DISCOVERY LABORATORIES, INC. AND SUBSIDIARY (a development stage company) Consolidated Balance Sheets (Unaudited) September 30, 1997 ASSETS Current assets: Cash and cash equivalents $ 536,000 Investments in United States government obligations 11,633,000 Investment in Ansan Pharmaceuticals, Inc. 1,300,000 Prepaid expenses 39,000 ------------ Total current assets 13,508,000 Computer equipment, net of depreciation 93,000 Deferred merger costs 327,000 Other assets 30,000 ------------ $ 13,958,000 ============ LIABILITIES Accrued expenses $ 448,000 ------------ Minority interest in preferred stock of subsidiary 2,200,000 ------------ Commitments and contingencies STOCKHOLDERS' EQUITY Series A convertible preferred stock, $.001 par value; 7,000,000 shares authorized; 2,200,256 shares issued and outstanding (liquidation preference $29,703,000) 2,000 Other preferred stock, $.001 par value; 3,000,000 shares authorized; none issued and outstanding Common stock, $.001 par value, 50,000,000 shares authorized, 6,747,256 shares issued and outstanding 7,000 Additional paid-in capital 18,999,000 Deficit accumulated during the development stage (7,698,000) ------------ Total stockholders' equity 11,310,000 ------------ $ 13,958,000 ============ See notes to financial statements F-1 DISCOVERY LABORATORIES, INC. AND SUBSIDIARY (a development stage company) Consolidated Statements of Operations (Unaudited) Nine Months Ended May 18, 1993 September 30, (Inception) to --------------------------- September 30, 1996 1997 1997 ----------- ----------- ----------- Interest income $ 594,000 $ 799,000 ----------- ----------- Expenses: Research and development $ 137,000 3,503,000 6,243,000 General and administrative 117,000 1,535,000 2,245,000 Interest 5,000 11,000 ----------- ----------- ----------- Total expenses 259,000 5,038,000 8,499,000 ----------- ----------- ----------- (259,000) (4,444,000) (7,700,000) ----------- ----------- ----------- Minority interest in net loss of subsidiary 2,000 ----------- Net loss $ (259,000) $(4,444,000) $(7,698,000) =========== =========== =========== Pro forma net loss per share $ (.26) $ (1.69) =========== =========== Pro forma weighted average common shares outstanding 1,009,443 2,629,772 =========== =========== See notes to financial statements F-2 DISCOVERY LABORATORIES, INC. AND SUBSIDIARY (a development stage company) Consolidated Statements of Changes in Stockholders' Equity (Unaudited) Deficit Accumulated Common Stock Preferred Stock Additional During the ------------------------ ----------------- Paid-in Development Shares Amount Shares Amount Capital Stage Total ---------- ----------- --------- ------ ----------- ----------- ----------- Balance - December 31, 1996 6,712,256 $ 7,000 2,200,256 $2,000 $19,003,000 $(3,254,000) $15,758,000 Private placement expenses (11,000) (11,000) Exercise of stock options 35,000 7,000 7,000 Net loss (4,444,000) (4,444,000) ---------- ----------- --------- ------ ----------- ----------- ----------- Balance - September 30, 1997 6,747,256 $ 7,000 2,200,256 $2,000 $18,999,000 $(7,698,000) $11,310,000 ========== =========== ========= ====== =========== =========== =========== See notes to financial statements F-3 DISCOVERY LABORATORIES, INC. AND SUBSIDIARY (a development stage company) Consolidated Statements of Cash Flows (Unaudited) May 18, 1993 Nine Months Ended (Inception) to September 30, September 30, -------------------------- 1996 1997 1997 ----------- ------------ ------------ Cash flows from operating activities: Net loss $ (259,000) $ (4,444,000) $ (7,698,000) Adjustments to reconcile net loss to net cash used in operating activities: Write-off of acquired research and development supplies 2,200,000 Write-off of licenses 683,000 683,000 Depreciation and amortization 3,000 48,000 72,000 Changes in: Prepaid expenses (20,000) (39,000) Other assets (30,000) (30,000) Accrued expenses 9,000 217,000 448,000 Expenses paid on behalf of company 18,000 Employee stock compensation 42,000 42,000 ----------- ------------ ------------ Net cash used in operating activities (205,000) (3,546,000) (4,304,000) ----------- ------------ ------------ Cash flows from investing activities: Investment in Ansan Pharmaceuticals, Inc. (1,300,000) (1,300,000) Acquisition of computer equipment (6,000) (54,000) (137,000) Acquisition of license (111,000) (711,000) Purchase of investments in United States government obligations (2,613,000) (15,677,000) Redemption of investments in United States government obligations 4,044,000 4,044,000 Deferred merger costs (327,000) (327,000) ----------- ------------ ------------ Net cash used in investing activities (117,000) (250,000) (14,108,000) ----------- ------------ ------------ Cash flows from financing activities: Private placement of units, net of expenses 6,482,000 (11,000) 18,925,000 Payment on stock subscriptions and proceeds on issuance of common stock 8,000 7,000 23,000 Short-term borrowings ----------- ------------ ------------ Net cash provided by (used in) financing activities 6,490,000 (4,000) 18,948,000 ----------- ------------ ------------ Net increase (decrease) in cash and cash equivalents 6,168,000 (3,800,000) 536,000 Cash and cash equivalents - beginning of period 3,000 4,336,000 ----------- ------------ ------------ Cash and cash equivalents - end of period $ 6,171,000 $ 536,000 $ 536,000 =========== ============ ============ See notes to financial statements F-4 DISCOVERY LABORATORIES, INC. AND SUBSIDIARY (a development stage company) NOTE A - THE COMPANY AND BASIS OF PRESENTATION Discovery Laboratories, Inc., a former Delaware Corporation ("Old Discovery"") was incorporated in Delaware on May 18, 1993 as MicroBio, Inc. Until Old Discovery's merger with and into the Registrant on November 25, 1997 (the "Merger"), Old Discovery was a development stage company formed to license and develop pharmaceutical products to treat a variety of human diseases. The consolidated financial statements include the accounts of Old Discovery and its majority owned subsidiary, Acute Therapeutics, Inc. ("ATI"). Intercompany balances and transactions have been eliminated. No allocation of the subsidiary's net loss for the nine-month periods ended September 30, 1997 and 1996 has been attributed to the minority interest since the accumulated losses exceed the minorities' common equity interest during such periods . In the opinion of management, the financial statements include all adjustments, consisting of normal recurring accruals, necessary for a fair presentation of Old Discovey's financial position at September 30, 1997 and results of operations and cash flows for the nine-month periods ended September 30, 1997 and 1996. The financial statements for the nine-months ended September 30, 1997 are not necessarily indicative of the results that may be expected for the year ending December 31, 1997. In November 1996 Old Discovery completed a private placement of its securities and received aggregate net proceeds of approximately $19,000,000. NOTE B - NET LOSS PER SHARE Pro forma net loss per share is computed based on the weighted average number of common shares outstanding for the periods adjusted to reflect the number of shares of the Registrant's common stock issued to the common stockholders of Old Discovery upon consummation of the Merger. Common stock equivalents are not included in the calculation of net loss per share as the effect would be antidilutive. NOTE C - COMMITMENTS ATI entered into a four-year employment agreement with its President, Chief Executive Officer and Chairman of the Board of Directors providing for a base salary of $225,000 per year plus an initial sign-on bonus of $50,000 to be paid the first week of January 1997, plus certain incentive bonuses. ATI also entered into a three-year employment agreement with an officer providing for an annual salary of $200,000 and various two-year consulting agreements providing for aggregate annual fees of $300,000 plus royalties on net commercial sales of licensed products sold by ATI or its sublicensees and an 18-month consulting agreement providing for monthly fees of $7,500. ATI leases its office and laboratory space pursuant to an operating lease requiring aggregate annual payments of approximately $67,000 through November 2001. Note D - Merger Pursuant to a merger agreement executed with the Registrant on July 16, 1997 (the "Merger Agreement"), Old Discovery's stockholders received approximately 90% of the combined entity. The Merger will be accounted for as a reverse acquisition with Old Discovery as the acquirer for financial reporting purposes. The Merger closed on November 25, 1997. Also on July 16, 1997 Old Discovery purchased 13,000 shares of Series A convertible preferred stock of the Registrant for $1,300,000 which amount was used by the Registrant to repay certain debt owed to its principal stockholder. The Series A convertible preferred stock was cancelled in the Merger. The Registrant's assets at September 30, 1997 consisted primarily of cash and short-term investments. F-5 DISCOVERY LABORATORIES, INC. AND SUBSIDIARY (a development stage company) Note E - Income Taxes At September 30, 1997, Old Discovery had available for federal income tax purposes net operating loss carryforwards of approximately $2,600,000 expiring through 2011, that may be used to offset future taxable income. The principal difference between the deficit accumulated during the development stage for financial reporting purposes and the net operating loss carryforward for tax purposes is primarily due to the write-off of the acquired research and development supplies and to certain general and administrative costs which are not currently deductible for tax purposes. Old Discovery provided a valuation reserve against the full amount of the deferred tax asset of $3,030,000 arising from net operating loss benefit of approximately $1,000,000 the research and development write-off of approximately $1,130,000 and general and administrative costs of approximately 900,000 since the likelihood of realization cannot be determined. The valuation reserve increased by approximately $1,223,000 and $7,000 for the years ended December 31, 1996 and December 31, 1995, respectively, and approximately $1,800,000 for the nine months ended September 30, 1997. Pursuant to Section 382 of the Internal Revenue Code, the utilization of this carryforward may be limited due to ownership changes which have occurred or may occur. F-6