four issued U.S. patents: one covering
the composition of matter issued in June 2000, two covering the use of PRO 2000
to prevent or treat HIV infection issued in March and October 1997, and one
covering the use of PRO 2000 to prevent pregnancy issued in September 1999. A
similar contraception patent has also issued in South Africa. Composition and
use claims are under review in several other territories, including Europe,
Canada, and Japan.

Dersalazine: The Company licensed from Uriach exclusive, worldwide rights
under patents and patent applications covering composition of matter, uses and
manufacturing processes for dersalazine and the cytokine antagonist portion of
the molecule following bacterial cleavage, including U.S. patents issued in
January 1998 and May 1998.

General: There can be no assurance that patent applications filed by the
Company or others, in which the Company has an interest as assignee, licensee
or prospective licensee, will result in patents being issued or that, if
issued, any of such patents will afford protection against competitors with
similar technology or products, or could not be circumvented or challenged. In
addition, certain products the Company is developing are not covered by any
patents and, accordingly, the Company will be dependent on obtaining market
exclusively under the Waxman-Hatch Act for such products. If the Company is
unable to obtain strong proprietary rights protection of its products after
obtaining regulatory clearance, competitors may be able to market competing
generic products by obtaining regulatory clearance, by demonstrating
equivalency to the Company's product, without being required to conduct the
lengthy clinical tests required of the Company. Certain of the Company's
agreements provide for reduced royalties, or forgo royalties altogether, in the
event of generic competition. See "Risk Factors--We may depend on market
exclusivity for trospium and other products."

The products being developed by the Company may conflict with patents which
have been or may be granted to competitors, universities or others. Third
parties could bring legal actions against the Company claiming patent
infringement and seeking damages or to enjoin manufacturing and marketing of
the affected product or the use of a process for the manufacture of such
products. If any such actions are successful, in addition to any potential
liability for damages and attorneys fees in certain cases, the Company could be
required to obtain a license, which may not be available, in order to continue
to manufacture or market the affected product or use the affected process. The
Company also relies upon unpatented proprietary technology and may determine in
some cases that its interest would be better served by reliance on trade
secrets or confidentiality agreements rather than patents. No assurance can be
made that others will not independently develop substantially equivalent
proprietary information and techniques or otherwise gain access to such
proprietary technology or disclose such technology or that the Company can
meaningfully protect its rights in such unpatented proprietary technology. The
Company may also conduct research on other pharmaceutical compounds or
technologies, the rights to which may be held by, or be subject to, patent
rights of third parties. Accordingly, if products based on such technologies
are commercialized, such commercial activities may infringe such patents or
other rights which would require the Company to obtain a license to such
patents or other rights. See "Risk Factors--We have limited patent protection
on our products."

GOVERNMENT REGULATION

Therapeutics: The Company's products will require, prior to
commercialization, regulatory clearance by the FDA and by comparable agencies
in most foreign countries. The nature and extent of regulation differs with

19

respect to different products. In order to test, produce and market certain
therapeutic products in the United States, mandatory procedures and safety
standards, approval processes, and manufacturing and marketing practices
established by the FDA must be satisfied.

An Investigational New Drug application ("IND") is required before human
clinical use in the United States of a new drug compound or biological product
can commence. The IND includes results of pre-clinical (animal) studies
evaluating the safety and efficacy of the drug and a detailed description of
the clinical investigations to be undertaken.

Clinical trials are normally done in three phases, although the phases may
overlap. Phase I trials are concerned primarily with the safety and
pharmacokinetics of the product. Phase II trials are designed primarily to
demonstrate effectiveness and safety in treating the disease or condition for
which the product is indicated. These trials typically explore various doses
and regimens. Phase III trials are expanded clinical trials intended to gather
additional information on safety and effectiveness needed to clarify the
product's benefit-risk relationship, discover less common side effects and
adverse reactions, and generate information for proper labeling of the drug,
among other things. The FDA receives reports on the progress of each phase of
clinical testing and may require the modification, suspension or termination of
clinical trials if an unwarranted risk is presented to patients. When data is
required from long-term use of a drug following its approval and initial
marketing, the FDA can require Phase IV, or post-marketing, studies to be
conducted.

With certain exceptions, once successful clinical testing is completed, the
sponsor can submit an NDA for approval of a drug. The process of completing
clinical trials for a new drug is likely to take a number of years and require
the expenditure of substantial resources. There can be no assurance that the
FDA or any foreign health authority will grant an approval on a timely basis,
or at all. The FDA may deny an NDA, in its sole discretion, if it determines
that its regulatory criteria have not been satisfied or may require additional
testing or information. Among the conditions for marketing approval is the
requirement that the prospective manufacturer's quality control and
manufacturing procedures conform to cGMP regulations. In complying with
standards set forth in these regulations, manufacturers must continue to expend
time, money and effort in the area of production, quality control and quality
assurance to ensure full technical compliance. Manufacturing facilities, both
foreign and domestic, also are subject to inspections by, or under the
authority of, the FDA and by other federal, state, local or foreign agencies.

Even after initial FDA or foreign health authority approval has been
obtained, further studies, including Phase IV post-marketing studies, may be
required to provide additional data on safety and will be required to gain
approval for the use of a product as a treatment for clinical indications other
than those for which the product was initially tested. Also, the FDA or foreign
regulatory authority will require post-marketing reporting to monitor the side
effects of the drug. Results of post-marketing programs may limit or expand the
further marketing of the products. Further, if there are any modifications to
the drug, including any change in indication, manufacturing process, labeling
or manufacturing facility, an application seeking approval of such changes may
be required to be submitted to the FDA or foreign regulatory authority. See
"Risk Factors--If we fail to comply with government regulations it could
negatively affect our business."

Patent Term Extension and Market Exclusivity: Under the Waxman-Hatch Act, a
patent which claims a product, use or method of manufacture covering drugs and
certain other products may be extended for up to five years to compensate the
patent holder for a portion of the time required for development and FDA review
of the product. The Waxman-Hatch Act also establishes periods of market
exclusivity, which are various periods of time following approval of a drug
during which the FDA may not approve, or in certain cases even accept,
applications for certain similar or identical drugs from other sponsors unless
those sponsors provide their own safety and effectiveness data.

The Company believes that citicoline may be entitled to patent extension and
that trospium and citicoline may be entitled to five years of market
exclusivity under the Waxman-Hatch Act. However, there can be no

20

assurance that the Company will be able to take advantage of either the patent
term extension or marketing exclusivity provisions or that other parties will
not challenge the Company's rights to such patent extension or market
exclusivity.

Other: The Federal Food, Drug, and Cosmetic Act, the Public Health Service
Act, the Federal Trade Commission Act, and other federal and state statutes and
regulations govern or influence the research, testing, manufacture, safety,
labeling, storage, record keeping, approval, advertising and promotion of drug,
biological, medical device and food products. Noncompliance with applicable
requirements can result in, among other things, fines, recall or seizure of
products, refusal to permit products to be imported into the U.S., refusal of
the government to approve product approval applications or to allow the Company
to enter into government supply contracts, withdrawal of previously approved
applications and criminal prosecution. The FDA may also assess civil penalties
for violations of the Federal Food, Drug, and Cosmetic Act involving medical
devices. The Federal Trade Commission may assess civil penalties for violations
of the requirement to rely upon a "reasonable basis" for advertising claims for
non-prescription and food products.

REDUX WITHDRAWAL (See Item 3. Legal Proceedings)

On September 15, 1997, the Company announced a market withdrawal of its
first prescription product, the weight loss medication Redux (dexfenfluramine
hydrochloride capsules) C-IV, which had been launched by AHP, the Company's
licensee, in June 1996. Since the withdrawal of Redux, the Company has been
named, together with other pharmaceutical companies, as a defendant in
approximately 3,200 product liability legal actions, some of which purport to
be class actions, in federal and state courts involving the use of Redux and
other weight loss drugs. To date, there have been no judgments against the
Company, nor has the Company paid any amounts in settlement of any of these
claims.

Background, Regulatory Approval, Labeling and Safety Issues: Redux
(dexfenfluramine) is chemically related to Pondimin (fenfluramine).
Fenfluramine is a drug made up of two mirror-image halves--a "right-handed"
half (d-isomer) and "left-handed" half (l-isomer)--and dexfenfluramine is the
right-handed isomer of fenfluramine (the left-handed half is
"levofenfluramine"). Dexfenfluramine alone is a separate drug from the combined
dexfenfluramine/levofenfluramine molecule that is fenfluramine.

Redux received clearance on April 29, 1996 by the FDA for marketing as a
twice-daily prescription therapy to treat obesity and was launched in June
1996. Until its withdrawal, under the AHP Agreements, Redux was marketed in the
U.S. by Wyeth-Ayerst and copromoted by the Company.

Included in the FDA-approved labeling for Redux were references to certain
risks that may be associated with dexfenfluramine and which were highlighted
during the FDA's review of the drug. One issue related to whether there is an
association between appetite suppressants, including dexfenfluramine, and the
development of primary pulmonary hypertension ("PPH"), a rare but serious lung
disorder estimated to occur in the general population at one to two cases per
million adults per year. An epidemiologic study conducted in Europe known as
IPPHS (International Primary Pulmonary Hypertension Study) examined risk
factors for PPH and showed that among other factors, weight reduction drugs,
including dexfenfluramine, and obesity itself were associated with a higher
risk of PPH. In the final report of IPPHS, published in The New England Journal
of Medicine (August 29, 1996), the authors re-classified and included certain
previously excluded cases of PPH, resulting in an increase in the estimated
yearly occurrence of PPH for patients taking appetite suppressants for greater
than three months' duration to be between 23 and 46 cases per million patients
per year. The revised labeling for Redux disclosed this revised estimate.

The FDA-approved labeling for Redux also included discussion as to whether
dexfenfluramine is associated with certain neurochemical changes in the brain.
Certain studies conducted by third parties related to this issue purport to
show that very high doses of dexfenfluramine cause prolonged serotonin
depletion in certain animals,

21

which some researchers believe is an indication of neurotoxicity. In connection
with the approval of Redux, the Company and Wyeth-Ayerst had agreed with the
FDA to conduct a Phase IV, or post-marketing, study with patients taking Redux.
Following the withdrawal of Redux, this study was terminated.

In July 1997, the Mayo Clinic reported observations of heart valve
abnormalities in 24 patients taking the combination of fenfluramine and
phentermine (commonly referred to as the "fen-phen" combination). The Mayo
Clinic cases were subsequently reported in an article appearing in the August
28, 1997 issue of The New England Journal of Medicine. This article was
accompanied by a letter to the editor from the FDA reporting additional cases
of heart valve disease in 28 patients taking the combination of phentermine and
fenfluramine, two patients taking fenfluramine alone, four patients taking
Redux alone and two patients taking Redux and phentermine.

The withdrawal of Redux was based on a preliminary analysis by the FDA of
potential abnormal echocardiogram findings associated with certain patients
taking Redux or the combination of fenfluramine with phentermine. These
observations, presented to the Company in September 1997, indicated an
incidence of approximately 30%. Although these observations reflected a
preliminary analysis of pooled information and were difficult to evaluate
because of the absence of matched controls and pretreatment baseline data for
these patients, the Company believed it was prudent, in light of this
information, to have withdrawn Redux from the market.

Additional adverse event reports of abnormal heart valve findings in
patients using Redux or fenfluramine alone or in combination with other weight
loss agents continue to be received by the Company, Wyeth-Ayerst, and the FDA.
These reports have included symptoms such as shortness of breath, chest pain,
fainting, swelling of the ankles or a new heart murmur.

Subsequent Clinical Studies: Subsequent to the withdrawal of Redux, a number
of studies have been conducted by third parties, including Wyeth-Ayerst, and
one study was conducted by the Company, to assess the differences in
cardiovascular clinical outcomes between patients who had taken Redux or the
fen-phen combination, compared to an untreated group. In general, these studies
were conducted and analyzed by independent panels of cardiologists to compare
the incidence of significant heart valve abnormalities in treated compared to
non-treated groups. Patients were selected and assigned to these groups
randomly. Readings of patient echocardiograms have generally been made on a
blinded basis by cardiologists who do not know from which group individual
echocardiograms were taken. Findings of these studies have been presented or
reported by their respective third party sponsors or researchers. Based on the
results of studies announced to date, the incidence of cardiac valve
abnormalities has been shown to be less than that suggested by the original FDA
preliminary analysis. In general, these studies have shown either no or
relatively small differences, although in some cases statistically significant,
between the incidence of cardiac valve abnormalities, as defined by the FDA,
among patients who took Redux and placebo-treated patients and that the
incidence of such abnormalities among Redux patients was less than previously
reported estimates. Findings from these studies differ with regard to the
strength and clinical significance of the association. Differences in trial
design preclude precise comparison. A summary of the results of the study
sponsored by the Company follows.

Interneuron Sponsored Clinical Study: Preliminary results of a blinded,
matched control group, multi-center clinical study sponsored by the Company and
presented on November 10, 1998 at the Scientific Sessions of the American Heart
Association showed a low overall incidence of FDA-defined cardiac valve
abnormalities among 223 patients who took Redux for three months or longer when
compared to 189 individuals who had not taken Redux. Final results were
published in the November 23, 1999 issue of Circulation. No severe and very few
moderate cases of valvular regurgitation were found in either Redux patients or
non-Redux subjects. The incidence of cardiac valve abnormalities among Redux
patients reported in this study, although statistically significant, was far
less than some previously reported estimates.

The average duration of Redux use among all Redux patients in this study was
approximately seven months. The study was designed to evaluate the impact of
long-term use of Redux alone upon the incidence of cardiac valve disease as
defined by the FDA. Market research data indicates that more than 80% of
patients who were

22

prescribed Redux in the U.S. received drug therapy for 90 days or less and only
approximately 6.5% of patients took Redux for six months or more.

Analyses were conducted based on echocardiographic data from the total
patient population entered into the study and also from the core group, which
included only the matched pairs. The FDA has defined significant cardiac valve
regurgitation as mild or greater aortic valve regurgitation and/or moderate or
greater mitral valve regurgitation. Previous reports had estimated rates of
cardiac valve regurgitation among anorexigen-treated patients of up to 30%.

Final analyses showed that among all study participants, 1.3% of Redux
patients and 0.5% of non-treated patients (p = not significant) met the FDA's
definition of mitral valve regurgitation. With respect to aortic valve
regurgitation, in all patients, 6.3% of Redux patients and 1.6% of non-treated
patients met the FDA's definition (p = 0.01). Among the core group of matched
pairs, 6.4% of Redux patients and 1.7% of non-treated controls (p = 0.03) met
this definition. Among the core group of matched pairs, there was no
statistically significant difference in mitral valve regurgitation. For all
patients with either aortic or mitral valve regurgitation meeting FDA criteria,
the incidence was 2.1% for controls and 7.6% for the Redux patients (p = 0.02).
In summary, the prevalence of aortic valve regurgitation was statistically
significantly greater in the Redux-treated group than in the control group.

When the time from discontinuation of Redux treatment to echocardiogram was
analyzed, there was a statistically significant difference in regurgitation
rates in Redux patients versus controls for the less than 8.3 month group but
not the greater than 8.3 month group, possibly indicating decreased prevalence
over time after discontinuation. There was a significant interaction between
Redux treatment and blood pressure at the time of echocardiogram, resulting in
an increased prevalence of aortic regurgitation with higher blood pressure.
This interaction did not exist for the control group. The Redux patients and
controls had similar blood pressures at baseline, but the Redux patients had
significantly higher post-echocardiogram blood pressures than did the controls.
Finally, concomitant use of a drug with MAO (monoamine oxidase) inhibitory
properties may be a factor contributing to the occurrence of regurgitation.
Such drugs were contraindicated with the use of Redux.

Marketing and Manufacturing: With respect to the marketing and manufacture
of Redux, the Company sublicensed U.S. marketing rights to AHP, while retaining
copromotion rights. Redux was launched in June 1996 and withdrawn in September
1997. The Company relied on AHP to target the obesity market and for
distribution and advertising and promotional activities. The Company copromoted
Redux through an approximately 30-person sales force to selected
diabetologists, endocrinologists, bariatricians, nutritionists and weight
management specialists, subject to certain restrictions. Under a contract
manufacturing agreement, Boehringer produced on behalf of the Company
commercial scale quantities of the finished dosage formulation of Redux in
capsule form.

Patents and Proprietary Rights: The Servier Agreements granted the Company
an exclusive license to sell dexfenfluramine in the U.S. under a patent
covering the use of dexfenfluramine to treat abnormal carbohydrate craving,
which was sublicensed by the Company to AHP. Use of dexfenfluramine for the
treatment of abnormal carbohydrate craving was patented by Drs. Richard Wurtman
and Judith Wurtman. Dr. Richard Wurtman was a consultant to and a director of
the Company. This use patent was assigned to MIT and licensed by MIT to
Servier, and pursuant to the Servier Agreements, was licensed to the Company.

EMPLOYEES

As of September 30, 2001, the Company had 19 full-time employees. None of
the Company's employees is represented by a labor union and the Company
believes its employee relations are satisfactory. The Company is highly
dependent upon certain key personnel and believes its future success will
depend in large part on its ability to retain such individuals and attract
other highly skilled management, marketing and scientific personnel. See "Risk
Factors--We depend upon key personnel and consultants."

23

ITEM 2. Properties

The Company leases an aggregate of approximately 22,800 square feet of
office space in Lexington, MA. The lease expires in April 2007 and provides for
annual rent of approximately $448,000. The Company has guaranteed certain of
Incara's lease obligations. See Note G of Notes to Consolidated Financial
Statements. The Company believes such space is adequate for its current needs.

ITEM 3. Legal Proceedings (See Item 1--Narrative Description of Business)

Product Liability Litigation: Subsequent to the market withdrawal of Redux
in September 1997, the Company has been named, together with other
pharmaceutical companies, as a defendant in approximately 3,200 legal actions,
many of which purport to be class actions, in federal and state courts relating
to the use of Redux. The actions generally have been brought by individuals in
their own right or on behalf of putative classes of persons who claim to have
suffered injury or who claim that they may suffer injury in the future due to
use of one or more weight loss drugs including Pondimin (fenfluramine),
phentermine and Redux. Plaintiffs' allegations of liability are based on
various theories of recovery, including, but not limited to, product liability,
strict liability, negligence, various breaches of warranty, conspiracy, fraud,
misrepresentation and deceit. These lawsuits typically allege that the short or
long-term use of Pondimin and/or Redux, independently or in combination
(including the combination of Pondimin and phentermine popularly known as
"fen-phen"), causes, among other things, PPH, valvular heart disease and/or
neurological dysfunction. In addition, some lawsuits allege emotional distress
caused by the purported increased risk of injury in the future. Plaintiffs
typically seek relief in the form of monetary damages (including economic
losses, medical care and monitoring expenses, loss of earnings and earnings
capacity, other compensatory damages and punitive damages), generally in
unspecified amounts, on behalf of the individual or the class. In addition,
some actions seeking class certification ask for certain types of purportedly
equitable relief, including, but not limited to, declaratory judgments and the
establishment of a research program or medical surveillance fund. On December
10, 1997, the federal Judicial Panel on Multidistrict Litigation issued an
Order allowing for the transfer or potential transfer of the federal actions to
the Eastern District of Pennsylvania for coordinated or consolidated pretrial
proceedings. To date, there have been no judgments against the Company, nor has
the Company paid any amounts in settlement of any of these claims.

The Company entered into the AHP Indemnity and Release Agreement on May 30,
2001 pursuant to which AHP agreed to indemnify the Company against certain
classes of product liability cases filed against Interneuron related to Redux.
The Company's indemnification covers existing plaintiffs who have already opted
out of AHP's national class action settlement of diet drug claims and claimants
alleging primary pulmonary hypertension. In addition, AHP has agreed to fund
all future legal costs related to the Company's defense of Redux-related
product liability cases. The agreement also provides for AHP to fund additional
insurance coverage to supplement the Company's existing product liability
insurance. The Company believes this total insurance coverage is sufficient to
address its potential remaining Redux product liability exposure. However,
there can be no assurance that uninsured or insufficiently insured
Redux-related claims or Redux-related claims for which the Company is not
otherwise indemnified or covered under the AHP Indemnity and Release Agreement
will not have a material adverse effect on the Company's future business,
results of operations or financial condition or that the potential of any such
claims would not adversely affect the Company's ability to obtain sufficient
financing to fund operations. Up to the date of the AHP Indemnity and Release
Agreement, the Company's defense costs were paid by, or subject to
reimbursement to the Company from, the Company's product liability insurers. To
date, there have been no Redux-related product liability settlements or
judgments paid by the Company or its insurers. In exchange for the
indemnification, defense costs, and insurance coverage provided to Interneuron
by AHP, the Company agreed to dismiss its suit against AHP filed in January
2000, its appeal from the order approving AHP's national class action
settlement of diet drug claims, and its cross-claims against AHP related to
Redux product liability legal actions.

Complaint Against AHP: On January 24, 2000, the Company announced it had
filed a complaint against AHP in the Superior Court of the Commonwealth of
Massachusetts (the "AHP Litigation"). The complaint sought unspecified but
substantial damages and attorneys' fees pursuant to common and statutory law
for AHP's knowing and willful deceptive acts and practices, fraud and
misrepresentations and breach of contract. AHP filed

24

an answer denying the allegations of such complaint. Pursuant to the AHP
Indemnity and Release Agreement, described above, such complaint was dismissed
on June 28, 2001.

Insurance Litigation: On August 7, 2001, Columbia Casualty Company, one of
the Company's insurers for the period May 1997 through May 1998, filed an
action in the United States District Court for the District of Columbia against
the Company. The lawsuit is based upon a claim for breach of contract and
declaratory judgment, seeking damages against the Company in excess of
$20,000,000, the amount that the plaintiff has paid to the Company under its
insurance policy. The plaintiff alleges that under the policy it was subrogated
to any claim for indemnification that Interneuron may have had against AHP
related to Redux and that such claim was compromised without its consent when
the Company entered into the AHP Indemnity and Release Agreement. The Company
plans to vigorously defend this litigation.

Securities Litigation Settlement: The Company and certain present or former
directors and/or officers of the Company were named as defendants in several
lawsuits, purporting to be class actions, filed in the Massachusetts Federal
Court by alleged purchasers of the Company's Common Stock, claiming violation
of the federal securities laws. On February 2, 2000, the Massachusetts Federal
Court entered the Final Judgment, which, among other things, granted final
judgment to and an approval of the settlement of the lawsuits on a class-wide
basis, covering a class period of March 24, 1997 to July 8, 1997. No appeal was
taken from the Final Judgment. The settlement amount was entirely funded by
insurance proceeds.

General: Pursuant to agreements between the parties, under certain
circumstances, the Company may be required to indemnify Servier, Boehringer and
other parties.

Although the Company maintains certain product liability and director and
officer liability insurance and intends to defend these and similar actions
vigorously, the Company has been required and may continue to be required to
devote significant management time and resources to these legal actions. In the
event of successful uninsured or insufficiently insured claims, or in the event
a successful indemnification claim were made against the Company and its
officers and directors, the Company's business, financial condition and results
of operations could be materially adversely affected. The uncertainties and
costs associated with these legal actions have had, and may continue to have,
an adverse effect on the market price of the Company's Common Stock and on the
Company's ability to obtain corporate collaborations or additional financing to
satisfy cash requirements, to retain and attract qualified personnel, to
develop and commercialize products on a timely and adequate basis, to acquire
rights to additional products, or to obtain product liability insurance for
other products at costs acceptable to the Company, or at all, any or all of
which may materially adversely affect the Company's business, financial
condition and results of operations. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations," "Risk Factors--The outcome
of the Redux litigation could materially harm us," and Note H of Notes to
Consolidated Financial Statements.

ITEM 4. Submission of Matters to a Vote of Security Holders

Not applicable.

25

EXECUTIVE OFFICERS

The following table sets forth the names and positions of the executive
officers of the Company:

Name Age Position
- ---- --- --------

Glenn L. Cooper, M.D....... 48 President, Chief Executive Officer and Chairman
Mark S. Butler............. 55 Executive Vice President, Chief Administrative
Officer and General Counsel
Michael W. Rogers.......... 41 Executive Vice President, Chief Financial Officer
and Treasurer
Bobby W. Sandage, Jr., Ph.D 48 Executive Vice President, Research and
Development and Chief Scientific Officer

Glenn L. Cooper, M.D. has been President, Chief Executive Officer and a
director of the Company since May 1993 and Chairman since January 2000. Dr.
Cooper was also Progenitor's President and Chief Executive Officer from
September 1992 to June 1994. Prior to joining Progenitor, Dr. Cooper was
Executive Vice President and Chief Operating Officer of Sphinx Pharmaceuticals
Corporation from August 1990. Dr. Cooper had been associated with Eli Lilly
since 1985, most recently, from June 1987 to July 1990, as Director, Clinical
Research, Europe, of Lilly Research Center Limited; from October 1986 to May
1987 as International Medical Advisor, International Research Coordination of
Lilly Research Laboratories; and from June 1985 to September 1986 as Medical
Advisor, Regulatory Affairs, Chemotherapy Division at Lilly Research
Laboratories. Dr. Cooper is a director and Vice Chairman of Proneuron
Biotechnologies, Inc., a private Israeli-based biotechnology company. Dr.
Cooper received his M.D. from Tufts University School of Medicine, performed
his postdoctoral training in Internal Medicine and Infectious Diseases at the
New England Deaconess Hospital and Massachusetts General Hospital and received
his B.A. from Harvard College.

Mark S. Butler joined the Company in December 1993 as Senior Vice President
and, in December 1995, was appointed Executive Vice President, Chief
Administrative Officer and General Counsel. Prior to joining the Company, Mr.
Butler was associated with the Warner-Lambert Company since 1979, serving as
Vice President, Associate General Counsel since 1990, as Associate General
Counsel from 1987 to 1990, Assistant General Counsel from 1985 to 1987 and in
various other legal positions from 1979 to 1985. From 1975 to 1979, Mr. Butler
was an attorney with the law firm of Shearman & Sterling.

Michael W. Rogers joined the Company in February 1999 as Executive Vice
President, Chief Financial Officer and Treasurer. From February 1998 to
December 1998, Mr. Rogers was Executive Vice President and Chief Financial and
Corporate Development Officer at Advanced Health Corporation, a publicly-traded
health care information technology company. From July 1995 to November 1997, he
was Vice President, Chief Financial Officer and Treasurer of AutoImmune, Inc.,
a publicly-traded biopharmaceutical company. From July 1994 to July 1995, Mr.
Rogers was Vice President, Investment Banking at Lehman Brothers, Inc. From
1990 to 1994, he was associated with PaineWebber, Inc., serving most recently
as Vice President, Investment Banking Division.

Bobby W. Sandage, Jr., Ph.D. joined the Company in November 1991 as Vice
President--Medical and Scientific Affairs and was appointed Vice
President--Research and Development in February 1992, Senior Vice
President--Research and Development in February 1994 and Executive Vice
President, Research and Development and Chief Scientific Officer in December
1995. From February 1989 to November 1991 he was Associate Director, Project
Management for the Cardiovascular Research and Development division of DuPont
Merck Pharmaceutical Company. From May 1985 to February 1989 he was affiliated
with the Medical Department of DuPont Critical Care, most recently as associate
medical director, medical development. Dr. Sandage is an adjunct professor in
the Department of Pharmacology at the Massachusetts College of Pharmacy. Dr.
Sandage received his Ph.D. in Clinical Pharmacy from Purdue University and his
B.S. in Pharmacy from the University of Arkansas.

26

RISK FACTORS

The following factors should be reviewed carefully, in conjunction with the
other information in this Report and the Company's consolidated financial
statements. These factors, among others, could cause actual results to differ
materially from those currently anticipated and contained in forward-looking
statements made in this Report and presented elsewhere by Company management
from time to time. See "Part I--Note Regarding Forward Looking Statements."

Our products are early stage and may not be successful or achieve market
acceptance.

We are investigating for therapeutic potential a variety of pharmaceutical
compounds, and other products at various stages of development. The products we
are developing are subject to the risk that any or all of them are found to be
ineffective or unsafe, or otherwise may fail to receive necessary regulatory
clearances. We are unable to predict whether any of our products will receive
regulatory clearances or be successfully manufactured or marketed. Further, due
to the extended testing and regulatory review process required before marketing
clearance can be obtained, the time frames for commercialization of any
products or procedures are long and uncertain. Even if our products receive
regulatory clearance, our products may not achieve or maintain market
acceptance.

We rely on the favorable outcome of clinical trials of our products.

Before obtaining regulatory approval for the commercial sale of any of the
pharmaceutical products we are developing, we or our licensees must demonstrate
that the product is safe and efficacious for use in each target indication. The
process of obtaining U.S. Food and Drug Administration and other regulatory
approval is lengthy and expensive. If clinical trials do not demonstrate the
safety and efficacy of certain products under development, we will be
materially adversely affected. The results of pre-clinical studies and early
clinical trials may not predict results that will be obtained in large-scale
testing or use. Clinical trials of products we are developing may not
demonstrate the safety and efficacy of such products. Regardless of clinical
trial results, the FDA may not approve marketing of the product. The costs to
obtain regulatory approvals could be considerable and the failure to obtain, or
delays in obtaining regulatory approval could have a significant negative
effect on our business performance and financial results. Even if pre-market
approval of a product is obtained, the FDA is authorized to impose
post-marketing requirements. A number of companies in the pharmaceutical
industry, including our company, have suffered significant setbacks in advanced
clinical trials or have not received FDA approval, even after promising results
in earlier trials. We withdrew our New Drug Application for citicoline to treat
ischemic stroke after the failure to meet our primary objective in a small
Phase III clinical study.

We will depend on Pfizer to develop, manufacture and market pagoclone.

Under our agreement with Pfizer, we do not have control over the development
or commercialization of pagoclone. We would be materially adversely affected if
Pfizer does not successfully develop pagoclone. We will be dependent on Pfizer
to manufacture pagoclone under current Good Manufacturing Practices
regulations. We will also be dependent on Pfizer for the marketing and
distribution of pagoclone.

We could be materially harmed if our agree