AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON SEPTEMBER 11, 1997

REGISTRATION NO. 333-32593

===============================================================================

SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

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AMENDMENT NO. 3 TO

FORM S-1

REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933

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MEGABIOS CORP.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

DELAWARE 8731 94-3156660
(STATE OR OTHER (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER
JURISDICTION OF CLASSIFICATION CODE NUMBER) IDENTIFICATION NUMBER)
INCORPORATION OR
ORGANIZATION)

----------------

863A MITTEN ROAD
BURLINGAME, CA 94010
(650) 697-1900
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF
REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)

----------------

PATRICK G. ENRIGHT
CHIEF FINANCIAL OFFICER AND VICE PRESIDENT
MEGABIOS CORP.
863A MITTEN ROAD
BURLINGAME, CA 94010
(650) 697-1900
(NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE,
OF AGENT FOR SERVICE)

----------------

COPIES TO:

ALAN C. MENDELSON, ESQ. ROBERT V. GUNDERSON, JR., ESQ.
PATRICK A. POHLEN, ESQ. DAVID T. YOUNG, ESQ.
COOLEY GODWARD LLP GUNDERSON DETTMER STOUGH VILLENEUVE
FIVE PALO ALTO SQUARE FRANKLIN & HACHIGIAN, LLP
3000 EL CAMINO REAL 155 CONSTITUTION DRIVE
PALO ALTO, CA 94306-2155 MENLO PARK, CA 94025
(650) 843-5000 (650) 321-2400

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APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after this Registration Statement becomes effective.

If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. [_]

If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following
box and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [_]

If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [_]

If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [_]

----------------

THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT
SHALL FILE A FURTHER AMENDMENT THAT SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION
8(a), MAY DETERMINE.

================================================================================

++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A +
+REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE +
+SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY +
+OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT +
+BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR +
+THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE +
+SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE +
+UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF +
+ANY SUCH STATE. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++

SUBJECT TO COMPLETION, DATED SEPTEMBER 11, 1997

2,500,000 SHARES

[LOGO OF MEGABIOS]

COMMON STOCK

All of the 2,500,000 shares of Common Stock offered hereby are being sold by
Megabios Corp. ("Megabios" or the "Company"). Prior to this offering, there has
been no public market for the Common Stock of the Company. It is currently
estimated that the initial public offering price for the Common Stock will be
between $11.00 and $13.00 per share. See "Underwriting" for a discussion of the
factors to be considered in determining the initial public offering price. The
Common Stock has been approved for quotation on the Nasdaq National Market
under the symbol "MEGA."

THE SHARES OF COMMON STOCK OFFERED HEREBY INVOLVE A HIGH DEGREE OF RISK. SEE
"RISK FACTORS" BEGINNING ON PAGE 6 FOR A DISCUSSION OF CERTAIN FACTORS THAT
SHOULD BE CONSIDERED BY PROSPECTIVE INVESTORS IN PURCHASING THE SHARES OF
COMMON STOCK OFFERED HEREBY.

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THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES
COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF
THIS PROSPECTUS. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.

- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------

Price to Underwriting Proceeds to
Public Discount (1) Company (2)
- --------------------------------------------------------------------------------

Per Share.................................... $ $ $
Total (3).................................... $ $ $

- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------

(1) See "Underwriting" for information concerning indemnification of the
Underwriters and other matters.

(2) Before deducting expenses payable by the Company estimated at $600,000.

(3) The Company has granted to the Underwriters a 30-day option to purchase up
to an additional 375,000 shares of Common Stock solely to cover over-
allotments, if any. If the Underwriters exercise this option in full, the
Price to Public will total $ , the Underwriting Discount will total
$ and the Proceeds to the Company will total $ . See
"Underwriting."

The shares of Common Stock are offered by the several Underwriters named
herein, subject to receipt and acceptance by them and subject to their right to
reject any order in whole or in part. It is expected that delivery of the
certificates representing such shares will be made against payment therefor at
the office of Montgomery Securities on or about , 1997.

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MONTGOMERY SECURITIES HAMBRECHT & QUIST

, 1997

DESCRIPTION OF GRAPHIC

This page will feature an hourglass-like image. The "hourglass" will contain
three blocks of language extracted from the prospectus which relate to (i) the
opportunity created by the field of genomics for gene-based therapeutics, (ii)
the limitations of gene delivery technology and (iii) the Company's
commercialization strategy and corporate partnerships to date.

TITLE: (Centered)
"Megabios Business Opportunity"

A. GENES AS POTENTIAL THERAPEUTIC PRODUCTS
. 100,000 genes in the human genome.
. At least 5,000 genes of known function.
. Many genes have been identified as potential therapeutic genes.
. Certain therapeutic genes may be attractive product candidates.

B. MEGABIOS' PROPRIETARY GENE DELIVERY SYSTEMS
. Lack of safe, effective gene delivery technology has limited the
development of gene-based therapeutics.
. Megabios develops proprietary gene delivery technology and provides
preclinical development expertise.
. Megabios' in vivo, non-viral gene delivery technology is designed to
avoid the limitations of other gene delivery systems.

C. PORTFOLIO OF PRODUCT CANDIDATES SPONSORED BY CORPORATE PARTNERS
. Megabios' goal is to create a portfolio of funded product development
programs.
. Clinical programs are expected to be sponsored through corporate
partnerships.
. Such collaborations are structured to provide research and development
funding, milestone payments and royalties.
. Megabios' three corporate partners are: Glaxo Wellcome plc for the
treatment of cystic fibrosis, Pfizer Inc for the treatment of cancer via
angiogenesis inhibition, and Eli Lilly and Company for the treatment of
cancer using BRCA-1.

----------------

CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN ACTIVITIES THAT
STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE SECURITIES OFFERED
HEREBY INCLUDING OVER-ALLOTMENT, STABILIZING TRANSACTIONS, SYNDICATE SHORT
COVERING TRANSACTIONS AND PENALTY BIDS. THESE TRANSACTIONS MAY BE EFFECTED ON
NASDAQ OR OTHERWISE AND, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME. FOR A
DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITING."

The Company was incorporated in California in April 1992 and will be
reincorporated in Delaware prior to effectiveness of this offering. The
Company's executive offices are located at 863A Mitten Road, Burlingame,
California 94010, and its telephone number is (650) 697-1900.

PROSPECTUS SUMMARY

The following summary is qualified in its entirety by the more detailed
information and the Financial Statements and Notes thereto appearing elsewhere
in this Prospectus. Unless otherwise indicated, all information in this
Prospectus assumes: (i) a 1-for-3 reverse split of the Company's outstanding
Common Stock and Preferred Stock to be effected prior to effectiveness of this
offering; (ii) the reincorporation of the Company in the State of Delaware to
be effected prior to effectiveness of this offering; (iii) the conversion of
all outstanding shares of Preferred Stock into shares of Common Stock to be
effected upon the closing of this offering; and (iv) no exercise of the
Underwriters' over-allotment option. Except for the historical information
contained herein, the discussion in this Prospectus contains forward-looking
statements that involve risks and uncertainties. The Company's actual results
could differ materially from those discussed herein. Factors that could cause
or contribute to such differences include, but are not limited to, those
discussed in "Risk Factors," "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and "Business," as well as those discussed
elsewhere in this Prospectus.

THE COMPANY

Megabios develops proprietary gene delivery systems and provides preclinical
development expertise to create gene-based therapeutics designed for the
treatment or prevention of genetic and acquired diseases. The Company has
developed several in vivo, non-viral gene delivery systems to address a number
of potential therapeutic applications using a variety of therapeutic genes. The
Company's clinical development and commercialization strategy is to enter into
collaborative research and development agreements or "corporate partnerships"
with pharmaceutical and biotechnology companies. To date, the Company has
established corporate partnerships with Glaxo Wellcome plc ("Glaxo Wellcome")
to develop a treatment for cystic fibrosis using the CFTR gene, Pfizer Inc
("Pfizer") to develop a treatment for solid tumors through angiogenesis
inhibition and Eli Lilly and Company ("Lilly") to develop treatments for breast
and ovarian cancer using the BRCA1 gene.

Gene-based therapy is an approach to the treatment or prevention of certain
diseases in which therapeutic genes are introduced into target cells to cause
the production of specific proteins needed to bring about a therapeutic effect.
To date, a limiting factor in gene-based therapy has been the lack of safe,
effective gene delivery systems. The Company's in vivo, non-viral gene delivery
systems are designed to avoid the significant limitations of ex vivo (whether
viral or non-viral) and in vivo, viral gene delivery. Furthermore, the Company
believes it has made progress in overcoming the limitations often associated
with in vivo, non-viral gene delivery approaches. The Company believes that its
proprietary, non-viral gene delivery systems may have the following benefits:
(i) therapeutically relevant gene expression; (ii) tissue-specific gene
delivery and expression; (iii) ease of handling and administration, stability
and scalable manufacturing methods and (iv) an improved safety profile. The
Company's portfolio of gene delivery systems is classified by series based on
the mode of administration and the cell type to which the gene-based
therapeutic is delivered, with each formulation within a series having distinct
specifications and potential applications. The Company intends to enter into
corporate partnerships using each of its gene delivery systems for multiple
potential applications.

Megabios' emphasis on entering into corporate partnerships is intended to
enable the Company to extend and leverage its technology platform, focus on
preclinical development of gene-based therapeutics and create a portfolio of
product development programs sponsored by its corporate partners. This strategy
limits the Company's exposure to capital-intensive activities such as large-
scale clinical trials, commercial manufacturing and sales and marketing, while
providing the opportunity to receive a substantial economic interest in the
products which it develops in conjunction with corporate partners, primarily
through the receipt of royalties on product sales. In addition, the Company
believes that creating a portfolio of product development programs will reduce
the Company's dependence on any particular product development program.

In April 1994, the Company entered into a corporate partnership with Glaxo
Wellcome to develop a gene-based therapeutic for the treatment of cystic
fibrosis. Cystic fibrosis is caused by a defect in the CFTR gene and is
believed to afflict approximately 55,000 patients in the United States and
Europe. The Company has conducted preclinical testing of a gene delivery system
in the MB100 Series as a carrier for the CFTR gene. These studies include
primate inhalation studies which have demonstrated expression of the human form
of the CFTR gene in the correct cell type and at levels believed to be
potentially therapeutic, with no evidence of inflammation, a common problem
associated with non-viral gene-based therapeutics. In June 1997, Glaxo Wellcome
commenced a Phase I/II clinical trial in cystic fibrosis patients using a gene
delivery system in the MB100 Series as a carrier for the CFTR gene.

In May 1996, the Company entered into a corporate partnership with Pfizer to
develop a gene-based therapeutic for the treatment of solid tumors using gene
delivery systems in the MB200 Series which are designed to deliver genes that
inhibit angiogenesis. Angiogenesis is the formation of new blood vessels needed
for solid tumors to survive and multiply. The initial disease targeted by this
corporate partnership is non-small cell lung cancer, which affects over 300,000
patients annually in the United States and Europe. Gene delivery systems in the
MB200 Series have been shown in animal models to achieve gene expression
selectively in the vascular endothelial cells of the lung and other tissues
following intravenous administration.

In May 1997, the Company entered into a corporate partnership with Lilly to
develop a gene-based therapeutic to treat breast and ovarian cancer using
BRCA1, a gene which has been identified as a putative tumor suppressor. There
are over 180,000 new cases of breast cancer and over 26,000 new cases of
ovarian cancer reported each year in the United States. When a tumor suppressor
gene, such as BRCA1, is missing or defective, a cell may begin to replicate
uncontrollably resulting in the formation of a tumor. Increased expression of
the BRCA1 gene in diseased tissue may inhibit or prevent the uncontrolled cell
growth associated with cancer, without causing any adverse effect in normal
cells. BRCA1 will be developed as a gene-based therapeutic initially using gene
delivery systems in the MB300 Series, which are administered via direct
injection, and gene delivery systems in the MB700 Series, which are
administered into the intraperitoneal cavity.

RISK FACTORS

The Common Stock offered hereby involves a high degree of risk. See "Risk
Factors."

THE OFFERING

Common Stock offered by the Company... 2,500,000 shares
Common Stock to be outstanding after
the offering......................... 12,225,939 shares(1)
Use of proceeds....................... For research and development activities,
leasehold improvements, the purchase of
capital equipment, working capital and
general corporate purposes.
Proposed Nasdaq National Market
symbol............................... MEGA

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(1) Based on 9,725,939 shares outstanding as of July 15, 1997. Excludes
(i) 476,189 shares of Common Stock issuable upon exercise of outstanding
stock options as of July 15, 1997 at a weighted average exercise price of
$1.22 per share, (ii) 84,008 shares of Common Stock issuable upon exercise
of warrants outstanding at July 15, 1997 at an exercise price of $3.88 per
share, (iii) an additional 781,699 shares of Common Stock reserved for
future grants pursuant to the Company's 1997 Equity Incentive Plan and (iv)
200,000 shares of Common Stock reserved for purchase pursuant to the
Company's 1997 Employee Stock Purchase Plan.

SUMMARY FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)

APRIL 23, 1992
(INCEPTION) TO YEAR ENDED JUNE 30,
JUNE 30, ----------------------------------
1993(1) 1994 1995 1996 1997
-------------- ------- ------- ------- -------

STATEMENTS OF OPERATIONS
DATA:
Collaborative research and
development revenue....... $ -- $ 500 $ 1,157 $ 1,890 $ 5,793
Operating expenses:
Research and development.. 593 1,922 4,691 6,487 8,598
General and
administrative........... 165 796 1,811 2,169 2,417
------ ------- ------- ------- -------
Total operating
expenses............... 758 2,718 6,502 8,656 11,015
------ ------- ------- ------- -------
Loss from operations....... (758) (2,218) (5,345) (6,766) (5,222)
Interest income (expense),
net....................... (20) 65 (84) (135) 275
------ ------- ------- ------- -------
Net loss................... $ (778) $(2,153) $(5,429) $(6,901) $(4,947)
====== ======= ======= ======= =======
Net loss per share(2)...... $(0.23) $ (0.60) $ (1.49) $ (1.81) $ (1.11)
====== ======= ======= ======= =======
Shares used in computing
net loss per share(2)..... 3,433 3,603 3,638 3,812 4,438
====== ======= ======= ======= =======
Pro forma net loss per
share(2).................. $ (0.50)
=======
Shares used in computing
pro forma net loss per
share(2).................. 9,926
=======

JUNE 30, 1997
------------------------
ACTUAL AS ADJUSTED(3)
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BALANCE SHEET DATA:
Cash, cash equivalents and short-term investments..... $ 24,269 $ 51,569
Working capital....................................... 21,629 48,929
Total assets.......................................... 29,978 57,278
Long-term debt........................................ 1,487 1,487
Accumulated deficit................................... (20,208) (20,208)
Total stockholders' equity............................ 25,223 52,523

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(1) The Company's financial data for fiscal 1992 and 1993 is not presented
separately as the Company's operations from April 23, 1992 to June 30, 1992
were immaterial.
(2) See Note 1 of Notes to Financial Statements for an explanation of the
computation of net loss and pro forma net loss per share.
(3) Adjusted to give effect to the receipt of the estimated net proceeds from
the sale of 2,500,000 shares of Common Stock offered by the Company hereby
at an assumed initial public offering price of $12.00 per share. See "Use
of Proceeds."

RISK FACTORS

An investment in the shares of Common Stock offered hereby involves a high
degree of risk. Accordingly, prospective investors should consider carefully
the following factors, together with the other information contained in this
Prospectus, in evaluating the Company and its business before purchasing the
shares of Common Stock offered hereby. This Prospectus contains forward-
looking statements that involve risk and uncertainty. Actual results and the
timing of certain events could differ materially from those projected in the
forward-looking statements as a result of the risk factors set forth below and
other factors discussed elsewhere in this Prospectus. See "Special Note
Regarding Forward-Looking Statements."

HISTORY OF OPERATING LOSSES; ACCUMULATED DEFICIT; UNCERTAINTY OF FUTURE
PROFITABILITY

Since its inception, the Company has been engaged in research and
development activities, has generated minimal revenues from operations and has
experienced significant operating losses. As of June 30, 1997, the Company had
an accumulated deficit of approximately $20.2 million. The process of
developing the Company's gene delivery systems will require significant
additional research and development, preclinical testing, clinical trials and
regulatory approvals. These activities, together with the Company's general
and administrative expenses, are expected to result in operating losses for
the foreseeable future. There can be no assurance that the Company will
generate revenues or achieve and sustain profitability in the future. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."

UNCERTAINTIES RELATED TO EARLY STAGE OF DEVELOPMENT

The Company is at an early stage of development and must be evaluated in
light of the uncertainties and complications present in an early stage
biotechnology company. Since the Company's inception in 1992, substantially
all of the Company's resources have been dedicated to the research and
development of gene delivery systems, and no revenues have been generated from
product sales. Because substantially all of the products under development by
the Company are in research or preclinical development, revenues from the sale
of any such products will not be realized for at least the next several years,
if at all. There can be no assurance that any of the Company's product
development efforts will be successfully completed, that any of the Company's
products will be proven to be safe and effective, that regulatory approvals
will be obtained at all or be as broad as sought, that the Company's products
will be capable of being produced in commercial quantities at reasonable cost
or that any products, if introduced, will achieve market acceptance.

DEPENDENCE ON CORPORATE PARTNERS; NEED FOR ADDITIONAL CORPORATE PARTNERSHIPS

The Company is highly dependent upon its separate corporate partnerships
with Glaxo Wellcome, Pfizer and Lilly. In connection with these corporate
partnerships, the Company has entered into agreements with Glaxo Wellcome (the
"Glaxo Wellcome Agreement"), Pfizer (the "Pfizer Agreement") and Lilly (the
"Lilly Agreement"). Under these agreements, each of Glaxo Wellcome, Pfizer and
Lilly were or are required to undertake certain collaborative activities with
the Company, fund research and development activities with the Company, make
certain payments to the Company upon achievement of related milestone events
and pay royalties to the Company if and when a product is commercialized by
its corporate partners. There can be no assurance that Glaxo Wellcome, Pfizer
or Lilly will devote sufficient resources to the Company's research programs
or product development efforts on a timely basis, and such resources could
vary and have varied due to factors unrelated to the Company's product
development efforts. If such corporate partners fail to conduct these
collaborative activities in a timely manner or at all, the preclinical or
clinical development or commercialization of the Company's gene delivery
systems will be delayed or terminated.

The Pfizer Agreement permits Pfizer to cancel the Company's research and
development program with Pfizer, for any reason, including reasons unrelated
to such program, after June 1998 upon six months prior notice. In order to
extend the program beyond June 1998, Pfizer is required prior to January 1998
to commit to purchase $10.0 million of the Company's Common Stock at a premium
to the then current market value, subject to certain adjustments. The Company
is uncertain whether Pfizer will exercise its option to extend the Pfizer
Agreement

and make the corresponding equity investment in the Company. Even if Pfizer
exercises its option, there can be no assurance that research funds or
milestone payments under the Pfizer Agreement will be received. The Lilly
Agreement permits Lilly to cancel the Company's research and development
program, for any reason, including reasons unrelated to such program, after
May 1999 upon three months prior notice. There can be no assurance that the
Lilly Agreement will be extended or that research funds or milestone payments
under the Lilly Agreement will be received. Megabios' research obligations and
Glaxo Wellcome's funding obligations under the Company's research program with
Glaxo Wellcome have been completed, and the Company will only receive future
payments, if any, under the Glaxo Wellcome Agreement through the achievement
of a certain milestone and the payment of royalties. There can be no assurance
that any of these corporate partnerships will result in successfully
commercialized products and the receipt by the Company of related royalty
revenues. Should the Company fail to receive research funds or should
milestones set forth in any or all of the Glaxo Wellcome Agreement, the Pfizer
Agreement or the Lilly Agreement not be achieved, or should Glaxo Wellcome,
Pfizer or Lilly breach or terminate their respective agreements, either prior
to scheduled termination or on a termination date, the Company's business,
financial condition and results of operations will be materially adversely
affected. See "Business--Corporate Partners."

The Company will need to enter into additional agreements with corporate
partners or otherwise raise substantial additional funds to conduct the
research and development, preclinical studies, clinical trials, manufacturing,
marketing and sales necessary to commercialize its gene delivery systems. The
Company expects that future revenues from corporate partnerships, if any, will
be dervied primarily from royalties on product sales. There can be no
assurance that the Company will be able to establish such additional corporate
partnerships on favorable terms, or at all, or that its current or future
corporate partnerships will be successful. In addition, there can be no
assurance that existing or future corporate partners will not pursue
alternative technologies or develop alternative products either on their own
or in collaboration with others, including the Company's competitors. There
also can be no assurance that disputes will not arise in the future with
respect to the ownership of rights to any technology developed with corporate
partners. Disagreements between corporate partners and the Company could lead
to delays or termination in the research, development or commercialization of
certain product candidates or result in litigation or arbitration, which would
be time consuming and expensive. Should any corporate partner fail to develop
or commercialize successfully any product to which it has obtained rights from
the Company, the Company's business, financial condition and results of
operations may be materially adversely affected. See "Business--Corporate
Partners."

UNCERTAINTY OF PRODUCT DEVELOPMENT AND GENE-BASED THERAPEUTICS

Before the Company or its corporate partners can obtain regulatory approval
for the commercial sale of any of its products, the Company or its corporate
partner must demonstrate, through preclinical studies and clinical trials,
that a potential product is safe and efficacious for use in each target
indication. There can be no assurance that the Company or its corporate
partners will be permitted to undertake clinical testing of the Company's
products, or, if permitted, that such products will receive other necessary
regulatory approvals. The Company or its corporate partners may also
experience delays in commencing clinical trials due to a variety of factors
including unfavorable or delayed preclinical study results, inability to
manufacture sufficient quantities of materials used for clinical trials,
delays or difficulties in patient enrollment, delays in regulatory approvals
and other factors. While the Company has demonstrated some evidence of the
utility of its gene delivery systems in preclinical animal studies, these
results do not predict safety or efficacy in humans, when, and if, clinical
trials are conducted. The Company's products may prove to have undesirable and
unintended side effects or other characteristics in preclinical development or
clinical trials that may prevent or limit their use. In addition, there can be
no assurance that any of the Company's products will ultimately obtain United
States Food and Drug Administration ("FDA") or other regulatory or foreign
marketing approval for any indication. See "Business--Corporate Partners" and
"--Government Regulation."

In addition to risks particular to the development of the Company's
products, the Company's products are also subject to risks particular to the
development of gene-based therapeutics. Gene-based therapy is a new and
rapidly evolving technology and is expected to undergo significant
technological changes in the future. While

many companies are seeking to identify therapeutic genes and understand their
function in the development and progression of various diseases, there is
limited clinical data available regarding the safety and efficacy of gene-
based therapeutics. The Company is not aware of any gene-based therapeutics
that have received marketing approval from the FDA or the regulatory bodies of
other countries. As a result of the limited data available or other factors,
clinical trials relating to gene-based therapeutics may take longer to
complete than clinical trials involving more traditional pharmaceuticals.
There can be no assurance that any gene-based therapeutics will be
demonstrated to be safe or effective or that the Company or its corporate
partners will be able to manufacture such gene-based therapeutics on a
commercial scale or in an economical manner.

UNCERTAINTY OF PATENT POSITION AND PROPRIETARY RIGHTS

The patent positions of biotechnology and pharmaceutical companies are often
uncertain and involve complex legal and factual questions, and the breadth of
claims allowed in biotechnology and pharmaceutical patents cannot be
predicted. In addition, there is a substantial backlog of biotechnology patent
applications at the U.S. Patent and Trademark Office (the "PTO") that may
delay the review and the potential issuance of patents. The Company's success
will depend to a significant degree on its ability to obtain patents and
licenses to patent rights, to maintain trade secrets and to operate without
infringing on the proprietary rights of others, both in the United States and
in other countries.

To date, the Company has filed a number of patent applications in the United
States and other countries and has participated as a licensee in the filing of
a number of patent applications in the United States and other countries. The
Company intends to continue to file applications as appropriate for patents
covering both its products and processes. There can be no assurance that
patents will issue from any of these applications, that any patent will issue
on technology arising from additional research or that patents that may issue
from such applications will be sufficient to protect the Company's technology.
Patent applications in the United States are maintained in secrecy until a
patent issues, and the Company cannot be certain that others have not filed
patent applications for technology covered by the Company's pending
applications or that the Company was the first to invent the technology that
is the subject of such patent applications. Competitors may have filed
applications for, or may have received patents and may obtain additional
patents and proprietary rights relating to, compounds, products or processes
that block or compete with those of the Company. The Company is aware of
patent applications filed and patents issued to third parties relating to gene
delivery technologies. The Company's development efforts are at an early
stage, however, and the Company currently is unable to verify that any such
patent applications or patents will have any effect on its products in
development. Should any of its competitors have filed patent applications in
the United States that claim technology also invented by the Company, the
Company may have to participate in interference proceedings declared by the
PTO in order to determine priority of invention and, thus, the right to a
patent for the technology in the United States, all of which could result in
substantial cost to the Company. In addition, litigation, which could result
in substantial cost to the Company, may be necessary to enforce any patents
issued to the Company or to determine the scope and validity of the
proprietary rights of third parties. There can be no assurance that any
patents issued to the Company or to licensors from whom the Company has
licensed rights will not be challenged, invalidated or circumvented, or that
the rights granted thereunder will provide proprietary protection or
commercial advantage to the Company.

The commercial success of the Company depends significantly on its ability
to operate without infringing upon the patents and other proprietary rights of
third parties. There can be no assurance that the Company's technologies do
not and will not infringe upon the patents or other proprietary rights of
third parties. In the event of such infringement, the Company and its
corporate partners may be enjoined from pursuing research, development or
commercialization of their products or may be required to obtain licenses to
these patents or other proprietary rights or to develop or obtain alternative
technologies. There can be no assurance that the Company or its corporate
partners will be able to obtain alternative technologies or any required
license on commercially reasonable terms, if at all. If such licenses or
alternative technologies are not obtained, the Company may be delayed or
prevented from pursuing the development of certain of its potential products
which could have a material adverse effect on the Company's business,
financial condition and results of operations.

The Company also relies on proprietary information and trade secrets,
including its proprietary database of preclinical in vivo experiments, to
develop and maintain its competitive position. There can be no assurance that
third parties will not independently develop equivalent proprietary
information or techniques, will not gain access to the Company's trade secrets
or disclose such technology to the public, or that the Company can maintain
and protect unpatented proprietary technology. The Company typically requires
its employees, consultants, collaborators, advisors and corporate partners to
execute confidentiality agreements upon commencement of employment or other
relationships with the Company. There can be no assurance, however, that these
agreements will provide meaningful protection or adequate remedies for the
Company's technology in the event of unauthorized use or disclosure of such
information, that the parties to such agreements will not breach such
agreements or that the Company's trade secrets will not otherwise become known
or be discovered independently by its competitors. See "Business--Patents and
Proprietary Technology."

NEED TO OBTAIN RIGHTS TO PROPRIETARY GENES AND TECHNOLOGY

A number of the gene sequences that the Company and its corporate partners
are investigating or may use in its products are or may become patented by
others. As a result, the Company or its corporate partners may be required to
obtain licenses to such gene sequences or other technology in order to use or
market such products. In addition, some of the products based on the Company's
gene delivery systems may require the use of multiple proprietary
technologies. Consequently, the Company or its corporate partners may be
required to make cumulative royalty payments to several third parties. Such
cumulative royalties could reduce amounts paid to the Company or be
commercially prohibitive. In connection with the Company's efforts to obtain
rights to such gene sequences or other proprietary technology, the Company may
find it necessary to convey rights to its technology to others. There can be
no assurance that the Company or its corporate partners will be able to obtain
any required licenses on commercially reasonable terms or at all. Failure by
the Company or a corporate partner to obtain a license to any technology
required to commercialize its products could have a material adverse effect on
the Company's business, financial condition and results of operations. See
"Business--Patents and Proprietary Technology."

NEED FOR ADDITIONAL FUTURE CAPITAL; UNCERTAINTY OF ADDITIONAL FUNDING

The Company will require additional funding after this offering in order to
continue its research and development activities. The Company has financed its
operations primarily through the sale of equity securities and through
corporate partnerships. The Company has generated no royalty revenues from
product sales, and no such revenues are expected for the foreseeable future,
if ever. The Company anticipates that its existing resources, including the
net proceeds of this offering, committed funding from existing corporate
partnerships and projected interest income, will enable the Company to
maintain its current and planned operations through fiscal 1999. However,
there can be no assurance that the Company will not require additional funding
prior to such time. The Company's future capital requirements will depend on
many factors, including scientific progress in its research and development
programs, the size and complexity of such programs, the scope and results of
preclinical studies and clinical trials, the ability of the Company to
establish and maintain corporate partnerships, the time and costs involved in
obtaining regulatory approvals, the time and costs involved in filing,
prosecuting and enforcing patent claims, competing technological and market
developments, the cost of manufacturing preclinical and clinical material and
other factors not within the Company's control. There can be no assurance that
such additional financing to meet the Company's funding requirements will be
available on acceptable terms or at all. If additional funds are raised by
issuing equity securities, substantial dilution to existing stockholders may
result. Insufficient funds may require the Company to delay, scale back or
eliminate some or all of its research or development programs or to relinquish
greater or all rights to products at an earlier stage of development or on
less favorable terms than the Company would otherwise seek to obtain. See "Use
of Proceeds" and "Management's Discussion and Analysis of Financial Condition
and Results of Operations."

SIGNIFICANT GOVERNMENT REGULATION; NO ASSURANCE OF REGULATORY APPROVAL

The production and marketing of the Company's products and its ongoing
research and development activities are subject to extensive regulation by
governmental authorities in the United States and other countries.

The Company believes that the commercial uses of its products will be
regulated as biologics by the FDA and comparable regulatory bodies of other
countries. Gene-based therapy is, however, a relatively new technology, and
the regulatory requirements governing gene-based therapeutics are uncertain.
This uncertainty may result in excessive costs or extensive delays in the
regulatory approval process, adding to the already lengthy review process for
human therapeutic products in general. The Company is not aware of any gene-
based therapeutics that have received marketing approval from the FDA or any
comparable regulatory body of other countries. The regulation of the Company's
products and its ongoing research is subject to change, and future legislative
or administrative acts in the United States or other countries could have a
material adverse effect on the Company's business, financial condition and
results of operations. Regulatory requirements ultimately imposed could
adversely affect the ability of the Company's corporate partners to clinically
test, manufacture or market products, and could significantly delay or reduce
the milestone or royalty payments payable to the Company.

Currently, the Company is conducting preclinical studies and a corporate
partner is conducting a clinical trial of one of the Company's gene delivery
systems. Prior to marketing in the United States, any drug, including any
biological product, developed by the Company or its corporate partners must
undergo rigorous preclinical studies, clinical trials and an extensive
regulatory approval process implemented by the FDA under the federal Food,
Drug and Cosmetic Act and, for biologics, the Public Health Service Act.
Satisfaction of such regulatory requirements, which includes satisfying the
FDA that the product is both safe and efficacious, typically takes several
years or more depending on the type, complexity and novelty of the product,
and requires a substantial commitment of resources. In addition, academic
institutions and companies conducting research in the gene-based therapy field
are using a variety of approaches and technologies. Any adverse results
generated by such academic institutions or companies in preclinical studies or
clinical trials could adversely affect the regulatory environment for gene-
based therapeutics generally, possibly leading to delays in the approval
process for the Company's products or preventing approval altogether.
Preclinical studies must be conducted in conformance with the FDA's Good
Laboratory Practice regulations. Before clinical trials may be commenced, an
Investigational New Drug Application ("IND") for each planned trial must be
filed with and cleared by the FDA. There can be no assurance that submission
of an IND will result in regulatory authorization to commence clinical trials.
The sponsors of any clinical trials of the Company's products will be
responsible for initiating and overseeing the clinical trials to demonstrate
the safety and efficacy that are necessary to obtain FDA marketing approval of
such products.

Clinical trials must meet FDA regulatory requirements for Institutional
Review Board ("IRB") oversight, informed consent and Good Clinical Practices.
The Company has limited experience in conducting preclinical studies and
clinical trials. The Company will rely primarily on its corporate partners to
conduct the clinical trials necessary to obtain regulatory approval, but it
may conduct initial clinical trials to attract corporate partners. There can
be no assurance that those clinical trials can be conducted at preferred
sites, sufficient test subjects can be recruited or clinical trials will be
started or completed successfully in a timely manner, or at all. Furthermore,
the FDA may suspend clinical trials at any time if it believes the subjects
participating in such trials are being exposed to unacceptable health risks or
if it finds deficiencies in the IND or the conduct of the trial. There can be
no assurance that the Company or its corporate partners will not encounter
problems in clinical trials that cause the Company or its corporate partners
or the FDA to delay, suspend or terminate such trials.

Manufacturing facilities in the United States are subject to periodic
inspection by the FDA and state authorities, and must comply with the FDA's
Good Manufacturing Practice ("GMP") regulations. Manufacturers of biologics
also must comply with the FDA's general biological product standards and also
may be subject to state regulation. Failure to comply with GMP or other
applicable regulatory requirements may result in withdrawal of marketing
approval, criminal prosecution, civil penalties, recall or seizure of
products, warning letters, total or partial suspension of production, FDA
refusal to review pending marketing approval applications or supplements to
approved applications, or injunctions, as well as other legal or regulatory
action against the Company or its corporate partners.

There can be no assurance that any product developed by the Company and its
corporate partners will prove safe and effective in clinical trials or will
meet all the applicable regulatory requirements necessary to receive

marketing approval from the FDA or any appropriate regulatory body in other
countries. Data obtained from preclinical studies and clinical trials are
susceptible to varying interpretations that could delay, limit or prevent
regulatory approvals. If regulatory approval is granted for a product, such
approval will be limited to only those disease states and conditions for which
the product is safe and effective, as demonstrated through clinical trials.
Furthermore, approval may require ongoing post-marketing studies. After a
product is approved for marketing, the product, its manufacturer and its
manufacturing facilities are subject to continued regulatory review oversight
and periodic FDA inspections. Discovery of previously unknown problems with a
product, manufacturer or facility may result in penalties such as restrictions
on such product, manufacturer or facility, including withdrawal of the product
from the market.

In order to market its products outside of the United States, the Company
and its corporate partners must also comply with numerous and varying
regulatory requirements of other countries implemented by authorities of such
other countries governing the design and conduct of clinical trials and
marketing approval. The approval procedures vary among countries and can
involve additional testing. The time required to obtain approval in other
countries may differ from that required to obtain FDA approval. The regulatory
approval process in other countries includes all of the risks associated with
obtaining FDA approval set forth above, and approval by the FDA does not
ensure approval by the regulatory authorities of any other country. See
"Business--Government Regulation."

INTENSE COMPETITION

The pharmaceutical and biotechnology industries are highly competitive. The
Company is aware of several pharmaceutical and biotechnology companies which
are exploring the field of gene-based therapy, are actively engaged in
research and development in areas related to gene-based therapy, or have
commenced clinical trials of gene-based therapeutics. Many of these companies
are addressing diseases which have been targeted by the Company or its
corporate partners. Megabios also may experience competition from companies
that have acquired or may acquire gene-based technology from universities and
other research institutions. As competitors develop their technologies, they
may develop proprietary positions in certain aspects of gene delivery and
gene-based therapeutics that may have a material adverse effect on the
Company's business, financial condition or results of operation. The Company
faces and will continue to face intense competition from other companies for
corporate partnerships with pharmaceutical and biotechnology companies, for
establishing relationships with academic and research institutions, and for
licenses to proprietary technology, including intellectual property related to
gene delivery systems. Corporate partners may also elect to internally develop
gene-based therapeutics which compete with the Company's products. In
addition, many other companies are developing non-gene-based therapies to
treat these same diseases.

Most of the Company's competitors and potential competitors have
substantially greater product development capabilities and financial,
scientific, manufacturing, managerial and human resources than the Company.
There can be no assurance that research and development by others will not
render the Company's delivery systems or the products developed by corporate
partners using the Company's delivery systems obsolete or non-competitive or
that any product developed by the Company or its corporate partners will be
preferred to any existing or newly developed technologies. In addition, there
can be no assurance that the Company's competitors will not develop safer,
more effective or less costly gene delivery systems, gene-based therapeutics
or non-gene-based therapies, achieve superior patent protection or obtain
regulatory approval or product commercialization earlier than the Company, any
of which could have a material adverse effect on the Company's business,
financial condition or results of operations. See "Business--Competition."

DEPENDENCE ON KEY PERSONNEL; NEED TO ATTRACT AND RETAIN KEY EMPLOYEES AND
CONSULTANTS

The Company is highly dependent on its executive officers and scientific
staff. In addition, the Company relies on consultants and advisors to assist
the Company in formulating its research and development strategy. The loss of
any of these persons could have a material adverse effect on the Company's
corporate partnerships, business, financial condition and results of
operations. The Company does not maintain key man life insurance on any of
such individuals.

In order to pursue its research and product development plans, the Company
is and will be required to attract and retain additional qualified scientific
and other personnel. There can be no assurance that the Company will be
successful in attracting and retaining these skilled persons who generally are
in high demand by pharmaceutical and biotechnology companies and by
universities and other research institutions. The failure to successfully
attract and retain qualified personnel, consultants and advisors may impede
the achievement of the Company's objectives and have a material adverse effect
on the Company's business, financial condition and results of operations. See
"Business--Scientific Advisory Board" and "Management."

LIMITED MANUFACTURING EXPERIENCE

The Company has limited experience in manufacturing and currently lacks the
resources or capability to manufacture any of its products on a commercial
scale. While the Company has a pilot manufacturing facility, successful large-
scale manufacturing of the Company's gene delivery systems or its products has
not been demonstrated by the Company or any third parties. The Company will be
dependent initially on corporate partners, licensees or other third parties
for commercial-scale manufacturing of its products. Successful large-scale
manufacturing of gene-based therapeutics has not been demonstrated by any
third parties. There can be no assurance that the Company will be able to
reach satisfactory agreements with its corporate partners, licensees or other
third parties or that these parties will be able to develop adequate
manufacturing capabilities for commercial-scale quantities of gene-based
therapeutic products. See "Business--Manufacturing and Commercialization."

UNCERTAINTY OF COMMERCIAL ACCEPTANCE

The Company's success is dependent on commercial acceptance of its products.
The Company believes that recommendations by physicians and health care payors
will be essential for commercial acceptance of its products. Concerns have
arisen regarding the potential safety and efficacy of gene-based therapeutics
using viral delivery systems. While the Company's gene delivery systems are
lipid-based and do not contain viruses, there can be no assurance that
physicians' and health care payors' evaluations of the Company's products will
not be unfavorably effected by concerns over viral gene-based therapies or
that they will conclude that the Company's products or technology are safe and
effective. There can be no assurance that products developed by the Company
and its corporate partners will achieve commercial acceptance among patients,
physicians or third-party payors. Failure to achieve commercial acceptance
would have a material adverse effect on the Company's business, financial
condition and results of operations.

UNCERTAINTY OF PRODUCT PRICING AND REIMBURSEMENT

The ability of Megabios' corporate partners to manufacture and sell its
products successfully will depend in part on the extent to which reimbursement
for the cost of such products and related treatments will be available from
government health administration authorities, private health insurers and
other organizations. Third-party payors are increasingly challenging the price
of medical products and services. Significant uncertainty exists as to the
reimbursement status of newly-approved health care products, and if the
Company and its corporate partners succeed in bringing any products to market,
there can be no assurance that these products will be considered cost
effective, that reimbursement will be available, or if available, that the
payors' reimbursement policies will not adversely affect the corporate
partner's ability to sell such products on a profitable basis, and thus the
Company's ability to derive revenue through royalties on sales of such
products.

PRODUCT LIABILITY EXPOSURE; AVAILABILITY OF INSURANCE

The manufacture and sale of therapeutic products involve an inherent risk of
product liability claims and associated adverse publicity. The Company
currently has only limited product liability insurance. The policy provides
for $5.0 million of coverage with a deductible of $2,500 per person and
$25,000 in the aggregate. There can be no assurance that the Company will be
able to maintain existing or obtain additional product liability insurance on
acceptable terms, if at all, or that it will provide adequate coverage against
potential liabilities. An

inability to obtain sufficient insurance coverage on reasonable terms or to
otherwise protect against potential product liability claims could prevent or
inhibit the commercialization of the Company's products. A successful product
liability claim brought against the Company in excess of its insurance
coverage, if any, could have a material adverse effect on the Company's
business, financial condition and results of operations. See "Business--
Product Liability Insurance."

HAZARDOUS AND RADIOACTIVE MATERIALS; ENVIRONMENTAL MATTERS

The Company's research and development processes involve the controlled use
of hazardous materials, chemicals and radioactive materials and produce waste
products. The Company is subject to federal, state and local laws and
regulations governing the use, manufacture, storage, handling and disposal of
such materials and waste products. There can be no assurance that
contamination or injury from these materials will not occur. In such event,
the Company could be held liable for any damages that result and any such
liability could exceed the resources of the Company. There can be no assurance
that the Company will not be required to incur significant costs to comply
with environmental laws and regulations, or that the Company's business,
financial condition or results of operations will not be materially adversely
affected by current or future environmental laws or regulations. See
"Business--Government Regulation."

ABSENCE OF PRIOR PUBLIC MARKET; VOLATILITY OF STOCK PRICE

Prior to this offering there has been no public market for the Common Stock,
and there can be no assurance that an active market will develop or be
maintained. The initial public offering price will be negotiated between the
Company and the representatives of the Underwriters and may not be indicative
of future market prices. See "Underwriting" for information related to the
method of determining the initial public offering price. The market price of
the shares of Common Stock, like that of the common stock of many other
biotechnology companies, is likely to be highly volatile. Factors such as the
Company's operating results, developments in the Company's relationships with
corporate partners, developments affecting the Company's corporate partners,
announcements of results of preclinical studies and clinical trials by the
Company, its corporate partners, its competitors or their products, regulatory
action or regulatory approval with respect to the Company, its corporate
partners, its competitors or their products, announcements of new products by
the Company or its competitors, developments related to patent or other
proprietary rights by the Company or its competitors, changes in the
recommendation of securities analysts with respect to the Common Stock, and
market conditions for biotechnology stocks in general may cause the market
price of the Common Stock to fluctuate, perhaps substantially. The Company
expects that operating results will fluctuate from quarter to quarter and that
such fluctuations may be substantial. In addition, in recent years the stock
market in general, and the shares of biotechnology and healthcare companies in
particular, have experienced extreme price fluctuations. These broad market
and industry fluctuations may have a material adverse effect on the market
price of the Common Stock. In the future, the Company's operating results may
be below the expectations of public market analysts and investors, and, as a
result, the price of the Common Stock would likely be materially adversely
affected.

CONTROL BY EXISTING STOCKHOLDERS; ANTI-TAKEOVER EFFECTS OF CERTAIN CHARTER
PROVISIONS AND DELAWARE LAW

After this offering, the Company's named executive officers, directors and
principal stockholders will beneficially own approximately 5,504,254 or 44.5%
of the outstanding shares of Common Stock (43.2% if the underwriters'
overallotment option is exercised in full). As a result, such persons may have
the ability to effectively control the Company and direct its affairs and
business. Such concentration of ownership may also have the effect of
delaying, deferring or preventing a change in control of the Company. In
addition, the Company's Board of Directors will have the authority to issue up
to 10,000,000 shares of Preferred Stock and to determine the price, rights,
preferences and privileges of those shares without any further vote or action
by the stockholders. The rights of the holders of Common Stock will be subject
to, and may be materially adversely affected by, the rights of the holders of
any Preferred Stock that may be issued in the future. The issuance of
Preferred Stock could have the effect of making it more difficult for a third
party to acquire a majority of the outstanding voting stock of the Company.
Furthermore, certain provisions of the Company's Restated Certificate

of Incorporation, including the provision for a staggered Board of Directors,
may have the effect of delaying or preventing changes in control or management
of the Company, which could adversely affect the market price of the Company's
Common Stock. In addition, the Company will be subject to the provisions of
Section 203 of the Delaware General Corporation Law (the "Delaware Law"), an
anti-takeover law. See "Principal Stockholders" and "Description of Capital
Stock."

SHARES ELIGIBLE FOR FUTURE SALE; REGISTRATION RIGHTS

Sales of a substantial number of shares of Common Stock in the public market
following this offering could adversely affect the market price for the
Company's Common Stock. The number of shares of Common Stock available for
sale in the public market is limited by restrictions under the Securities Act
of 1933, as amended (the "Securities Act"), and lock-up agreements pursuant to
which all directors and executive officers and certain other stockholders of
the Company have agreed not to sell or otherwise dispose of any of their
shares without the prior written consent of the Company or Montgomery
Securities. However, Montgomery Securities or the Company, as applicable, may
at any time without notice, release all or any portion of the securities
subject to lock-up agreements. The Company has agreed with Montgomery
Securities not to release any stockholder from such lock-up agreement between
the stockholder and the Company without the consent of Montgomery Securities.
As a result of such restrictions and based upon the number of shares
outstanding on July 15, 1997, on the date of this Prospectus approximately
22,645 shares, other than the 2,500,000 shares offered hereby, will be
eligible for sale pursuant to subsection (k) of Rule 144 promulgated under the
Securities Act. An additional 8,045,052 shares and 96,709 shares issuable upon
exercise of outstanding vested options will be eligible for sale 180 days
after the date of this Prospectus upon expiration of the lock-up agreements
and in compliance with certain limitations set forth in the Securities Act. An
additional 1,385,706 shares held by existing stockholders will become eligible
for sale at various times over a period of less than one year. The remaining
272,536 shares currently held by existing stockholders will be subject to
rights of repurchase in favor of the Company that expire at various dates
through May 2001 pursuant to monthly vesting. After this offering, the holders
of approximately 8,154,779 shares of Common Stock will be entitled to certain
demand and piggyback registration rights with respect to registration of such
shares under the Securities Act. If such holders, by exercising their demand
or piggyback registration rights, cause a large number of securities to be
registered and sold in the public market, such sales could have an adverse
effect on the market price for the Company's Common Stock. If the Company were
to include in a Company-initiated registration shares held by such holders
pursuant to the exercise of their piggyback registration rights, such sales
may have an adverse effect on the Company's ability to raise needed capital.
See "Shares Eligible For Future Sale" and "Description of Capital Stock--
Registration Rights."

DILUTION; ABSENCE OF DIVIDENDS

The initial public offering price will be substantially higher than the book
value per share of Common Stock. Assuming an initial public offering price of
$12.00 per share, investors purchasing shares of Common Stock in this offering
will incur immediate, substantial dilution of $7.70 per share in the net
tangible book value of Common Stock. Additional dilution will occur upon the
exercise of outstanding options and warrants. See "Dilution." The Company has
never declared or paid any cash dividends and does not anticipate paying cash
dividends in the foreseeable future. See "Dividend Policy."

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

Certain statements contained in this Prospectus, including without
limitation, statements containing the words "believes," "anticipates,"
"expects" and words of similar import, constitute "forward-looking
statements." Such forward-looking statements involve known and unknown risks,
uncertainties and other factors which may cause the actual results,
performance or achievements of Megabios, or industry results, to be materially
different from any future results, performance or achievements expressed or
implied by such forward-looking statements. Such factors include, among
others: the early stage of development of the Company and its products;
dependence on corporate partnerships and need for additional corporate
partnerships; uncertainty of product development and gene-based therapeutics;
dependence on proprietary technology and uncertainty of patent protection;
existing government regulation and changes in, or the failure to comply with,
government regulation; intense competition; history of operating losses; the
Company's need for additional financing; dependence on key personnel; limited
manufacturing experience; uncertainty of commercial acceptance of its products
and other factors referenced in this Prospectus. Certain of these factors are
discussed in more detail elsewhere in this Prospectus, including, without
limitation, under the captions "Prospectus Summary," "Risk Factors,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Business." Given these uncertainties, prospective investors
are cautioned not to place undue reliance on such forward-looking statements.
Megabios disclaims any obligation to update any such factors or to publicly
announce the result of any revisions to any of the forward-looking statements
contained herein to reflect future events or developments.

USE OF PROCEEDS

The net proceeds to the Company from the sale of the shares of Common Stock
offered hereby are estimated to be $27,300,000 ($31,485,000 if the over-
allotment option is exercised in full) at an assumed initial public offering
price of $12.00 per share after deducting underwriting discounts and estimated
offering expenses payable by the Company.

The Company intends to use approximately $15.0 million of the net proceeds
of the offering to fund research and development activities, including the
development of existing and future gene delivery systems. Approximately $4.0
million of the net proceeds will be used for leasehold improvements to the
Company's facilities and approximately $4.0 million of the net proceeds will
be used for the purchase of certain capital equipment to be used primarily in
the Company's pilot manufacturing facility. The balance of the net proceeds of
the offering are expected to be used for working capital and general corporate
purposes. These corporate purposes may include the purchase of technology
assets and licenses. The Company has no present understandings, commitments or
arrangements with respect to the purchase of any technology assets or
licenses, and the amount and timing of these expenditures will depend on
numerous factors, including the progress of the Company's research programs
and its ability to attract additional corporate partners. Pending application
of the net proceeds of the offering as described above, the Company intends to
invest such proceeds in short-term, investment-grade, interest-bearing
financial instruments.

DIVIDEND POLICY

The Company has never declared or paid any cash dividends on its capital
stock. The Company currently intends to retain any future earnings to finance
the growth and development of its business and therefore does not anticipate
paying any cash dividends in the foreseeable future. The Company's term loan
with a commercial bank, which expires in August 1998, prohibits the payment of
dividends.

CAPITALIZATION

The following table sets forth as of June 30, 1997, (i) the pro forma
capitalization of the Company giving effect to the conversion of all
outstanding shares of Preferred Stock into Common Stock and the
reincorporation of the Company into Delaware and (ii) the pro forma
capitalization as adjusted to give effect to the receipt by the Company of the
estimated net proceeds from the sale of the shares of Common Stock offered
hereby at an assumed initial public offering price of $12.00 per share, after
deducting the underwriting discounts and estimated offering expenses payable
by the Company. This table should be read in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the Financial Statements and Notes thereto included elsewhere in this
Prospectus.

JUNE 30, 1997
----------------------
PRO FORMA AS ADJUSTED
--------- -----------
(IN THOUSANDS)

Current portion of long-term debt........................ $ 1,233 $ 1,233
Long-term debt........................................... 1,487 1,487
Stockholders' equity(1):
Preferred stock, $.001 par value; 10,000,000 shares
authorized; no shares issued and outstanding, pro forma
and as adjusted........................................ -- --
Common stock, $.001 par value; 30,000,000 shares
authorized; 9,722,506 shares issued and outstanding,
pro forma; 12,222,506 shares issued and outstanding, as
adjusted, at amounts paid-in........................... 46,110 73,410
Deferred compensation, net of amortization............... (679) (679)
Accumulated deficit...................................... (20,208) (20,208)
-------- --------
Total stockholders' equity............................ 25,223 52,523
-------- --------
Total capitalization................................. $ 27,943 $ 55,243
======== ========

- --------
(1) Based on 9,722,506 shares outstanding as of June 30, 1997. Excludes (i)
479,622 shares of Common Stock issuable upon exercise of outstanding stock
options as of June 30, 1997 at a weighted average exercise price of $1.22
per share, (ii) 84,008 shares of Common Stock issuable upon exercise of
warrants outstanding at June 30, 1997 at an exercise price of $3.88 per
share, (iii) an additional 781,699 shares of Common Stock reserved for
future grants pursuant to the Company's 1997 Equity Incentive Plan and
(iv) 200,000 shares of Common Stock reserved for purchase pursuant to the
Company's 1997 Employee Stock Purchase Plan.

DILUTION

The pro forma net tangible book value of the Company as of June 30, 1997 was
approximately $25.2 million, or $2.59 per share of Common Stock. Pro forma net
tangible book value per share is determined by dividing the net tangible book
value (tangible assets less total liabilities) of the Company by the number of
shares of Common Stock outstanding at that date, including shares of Common
Stock from the conversion of the Preferred Stock immediately prior to the
consummation of the Offering. Without taking into account any other changes in
the net tangible book value after June 30, 1997, other than to give effect to
the receipt by the Company of the estimated net proceeds from the sale of
2,500,000 shares of Common Stock offered by the Company hereby at an assumed
initial public offering price of $12.00 per share, the pro forma net tangible
book value of the Company as of June 30, 1997, would have been $52.5 million,
or $4.30 per share. This represents an immediate increase in the pro forma net
tangible book value of $1.71 per share to existing stockholders and an
immediate dilution of $7.70 per share to new public investors. The following
table illustrates this per share dilution:

Assumed initial public offering price........................... $12.00
Pro forma net tangible book value before offering.............. $2.59
Increase attributable to new public investors(1)............... 1.71
-----
Pro forma net tangible book value after offering................ 4.30
------
Dilution to new public investors................................ $ 7.70
======

The following table summarizes, on a pro forma basis, as of June 30, 1997,
the difference between existing stockholders and purchasers of shares in the
offering (at an assumed initial public offering price of $12.00 per share and
before deducting underwriting discounts and estimated offering expenses
payable by the Company) with respect to the number of shares of Common Stock
purchased from the Company, the total consideration paid and the average price
per share paid:

SHARES PURCHASED(1) TOTAL CONSIDERATION AVERAGE
------------------------------------------ PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
------------ --------------------- ------- ---------

Existing stockholders.. 9,722,506 79.5% $45,534,000 60.3% $4.68
New public investors... 2,500,000 20.5 30,000,000 39.7 12.00
------------ ------- ----------- -----
Total................ 12,222,506 100.0% $75,534,000 100.0%
============ ======= =========== =====

- --------
(1) The foregoing computations exclude (i) 479,622 shares of Common Stock
issuable upon exercise of stock options outstanding as of June 30, 1997,
at a weighted average exercise price of $1.22 per share, (ii) 84,008
shares of Common Stock issuable upon exercise of warrants outstanding at
June 30, 1997, at an exercise price of $3.88 per share, (iii) an
additional 781,699 shares of Common Stock reserved for future grants
pursuant to the Company's 1997 Equity Incentive Plan and (iv) 200,000
shares of Common Stock reserved for purchase pursuant to the Company's
1997 Employee Stock Purchase Plan. To the extent that options or warrants
are exercised and shares of Common Stock are issued, there will be further
dilution to new investors. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Liquidity and Capital
Resources," "Management--Stock Plans" and "Description of Capital Stock."

SELECTED FINANCIAL DATA

The selected financial data presented below for the years ended June 30,
1995, 1996 and 1997 and the balance sheet data as of June 30, 1996 and 1997
are derived from the financial statements of the Company included elsewhere in
this Prospectus which have been audited by Ernst & Young LLP, independent
auditors. The Statements of Operations Data for the period from April 23, 1992
(Inception) to June 30, 1993 and for the year ended June 30, 1994 and the
balance sheet data as of June 30, 1993, 1994 and 1995 are derived from
financial statements audited by Ernst & Young LLP not included in this
Prospectus. The data should be read in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the Financial Statements and the Notes thereto included elsewhere in this
Prospectus. The Company has not paid any cash dividends.

APRIL 23,
1992
(INCEPTION) TO YEAR ENDED JUNE 30,
JUNE 30, ----------------------------------
1993(1) 1994 1995 1996 1997
-------------- ------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)

JUNE 30,
-------------------------------------------
1993 1994 1995 1996 1997
----- ------- ------- -------- --------
(IN THOUSANDS)

BALANCE SHEET DATA:
Cash, cash equivalents and short-
term investments(3)............. $ 374 $ 1,886 $ 282 $ 5,253 $ 24,269
Working capital(3)............... (702) 758 (873) 3,568 21,629
Total assets(3).................. 430 4,344 4,969 9,956 29,978
Long-term debt................... -- 412 1,305 1,894 1,487
Accumulated deficit.............. (778) (2,931) (8,360) (15,261) (20,208)
Total stockholders' equity(3).... (701) 2,436 2,219 6,086 25,223

(3) The increase from June 30, 1996 to June 30, 1997 reflects the receipt of
approximately $24.0 million in net proceeds from the issuance of Series E
and Series F Preferred Stock in fiscal 1997.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS

The discussion below contains certain forward-looking statements that are
based on the beliefs of the Company's management, as well as assumptions made
by, and information currently available to, the Company's management. The
Company's future results, performance or achievements could differ materially
from those expressed in, or implied by, any such forward-looking statements.
See "Risk Factors" for a discussion of factors that could cause or contribute
to such material differences. The following presentation of Management's
Discussion and Analysis of Financial Condition and Results of Operations
should be read in conjunction with the Company's Financial Statements and
Notes thereto and other financial information included therein.

OVERVIEW

Megabios, incorporated in 1992, develops proprietary gene delivery systems
and provides preclinical development expertise to create gene-based
therapeutics designed for the treatment or prevention of genetic and acquired
diseases. The Company has developed several in vivo, non-viral gene delivery
systems to address a number of potential therapeutic applications using a
variety of therapeutic genes. The Company's clinical development and
commercialization strategy is to enter into corporate partnerships with
pharmaceutical and biotechnology companies. The Company has established
corporate partnerships with Glaxo Wellcome, Pfizer and Lilly. To date,
substantially all revenue has been generated by collaborative research and
development revenue from corporate partners, and no revenue has been generated
from product sales. Under its corporate partnerships the Company receives
research and development funding on a quarterly basis in advance of payment of
associated research and development costs. The Company expects that future
revenue will be derived in the short-term from research and development
revenue and milestone payments and in the long-term from royalties on product
sales.

A substantial portion of the Company's revenues to date have been from
payments under the Glaxo Wellcome Agreement and Pfizer Agreement, totaling
approximately $4.8 million and $3.6 million, respectively, through June 30,
1997.

In April 1994, the Company entered into a corporate partnership with Glaxo
Wellcome to develop a gene-based therapeutic for the treatment of cystic
fibrosis. The terms of the Glaxo Wellcome Agreement provide Glaxo Wellcome
with the exclusive rights to manufacture, market and sell gene-based
therapeutics incorporating the Company's gene delivery systems for the
treatment of cystic fibrosis. In addition to having received $5.0 million in
research funding, the Company is entitled to receive a milestone payment from
Glaxo Wellcome upon the commencement of a Phase III clinical trial, a portion
of which will be credited against future royalties, as well as royalties on
the sale of products resulting from the corporate partnership, if any. The
research and development funding portion of the Glaxo Wellcome Agreement
terminated in April 1997. The Company has completed all of its obligations
under the Glaxo Wellcome Agreement and will receive future payments, if any,
under the Glaxo Wellcome Agreement only through the achievement of a certain
milestone and the payment of royalties. See "Business--Corporate Partners."

In May 1996 the Company entered into a corporate partnership with Pfizer to
develop a gene-based therapeutic for the treatment of solid tumors. Under the
Pfizer Agreement, the Company is responsible for performing research and
preclinical development activities for a period of up to four years. The
Pfizer Agreement provides that Pfizer receive the exclusive rights to develop,
make, use and sell gene-based therapeutics resulting from the corporate
partnership. The Company will be entitled to receive up to $16.4 million in
research and development funding if the agreement continues for four years, as
well as up to $20.0 million in payments upon the achievement of certain
clinical milestones, which milestone payments will be credited against future
royalties, if any. In addition, if a product receives marketing approval from
the FDA or an equivalent agency in another country, the Company is entitled to
receive royalties on sales of products resulting from the corporate
partnership. The Pfizer Agreement permits Pfizer to terminate the program for
any reason after June 1998 upon six months of prior notice. If Pfizer elects
to extend the research term beyond two years, it will be required, prior to
January 1998, to commit to purchase within 60 days $10.0 million of the
Company's Common Stock at a premium to the then current market value, subject
to certain adjustments. See "Business--Corporate Partners."

In May 1997, the Company entered into a corporate partnership with Lilly to
develop a gene-based therapeutic using BRCA1. Under the Lilly Agreement, the
Company is responsible for performing research and preclinical development
activities for a period of up to four years. The Lilly Agreement provides that
Lilly receive the exclusive rights to develop, make, use and sell gene-based
therapeutics using BRCA1 resulting from the corporate partnership. The Company
will be entitled to receive at least $7.0 million in research and development
funding during the first two years of the agreement, which may be extended for
up to two additional years provided that the Company and Lilly agree on an
appropriate level of research and development funding for such extension
period. In addition, the Company may receive up to $27.5 million in payments
upon the achievement of certain preclinical and clinical milestones, and if a
product receives marketing approval from the FDA or an equivalent agency in
another country, the Company is entitled to receive royalties on sales of
products resulting from the corporate partnership. The Lilly Agreement permits
Lilly to terminate the program for any reason after May 1999 upon three months
prior notice. See "Business--Corporate Partners."

The Company has incurred significant losses since inception and expects to
incur substantial losses for the foreseeable future, primarily due to the
expansion of its research and development programs and because the Company
does not expect to generate revenues from the sale of products in the
foreseeable future, if at all. The Company expects that operating results will
fluctuate from quarter to quarter and that such fluctuations may be
substantial. As of June 30, 1997, the Company's accumulated deficit was
approximately $20.2 million.

The Company's business is subject to significant risks, including the risks
inherent in its research and development efforts, reliance on corporate
partners, uncertainties associated with obtaining and enforcing patents, the
lengthy, expensive and uncertain regulatory approval process, competition from
other companies' products, and the need for additional capital. See "Risk
Factors."

RESULTS OF OPERATIONS

FISCAL YEARS ENDED JUNE 30, 1997, 1996 AND 1995

Revenue. Revenue from corporate partnerships totaled approximately $5.8
million, $1.9 million, and $1.2 million for the years ended June 30, 1997,
1996 and 1995, respectively. The 1997 revenue was attributable solely to
amounts earned for research performed under the Company's corporate
partnerships with Glaxo Wellcome, Pfizer and Lilly, of approximately $2.0
million, $3.4 million and $270,000, respectively. The 1996 revenue was
attributable to amounts earned for research performed under the Company's
corporate partnerships with Glaxo Wellcome and Pfizer of approximately $1.63
million and $265,000, respectively and the 1995 revenue resulted entirely from
research payments under the Glaxo Wellcome corporate partnership. No revenues
from milestones have been earned under any corporate partnerships to date.

Research and Development Expenses. Research and development expenses
increased to $8.6 million in 1997 from $6.5 million in 1996 and $4.7 million
in 1995. The increases in each period were primarily attributable to increased
payroll and personnel expenses as the Company hired additional research and
development personnel to support its independent research and collaborative
programs, increased purchases of laboratory supplies, increased equipment and
leasehold improvement depreciation, increased facilities expenses in
connection with the build-out of the present facility and an increased use of
consultants and analytical lab services. The Company expects to expand its
independent research and collaborative programs in future periods, which will
result in increased research and development expenses in absolute dollars.

General and Administrative Expenses. General and administrative expenses
increased to $2.4 million in 1997 from $2.2 million in 1996 and $1.8 million
in 1995. The increases in each period were primarily attributable to increased
payroll and personnel expenses as the Company hired additional management, and
to increased consulting, legal, professional, travel and other fees and
expenses associated with an increase in business development activities.
General and administrative expenses are expected to increase in absolute
dollars in the future to support the Company's expanding business activities
and the increased costs expected to be incurred as a publicly-traded company.

Interest Income (Expense), Net. Interest income (expense), net increased to
$275,000 in 1997 compared with interest income (expense), net from ($135,000)
in 1996 and ($84,000) in 1995. Interest income increased to $656,000 in 1997
from $230,000 in 1996 and $56,000 in 1995. Increases in interest income
resulted from the

change in average cash and investment balances as a result of sales of equity
securities of the Company. Interest expense increased to $381,000 in 1997 from
$365,000 in 1996 and $140,000 in 1995. The increase in interest expense in
1997 was due to the higher average outstanding balance on an equipment
financing line of credit. The increase in interest expense in 1996 was
attributable to amounts due under a term loan executed in early 1996 and to
the increased utilization of an equipment financing line of credit.

LIQUIDITY AND CAPITAL RESOURCES

The Company has financed its operations since inception primarily through
the sale of equity securities, funds provided under corporate partnerships and
equipment and leasehold improvement financing. As of June 30, 1997, the
Company had received approximately $45.4 million in net proceeds from the sale
of equity securities and approximately $10.2 million for license fees and
research support payments under corporate partnerships.

Cash, cash equivalents and short-term investments at June 30, 1997 were
$24.3 million compared to $5.3 million at June 30, 1996. The increase was due
primarily to the proceeds received from the sale of equity securities and
research payments received under corporate partnerships, offset by net cash
used in operations.

Net cash used in the Company's operations decreased to $2.8 million for 1997
from $5.5 million for 1996. The decrease was primarily due to the increased
research and development funding from corporate partnerships. The Company's
capital expenditures for 1997 and 1996 were $1.9 million and $1.1 million,
respectively.

In May 1996, the Company entered into an equipment financing agreement for
up to $2.7 million. As of June 30, 1997, the Company had borrowed
approximately $1.6 million under this agreement for equipment purchases
structured as loans. These loans are being repaid over 48 months at interest
ranging from 15.2% to 16.2% per annum. In connection with this agreement, the
Company issued to the lender a warrant to purchase 38,238 shares of the
Company's Series C Preferred Stock at an exercise price of $3.88 per share.
The warrant expires at the earlier of April 30, 2006 or five years after the
closing of this offering.

In June 1995, the Company obtained a $1.5 million line of credit from a
commercial bank. In August 1995, the Company converted this line of credit
into a $1.5 million term loan bearing interest at the prime rate plus 2%. The
loan is payable in 36 equal monthly installments beginning August 31, 1995. In
connection with the term loan, the Company issued to the lender a warrant to
purchase 24,140 shares of Series C Preferred Stock at an exercise price of
$3.88 per share. The warrant expires on the earlier of June 1, 2000, or a
merger or sale of substantially all of the Company's assets.

In December 1993, the Company entered into a financing agreement for up to
$2.3 million with another financing company. As of June 30, 1997, the Company
had borrowed $1.9 million under the agreement for equipment purchases and
tenant improvements structured as loans. These loans are being repaid over 42
months at interest rates ranging from 13.8% to 16.2% per annum. In connection
with this agreement, the Company issued a warrant to purchase 21,630 shares of
the Company's Series B Preferred Stock at an exercise price of $3.88 per
share. The warrant expires on the earliest of May 13, 2000, or the day prior
to the effectiveness of a registration statement covering an underwritten
offering of the Company's securities with aggregate gross proceeds of at least
$7.5 million, or a merger or sale of substantially all of the Company's
assets.

The Company anticipates that its existing resources, including the net
proceeds of this offering, committed funding from existing corporate
partnerships and projected interest income, will enable the Company to
maintain its current and planned operations through fiscal 1999. However,
there can be no assurance that the Company will not require additional funding
prior to such time. The Company's future capital requirements will depend on
many factors, including scientific progress in its research and development
programs, the size and complexity of such programs, the scope and results of
preclinical studies and clinical trials, the ability of the Company to
establish and maintain corporate partnerships, the time and costs involved in
obtaining regulatory approvals, the time and costs involved in filing,
prosecuting and enforcing patent claims, competing technological and market
developments, the cost of manufacturing preclinical and clinical materials and
other factors not within the

Company's control. There can be no assurance that additional financing to meet
the Company's funding requirements will be available on acceptable terms or at
all. If additional funds are raised by issuing equity securities, substantial
dilution to existing stockholders may result. Insufficient funds may require
the Company to delay, scale back, or eliminate some or all of its research or
development programs or to relinquish greater or all rights to products at an
earlier stage of development or on less favorable terms than the Company would
otherwise seek to obtain.

The Company recorded deferred compensation representing the difference
between the exercise price of options granted and the deemed fair market value
of its Common Stock at the time of grant. Deferred compensation of
approximately $750,000 was recorded through June 30, 1997, and an additional
$390,000 is expected to be recorded for options granted subsequent to June 30,
1997. Deferred compensation will be recognized as an expense over the related
vesting term of the options, generally four years.

The Company has not generated significant taxable income to date. At June
30, 1997, the net operating losses available to offset future taxable income
for federal income tax purposes were approximately $15.6 million. Because the
Company has experienced ownership changes, future utilization of the
carryforwards may be limited in any one fiscal year pursuant to Internal
Revenue Code regulations. The carryforwards expire at various dates beginning
in 2008 through 2012 if not utilized. As a result of the annual limitation, a
portion of these carryforwards may expire before becoming available to reduce
the Company's federal income tax liabilities.

BUSINESS

Megabios develops proprietary gene delivery systems and provides preclinical
development expertise to create gene-based therapeutics designed for the
treatment or prevention of genetic and acquired diseases. The Company has
developed several in vivo, non-viral gene delivery systems to address a number
of potential therapeutic applications using a variety of therapeutic genes.
The Company's clinical development and commercialization strategy is to enter
into collaborative research and development agreements or "corporate
partnerships" with pharmaceutical and biotechnology companies. To date, the
Company has established corporate partnerships with Glaxo Wellcome to develop
a treatment for cystic fibrosis using the CFTR gene, Pfizer to develop a
treatment for solid tumors through angiogenesis inhibition and Lilly to
develop treatments for breast and ovarian cancer using the BRCA1 gene.

BACKGROUND

Genes and Gene-based Therapeutics

Genes provide the "code" for proteins, which determine the nature and
function of cells and tissues in all living organisms. The study of genes and
their function ("genomics") provides the fundamental basis for understanding
human health and disease and has led to the identification of many genes with
potential therapeutic utility ("therapeutic genes").

The entire genetic content of an organism is known as its genome. In humans,
the genome is believed to contain approximately 100,000 genes, each of which
is composed of a unique sequence of DNA molecules that encode genetic
instructions. These genetic instructions enable cells to carry out their
normal biological functions. The process by which an organism utilizes genetic
instructions and produces proteins is known as gene expression. The expression
of a defective gene, or the over- or under-expression of a normal gene, is
responsible for certain disease conditions. For example, the expression of a
single defective gene is known to cause cystic fibrosis and sickle cell
anemia, and the defective expression of multiple genes is believed to be
involved in the progression of diseases such as cancer and diabetes, as well
as cardiovascular, neurological and other diseases.

The worldwide effort to decipher the human genome and to understand the
function of its constituent genes is yielding important insights into the
roles that genes play in disease conditions, as well as how genes may be
useful in the treatment of such diseases. It is estimated that there are at
least 5,000 genes of known function, many of which have been identified as
potential therapeutic genes. Various companies and academic institutions are
investing substantial financial and human resources to identify additional
therapeutic genes, and the Company believes that this process will create
opportunities for gene-based therapeutics.

Gene-based therapy is an approach to the treatment or prevention of certain
diseases in which therapeutic genes are introduced into target cells to cause
the production of specific proteins needed to bring about a therapeutic
effect. For gene-based therapy to be effective, the therapeutic gene must be
delivered to the target cell, transported across the outer membrane and into
the cell, where it can be expressed. The expressed protein may remain within
the cell for an intracellular effect, be transported to the cell membrane to
exert a cell surface effect or be secreted into the bloodstream to have a
systemic effect. Most gene-based therapies utilize a delivery system, or
vector, into which the therapeutic gene is incorporated to facilitate its
delivery to, and uptake by, the target cell.

EXPRESSION OF A THERAPEUTIC GENE IN A TARGET CELL

[ARTWORK APPEARS HERE]

Gene Delivery Approaches

To date, a limiting factor in gene-based therapy has been the lack of safe,
effective gene delivery systems. A number of gene delivery approaches are
being developed, each of which has exhibited certain limitations. These
approaches may be categorized by their mode of administration, ex vivo
(outside the body) or in vivo (inside the body), and by the nature of the gene
delivery system (viral or non-viral).

Many clinical trials of potential gene-based therapeutics have used ex vivo,
viral gene delivery. Ex vivo gene-based therapies involve procedures in which
selected cells are removed from the patient, transduced with the therapeutic
gene, expanded in number, cleansed of contaminants and then reintroduced into
the same patient. This lengthy and labor-intensive process significantly
differs from traditional pharmaceutical administration and may result in a
complex, high-cost procedure.

In an effort to overcome these limitations, certain companies are developing
in vivo gene delivery systems that employ viruses to deliver the therapeutic
gene into target cells. Although in vivo, viral gene delivery approaches may
be suitable for certain applications, the Company believes that several issues
resulting from the use of viruses may limit their broad application. Certain
types of viral gene delivery systems permanently alter the DNA of the target
cell due to integration of the virus carrying the therapeutic gene into the
DNA of the cell. This permanent and potentially random integration may result
in the inability to regulate the gene-based therapeutic, the inactivation of a
beneficial gene or the unintended activation of a harmful gene. In addition,
certain viral gene delivery systems have been shown to cause immune reactions,
limiting their use for chronic diseases that may require repeat dosing. Viral
gene delivery systems may also have limitations as to the size of the
therapeutic gene that can be delivered. Furthermore, the Company believes that
it may be difficult and expensive to manufacture and purify the desired viral
strain due to the risks associated with handling viruses.

To overcome the concerns associated with the use of viruses, in vivo, non-
viral gene delivery methods are being developed. Such methods typically
include the insertion of a therapeutic gene into a circular segment of DNA
known as a DNA plasmid, which is designed to control expression of the
therapeutic gene in the cell. The plasmid is packaged with a carrier, often a
lipid-based formulation, and delivered into the target cell by various modes
of administration, including inhalation, intravenous administration, direct
injection and intraperitoneal administration. These traditional modes of
administration are familiar to physicians and may be more convenient and cost
effective than ex vivo approaches. In addition, DNA plasmids degrade over time
and do not integrate into the host genome. Therefore, plasmid-based systems
avoid the potentially random integration associated with some viral approaches
and allow for more flexible treatment since the gene is not permanently
expressed. In

spite of the advantages of in vivo, non-viral delivery approaches, their
development has been limited by a number of considerations, including low
levels and short duration of gene expression, non-specific cell targeting,
inflammation or other adverse effects and manufacturing difficulties.

MEGABIOS' IN VIVO, NON-VIRAL GENE DELIVERY APPROACH

The Company's in vivo, non-viral gene delivery systems are designed to avoid
the significant limitations of ex vivo (whether viral or non-viral) and in
vivo, viral gene delivery. Furthermore, the Company believes it has made
progress in overcoming the limitations often associated with in vivo, non-viral
gene delivery approaches. The Company's proprietary gene delivery systems
consist primarily of two components: (i) DNA plasmids containing a therapeutic
gene that controls its proper expression; and (ii) lipids and other agents that
facilitate the delivery of the DNA plasmids into the target cell. In most of
its gene delivery systems, the Company combines negatively charged DNA with
novel, positively charged lipids and neutral lipids to form DNA:lipid
complexes. These complexes are the active ingredient in the Company's gene
delivery systems. Certain of the Company's other gene delivery systems utilize
polymers and peptides instead of lipids to facilitate the delivery of DNA
plasmids.

MEGABIOS' NON-VIRAL, LIPID-BASED GENE DELIVERY SYSTEMS

[ARTWORK APPEARS HERE]

The Company's portfolio of gene delivery systems is classified by series
based on the mode of administration and the cell type to which the gene-based
therapeutic is delivered, with each formulation within a series having distinct
specifications and potential applications. For example, different gene delivery
systems within the MB200 Series result in different patterns of expression
following intravenous administration. To date, the Company has developed seven
series of gene delivery systems and expects to design additional series of gene
delivery systems, expanding the scope of its commercial opportunities. The
Company believes its proprietary, non-viral gene delivery systems may have the
following benefits:

Therapeutically Relevant Gene Expression. Megabios has developed DNA
plasmids that, following their formulation with lipids and their
administration to animals, produce therapeutically relevant protein levels
that persist for up to two months. Following intravenous administration to
mice of the gene for a commercially available cytokine, the cytokine was
detected in the blood at levels consistent with those required for
therapeutic effect. Similarly, following aerosol administration to primates
of the therapeutic gene to treat cystic fibrosis, the resulting human
protein was produced in the correct cell type (lung epithelial cells) and
at levels believed to be potentially therapeutic.

Tissue-specific Gene Delivery and Expression. The Company believes that its
gene delivery systems result in specific targeting to certain tissues and a
number of cell types. In preclinical studies, the Company has demonstrated
that various formulations are taken up selectively by (i) ciliated
epithelial cells lining the airways of the lungs following aerosol
administration, (ii) vascular endothelial cells lining the blood vessels of
several tissues, including lung, heart, spleen and lymphatic tissues,
following intravenous administration, (iii) solid tumors following direct
administration either into the tumor or other local tissues, (iv) antigen

presenting cells following intramuscular, intradermal, subcutaneous or
intravenous injection, (v) circulating macrophages following intravenous
administration and (vi) cells in the central nervous system following
direct injection. For example, in a preclinical study to test the pattern
of uptake of two intravenous formulations, one formulation resulted in over
90% of observable gene expression in the vascular endothelial cells of the
lungs, while the other formulation resulted in over 90% of observable gene
expression in the spleen. In addition, following direct injection in
animals, the Company's formulations have been demonstrated to result in
transfection of solid tumors and muscle and brain tissue.

Ease of Handling and Administration, Stability and Scalable Manufacturing
Methods. The Company's gene delivery systems are designed to be handled and
administered like traditional pharmaceuticals. These gene delivery systems
are also designed to be stable when refrigerated and are intended to be
distributed like other pharmaceuticals. Megabios has demonstrated that it
can produce clinical-grade DNA plasmids, DNA:lipid complexes and
formulations under controlled conditions without the expense and handling
requirements associated with viral gene delivery systems. In addition,
Megabios has developed manufacturing and production methods designed to be
scaled to meet commercial requirements and has produced DNA plasmids at a
contract manufacturer at the 1,000 liter scale.

Improved Safety Profile. Megabios has tested its gene delivery systems in
hundreds of in vivo, preclinical experiments. In animal models, the
Company's aerosol gene delivery systems do not appear to cause serious
adverse effects, such as inflammation, which has been seen following the
aerosol administration of lipid-based gene delivery systems under
development by other companies. Megabios believes that its gene delivery
systems may allow for repeat administration of gene-based therapeutics for
the treatment of chronic diseases, such as asthma and other inflammatory
conditions.

The Company has also developed techniques that allow it to screen genes for
potential therapeutic utility. Because the Company believes that in vitro gene
expression experiments do not correlate well with in vivo results, Megabios
has focused on testing its gene delivery systems in animals. The Company has
developed a methodology to test therapeutic genes in vivo in rapid succession.
For example, in a matter of weeks, the Company can prepare plasmids containing
different therapeutic genes, formulate them in an appropriate lipid-based
delivery system and administer the formulations to animals. After testing
several different genes, the Company can demonstrate the potential clinical
utility of a panel of therapeutic genes, facilitating selection of the gene-
based therapeutic to be developed. In addition, Megabios has expertise in the
selection of appropriate animal models, as well as in the development of
various assays and analytical techniques, to assess the performance of
formulations containing various genes. While the results of preclinical animal
studies do not predict safety or efficacy in humans, when, and if, further
clinical trials are conducted, the Company believes that its gene screening
capability and its experience in preclinical development will enable it to
accelerate the development of gene-based therapeutics and thereby attract
corporate partners.

COMMERCIALIZATION STRATEGY

The Company provides technology and preclinical development expertise that
it believes will be critical to the successful commercialization of many
therapeutic genes. The Company's commercialization strategy is to enter into
corporate partnerships with pharmaceutical and biotechnology companies to
develop gene-based therapeutics. Megabios corporate partnerships' are
structured to provide the Company with funding for research and development,
milestone payments and, upon commercialization, product royalties. This
strategy is intended to enable Megabios to extend and leverage its technology
platform, focus on preclinical development of gene-based therapeutics and
create a portfolio of product development programs sponsored by its corporate
partners. The key components of the Company's commercialization strategy are
to:

Exploit Broad Technology Platform. The Company believes that its gene
delivery systems can be used for multiple therapeutic applications. The
Company's goal is to establish several corporate partnerships for each
series of gene delivery systems that it has developed, since the plasmid
component of its formulations may contain any of several genes. For
example, the Company has entered into a corporate partnership with Glaxo
Wellcome to develop a gene-based therapeutic to treat cystic fibrosis using
the Company's aerosol gene

delivery technology, referred to as the MB100 Series. Gene delivery systems
in the MB100 Series may also be useful with different therapeutic genes to
treat other pulmonary diseases, such as asthma. Therefore, once a
particular gene delivery technology has been developed, it may be
commercialized with several partners for several different diseases. The
Company intends to expand its technology platform to include additional
non-viral gene delivery systems which target additional tissues and cell
types, creating an even broader portfolio of potential commercial
applications.

Focus Resources on Conversion of Genes into Drug Candidates. The Company
intends to focus on (i) DNA plasmid development to optimize expression of
the therapeutic gene, (ii) formulation development to achieve appropriate
targeting of the therapeutic gene to various cell types, (iii) gene
screening to validate the potential utility of a therapeutic gene, (iv)
preclinical studies, including animal models of disease, toxicology and
pharmacological testing, (v) assay development in support of preclinical
studies and clinical trials and (vi) supply of material for preclinical
studies and early clinical trials. Under certain circumstances, the Company
may sponsor early clinical testing of a potential gene-based therapeutic to
attract prospective corporate partners. In most cases, however, the
Company's corporate partners will be responsible for clinical trials,
sales, marketing, and large-scale clinical and commercial manufacturing. By
limiting its role primarily to research and preclinical development of gene
delivery systems, the Company believes it will be able to build and
maintain its expertise in the area of in vivo, non-viral gene delivery.

Diversify Through Multiple Projects and Corporate Partners. The Company's
strategy is to structure its corporate partnerships so that its research
and development activities on behalf of corporate partners will be fully
subsidized. Other potential payments that may be received by the Company
from corporate partners, including licensing fees, equity investments and
milestone payments, will be used to fund the further development of the
Company's core technology. The Company believes this will limit financial
risk by eliminating its exposure to capital-intensive activities such as
large-scale clinical trials, commercial manufacturing and sales and
marketing, while enabling the Company to continue to advance its core
technology. In addition, the Company believes that creating a portfolio of
product development programs will reduce the Company's dependence on any
particular product development program.

CORPORATE PARTNERS

The Company has entered into three collaborative research and development
agreements or "corporate partnerships" and is actively seeking additional
partnerships with pharmaceutical and biotechnology companies. Many of these
companies have identified therapeutic genes, but Megabios believes many such
companies do not possess the technology or the know-how to develop gene-based
therapeutics. Megabios seeks license fees, equity investments, funding for
research and development, milestone payments and royalties on product sales in
exchange for commercial licenses to the Company's gene delivery technologies
and access to its preclinical development expertise.

Glaxo Wellcome

In April 1994, the Company entered into a corporate partnership with Glaxo
Wellcome to develop a gene-based therapeutic for the treatment of cystic
fibrosis. Cystic fibrosis is the most common lethal genetic disease in
Caucasians, occurring in about 1 in 3,000 live births. The disease is believed
to afflict approximately 55,000 patients in the United States and Europe.
Cystic fibrosis is caused by a defect in the CFTR gene. This defect results in
production of defective CFTR protein, leading to the build-up of mucus in the
lungs that often results in multiple infections, loss of lung function and
premature death. The median life expectancy of a patient with cystic fibrosis
is approximately 30 years. Patients with cystic fibrosis typically incur
annual medical costs ranging from $15,000 to $55,000. The Company believes
that a gene-based therapeutic which results in increased levels of normal CFTR
protein on the surface of ciliated epithelial cells may slow or halt the
progression of this disease while reducing the total cost of patient care.

The Company has conducted preclinical testing of a gene delivery system in
the MB100 Series as a carrier for the CFTR gene. Data from these studies,
including the administration of the gene to primates via inhalation,

have demonstrated expression of the human form of the CFTR gene in the correct
location in the appropriate cell type with no evidence of inflammation, a
common problem associated with non-viral gene-based therapeutics. In addition,
approximately 20% of the target cells were shown to produce CFTR protein six
weeks after a single administration, which exceeds the level believed to be
the threshold for achieving a therapeutic effect. The Company believes that
these results suggest that this product may be useful in the treatment of
cystic fibrosis. In June 1997, Glaxo Wellcome commenced a Phase I/II clinical
trial in cystic fibrosis patients with cystic fibrosis using a gene delivery
system in the MB100 Series as a carrier for the CFTR gene.

Under the Glaxo Wellcome Agreement, the Company conducted research and
preclinical development activities for a three-year period ended April 1997.
The terms of the Glaxo Wellcome Agreement provide Glaxo Wellcome with the
exclusive rights to manufacture, market and sell gene-based therapeutics
incorporating the Company's gene delivery systems for the treatment of cystic
fibrosis. Glaxo Wellcome will be responsible for clinical trials, large-scale
clinical and commercial manufacturing, and sales and marketing of any
potential gene-based therapeutics resulting from the corporate partnership. In
addition to having received $5.0 million in research funding, the Company is
entitled to receive a milestone payment from Glaxo Wellcome upon the
commencement of a Phase III clinical trial, a portion of which will be
credited against future royalties, as well as royalties on the sales of
products resulting from the corporate partnership. The Company has completed
all of its obligations under the Glaxo Wellcome Agreement and will receive
future payments, if any, only through the achievement of a certain milestone
and the payment of royalties.

Pfizer

In May 1996, the Company entered into a corporate partnership with Pfizer to
develop a gene-based therapeutic for the treatment of solid tumors using gene
delivery systems in the MB200 Series which are designed to deliver genes that
inhibit angiogenesis. In order to survive and multiply, clusters of cancer
cells, referred to as solid tumors, require oxygen and other nutrients that
are delivered via the bloodstream. To access this blood supply, cancer cells
initiate a biochemical process that stimulates angiogenesis (the process by
which new blood vessels are formed), creating a new network of blood vessels
that nourish the tumor and remove waste products. As cancer cells grow and
metastasize (spread from primary sites to secondary sites), they stimulate
angiogenesis to form and nourish new tumors. Angiogenesis inhibitors have been
shown to slow or stop the formation of new blood vessels and therefore the
growth and spread of solid tumors.

The Company's gene-based therapeutic under development with Pfizer is
intended to inhibit angiogenesis associated with the formation and growth of
solid tumors. Gene delivery systems in the MB200 Series have been shown in
animal models to achieve gene expression selectively in vascular endothelial
cells of the lungs and other tissues. The initial disease targeted in the
Pfizer collaboration is non-small cell lung cancer ("NSCLC"). It is estimated
that there are approximately 300,000 new cases of NSCLC each year in the
United States and Europe. The Company believes there is no adequate treatment
for NSCLC. The median survival for patients with advanced forms of the disease
is approximately six months after diagnosis. The Company believes that a
therapy which is useful for the treatment of NSCLC also may be useful for
other solid tumors, such as cancer of the breast, prostate and ovaries.

The Pfizer Agreement provides that Pfizer receive the exclusive rights to
develop, make, use and sell gene-based therapeutics resulting from the
corporate partnership. Under the Pfizer Agreement, the Company is conducting
research and preclinical development activities and will receive funding for
such activities through at least June 1998. Pfizer will be responsible for
clinical trials, large-scale clinical and commercial manufacturing, and sales
and marketing of any potential gene-based therapeutics resulting from the
corporate partnership. The Company will be entitled to receive up to $16.4
million in research and development funding if the agreement continues for
four years, as well as up to $20.0 million in payments upon the achievement of
certain clinical milestones, which milestone payments will be credited against
future royalties, if any. In addition, if a product receives marketing
approval from the FDA or an equivalent agency in another country, the Company
is entitled to receive royalties on sales of products resulting from the
corporate partnership. In connection with the execution of the Pfizer
Agreement, Pfizer purchased 484,697 shares of Series D Preferred Stock for
$3.5 million. Such shares convert into 484,697 shares of Common Stock upon the
offering, representing approximately 4.0%

of the Company's outstanding Common Stock (assuming 12,225,939 shares of
Common Stock outstanding after the offering). The Pfizer Agreement permits
Pfizer to terminate the program for any reason, including reasons unrelated to
such program, after June 1998 upon six months prior notice. If Pfizer elects
to extend the research term beyond two years, it will be required, prior to
January 1998, to commit to purchase within 60 days $10.0 million of the
Company's Common Stock at a premium to the then current market value, subject
to certain adjustments. The Company is uncertain whether Pfizer will exercise
its option to extend the Pfizer Agreement and make the corresponding equity
investment in the Company. Under the terms of the Pfizer Agreement, Pfizer's
aggregate ownership in the Company may not exceed 19.99% of the Company's
outstanding capital stock.

Under the Pfizer Agreement, the Company is responsible for performing
research and preclinical development activities for a period of up to four
years. The Company's responsibilities include DNA plasmid development,
formulation development, assay development, preclinical studies including
toxicology and pharmacological testing and supply of material for preclinical
studies. In addition, the Company is conducting gene screening using gene
delivery systems in the MB200 Series using intravenous administration to
determine the relative utility of various therapeutic genes believed to
inhibit angiogenesis.

Lilly

In May 1997, the Company entered into a corporate partnership with Lilly to
develop gene-based therapeutics using BRCA1, a gene which has been identified
as a putative tumor suppressor. In normal cells, tumor suppressor genes act to
inhibit cell division. When a tumor suppressor gene, such as BRCA1, is missing
or defective, a cell may begin to replicate uncontrollably, resulting in the
formation of a tumor. Various scientific publications have associated defects
in BRCA1 with breast, ovarian and prostate cancers. Increased expression of
the BRCA1 gene in diseased tissue may inhibit or prevent the uncontrolled cell
growth associated with cancer, without causing any adverse effect in normal
cells. BRCA1 will be developed as a gene-based therapeutic initially using
gene delivery systems in the MB300 Series, which are administered via direct
injection, and gene delivery systems in the MB700 Series, which are
administered into the intraperitoneal cavity.

The Company's gene-based therapeutic under development with Lilly is
initially focused on the delivery and expression of BRCA1 in diseased cells in
breast and ovarian tissue. Preliminary studies of Megabios' gene delivery
systems indicate that gene delivery systems in the MB300 Series may be useful
in the targeting of genes to ovarian and breast tissues. There are over
180,000 new cases of breast cancer and over 26,000 new cases of ovarian cancer
reported each year in the United States. In addition, other gene delivery
systems will be tested and potentially developed for the purpose of delivering
BRCA1 to various tissues using other modes of administration, including
intraperitoneal and intravenous administration.

Under the Lilly Agreement, the Company is responsible for performing
research and preclinical development activities for a period of up to four
years. The Lilly Agreement provides that Lilly receive the exclusive rights to
develop, make, use and sell gene-based therapeutics incorporating BRCA1
resulting from the corporate partnership. Under the Lilly Agreement, the
Company will conduct research and preclinical development activities and will
receive funding for a minimum of two years. Lilly will be responsible for
clinical trials, large-scale clinical and commercial manufacturing, and sales
and marketing of any gene-based therapeutics resulting from the corporate
partnership. The Company will be entitled to receive at least $7.0 million in
research and development funding during the first two years of the agreement,
which may be extended for up to two additional years provided that Lilly and
the Company agree on an appropriate level of research and development funding
for such extension period. In addition, the Company may receive up to $27.5
million in payments upon the achievement of certain preclinical and clinical
milestones and, if a product receives marketing approval from the FDA or an
equivalent foreign agency, the Company is entitled to receive royalties on
sales of products resulting from the corporate partnership. In connection with
the execution of the Lilly Agreement, Lilly purchased 285,714 shares of the
Company's Series F Preferred Stock for $3.0 million. Such shares convert into
285,714 shares of Common Stock upon the offering, representing approximately
2.34% of the Company's outstanding Common Stock (assuming 12,225,939 shares of
Common Stock outstanding after the offering). The Lilly Agreement permits
Lilly to terminate the program for any reason, including reasons unrelated to
such program, after May 1999 upon three months prior notice.

The Company is highly dependent upon its corporate partnerships with Glaxo
Wellcome, Pfizer and Lilly. There can be no assurance that either, or both of,
the Pfizer Agreement or the Lilly Agreement will be extended, that research
funds under the Pfizer Agreement or the Lilly Agreement or milestone payments
contemplated by any of the Company's corporate partnerships will be received,
that the equity investment contemplated by the Pfizer Agreement will be
consummated, or that any of these corporate partnerships will result in
successfully commercialized products and the receipt by the Company of related
royalty revenues. Should the Company fail to receive research funds or should
milestones set forth in any or all of the Glaxo Wellcome Agreement, the Pfizer
Agreement or the Lilly Agreement not be achieved, or should Glaxo Wellcome,
Pfizer or Lilly breach or terminate their respective agreements, either prior
to scheduled termination or on the termination date, the Company's business,
financial condition and results of operations will be materially adversely
affected. The Company will also need to enter into additional corporate
partnerships, and there can be no assurance that the Company will be able to
do so on favorable terms, or at all. Should any corporate partner fail to
develop or commercialize successfully any product to which it has obtained
rights from the Company, the Company's business, financial condition and
results of operations may be materially adversely affected.

MEGABIOS' GENE DELIVERY SYSTEMS

The Company has developed several gene delivery systems and has identified a
number of potential therapeutic applications for each of these systems using a
variety of therapeutic genes. The Company's portfolio of gene delivery systems
are classified by series based on the mode of administration and the cell type
to which the gene-based therapeutic is delivered, with each formulation within
a series having distinct specifications and potential applications. For
example, one gene delivery system in the MB100 Series has been optimized for
the aerosol delivery of the CFTR gene to ciliated epithelial cells in the
lungs, while a different aerosol gene delivery system in the same series is
under development to deliver genes for the treatment of asthma. The table
below summarizes the Company's gene delivery systems, potential applications
and agreements with corporate partners:

DELIVERY SYSTEM
(MODE OF ADMINISTRATION) CELL TYPE(S) TRANSFECTED POTENTIAL APPLICATIONS STATUS(1)
------------------------ ------------------------ ------------------------------------ ---------------------

MB100 Series Ciliated Cystic fibrosis Phase I/II with Glaxo
(Inhalation) epithelial cells Asthma Wellcome
in the lungs and Inflammation of the lungs Preclinical
respiratory tract Mucosal immunization Research
Infectious diseases of the lungs Research
Research

MB200 Series Vascular Angiogenesis inhibition (cancer) Preclinical with
(Intravenous injection) endothelial cells Angiogenesis inhibition (non-cancer) Pfizer
in the lungs, Protein replacement therapy Preclinical
heart, spleen and Cardiovascular diseases Preclinical
lymph nodes Inflammatory diseases Preclinical
Research

MB300 Series Solid tumor cells Cancer (using BRCA1) Preclinical with
(Direct injection) Cancer (other genes) Lilly
Preclinical

MB400 Series Various cells Preventive vaccines Research
(Intramuscular, involved in Therapeutic vaccines Research
intradermal, antigen Immunotherapy (cancer, infectious Research
subcutaneous and presentation diseases, autoimmune diseases)
intravenous injection)

MB500 Series Circulating Infectious diseases Research
(Intravenous injection) macrophages Hyperlipidemia Research

MB600 Series Cells in the Neurodegenerative diseases Research
(Direct injection) central nervous Cancer Research
system

MB700 Series Solid tumor cells Cancer (using BRCA1) Preclinical with
(Intraperitoneal Cancer (other genes) Lilly
injection) Research

- --------
(1) "Phase I/II" indicates that the compound is being tested in humans for
safety and preliminary indications of biological activity in a limited
patient population.

"Preclinical" indicates that Megabios is conducting efficacy, pharmacology
and/or toxicology testing of a gene delivery system in animal models or
biochemical or cell culture assays.

"Research" includes the development of animal models and assay systems,
discovery of prototype gene delivery systems and evaluation and refinement
of prototype gene delivery systems in in vitro and in vivo testing.

MB100 Series

The Company has developed a class of gene delivery systems, the MB100
Series, which, following aerosol administration to animals, results in genes
being taken up and expressed primarily by ciliated epithelial cells in the
lungs and respiratory tract. The Company believes that the MB100 Series may be
useful in the delivery of therapeutic genes for a variety of purposes,
including treatment of cystic fibrosis, asthma, inflammatory conditions and
infectious diseases of the lungs, as well as for mucosal immunization. One of
these gene delivery systems is the subject of the Company's corporate
partnership with Glaxo Wellcome to develop a gene-based therapeutic for the
treatment of cystic fibrosis. See "--Corporate Partners--Glaxo Wellcome."

The Company intends to enter into a corporate partnership to develop the
MB100 Series for the treatment of asthma. Asthma, characterized by obstruction
of airways in the lung, is estimated to affect 5% of the population in the
United States, or approximately 13 million people. Certain genes believed to
be associated with the onset and progression of asthma have been identified,
and various companies are investing heavily in further understanding the
genetic cause of asthma. The Company believes that the MB100 Series may be
useful for the delivery of therapeutic genes to treat asthma as well as other
therapeutic genes to treat other inflammatory diseases in the lungs.

The Company also intends to conduct studies using the MB100 Series together
with certain therapeutic genes to achieve mucosal immunity. Mucosal immunity
is a form of immunization resulting from the introduction of an antigen to the
mucosal cells lining the airways of the lungs, oral cavity or nasal passages.
The Company believes that the MB100 Series may be useful to deliver
therapeutic genes that result in mucosal immunity in diseases, such as
tuberculosis and pneumonia. The Company believes that the MB100 Series also
may be useful to deliver therapeutic genes for the treatment of other
pulmonary disorders, such as infectious diseases.

MB200 Series

Megabios has developed a class of gene delivery systems, the MB200 Series,
which, following intravenous administration, are taken up preferentially by
vascular endothelial cells in the lungs and other tissues. The Company
believes that gene delivery systems in the MB200 Series, in combination with
various genes, may be useful in the treatment of several diseases that are
associated with angiogenesis, including cancer, macular degeneration, diabetic
retinopathy, rheumatoid arthritis and psoriasis. In addition, Megabios
believes that gene delivery systems in the MB200 Series may be useful for
protein replacement therapy and to treat other medical disorders such as
cardiovascular and inflammatory diseases. Megabios has entered into a
corporate partnership with Pfizer to develop a gene-based therapeutic to treat
solid tumors using gene delivery systems in the MB200 Series which are
designed to deliver genes that inhibit angiogenesis. See "--Corporate
Partners--Pfizer."

In preclinical studies, administration of a gene delivery system in the
MB200 Series has resulted in expression levels of a therapeutic protein
consistent with those required for a therapeutic effect. These preclinical
studies suggest that a gene delivery system in the MB200 Series could be used
for protein replacement therapy, in which the gene coding for a therapeutic
protein is administered rather than the protein itself. The Company believes
that the use of gene-based therapeutics in this manner may be a viable
alternative when therapeutic levels of a protein are difficult to sustain or
when the therapeutic protein is difficult or expensive to manufacture.

In addition, the Company believes that the ability to target certain cell
types with gene delivery systems in the MB200 Series may be useful in
developing gene-based therapeutics for a number of other medical disorders.
For example, Megabios believes that the administration of gene delivery
systems in the MB200 Series combined with certain therapeutic genes that
stimulate angiogenesis may be useful to treat certain cardiovascular diseases,
such as peripheral vascular disease and atherosclerosis, both of which may
result in the blockage of blood vessels, leading to heart attacks and strokes.
In addition, the use of gene delivery systems in the MB200 Series to deliver
therapeutic genes coding for anti-inflammatory agents may be useful to treat
inflammatory diseases following intravenous administration.

MB300 Series

Megabios has developed a class of gene delivery systems, the MB300 Series,
which, following direct injection in animals, are taken up by cancer cells and
may be useful for the treatment of certain solid tumors. In preclinical
studies involving a canine model of spontaneously occurring oral melanoma, a
gene delivery system in the MB300 Series was used to deliver two therapeutic
genes. The data from this study indicated that a majority of the dogs that
received the treatment regimen exceeded their expected median survival period.
These dogs also had a higher number of activated white blood cells compared to
untreated animals, which suggests that the therapeutic genes augmented the
immune response to the tumor cells resulting in an increased survival rate for
these animals. The Company believes that these results support the potential
utility of the gene delivery systems in the MB300 Series to facilitate
immunotherapy approaches for the treatment of multiple forms of cancer.

Other gene delivery systems in the MB300 Series have been tested by the
Company to facilitate the treatment of multiple forms of cancer using
different approaches, such as through the delivery of suicide genes or tumor
suppressor genes. Megabios has entered into a corporate partnership with Lilly
to develop gene-based therapeutics using the MB300 Series as well as other
gene delivery systems, to deliver the BRCA1 gene to treat breast cancer and
ovarian cancer. See "--Corporate Partners--Lilly." The Company intends to
pursue additional corporate partnerships to develop gene-based therapeutics to
treat cancer using other (non-BRCA1) therapeutic genes.

MB400 Series

The Company is developing a class of gene delivery systems, the MB400
Series, designed to administer genetic vaccines following various modes of
administration, including intramuscular, intradermal, subcutaneous or
intravenous injection. To date, the use of DNA for vaccination purposes has
been limited by inadequate levels of expression of the vaccine antigen in the
appropriate cell type. The Company has designed and screened many delivery
systems, some of which may have improved targeting and expression
characteristics. If successful, these efforts could result in novel
formulations that may allow the treatment or prevention of certain diseases,
including infections and autoimmune diseases, as well as certain forms of
cancer, through a genetic vaccine approach.

Other Gene Delivery Systems

The Company is developing other classes of gene delivery systems for
additional therapeutic applications. For example, the Company believes that
the MB500 Series, which is designed to deliver genes to circulating
macrophages, has potential utility in various infectious diseases and
hyperlipidemia. The MB600 Series is designed to deliver genes to cells in the
central nervous system, which is an important target for the potential
treatment of neurodegenerative diseases, including Parkinson's and Alzheimer's
disease, as well as for the treatment of certain cancers. The MB700 Series is
designed to result in the delivery of genes to solid tumor cells following
intraperitoneal administration.

There can be no assurance that any of the Company's gene delivery systems
will have the performance attributes to justify their further development or
to attract corporate partners. While the Company has demonstrated some
evidence of the utility of its gene delivery systems in preclinical animal
studies, these results do not predict safety or efficacy in humans, when, and
if, further clinical trials are conducted. The Company's products may prove to
have undesirable and unintended side effects or other characteristics that may
prevent or limit their use. There can be no assurance that any of the
Company's products will ultimately obtain FDA or other regulatory or foreign
marketing approval for any indication. The Company's products are also subject
to risks particular to the development of gene-based therapeutics. Gene-based
therapy is a new and rapidly evolving technology and is expected to undergo
significant technological changes in the future. As a result of the limited
clinical data available regarding the safety and efficacy of gene-based
therapeutics and other factors, clinical trials relating to gene-based
therapeutics may take longer to complete than clinical trials involving more
traditional pharmaceuticals. There can be no assurance that any gene-based
therapeutics will be demonstrated to be safe or effective or that the Company
or its corporate partners will be able to manufacture such gene-based
therapeutics on a commercial scale or in an economical manner.

TECHNOLOGY LICENSES

Megabios actively reviews technologies under development at academic and
other research institutions. The Company believes that such institutions are
an important source of breakthrough technologies and has entered into and
intends to enter into additional licensing arrangements to expand its core
technology.

The Company has an exclusive license to certain patent applications held by
The Regents of the University of California ("The Regents") related to in
vivo, non-viral delivery of genes using positively charged lipids, including
delivery by various modes of administration and for use in the treatment of
cystic fibrosis. One patent has issued in the United States and one Notice of
Allowance has been received in the United States with respect to two patent
applications and two equivalent notices have been received in a foreign
country. Under the terms of the agreement, the Company has paid a license fee
and is obligated to make payments upon the achievement of certain clinical
milestones and royalty payments on sales of products, if any. The Company has
certain obligations regarding the process and timing of clinical activities
and seeking FDA approval in the pursuit of development, manufacture and sale
of products based on the claims contained in such patent applications. The
Regents may terminate the license or convert it to a nonexclusive license upon
60 days notice if the Company fails to meet certain milestones. However, the
date by which such milestones must be completed may be extended by the Company
for up to three years upon payment of a specified fee for each year a date is
extended. In addition, the Regents may also terminate the license upon 60 days
notice for a material violation or material failure to perform any covenant
under the license.

PATENTS AND PROPRIETARY TECHNOLOGY

Patents and other proprietary rights are important to the Company's
business. The Company's policy is to file patent applications and to protect
technology, inventions and improvements to inventions that are commercially
important to the development of its business. The Company also relies on trade
secrets, confidentiality agreements and other measures to protect its
technology and proposed products. The Company's failure to obtain patent
protection or otherwise protect its proprietary technology or proposed
products may have a material adverse effect on the Company's competitive
position and business prospects.

The Company has rights under its license with The Regents to one issued
United States patent which expires in 2014. In addition, the Company has
eleven pending patent applications in the United States as well as foreign
counterparts of these applications. The Company has received Notices of
Allowance in the United States with respect to three patent applications. The
patent application process takes several years and entails considerable
expense. In addition to its own patent applications, the Company has acquired
exclusive worldwide licenses to patent applications from The Regents. There is
no assurance that additional patents will issue from these applications or, if
patents do issue, that the claims allowed will be sufficient to protect the
Company's technology.

The patent positions of pharmaceutical and biotechnology firms are often
uncertain and involve complex legal and factual questions. Further, the
breadth of claims allowed in biotechnology patents is unpredictable. Patent
applications in the United States are maintained in secrecy until a patent
issues, and the Company cannot be certain that others have not filed patent
applications for technology covered by the Company's pending

applications or that the Company was the first to invent the technology that
is the subject of such patent application. Competitors may have filed
applications for, or may have received patents and may obtain additional
patents and proprietary rights relating to, compounds, products or processes
that block or compete with those of the Company. While the Company is aware of
patent applications filed and patents issued to third parties relating to
genes, gene delivery technologies and gene-based therapeutics, there can be no
assurance that any such patent applications or patents will not have a
material adverse effect on products the Company or its corporate partners are
developing or may seek to develop in the future. There can be no assurance
that third parties will not assert patent or other intellectual property
infringement claims against the Company with respect to its products or
technology or other matters.

Patent litigation is widespread in the biotechnology industry. Litigation
may be necessary to defend against or assert claims of infringement, to
enforce patents issued to the Company, to protect trade secrets or know-how
owned or licensed by the Company, or to determine the scope and validity of
the proprietary rights of third parties. Although no third party has asserted
that the Company is infringing such third party's patent rights or other
intellectual property, there can be no assurance that litigation asserting
such claims will not be initiated, that the Company would prevail in any such
litigation, or that the Company would be able to obtain any necessary licenses
on reasonable terms, if at all. Any such claims against the Company, with or
without merit, as well as claims initiated by the Company against third
parties, can be time-consuming and expensive to defend or prosecute and to
resolve. If other companies prepare and file patent applications in the United
States that claim technology also claimed by the Company, the Company may have
to participate in interference proceedings to determine priority of invention,
which could result in substantial cost to the Company even if the outcome is
favorable to the Company.

MANUFACTURING AND COMMERCIALIZATION

The Company's focused commercialization strategy is based on entering
corporate partnerships with pharmaceutical and biotechnology companies whereby
the Company will primarily pursue preclinical development of gene-based
therapeutics, and the Company's partners will be responsible for clinical
trials, sales, marketing, and large-scale clinical and commercial
manufacturing. Under the terms of the Glaxo Wellcome Agreement, Pfizer
Agreement and Lilly Agreement, the Company's corporate partners have received
exclusive rights for large-scale, clinical and commercial manufacturing of the
gene-based therapeutics for use in the areas covered by these agreements.

The Company has demonstrated that its DNA plasmids, DNA:lipid complexes and
formulations can be produced at pilot scale and believes that commercial
quantities of material may be prepared using conventional fermentation and
purification processes. The Company currently operates a pilot manufacturing
facility and has produced DNA plasmids at a contract manufacturer at the 1,000
liter scale. The lipid components of Megabios' gene delivery systems can be
synthesized using readily scalable, organic synthesis procedures. To date, the
Company has obtained access to lipid manufacturing through arrangements with
contract manufacturers. Preparation of DNA:lipid complexes is carried out at
the Company's pilot manufacturing facility using proprietary processes.

The Company has supplied clinical-grade material to Glaxo Wellcome for use
in a Phase I/II clinical trial of a gene-based therapeutic to treat cystic
fibrosis. Glaxo Wellcome is in the process of scaling up its production
capabilities using the Company's proprietary processes and methods to meet
clinical requirements. Under the Pfizer Agreement and the Lilly Agreement,
Megabios is obligated to provide material used in preclinical testing and may
supply material for clinical trials.

Megabios does not currently operate manufacturing facilities for commercial
production of its gene delivery systems. The Company has no experience in, and
currently lacks the resources and capability to, manufacture or market any of
its products on a commercial scale. Accordingly, the Company will be dependent
initially on corporate partners, licensees or other third parties for
commercial-scale manufacturing of its products. Successful large-scale
manufacturing of gene-based therapeutics has not been demonstrated by any
third parties. There can be no assurance that the Company will be able to
reach satisfactory agreements with its partners or that its corporate partners
will be able to develop adequate manufacturing capabilities for production of
commercial-scale quantities of gene-based therapeutics.

Under the terms of the Glaxo Wellcome Agreement, Pfizer Agreement and Lilly
Agreement, the corporate partners have received exclusive rights to market and
sell the Company's gene-based therapeutics that are developed pursuant to
these corporate partnerships. The Company is highly dependent upon each of its
corporate partnerships with Glaxo Wellcome, Pfizer and Lilly. The Company
cannot control whether Glaxo Wellcome, Pfizer or Lilly will devote sufficient
resources to the commercialization of the Company's potential products on a
timely basis, and such resources could vary due to factors unrelated to the
Company's products. If such corporate partners fail to conduct these
activities in a timely manner or at all, the commercialization of the
Company's products could be delayed or terminated. There can be no assurance
that any of these corporate partnerships will result in successfully
manufactured or commercialized products and the receipt by the Company of
related royalty revenues. Failure of the Company's corporate partners to
manufacture successfully the potential products for large-scale clinical
trials or commercial use, or to commercialize successfully the potential
products, would have a material adverse effect on the Company's business,
financial condition and results of operations.

GOVERNMENT REGULATION

The production and marketing of the Company's products and its research and
development activities are subject to extensive regulation for safety,
efficacy and quality by numerous governmental authorities in the United States
and other countries. In the United States, pharmaceutical products are subject
to rigorous regulation by the FDA. The Company believes that the commercial
uses of its products will be regulated as biologics by the FDA and comparable
foreign regulatory bodies. Biologics are regulated under certain provisions of
the Public Health Service Act and the Federal Food, Drug, and Cosmetic Act.
These laws and the regulations promulgated thereunder govern, among other
things, testing, manufacturing, safety, efficacy, labeling, storage, record
keeping, and the promotion, marketing and distribution of biological products.
At the FDA, the Center for Biologics Evaluation and Research is responsible
for the regulation of biological products and has handled FDA's regulation of
most gene-based therapeutics to date. Gene-based therapy, however, is a
relatively new technology and the regulatory requirements governing gene-based
therapeutics are uncertain. The Company is not aware of any gene-based
therapeutics that have received marketing approval from the FDA or any
comparable foreign authorities.

The necessary steps before a new biological product may be marketed in the
United States include: (i) preclinical laboratory tests and in vivo
preclinical studies; (ii) the submission to the FDA of an IND for clinical
testing, which must become effective before clinical trials commence; (iii)
under certain circumstances, approval by a special advisory committee convened
to review IND's involving gene-based therapeutics; (iv) adequate and well-
controlled clinical trials to establish the safety and efficacy of the
product; (v) the submission to the FDA of a product license application and
establishment license application ("PLA/ELA") and (vi) FDA approval of the
PLA/ELA prior to any commercial sale or shipment of the biologic. The FDA has
eliminated the requirement of a separate ELA for certain categories of
biotechnology products, including, for example, therapeutic recombinant DNA-
derived products. At this time, however, it is unclear whether these new
regulations would apply to gene-

based therapeutics. Furthermore, the FDA has announced its intention
ultimately to review all new biologic products under a single biologics
license application. However, it is impossible to predict when this procedure
will be adopted.

Manufacturing facilities in the United States are subject to periodic
inspection by the FDA and state authorities, and must comply with GMP.
Manufacturers of biologics also must comply with FDA general biological
product standards and also may be subject to state regulation. Failure to
comply with GMP or other applicable regulatory requirements may result in
withdrawal of marketing approval, criminal prosecution, civil penalties,
recall or seizure of products, warning letters, total or partial suspension of
production, FDA refusal to review pending marketing approval applications or
supplements to approved applications, or injunctions, as well as other legal
or regulatory action against the Company or its corporate partners.

Preclinical tests include laboratory evaluation of the product, as well as
animal studies to assess the potential safety and efficacy of the product.
Preclinical safety tests must be conducted by laboratories that comply with
FDA regulations regarding Good Laboratory Practice. The results of the
preclinical tests, together with manufacturing information and analytical
data, are submitted to the FDA as a part of an IND, which must become
effective before clinical trials may commence. The IND will automatically
become effective 30 days after receipt by the FDA unless the FDA indicates
prior to the end of the 30-day period that the proposed protocol raises
concerns that must be resolved before the FDA will allow the trials to proceed
as outlined in the IND. In such case, there can be no assurance that such
resolution will be achieved in a timely fashion, if at all. In addition, the
FDA may impose a clinical hold on an ongoing clinical trial, in which case the
study cannot recommence without FDA authorization under terms sanctioned by
the agency. There be no assurance that the Company's corporate partners will
not encounter problems in clinical trials that cause the Company's corporate
partners or the FDA to delay, suspend or terminate such trials.

Clinical trials involve the administration of the investigational product to
healthy volunteers or to patients, under the supervision of a qualified
principal investigator. Clinical trials are conducted in accordance with Good
Clinical Practices under protocols that detail the objectives of the trial,
inclusion and exclusion criteria, the parameters to be used to monitor safety,
and the efficacy criteria to be evaluated. Each protocol must be submitted to
the FDA as part of the IND. Further, each clinical trial must be reviewed and
approved by an independent IRB at the academic or medical institution at which
the trial will be conducted. The IRB will consider, among other things,
ethical factors and the safety of human subjects. The IRB may require changes
in a protocol, and there can be no assurance that submission of an IND will
permit a study to be initiated or completed.

Clinical trials are conducted in three sequential phases, but the phases may
overlap. In Phase I, the initial introduction of the product into healthy
human subjects or patients, the drug is tested to assess safety, metabolism,
pharmacokinetics and pharmacological actions associated with increasing doses.
Phase II usually involves studies in a limited patient population to (i)
determine the efficacy of the potential product for specific, targeted
indications, (ii) determine dosage tolerance and optimal dosage and (iii)
further identify possible adverse effects and safety risks. If a compound is
found to be effective and to have an acceptable safety profile in Phase II
evaluations, Phase III trials are undertaken to evaluate further clinical
efficacy and to test further for safety within a broader patient population at
geographically dispersed clinical sites. There can be no assurance that Phase
I, Phase II or Phase III testing will be completed successfully within any
specific time period, if at all, with respect to any of the Company's or its
corporate partners' products subject to such testing. In addition, after
marketing approval is granted, the FDA may require post-marketing clinical
studies which typically entail extensive patient monitoring and may result in
restricted marketing of the product for an extended period of time.

The results of the pharmaceutical development, preclinical studies and
clinical trials are submitted to the FDA in the form of a PLA/ELA for approval
of the manufacture, marketing and commercial shipment of the biological
product. The testing and approval process is likely to require substantial
time, effort and financial and human resources, and there can be no assurance
that any approval will be granted on a timely basis, if at all or that any
product developed by the Company and its corporate partners will prove safe
and effective in clinical

trials or will meet all the applicable regulatory requirements necessary to
receive marketing approval from the FDA or the comparable regulatory body of
other countries. Data obtained from preclinical studies and clinical trials
are subject to interpretations that could delay, limit or prevent regulatory
approval. The FDA may deny the PLA/ELA if applicable regulatory criteria are
not satisfied, require additional testing or information, or require
postmarketing testing and surveillance to monitor the safety or efficacy of a
product. Moreover, if regulatory approval of a biological product is granted,
such approval may entail limitations on the indicated uses for which it may be
marketed. Finally, product approvals may be withdrawn if compliance with
regulatory standards is not maintained or if problems occur following initial
marketing. Among the conditions for PLA/ELA approval is the requirement that
the prospective manufacturer's quality control and manufacturing procedures
conform to the appropriate GMP regulations, which must be followed at all
times. In complying with standards set forth in these regulations,
manufacturers must continue to expend time, financial resources and effort in
the area of production and quality control to ensure full compliance.

For clinical investigation and marketing outside the United States, the
Company and its corporate partners may be subject to FDA as well as regulatory
requirements of other countries. The FDA regulates the export of biological
products, whether for clinical investigation or commercial sale. In Europe,
the approval process for the commencement of clinical trials varies from
country to country. The regulatory approval process in other countries
includes requirements similar to those associated with FDA approval set forth
above. Approval by the FDA does not ensure approval by the regulatory
authorities of other countries.

The Company's research and development processes involve the controlled use
of hazardous materials, chemicals and radioactive materials, and produce waste
products. The Company is subject to federal, state and local laws and
regulations governing the use, manufacture, storage, handling and disposal of
such materials and waste products. Although the Company believes that its
safety procedures for handling and disposing of such materials comply with the
standards prescribed by such laws and regulations, the risk of accidental
contamination or injury from these materials cannot be eliminated completely.
In the event of such an accident, the Company could be held liable for any
damages that result and any such liability could exceed the resources of the
Company. Although the Company believes that it is in compliance in all
material respects with applicable environmental laws and regulations, there
can be no assurance that it will not be required to incur significant costs to
comply with environmental laws and regulations in the future, or that any the
operations, business or assets of the Company will not be materially adversely
affected by current or future environmental laws or regulations.

COMPETITION

Gene delivery and gene-based therapy are relatively new, rapidly evolving
areas of science in which significant and unexpected technological advances
are likely. Rapid technological development could result in the Company's
products or technologies becoming obsolete before the Company recovers a
significant portion of its related research, development and capital
expenditures. The Company is aware of several pharmaceutical and biotechnology
companies which are exploring the field of gene-based therapy, are actively
engaged in research and development in areas related to gene-based therapy, or
have commenced clinical trials of gene-based therapeutics. Many of these
companies are addressing diseases which have been targeted by the Company or
its corporate partners. Megabios also may experience competition from
companies that have acquired or may acquire gene-based technology from
universities and other research institutions. As competitors develop their
technologies, they may develop proprietary positions in certain aspects of
gene delivery and gene-based therapeutics that may materially and adversely
affect Megabios. In addition, the Company faces and will continue to face
competition from other companies for corporate partnerships with
pharmaceutical and biotechnology companies, for establishing relationships
with academic and research institutions, and for licenses to proprietary
technology, including intellectual property related to gene delivery systems.
Corporate partners may also elect to internally develop gene-based
therapeutics which compete with the Company's products. In addition, many
other companies are developing non-gene-based therapies to treat these same
diseases.

Company. There can be no assurance that research and development by others
will not render the Company's delivery systems or the products developed by
corporate partners using the Company's delivery systems obsolete or non-
competitive or that any product developed by the Company or its corporate
partners will be preferred to any existing or newly developed technologies. In
addition, there can be no assurance that the Company's competitors will not
develop safer, more effective or less costly gene delivery systems, gene-based
therapeutics or non-gene based therapies, achieve superior patent protection
or obtain regulatory approval or product commercialization earlier than the
Company, any of which could have a material adverse effect on the Company's
business, financial condition or results of operations.

PRODUCT LIABILITY INSURANCE

The manufacture and sale of human therapeutic products involve an inherent
risk of product liability claims and associated adverse publicity. The Company
currently has only limited product liability insurance, and there can be no
assurance that it will be able to maintain existing or obtain additional
product liability insurance on acceptable terms or with adequate coverage
against potential liabilities. Such insurance is expensive, difficult to
obtain and may not be available in the future on acceptable terms, or at all.
An inability to obtain sufficient insurance coverage on reasonable terms or to
otherwise protect against potential product liability claims could prevent or
inhibit the commercialization of products by the Company. A product liability
claim brought against the Company in excess of its insurance coverage, if any,
or a product withdrawal, could have a material adverse effect upon the
Company's business, financial condition and results of operations.

EMPLOYEES

As of July 15, 1997, Megabios employed 63 individuals full-time, including
17 who hold doctoral degrees. Of the Company's total work force, 52 employees
are engaged in or directly support research and development activities, and 11
are engaged in business development, finance and administrative activities.
The Company's employees are not represented by a collective bargaining
agreement. The Company believes its relationships with its employees are good.

FACILITIES

The Company currently leases approximately 45,300 square feet in Burlingame,
California, of which approximately 34,700 square feet is occupied or under
construction (the "Facility"). The Facility has been built to the Company's
specifications to accommodate the Company's laboratory, support and
administrative needs and includes a pilot manufacturing facility designed to
supply material required for preclinical research and development. The term of
the lease for the 34,700 square feet in use expires in 2004, at which time the
Company has the option to renew the lease. Approximately 10,600 square feet of
the Facility is not currently occupied by the Company and is expected to be
built-out for use as a manufacturing facility. The term of the lease for this
portion of the facility expires in 2007, at which time the Company has the
option to renew the lease. Megabios believes that the Facility and its
expansion will be adequate to meet the Company's needs for the foreseeable
future.

SCIENTIFIC ADVISORY BOARD

Megabios' Scientific Advisory Board ("SAB") consists of academic and
industry experts in the fields of gene-based therapeutics, molecular biology,
drug delivery, immunology and infectious diseases. The Company meets with the
members of the SAB on an ad hoc basis to discuss research and development
strategies, and certain members communicate with the Company's scientists
periodically to discuss the details of specific projects. All SAB members own
shares or have been granted options to acquire Common Stock of the Company.
Each SAB member has entered into a consulting agreement which provides for
certain cash compensation and specifies the terms and scope of the advisory
relationship with the Company, which provides that the SAB member will not
consult or otherwise provide services to any other Company engaged in the
development of gene-based therapeutics without the prior consent of Megabios.
The Company does not believe that termination of any individual consulting
agreement would materially affect its business. All of the SAB members are

employed by employers other than the Company and may have other commitments
and consulting advisory contracts with other entities which may compete for
such member's time and with their obligations to the Company.

Abul K. Abbas, M.B.B.S., has served as Head of the Immunology Research
Division in the Department of Pathology at Brigham and Women's Hospital, and
Professor of Pathology at Harvard Medical School since July 1991. He is a
member of the American Association of Pathologists and the American
Association of Immunologists. Dr. Abbas received his medical degree from the
All-India Institute of Medical Sciences, New Delhi, India.

Donald E. Ganem, M.D., has served as Investigator, Howard Hughes Medical
Institute since September 1994 and Professor of Microbiology and Medicine,
University of California, San Francisco since July 1990. He is a member of the
American Academy of Microbiology, the American Society for Virology and the
Infectious Diseases Society of America. Dr. Ganem received his M.D. from
Harvard University.

Raju Kucherlapati, Ph.D., has served as the Lola and Saul Kramer Professor
and Chairman of the Department of Molecular Genetics at Albert Einstein
College of Medicine since 1989. He was a founder and serves on the Board of
Directors of both Cell Genesys, Inc. ("Cell Genesys") and Millennium
Pharmaceuticals, Inc.. Dr. Kucherlapati received his Ph.D. from the University
of Illinois and did post-doctoral training at Yale University. Dr.
Kucherlapati also serves on the Board of Directors of the Company.

Robert S. Langer, Sc.D., has served as the Kenneth J. Germeshausen Professor
of Chemical and Biomedical Engineering at the Massachusetts Institute of
Technology ("MIT") since July 1988. He is a member of the Institute of
Medicine, the National Academy of Engineering and the National Academy of
Sciences. Dr. Langer received his Sc.D. in Chemical Engineering from MIT. He
also serves as a consultant to the Company.

Stuart H. Orkin, M.D., has served as the Leland Fikes Professor of Pediatric
Medicine at Harvard University since June 1987 and Investigator, Howard Hughes
Medical Institute since March 1986. From 1989 to 1990, he was the President of
The American Society of Clinical Investigation. He is a member of the National
Academy of Sciences, the American Academy of Arts and Sciences, and the
American Society of Human Genetics. Dr. Orkin received his M.D. from Harvard
University.

MANAGEMENT

EXECUTIVE OFFICERS, DIRECTORS AND KEY EMPLOYEES

The executive officers, directors and key employees of the Company and their
ages as of July 15, 1997 are as follows:

NAME AGE POSITION
---- --- --------

Executive Officers
Benjamin F. McGraw, III, 48 Chairman, Chief Executive Officer and President
Pharm.D. ..............
Patrick G. Enright...... 35 Chief Financial Officer and Vice President
Rodney Pearlman, Ph.D. . 46 Vice President, Research and Development

Key Employees
Simba Gill, Ph.D. ...... 33 Vice President, Business Development
Beatrice C. Langton- Senior Director, Life Sciences
Webster, Ph.D. ........ 39
Lee B. Bussey, Ph.D. ... 44 Director, Bioprocessing
Helen Jenkins........... 34 Director, Project Development
Ralph W. Niven, Ph.D. .. 37 Director, Pharmaceutics and Delivery
Robert I. Grove, Ph.D. . 49 Principal Scientist, Cardiovascular
Jackie Papkoff, Ph.D.... 41 Principal Scientist, Oncology

Directors
Frank J. Caufield(1).... 57 Director
Edward L. Erickson...... 50 Director
A. Grant Heidrich(2).... 44 Director
Russell C. Hirsch, M.D., Director
Ph.D.(1)............... 34
Raju Kucherlapati, Director
Ph.D.(2)............... 54

- --------
(1) Member of the Audit Committee

(2) Member of the Compensation Committee

Benjamin F. McGraw, III, Pharm.D., joined the Company as President, Chief
Executive Officer and director in September 1994 and became Chairman of the
Board of Directors in February 1997. From April 1993 to September 1994, Dr.
McGraw was Corporate Vice President for Corporate Development for Allergan,
Inc., a pharmaceutical company. From November 1990 to April 1993, he served as
President of MedTech Trends, Inc., an investment advisory company. From
November 1991 to April 1993, Dr. McGraw was President of Carerra Capital
Management, Inc., an investment company, where he was the fund manager for a
limited partnership that invested in health care companies. From July 1989 to
November 1990, Dr. McGraw was Vice President, Development at Marion Merrell
Dow, Inc., a pharmaceutical company. From November 1987 to July 1989, he was
Vice President, Development at Marion Laboratories, Inc., a pharmaceutical
company. Dr. McGraw received his Doctor of Pharmacy from the University of
Tennessee Center for the Health Sciences.

Patrick G. Enright joined the Company as Chief Financial Officer and Vice
President in March 1995. From September 1993 to June 1994, Mr. Enright was
Senior Vice President of Finance and Business Development for Boehringer
Mannheim Therapeutics ("Boehringer Mannheim"), a pharmaceutical company and a
subsidiary of Corange Ltd. From September 1989 to September 1993, Mr. Enright
was employed at PaineWebber Incorporated, an investment banking firm, where he
became a Vice President in January 1992. From June 1984 to August 1989, he was
employed by Sandoz Corporation, a pharmaceutical company. Mr. Enright received
his M.B.A. from The Wharton School of Business at the University of
Pennsylvania and his B.S. in Biological Sciences from Stanford University.

Rodney Pearlman, Ph.D., has served as Vice President, Research and
Development since January 1995. From January 1988 to December 1994, Dr.
Pearlman was Director of Pharmaceutical Research and Development

at Genentech, Inc. ("Genentech"), a biotechnology company. At Genentech, he
was a Project Team Leader for Human Growth Hormone from March 1992 to June
1994. From September 1987 to December 1994, Dr. Pearlman was a senior
scientist at Genentech. Dr. Pearlman joined Genentech as a scientist in
September 1984. Prior to joining Genentech, he was an Assistant Professor of
Pharmaceutics at the University of Texas at Austin. From 1978 to 1981, Dr.
Pearlman was a Senior Scientist at Lilly. Dr. Pearlman received his Ph.D. in
Pharmaceutical Chemistry from the University of Kansas.

Simba Gill, Ph.D., joined the Company as Director, Business Development in
November 1995 and has served as Vice President, Business Development since
March 1997. From January 1995 to October 1995, Dr. Gill was Director of
Business Development at Systemix, Inc. ("Systemix"), a biotechnology company.
From September 1994 to December 1994, he was an independent consultant to
Systemix. From April 1991 to September 1994, Dr. Gill held various positions
at Boehringer Mannheim including Global Product Manager for Erythropoietin,
Global Business Development Manager focusing on Genomics and Gene Therapy and
Director of New Diagnostics Business Development. Dr. Gill received his Ph.D.
in Molecular Immunology from King's College, London University and his M.B.A.
from INSEAD, Fontainebleau, France.

Beatrice C. Langton-Webster, Ph.D., joined the Company as Director, Life
Sciences in November 1996 and has served as Senior Director, Life Sciences
since March 1997. From June 1992 to November 1996, Dr. Langton-Webster was the
Head of the Oncology Strategic Research Unit at Berlex Biosciences, a
subsidiary of Schering AG, a pharmaceutical company. From September 1985 to
October 1990, Dr. Langton-Webster was a Senior Research Scientist at Triton
Biosciences, a biotechnology company. Dr. Langton-Webster received her Ph.D.
in Medical Microbiology and Immunology from the University of California at
Davis.

Lee B. Bussey, Ph.D., has served as Director, Bioprocessing since June 1994.
From August 1990 to June 1994, Dr. Bussey was the Technical Manager of
Bioprocessing for Pel-Freez Biologicals, a biotechnology company. Dr. Bussey
received his Ph.D. in Microbiology from the University of California at Davis.

Helen Jenkins joined the Company as Project Manager in July 1994 and has
served as Director, Project Development since April 1996. From May 1993 to
June 1994, she was Product Manager at Glycomed Incorporated, a biotechnology
company. From August 1990 to May 1993, Ms. Jenkins served as a Project
Coordinator and a Senior Project Coordinator at Genentech. Ms. Jenkins
received her B.S. in Biochemistry from the California Polytechnic State
University at San Luis Obispo and her M.A. in Cellular and Molecular Biology
from San Francisco State University.

Ralph W. Niven, Ph.D. joined Megabios in January 1996 as a Senior Scientist
and has served as Director, Pharmaceutics and Delivery since October 1996.
From July 1991 to December 1995, Dr. Niven was a Research Scientist at Amgen
Inc., a biopharmaceutical company. Dr. Niven received his Ph.D. in
Pharmaceutical Sciences from the University of Kentucky.

Robert I. Grove, Ph.D., joined the Company as Principal Scientist,
Cardiovascular in March 1997. From November 1993 to March 1997, Dr. Grove was
Senior Scientific Investigator/Assistant Director and Group Leader of the
Hypercholesterolemia team in the Gene Therapy Department of Immune Response
Corporation, a biotechnology company. From January 1985 to November 1993, he
served as Senior Research Investigator in the preclinical Cardiovascular
Research Growth Regulators, and Autoimmunity and Transplantation Departments
of Bristol-Myers Squibb, a pharmaceutical company. Dr. Grove received his
Ph.D. in biochemistry from the University of South Florida.

Jackie Papkoff, Ph.D., joined the Company as Senior Scientist in February
1996 and has served as Principal Scientist, Oncology since November 1996. From
July 1993 to February 1996, Dr. Papkoff was a Senior Scientist at Sugen, Inc.,
a biotechnology company. From January 1993 to June 1993, she served as Group
Leader of the Tumor Biology Department and from January 1987 to January 1993,
Dr. Papkoff served as a Staff Researcher in the Biochemistry Department of
Syntex Research, a pharmaceutical company. Dr. Papkoff received her Ph.D. in
Biology from the University of California at San Diego.

Frank J. Caufield has served as a director of the Company since November
1992. Since 1978 he has held the position of partner of Kleiner Perkins
Caufield & Byers, a venture capital partnership. He serves on the Board of
Directors of Raster Graphics, Inc. and America Online, Inc. He received his
M.B.A. from the Harvard Business School and his B.S. in Engineering from the
United States Military Academy.

Edward L. Erickson has served as a director of the Company since July 1995.
Since June 1993, he has served as the President, Chief Executive Officer and a
director of DepoTech Corporation, a biopharmaceutical company in the field of
drug delivery. From 1991 to 1993, Mr. Erickson was the President, Chief
Executive Officer and a director of Cholestech Corporation, a medical products
company. Prior to joining Cholestech Corporation, he held senior management
positions with two international, publicly-traded biomedical companies, The
Ares-Serono Group and Amersham International plc. Mr. Erickson received his
M.B.A. from the Harvard Business School and his B.S. and M.S. degrees in
Mathematics from the Illinois Institute of Technology.

A. Grant Heidrich, III, has served as a director of the Company since August
1993. Mr. Heidrich joined Mayfield Fund ("Mayfield"), a venture capital firm,
in 1982 and has been a general partner or managing member of several venture
capital funds affiliated with Mayfield since 1983. Mr. Heidrich serves on the
Board of Directors of Millennium Pharmaceuticals, Inc. Mr. Heidrich received
his M.B.A. from Columbia University Graduate School of Business and his B.A.
in Human Biology from Stanford University.

Russell C. Hirsch, M.D., Ph.D., has served as a director of the Company
since August 1993. He joined Mayfield 1992, and has been a managing member of
several venture capital funds affiliated with Mayfield since 1995. From 1984
to 1992, Dr. Hirsch conducted research in the laboratories of Nobel Laureate
Harold Varmus, M.D., and Don Ganem, M.D., at the University of California, San
Francisco. Dr. Hirsch received his M.D. and Ph.D. in Biochemistry from the
University of California, San Francisco.

Raju Kucherlapati, Ph.D., has served as a director of the Company since
March 1995 and also serves on the Company's Scientific Advisory Board. Dr.
Kucherlapati has served as the Lola and Saul Kramer Professor and Chairman of
the Department of Molecular Genetics at Albert Einstein College of Medicine
since 1989. He was a founder of and serves on the Board of Directors of both
Cell Genesys and Millennium Pharmaceuticals, Inc. Dr. Kucherlapati received
his Ph.D. from the University of Illinois.

BOARD COMPOSITION

The Company currently has authorized eight directors. In accordance with the
terms of the Company's Restated Certificate of Incorporation, effective upon
the closing of this offering, the terms of office of the Board of Directors
will be divided into three classes: Class I, whose term will expire at the
annual meeting of stockholders to be held in 1998; Class II, whose term will
expire at the annual meeting of stockholders to be held in 1999; and Class
III, whose term will expire at the annual meeting of stockholders to be held
in 2000. The Class I directors are Benjamin F. McGraw, III and Frank J.
Caufield, the Class II directors are A. Grant Heidrich, III and Edward L.
Erickson, and the Class III directors are Raju Kucherlapati and Russell C.
Hirsch. At each annual meeting of stockholders after the initial
classification, the successors to directors whose term will then expire will
be elected to serve from the time of election and qualification until the
third annual meeting following election. In addition, the Company's Restated
Certificate of Incorporation provides that the authorized number of directors
may be changed only by resolution of the Board of Directors. Any additional
directorships resulting from an increase in the number of directors will be
distributed among the three classes so that, as nearly as possible, each class
will consist of one-third of the directors. This classification of the Board
of Directors may have the effect of delaying or preventing changes in control
or management of the Company. Although directors of the Company may be removed
for cause by the affirmative vote of the holders of a majority of the Common
Stock, the Company's Restated Certificate of Incorporation provides that
holders of two-thirds of the Common Stock must vote to approve the removal of
a director without cause.

BOARD COMMITTEES

The Audit Committee of the Board of Directors reviews the internal
accounting procedures of the Company and consults with and reviews the
services provided by the Company's independent auditors. The Compensation
Committee of the Board of Directors reviews and recommends to the Board of
Directors the compensation and benefits of all officers of the Company and
reviews general policy relating to compensation and benefits of employees of
the Company. The Compensation Committee also administers the issuance of stock
options and other awards under the Company's stock plans.

DIRECTOR COMPENSATION

The Company does not currently provide cash compensation to directors for
services in such capacity, but directors may be reimbursed for certain
expenses in connection with attendance at Board and Committee meetings. In
January 1995, the Board granted an option to Dr. Kucherlapati to purchase
13,333 shares of Common Stock at an exercise price of $0.30 per share. In
September 1995, the Board granted an option to Mr. Erickson to purchase 13,333
shares of Common Stock at an exercise price of $0.30 per share. The Company
intends to consider compensating non-employee directors in the future. In
February 1997, for his service as a member of the Company's SAB, the Board
granted an option to Dr. Kucherlapati to purchase an additional 13,333 shares
of Common Stock at an exercise price of $1.50 per share.

EXECUTIVE COMPENSATION

The following table sets forth certain compensation awarded or paid by the
Company during the fiscal year ended June 30, 1997 to its President and Chief
Executive Officer and the Company's other executive officers who earned more
than $100,000 during the fiscal year ended June 30, 1997 (collectively, the
"Named Executive Officers"):

SUMMARY COMPENSATION TABLE

LONG-TERM
COMPENSATION
AWARDS
ANNUAL ------------
COMPENSATION(1) SECURITIES ALL OTHER
------------------ UNDERLYING COMPENSATION
NAME AND PRINCIPAL POSITION SALARY($) BONUS($) OPTIONS(#) ($)(2)
- --------------------------- --------- -------- ------------ ------------

Benjamin F. McGraw, III, Pharm.D.. $258,174 $25,000 73,333 $509
Chairman, Chief Executive Officer
and President

Patrick G. Enright................ 166,539 16,000 30,000 329
Chief Financial Officer and Vice
President

Rodney Pearlman, Ph.D............. 169,904 16,500 25,000 335
Vice President, Research and
Development

- --------
(1) In accordance with Securities and Exchange Commission ("Commission")
rules, other annual compensation in the form of perquisites and other
personal benefits has been omitted where the aggregate amount of such
perquisites and other personal benefits constitutes less than the lesser
of $50,000 or 10% of the total annual salary and bonus for the Named
Executive Officer for the fiscal year.
(2) Represents insurance premiums paid by the Company with respect to group
life insurance for the benefit of the Named Executive Officer.

OPTION GRANTS IN LAST FISCAL YEAR

The following table sets forth each grant of stock options made during the
fiscal year ended June 30, 1997, to each of the Named Executive Officers:

INDIVIDUAL GRANTS
------------------------------------------------- POTENTIAL REALIZABLE
PERCENTAGE OF VALUE AT ASSUMED
NUMBER OF TOTAL OPTIONS ANNUAL RATES OF STOCK
SECURITIES GRANTED TO PRICE APPRECIATION FOR
UNDERLYING EMPLOYEES IN EXERCISE OPTION TERM(4)
OPTIONS FISCAL YEAR PRICE EXPIRATION -----------------------
NAME GRANTED (#)(1) (%)(2) ($/SH)(3) DATE 5% ($) 10% ($)
---- -------------- ------------- --------- ---------- ----------- -----------

Benjamin F. McGraw, III, 73,333 18.9% $1.50 02/28/07 $ 1,324,394 $ 2,169,199
Pharm.D. ..............
Chairman, Chief
Executive
Officer and President
Patrick G. Enright...... 30,000 7.7 1.50 02/28/07 541,800 887,400
Chief Financial Officer
and Vice President
Rodney Pearlman, Ph.D... 25,000 6.4 1.50 02/28/07 451,400 739,500
Vice President,
Research and
Development

- --------
(1) Twenty-five percent of such options granted vest one year from the vesting
commencement date with remaining options vesting at a rate of 1/36th per
month over three years. Options may be exercised immediately pursuant to
early exercise provisions contained in option agreements. Any shares
issued pursuant to such early exercise provisions are subject to
repurchase upon termination of employment. Such repurchase option
terminates at the rate of twenty five percent after one year from the
vesting commencement date and thereafter at a rate of 1/36th per month
over three years. The options expire 10 years from the date of grant, or
earlier upon termination of employment.
(2) Based on an aggregate of 388,680 options granted to employees, consultants
and directors of the Company during fiscal year ended June 30, 1997,
including the Named Executive Officers.
(3) The exercise price per share of each option was equal to the fair market
value of the Common Stock on the date of grant as determined by the Board
of Directors.
(4) The 5% and 10% assumed annual rates of compounded stock price appreciation
are mandated by rules of the Securities and Exchange Commission. There can
be no assurance provided to any executive officer or any other holder of
the Company's securities that the actual stock price appreciation over the
10-year term will be at the assumed 5% or 10% levels or at any other
defined level. Unless the market price of the Common Stock appreciates
over the option term, no value will be realized from the option grants
made to the executive officers. The potential realizable value is
calculated by assuming that the assumed initial public offering price of
$12.00 per share appreciates at the indicted rate for the entire term of
the option and that the option is exercised at the exercise price and sold
on the last day of its term at the appreciated price.

AGGREGATE OPTION EXERCISES IN FISCAL 1997 AND JUNE 30, 1997 OPTION VALUES

The following table sets forth for each of the Named Executive Officers the
shares acquired and the value realized on each exercise of stock options
during the fiscal year ended June 30, 1997 and the number and value of
securities underlying unexercised options held by the Named Executive Officers
at June 30, 1997:

NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY
OPTIONS AT OPTIONS AT
JUNE 30, 1997(#)(1) JUNE 30, 1997($)(2)
---------------------- --------------------
SHARES
ACQUIRED ON VALUE EXERCISABLE/ EXERCISABLE/
NAME EXERCISE(#)(1) REALIZED($)(2) UNEXERCISABLE UNEXERCISABLE
---- -------------- -------------- ---------------------- --------------------

Benjamin F. McGraw, III, -- -- 73,333/0 $769,997/0
Pharm.D................
Chairman, Chief
Executive Officer
and President
Patrick G. Enright...... -- -- 30,000/0 315,000/0
Chief Financial Officer
and Vice President
Rodney Pearlman, Ph.D... 29,166 $341,242 25,000/0 262,500/0
Vice President,
Research and
Development

- --------
(1) Options may be exercised immediately pursuant to early exercise provisions
contained in option agreements. Any shares issued pursuant to such early
exercise provisions are subject to repurchase at the original exercise
price paid per share upon termination of employment. Such repurchase
option terminates at the rate of twenty five percent after one year from
the vesting commencement date and thereafter at a rate of 1/36th per month
over three years.
(2) Value realized and value of unexercised in-the-money options is based on a
value of $12.00 per share of the Company's Common Stock, the assumed
initial public offering price, even though at the time of grant the fair
market value of the Common Stock was determined by the Board of Directors
to be $0.30 to $1.50 per share. Amounts reflected are based on the assumed
value minus the exercise price multiplied by the number of shares acquired
on exercise and do not indicate that the optionee sold such stock.

EMPLOYMENT AGREEMENTS

In August 1994, the Company entered into an employment agreement with Dr.
McGraw providing for an annual compensation of $250,000, an option to purchase
up to 250,000 shares of Common Stock at $0.30 per share subject to a four-year
vesting schedule, a signing bonus of $65,000 payable in quarterly
installments, certain relocation expenses and a severance payment equal to
twelve months salary in the event of termination without cause.

In February 1995, the Company entered into an employment agreement with Mr.
Enright providing for an annual compensation of $160,000, an option to
purchase up to 91,666 shares of Common Stock at an exercise price of $0.30 per
share subject to a four-year vesting schedule, a $10,000 signing bonus and
payment of certain relocation expenses.

In November 1994, the Company entered into an employment agreement with Dr.
Pearlman providing for an annual compensation of $165,000, an option to
purchase up to 83,333 shares of Common Stock at an exercise price of $0.30 per
share subject to a four-year vesting schedule and a $30,000 bonus payable in
quarterly installments during 1995.

In January 1996, the Board of Directors approved the Change of Control
Policy for the protection of the Company's executive officers. In the event of
a merger in which the Company is not the surviving entity or a transaction or
series of transactions in which more than 50% of the Company's voting power is
transferred or

the sale of all or substantially all the assets of the Company (each a "Change
of Control"), an executive officer will continue to receive salary and
benefits for twelve months from the date of his or her termination unless such
termination is for cause (or voluntary termination of his or her employment
for good cause). Further, in the event of a Change of Control, all outstanding
stock options of each executive officer shall automatically accelerate by the
greater of twelve months or the number of full months during which the officer
has been employed by the Company. However, the Board of Directors of the
Company may provide that options be assumed by the acquiror, remain
outstanding or provide for a replacement benefit equal in value.

STOCK PLANS

Equity Incentive Plan. The Company's 1997 Equity Incentive Plan (the
"Incentive Plan") was adopted by the Board of Directors in July 1997 as an
amendment and restatement of the Company's 1993 Stock Option Plan (the "1993
Plan"). There are currently 2,100,000 shares of Common Stock authorized for
issuance under the Incentive Plan.

The Incentive Plan provides for the grant of incentive stock options under
the Internal Revenue Code of 1986, as amended (the "Code"), to employees
(including officers and employee-directors) and nonstatutory stock options,
restricted stock purchase awards and stock bonuses to employees, directors and
consultants. The Incentive Plan is administered by the Board of Directors or a
committee appointed by the Board which determines recipients and types of
awards to be granted, including the exercise price, number of shares subject
to the award and the exercisability thereof.

The terms of stock options granted under the Incentive Plan generally may
not exceed 10 years. The exercise price of options granted under the Incentive
Plan is determined by the Board of Directors, provided that the exercise price
for an incentive stock option cannot be less than 100% of the fair market
value of the Common Stock on the date of the option grant and the exercise
price for a nonstatutory stock option cannot be less than 85% of the fair
market value of the Common Stock on the date of option grant. Options granted
under the Incentive Plan vest at the rate specified in the option agreement.
No stock option may be transferred by the optionee other than by will or the
laws of descent or distribution, provided that a nonstatutory stock option may
be transferable if provided in the option agreement, and provided further that
an optionee may designate a beneficiary who may exercise the option following
the optionee's death. An optionee whose relationship with the Company or any
related corporation ceases for any reason (other than by death or permanent
and total disability) may exercise options in the three-month period following
such cessation (unless such options terminate or expire sooner or later by
their terms). Options may be exercised for up to twelve months after an
optionee's relationship with the Company and its affiliates ceases due to
death or disability (unless such options expire sooner or later by their
terms).

No incentive stock option may be granted to any person who, at the time of
the grant, owns (or is deemed to own) stock possessing more than 10% of the
total combined voting power of the Company or any affiliate of the Company,
unless the option exercise price is at least 110% of the fair market value of
the stock subject to the option on the date of grant, and the term of the
option does not exceed five years from the date of grant. The aggregate fair
market value, determined at the time of grant, of the shares of Common Stock
with respect to which incentive stock options are exercisable for the first
time by an optionee during any calendar year (under all such plans of the
Company and its affiliates) may not exceed $100,000. Upon the expiration of
the transition rule extending the effective date of code section 162(m) for
newly public companies no person shall be eligible to receive options covering
more than 500,000 shares in any calendar year.

Shares subject to stock awards that have expired or otherwise terminated
without having been exercised in full (or vested in the case of restricted
stock awards) shall again become available for the grant of awards under the
Incentive Plan.

The Board of Directors has the authority to reprice outstanding options and
to offer optionees the opportunity to replace outstanding options with new
options for the same or a different number of shares.

Restricted stock purchase awards granted under the Incentive Plan may be
granted pursuant to a repurchase option in favor of the Company in accordance
with a vesting schedule and at a price determined by the Board of Directors.
Restricted stock purchases must be at a price equal to at least 85% of the
stock's fair market value on the award date, but stock bonuses may be awarded
in consideration of past services without a purchase payment. Rights under a
stock bonus or restricted stock bonus agreement may not be transferred other
than by will, the laws of descent and distribution or a domestic relations
order while the stock awarded pursuant to such an agreement remains subject to
the agreement.

Upon a change in control of the Company, the vesting of options held by
executive officers will accelerate by the greater of 12 months or the number
of months of the executive officer's employment, unless the Board of Directors
finds that it is in the best interest of the Company's stockholders and the
optionees to provide otherwise. If such a finding is made, the options shall
either remain outstanding or be assumed by the acquiror (with the optionee
being entitled to receive the same consideration as was received by the
Company's stockholders in the change of control transaction) or the Board of
Directors and/or the acquiror shall adopt a replacement benefit which shall
(at a minimum) provide value to the executive officer on the vesting dates of
the non-accelerated options substantially equal to the value the executive
officer would have received if the shares had participated in all steps of the
transaction. With respect to optionees who are not executive officers, upon a
change in control any options shall remain outstanding, be assumed by the
acquiror or be substituted with similar options. In the event the acquiror
refuses to assume, substitute or continue any options, then such options shall
be terminated if not exercised prior to the change of control. For purposes of
this Plan, "Change in Control" means: any consolidation or merger of the
Company with or into any other entity or person, or any other corporate
reorganization, in which the Company is not the continuing or surviving
entity, or any transaction or series of related transactions by the Company in
which in excess of 50% of the Company's voting power is transferred, or any
sale, lease, license or other disposition of all or substantially all of the
assets of the Company.

As of June 30, 1997, 878,224 shares of Common Stock had been issued upon the
exercise of options granted under the 1993 Plan and the Incentive Plan (39,545
of which had been repurchased and of which were subject to repurchase),
options to purchase 479,622 shares of Common Stock at a weighted average
exercise price of $1.22 were outstanding and 121,699 shares remained available
for future grant. The Incentive Plan will terminate in July 2007 unless sooner
terminated by the Board of Directors. As of June 30, 1997, no stock bonuses or
restricted stock have been granted under the Incentive Plan.

Employee Stock Purchase Plan. In July 1997, the Company's Board of Directors
approved the Employee Stock Purchase Plan (the "Purchase Plan") covering an
aggregate of 200,000 shares of Common Stock. The Purchase Plan is intended to
qualify as an employee stock purchase plan within the meaning of Section 423
of the Code. Under the Purchase Plan, the Board of Directors may authorize
participation by eligible employees, including officers, in periodic offerings
following the adoption of the Purchase Plan. The offering period for any
offering will be no more than 27 months.

Employees are eligible to participate if they are employed by the Company or
an affiliate of the Company designated by the Board of Directors and are
employed at least 20 hours per week and five months per year. Employees who
participate in an offering can have up to 15% of their earnings withheld
pursuant to the Purchase Plan and applied, on specified dates determined by
the Board of Directors, to the purchase of shares of Common Stock. The price
of Common Stock purchased under the Purchase Plan will be equal to 85% of the
lower of the fair market value of the Common Stock on the commencement date of
each offering period or the relevant purchase date. Employees may end their
participation in the offering at any time during the offering period, and
participation ends automatically on termination of employment with the
Company.

In the event of certain changes of control, the Company and the Board of
Directors has discretion to provide that each right to purchase Common Stock
will be assumed or an equivalent right substituted by the successor
corporation, or the Board may shorten the offering period and provide for all
sums collected by payroll deductions to be applied to purchase stock
immediately prior to the change in control. The Purchase Plan will terminate
at the Board's discretion.

LIMITATION OF LIABILITY AND INDEMNIFICATION MATTERS

The Company's Bylaws provide that the Company will indemnify its directors
and executive officers and may indemnify its other officers, employees and
other agents to the fullest extent permitted by Delaware law. The Company is
also empowered under its Bylaws to enter into indemnification contracts with
its directors and officers and to purchase insurance on behalf of any person
it is required to permitted to indemnify. Pursuant to this provision, the
Company expects to enter into indemnification agreements with each of its
directors and executive officers.

The Company has obtained officer and director liability insurance with
respect to liabilities arising out of certain matters, including matters
arising under the Securities Act. In addition, the Company's Restated
Certificate of Incorporation provides that, to the fullest extent permitted by
Delaware law, the Company's directors will not be liable for monetary damages
for breach of the directors' fiduciary duty of care to the Company and its
stockholders. This provision in the Restated Certificate of Incorporation does
not eliminate the duty of care, and in appropriate circumstances equitable
remedies such as an injunction or other forms of non-monetary relief would
remain available under Delaware law. Under current Delaware law, a director's
liability to the Company or its stockholders may not be limited with respect
to any breach of the director's duty of loyalty to the Company or its
stockholders, for acts or omissions not in good faith or involving intentional
misconduct, for knowing violations of law, for any transaction from which the
director derived an improper personal benefit, for improper transactions
between the director and the Company and for improper distributions to
stockholders and loans to directors and officers. This provision also does not
affect a director's responsibilities under any other laws, such as the federal
securities laws or state or federal environmental laws.

There is no pending litigation or proceeding involving a director or officer
of the Company as to which indemnification is being sought, nor is the Company
aware of any pending or threatened litigation that may result in claims for
indemnification by any director or officer.

CERTAIN TRANSACTIONS

In August 1994, Mayfield VII, Mayfield Associates Fund II, William L. Brown,
a former director and a 5% stockholder of the Company, and Frank J. Caufield,
a director of the Company, extended bridge loans to the Company in an
aggregate principal amount of $250,000 in order to provide temporary working
capital for the Company. Mr. Heidrich, a director of the Company, is a member
of Mayfield Fund, the general partner of Mayfield VII and Mayfield Associates
Fund II. The loans accrued interest at 5.8% per annum. The outstanding
principal balance and accrued interest on the loans automatically converted
into 64,442 shares of Series C Preferred Stock upon the first closing of the
Company's sale of Series C Preferred Stock in September 1994.

From September 1994 through October 1995, 37 investors purchased an
aggregate of 3,184,424 shares of the Company's Series C Preferred Stock at a
per share price of $3.88. Dr. McGraw, the Company's Chairman of the Board,
President and Chief Executive Officer, purchased 33,333 shares of Series C
Preferred Stock. Frank J. Caufield purchased 45,062 shares of Series C
Preferred Stock. William L. Brown purchased 57,937 shares of Series C
Preferred Stock. Institutional Venture Partners V and Institutional Venture
Management V, together holders of more than 5% of the Common Stock, purchased
312,701 and 6,380 shares, respectively, of Series C Preferred Stock. Various
entities affiliated with Burr, Egan, Deleage & Co., a holder of more than 5%
of the Common Stock, purchased shares of Series C Preferred Stock as follows:
Alta V Limited Partnership, 509,643 shares; and Custom House Partners, 5,356
shares. Mayfield VII and Mayfield Associates Fund II, together holders of more
than 5% of the Common Stock, purchased 611,724 and 32,195 shares,
respectively, of Series C Preferred Stock. The Series C Preferred shares
purchased by the holders of more than 5% of the Common Stock and their
affiliates and by Dr. McGraw were purchased on the same terms and conditions
as Series C Preferred shares purchased by other investors.

In October 1996, 24 investors purchased an aggregate of 1,333,333 shares of
the Company's Series E Preferred Stock at a per share price of $7.50. Lombard
Odier & Cie, a holder of more than 5% of the Common Stock, purchased
359,999 shares of Series E Preferred Stock. Triaxis Trust AG, a beneficial
owner of more than 5% of the Common Stock, purchased shares of Series E
Preferred Stock as follows: ABN Amro Bank as nominee for various investors,
321,667 shares and Ueberseebank AG as nominee for various investors, 65,000
shares. Entities affiliated with Burr, Egan, Deleage & Co. purchased shares of
Series E Preferred Stock as follows: Alta V Limited Partnership,
65,973 shares; and Custom House Partners, 693 shares. The Series E Preferred
shares purchased by the holders of more than 5% of the Common Stock of the
Company and their affiliates were purchased on the same terms and conditions
as Series E Preferred shares purchased by other investors. In connection with
the sale of the Series E Preferred Stock, the Company also issued 13,333
shares of Common Stock to Hans-Peter John who is the Chairman of the Board and
a partner of Triaxis Trust AG, as compensation for services as placement
agent.

In May and June 1997, 17 investors purchased an aggregate of 1,333,332
shares of the Company's Series F Preferred Stock at a per share price of
$10.50. Lombard Odier & Cie, a holder of more than 5% of the Common Stock,
purchased 333,333 shares of Series F Preferred Stock. Triaxis Trust AG,
purchased shares of Series F Preferred Stock as follows: ABN Amro Bank, as
nominees for various entities, 83,333 shares; Bank Julius Baer, as nominee for
various entities, 5,000 shares; Credit Suisse, as nominees for various
entities, 90,000 shares; Centrum Bank, as nominee for various entities, 10,000
shares; Ueberseebank AG, as nominee for various entities, 10,000 shares; and
Bank Eduoard Constant, as nominees for various entities, 35,000 shares. The
Series F Preferred Shares purchased by the holders of more than 5% of the
Common Stock of the Company and their affiliates were purchased on the same
terms and conditions as Series F Preferred Shares purchased by other
investors.

The Company has entered into indemnification agreements with its directors
and executive officers for the indemnification of and advancement of expenses
to such persons to the full extent permitted by law. The Company also intends
to execute such agreements with its future directors and executive officers.

The Company believes that the foregoing transactions were in its best
interest. As a matter of policy the transactions were, and all future
transactions between the Company and any of its officers, directors or
principal stockholders will be, approved by a majority of the independent and
disinterested members of the Board of Directors, will be on terms no less
favorable to the Company than could be obtained from unaffiliated third
parties and will be in connection with bona fide business purposes of the
Company.

PRINCIPAL STOCKHOLDERS

The following table sets forth certain information regarding the beneficial
ownership of the Company's Common Stock as of July 15, 1997 and as adjusted to
reflect the sale of the Common Stock being offered hereby by: (i) each
stockholder who is known by the Company to own beneficially more than 5% of
the Common Stock; (ii) each Named Executive Officer of the Company; (iii) each
director of the Company and (iv) all directors and executive officers of the
Company as a group. Unless otherwise indicated below, to the knowledge of the
Company, all persons listed below have sole voting and investment power with
respect to their shares of Common Stock, except to the extent authority is
shared by spouses under applicable law.

PERCENTAGE OF SHARES
BENEFICIALLY OWNED(1)
SHARES -----------------------
BENEFICIALLY PRIOR TO AFTER
BENEFICIAL OWNER OWNED OFFERING OFFERING
---------------- ------------ ---------- ----------

Entities affiliated with Mayfield Fund(2). 1,287,668 13.2% 10.5%
2800 Sand Hill Road
Menlo Park, CA 94025
Lombard Odier & Cie(3).................... 693,332 7.1% 5.7%
11 Rue de la Corraterie
1211 Geneva
Switzerland
Entities affiliated with
Institutional Venture Partners(4)........ 640,955 6.6% 5.2%
3000 Sand Hill Road
Suite 2-290
Menlo Park, CA 94025
Triaxis Trust AG(5)....................... 633,333 6.5% 5.2%
Burglistrasse 6 Postfach
CH-8027 Zurich Switzerland
Entities affiliated with
Burr, Egan, Deleage & Co(6).............. 581,665 6.0% 4.8%
One Embarcadero Center, #4050
San Francisco, CA 94111
William L. Brown.......................... 531,817 5.5% 4.3%
Two Embarcadero Center, #1660
San Francisco, CA 94111
Benjamin F. McGraw, III, Pharm.D.(7)...... 406,666 4.1% 3.3%
Patrick G. Enright(8)..................... 144,499 1.5% 1.1%
Rodney Pearlman, Ph.D.(9)................. 137,499 1.4% 1.1%
Edward Erickson(10)....................... 13,333 * *
Frank J. Caufield......................... 406,821 4.2% 3.3%
A. Grant Heidrich(2)...................... 1,287,668 13.2% 10.5%
Russell C. Hirsch, M.D., Ph.D............. 0 * *
Raju Kucherlapati(11)..................... 26,666 * *
All directors and executive officers as a
group (8 persons)(12).................... 2,423,152 24.5% 19.6%

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* Represents beneficial ownership of less than 1% of the outstanding shares
of the Company's Common Stock.
(1) Beneficial ownership is determined in accordance with the rules of the
Commission and generally includes voting or investment power with respect
to securities. Beneficial ownership also includes shares of stock subject
to options and warrants currently exercisable or convertible, or
exercisable or convertible within 60 days of the date of this table.
Percentage of beneficial ownership is based on 9,725,939 shares of Common
Stock outstanding as of July 15, 1997 and 12,225,939 shares of Common
Stock outstanding after completion of this offering.
(2) Includes 1,226,505 shares held by Mayfield VII and 61,163 shares held by
Mayfield Associates Fund II. Mr. Heidrich is a member of Mayfield Fund,
the general partner of Mayfield Associates Fund II and Mayfield VII. Mr.
Heidrich disclaims beneficial ownership of all such shares held by
Mayfield VII or Mayfield Associates Fund II, except to the extent of his
proportionate pecuniary interest therein.
(3) Shares are held in the name of Ryco & Co, as nominee for Lombard Odier &
Cie.
(4) Includes 628,138 shares held by Institutional Venture Partners V and
12,817 held by Institutional Venture Management V.
(5) Triaxis Trust acts as financial advisor for various investors and has
voting and dispositive power over the shares held by such investors.
Includes an aggregate 405,000 shares held in the name of ABN Amro Bank as
nominee for various investors, 5,000 shares held in the name of Bank
Julius Baer, as nominee for various investors, 35,000 shares held in the
name of Banque Eduoard Constant, as nominee for various investors, 10,000
shares held in the name of Centrum Bank, as nominee for various
investors, 90,000 shares held in the name of Credit Suisse as nominee for
various investors, 75,000 shares held in the name of Ueberseebank AG as
nominee for various investors and 13,333 shares held by Hans-Peter John,
the Chairman of the Board and a partner of Triaxis Trust.
(6) Includes 575,616 shares held by Alta V Limited Partnership and 6,049
shares held by Customs House Partners. The principals of Burr, Egan,
Deleage & Co. are general partners of Alta V Management Partners, L.P.
(which is a general partner of Alta V Limited Partnership), and Customs
House Partners. The principals of Burr, Egan, Deleage & Co. disclaim
beneficial ownership of all such shares held by the foregoing funds,
except to the extent of their proportionate pecuniary interests therein.
(7) Includes 300,000 shares Dr. McGraw acquired pursuant to the exercise of
stock options, 92,708 of which will be subject to repurchase by the
Company as of September 13, 1997. Also includes 73,333 shares Dr. McGraw
has the right to acquire pursuant to an option exercisable within 60
days, all of which will be subject to repurchase by the Company at such
date, if issued.
(8) Includes 2,000 shares held by Enright Capital Advisors, an investment
partnership of which Mr. Enright is a partner. Mr. Enright disclaims
beneficial ownership of all such shares owned by the foregoing
partnership, except to the extent of his proportionate pecuniary interest
therein. Includes 112,499 shares Mr. Enright acquired pursuant to the
exercise of stock options, 46,961 of which will be subject to repurchase
by the Company as of September 13, 1997. Also includes 30,000 shares Mr.
Enright has the right to acquire pursuant to an option exercisable within
60 days, all of which will be subject to repurchase by the Company at
such date, if issued.
(9) Includes 112,499 shares Dr. Pearlman acquired pursuant to the exercise of
stock options, 45,398 of which will be subject to repurchase by the
Company as of September 13, 1997. Also includes 25,000 shares Dr.
Pearlman has the right to acquire pursuant to options exercisable within
60 days, all of which will be subject to repurchase by the Company at
such date, if issued.
(10) Includes 13,333 shares Mr. Erickson acquired pursuant to the exercise of
stock options, 6,389 of which will be subject to repurchase by the
Company as of September 13, 1997.
(11) Includes 26,666 shares Dr. Kucherlapati has the right to acquire pursuant
to options exercisable within 60 days, 16,666 of which will be subject to
repurchase by the Company at such date, if issued.
(12) Includes 1,287,668 shares held by entities affiliated with certain
directors of the Company as described in footnote 2 above and 154,999
shares subject to options exercisable within 60 days.

DESCRIPTION OF CAPITAL STOCK

Upon completion of this offering, the authorized capital stock of the
Company will consist of 30,000,000 shares of Common Stock, $.001 par value,
and 10,000,000 shares of Preferred Stock, $.001 par value.

COMMON STOCK

As of July 15, 1997, there were 1,571,160 shares of Common Stock outstanding
held of record by approximately 64 stockholders. There will be 12,225,939
shares of Common Stock outstanding after giving effect to the sale of
2,500,000 shares of Common Stock offered by the Company hereby and after
giving effect to the conversion of all shares of Preferred Stock into an
aggregate of 8,154,779 shares of Common Stock.

The holders of Common Stock are entitled to one vote for each share held of
record on all matters submitted to a vote of the stockholders. The holders of
Common Stock are entitled to receive ratably such dividends as may be declared
by the Board of Directors out of funds legally available therefor. See
"Dividend Policy." In the event of a liquidation, dissolution or winding up of
the Company, holders of the Common Stock are entitled to share ratably in all
assets remaining after payment of liabilities. Holders of Common Stock have no
preemptive rights and no right to convert their Common Stock into any other
securities. There are no redemption or sinking fund provisions applicable to
the Common Stock. All outstanding shares of Common Stock are, and all shares
of Common Stock to be outstanding upon completion of this offering will be,
fully paid and nonassessable.

PREFERRED STOCK

The Board of Directors has the authority, without further action by the
stockholders, to issue up to 10,000,000 shares of Preferred Stock, $.001 par
value, in one or more series and to fix the rights, preferences, privileges
and restrictions thereof, including dividend rights, conversion rights, voting
rights, terms of redemption, liquidation preferences, sinking fund terms and
the number of shares constituting any series or the designation of such
series, without any further vote or action by stockholders. The issuance of
Preferred Stock could adversely affect the voting power of holders of Common
Stock and the likelihood that such holders will receive dividend payments and
payments upon liquidation and could have the effect of delaying, deferring or
preventing a change in control of the Company. The Company has no present plan
to issue any shares of Preferred Stock.

WARRANTS

As of July 15, 1997, the Company had outstanding warrants to purchase 84,008
shares of Common Stock at an exercise price of $3.88 per share. The warrants
expire at various times from the day prior to the effectiveness of this
initial public offering to five years following the closing of this initial
public offering. Each warrant contains provisions for the adjustment of the
exercise price and the aggregate number of shares issuable upon the exercise
of the warrant under certain circumstances, including stock dividends, stock
splits, reorganizations, reclassification, consolidations and certain dilutive
sales of the securities for which the warrant is exercisable below the then
existing exercise price. Each warrant may be exercised, without the payment of
cash, for the number of shares of Common Stock purchasable, at the current
market value of the Common Stock, by the difference between the aggregate
exercise price of the warrant and the value, at the current market price per
share of Common Stock of the aggregate number of shares purchasable under the
warrant.

REGISTRATION RIGHTS

Following this offering, holders (or their permitted transferees)
("Holders") of 8,154,779 shares of Common Stock and warrants to purchase
84,008 shares of Common Stock will be entitled to certain rights with respect
to the registration of their shares under the Securities Act. Under the terms
of that certain Amended and Restated Investor Rights Agreement dated May 23,
1997 (the "Investor Rights Agreement"), if the Company proposes to register
any of its securities under the Securities Act, either for its own account or
the account of

others, certain of the Holders are entitled to notice of such registration and
are entitled to include their shares of Common Stock; provided, among other
conditions, that the underwriters of any offering have the right to limit the
number of such shares included in such registration or exclude such shares
entirely. Certain of the Holders may also require the Company, at the
Company's expense, to register all or a portion of their shares of Common
Stock on form S-3 when such form becomes available to the Company, subject to
certain conditions and limitations. In addition, certain of the Holders may
also require the Company, beginning 180 days after the date of this
Prospectus, on not more than two occasions, to file a registration statement
under the Securities Act at the Company's expense with respect to their shares
of Common Stock, and the Company is required to use its best efforts to effect
such registration, subject to certain conditions and limitations. In addition,
one holder of 484,697 shares of Common Stock has a right to include its shares
of Common Stock only in connection with the first firm underwritten public
offering after May 30, 2001.

DELAWARE LAW AND CERTAIN CHARTER PROVISIONS

The Company is subject to the provisions of Section 203 of the Delaware Law,
an anti-takeover law. In general, the statute prohibits a publicly held
Delaware corporation from engaging in a "business combination" with an
"interested stockholder" for a period of three years after the date of the
transaction in which the person became an interested stockholder, unless the
business combination is approved in a prescribed manner. For purposes of
Section 203, a "business combination" includes a merger, asset sale or other
transaction resulting in a financial benefit to the interested stockholder,
and an "interested stockholder" is a person who, together with affiliates and
associates, owns (or within three years prior, did own) 15% or more of the
corporation's voting stock.

The Company's Certificate of Incorporation and Bylaws also require that,
effective upon the closing of this offering, any action required or permitted
to be taken by stockholders of the Company must be effected at a duly called
annual or special meeting of the stockholders and may not be effected by a
consent in writing. In addition, special meetings of the stockholders of the
Company may be called only by the Board of Directors, the Chairman of the
Board, the Chief Executive Officer of the Company or by any person or persons
holding shares representing at least 10% of the outstanding capital stock. The
Company's Certificate of Incorporation also provides for a classified Board
and specifies that the authorized number of directors may be changed only by
resolution of the Board of Directors. See "Management--Board Composition."
These provisions may have the effect of deterring hostile takeovers or
delaying changes in control or management of the Company.

TRANSFER AGENT AND REGISTRAR

First National Bank of Boston has been appointed as the transfer agent and
registrar for the Company's Common Stock.

SHARES ELIGIBLE FOR FUTURE SALE

Prior to this offering, there has not been any public market for the Common
Stock of the Company. Further sales of substantial amounts of Common Stock in
the open market may adversely affect the market price of the Common Stock
offered hereby.

Upon completion of this offering, based on the number of shares outstanding
as of July 15, 1997, the Company will have outstanding an aggregate of
12,247,569 shares of Common Stock assuming (i) the issuance by the Company of
2,500,000 shares of Common Stock offered hereby, (ii) the issuance of 21,630
shares of Common Stock relating to an outstanding warrant to purchase Common
Stock that expires upon this Offering and no issuance of 62,378 shares of
Common Stock relating to other outstanding warrants, (iii) no exercise of
exercisable vested options to purchase 64,371 shares of Common Stock, and (iv)
no exercise of the Underwriters' over-allotment option to purchase 375,000
shares of Common Stock. Of these shares, 2,500,000 shares sold in this
offering will be freely tradable without restriction or further registration
under the Securities Act, except for shares held by "affiliates" of the
Company as that term is defined in Rule 144 under the Securities Act (whose
sales would be subject to certain limitations and restrictions described
below) and the regulations promulgated thereunder.

The remaining 9,725,939 shares held by officers, directors, employees,
consultants and other stockholders of the Company were sold by the Company in
reliance on exemptions from registration requirements of the Securities Act
and are "restricted" securities within the meaning of Rule 144 under the
Securities Act. As a result, on the date of this prospectus, approximately
22,645 shares, other than the 2,500,000 shares offered hereby, will be
eligible for sale pursuant to subsection (k) of Rule 144 promulgated under the
Securities Act. An additional 8,045,052 shares and 96,709 shares issuable upon
exercise of outstanding vested options will be eligible for sale 180 days
after the date of this Prospectus upon expiration of the lock-up agreements
described below and in compliance with certain limitations set forth in the
Securities Act. An additional 1,385,706 shares held by existing shareholders
will become eligible for sale at various times over a period of less than one
year. The remaining 272,536 shares currently held by existing shareholders
will be subject to rights of repurchase in favor of the Company that expire at
various dates through May 2001 pursuant to monthly vesting.

Each officer, director and certain stockholders of the Company have agreed
that for a period of 180 days after the date of this Prospectus, they will
not, directly or indirectly, offer, sell, contract to sell, grant any option
to sell or otherwise dispose of, directly or indirectly, any shares of Common
Stock or securities convertible into or exchangeable for, or any rights to
purchase or acquire, Common Stock, without the prior written consent of the
Company or Montgomery Securities, as applicable. Montgomery Securities or the
Company, as applicable, at any time without notice, may release all or any
portion of the securities subject to the 180-day lock-up agreement. The
Company has agreed with Montgomery Securities not to release any stockholder
from such lock-up agreement between the stockholder and the Company without
the prior written consent of Montgomery Securities.

In general, under rule 144 as currently in effect, beginning 90 days after
the date of this Prospectus, an affiliate of the Company, or person (or
persons whose shares are aggregated) who has beneficially owned Restricted
Shares that were not acquired from the Company or an affiliate of the Company
within the previous one year, will be entitled to sell in any three-month
period a number of shares that does not exceed the greater of (i) 1% of the
then outstanding shares of the Company's Common Stock (approximately 122,475
shares immediately after this offering) or (ii) the average weekly trading
volume of the Company's Common Stock in the Nasdaq National Market during the
four calendar weeks immediately preceding the date on which notice of the sale
is filed with the Securities and Exchange Commission. Sales pursuant to Rule
144 are subject to certain requirements relating to manner of sale, notice and
availability of current public information about the Company. A person (or
person whose shares are aggregated) who is not deemed to have been an
affiliate of the Company at any time during the 90 days immediately preceding
the sale and who beneficially owns Restricted Shares is entitled to sell such
shares pursuant to Rule 144(k) without regard to the limitations described
above; provided that at least two years have elapsed since the later of the
date the shares were acquired from the Company or from an affiliate of the
Company.

An employee, officer or director of or consultant to the Company who
purchased or was awarded shares or options to purchase shares pursuant to a
written compensatory plan or contract is entitled to rely on the resale
provisions of Rule 701 under the Securities Act, which permits affiliates and
non-affiliates to sell their Rule 701 shares without having to comply with
Rule 144's holding period restrictions, in each case commencing 90 days after
the date of this Prospectus. In addition, non-affiliates may sell Rule 701
shares without complying with public information, volume and notice provisions
of Rule 144.

The Company intends to file a registration statement under the Securities
Act to register shares of Common Stock reserved for issuance under the
Incentive Plan and the Purchase Plan, thus permitting the resale of such
shares by non-affiliates in the public market without restriction under the
Securities Act. Such registration statement will become effective immediately
upon filing.

As of the date of this Prospectus, warrants to purchase an aggregate of
84,008 shares of Common Stock were outstanding, all of which are subject to
the 180-day lock-up.

In addition, after this offering, the holders of approximately 8,154,779
shares will be entitled to certain rights with respect to registration of such
shares under the Securities Act. Registration of such shares under the
Securities Act would result in such shares becoming freely tradable without
restriction under the Securities Act (except for shares purchased by
affiliates of the Company) immediately upon the effectiveness of such
registration. See "Description of Capital Stock--Registration Rights."

UNDERWRITING

The Underwriters named below, represented by Montgomery Securities and
Hambrecht & Quist LLC (the "Representatives"), have severally agreed, subject
to the terms and conditions set forth in the Underwriting Agreement (the
"Underwriting Agreement") by and between the Company and the Underwriters, to
purchase from the Company the aggregate number of shares of Common Stock
indicated below opposite their respective names at the initial public offering
price less the underwriting discount set forth on the cover page of this
Prospectus. The Underwriting Agreement provides that the obligations of the
Underwriters to pay for and accept delivery of the shares of Common Stock are
subject to certain conditions precedent, and that the Underwriters are
committed to purchase all of such shares if they purchase any.

NUMBER
UNDERWRITERS OF SHARES
------------ ---------

Montgomery Securities..............................................
Hambrecht & Quist LLC..............................................
---------
Total............................................................ 2,500,000
=========

The Representatives have advised the Company that the Underwriters propose
initially to offer the Common Stock to the public on the terms set forth on
the cover page of this Prospectus. The Underwriters may allow selected dealers
a concession of not more than $ per share, and the Underwriters may allow,
and such dealers may reallow, a concession of not more than $ per share to
certain other dealers. After the initial public offering, the offering price
and other selling terms may be changed by the Representatives. The Common
Stock is offered subject to receipt and acceptance by the Underwriters, and to
certain other conditions, including the right to reject orders in whole or in
part.

The Company has granted an option to the Underwriters, exercisable during
the 30-day period after the date of this Prospectus, to purchase up to a
maximum of 375,000 additional shares of Common Stock to cover over-allotments,
if any, at the same price per share as the initial 2,500,000 shares to be
purchased by the Underwriters. To the extent that the Underwriters exercise
such option, each of the Underwriters will be committed, subject to certain
conditions, to purchase such additional shares in approximately the same
proportion as set forth in the above table. The Underwriters may purchase such
shares only to cover over-allotments made in connection with the initial
public offering.

The Representatives have advised the Company that the Underwriters do not
expect to confirm sales to any accounts over which they exercise discretionary
authority in excess of 5% of the number of shares of Common Stock offered
hereby.

The Underwriting Agreement provides that the Company will indemnify the
several Underwriters against certain liabilities, including civil liabilities
under the Securities Act, or will contribute to payments the Underwriters may
be required to make in respect thereof.

For a period of 180 days after the effectiveness of the Registration
Statement, without the prior written consent of Montgomery Securities and/or
the Company, as applicable, the Company and holders of 9,562,429 shares of
Common Stock including the Company's directors and executive officers have
agreed not to offer, sell

or contract to sell, grant any option to purchase, make any short sale, pledge
or otherwise dispose of, directly or indirectly, any shares of Common Stock or
securities exchangeable or exercisable for or convertible into shares of, or
any other rights to purchase or acquire Common Stock of the Company other than
issuances pursuant to existing employee compensation plans and transfers into
trusts for the benefit of the original holder or members of the original
holder's immediate family.

Prior to the initial public offering, there has been no public market for
the Common Stock of the Company. Consequently, the initial public offering
price for the Common Stock will be negotiated between the Company and the
Representatives. Among the factors to be considered in determining the initial
public offering price of the Common Stock will be prevailing market and
economic conditions, market valuations of other companies engaged in
activities similar to the Company, estimates of the business potential and
prospects of the Company, the present state of the Company's business
operations, the Company's management and other factors deemed relevant.

The Representatives, on behalf of the Underwriters, may engage in over-
allotment, stabilizing transactions, syndicate covering transactions and
penalty bids in accordance with Regulation M under the Exchange Act. Over-
allotment involves syndicate sales in excess of the offering size, which
creates a syndicate short position. Stabilizing transactions permit bids to
purchase the underlying security so long as the stabilizing bids do not exceed
a specified maximum. Syndicate covering transactions involve purchases of the
Common Stock in the open market after the distribution has been completed in
order to cover syndicate short positions. Penalty bids permit the
Representatives to reclaim a selling concession from a syndicate member when
the Common Stock originally sold by such syndicate member is purchased in a
syndicate covering transaction to cover syndicate short positions. Such
stabilizing transactions, syndicate covering transactions and penalty bids may
cause the price of the Common stock to be higher than it would otherwise be in
the absence of such transactions. These transactions may be effected on the
Nasdaq National Market or otherwise and, if commenced, may be discontinued at
any time.

LEGAL MATTERS

The validity of the Common Stock offered hereby will be passed upon for the
Company by Cooley Godward LLP ("Cooley Godward"), Palo Alto, California.
Certain legal matters in connection with this offering will be passed upon for
the Underwriters by Gunderson Dettmer Stough Villeneuve Franklin & Hachigian,
LLP, Menlo Park, California. As of the date of this Prospectus, certain
members of Cooley Godward own an aggregate of 11,587 shares of Common Stock of
the Company.

EXPERTS

The financial statements of Megabios Corp. as of June 30, 1996 and 1997, and
for each of the three years in the period ended June 30, 1997 appearing in
this Prospectus and Registration Statement have been audited by Ernst & Young
LLP, independent auditors and are included in reliance upon such report given
upon the authority of such firm as experts in accounting and auditing.

The statements in this Prospectus under the captions "Risk Factors--
Uncertainty of Patent Position and Proprietary Rights" and "Business--Patents
and Proprietary Technology" have been reviewed and approved by McDonnell,
Boehnen, Hulbert, Berghoff Ltd., special patent counsel for the Company, as
experts in such matters, and are included herein in reliance upon such review
and approval.

ADDITIONAL INFORMATION

A Registration Statement on Form S-1, including amendments thereto, relating
to the Common Stock offered hereby has been filed by the Company with the
Commission, Washington, D.C. This Prospectus does not contain all of the
information set forth in the Registration Statement and the exhibits and
schedules thereto. Statements contained in this Prospectus as to the contents
of any contract or other document referred to are not necessarily complete,
and in each instance reference is made to the copy of such contract or other
document filed as an exhibit to the Registration Statement, each such
statement being qualified in all respects by such reference. For further
information with respect to the Company and the Common Stock offered hereby,
reference is made to the Registration Statement and the exhibits and schedules
thereto. A copy of the Registration Statement may be inspected by anyone
without charge at the Commission's principal office in Washington, D.C. and
copies of all or any part thereof may be obtained from the Public Reference
Section of the Commission, 450 Fifth Street, N.W., Judiciary Plaza,
Washington, D.C. 20549, upon payment of certain fees prescribed by the
Commission. In addition, the Commission maintains a Web site
(http://www.sec.gov) that contains reports, proxy and information statements
and other information regarding registrants that file electronically with the
Commission through the Electronic Data Gathering, Analysis, and Retrieval
system.

MEGABIOS CORP.

INDEX TO FINANCIAL STATEMENTS

Report of Independent Auditors.............................................. F-2
Financial Statements
Balance Sheets............................................................ F-3
Statements of Operations.................................................. F-4
Statement of Shareholders' Equity......................................... F-5
Statements of Cash Flows.................................................. F-6
Notes to Financial Statements............................................... F-7

F-1

REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

The Board of Directors and Shareholders
Megabios Corp.

We have audited the accompanying balance sheets of Megabios Corp. as of June
30, 1996 and 1997, and the related statements of operations, shareholders'
equity and cash flows for each of the three years in the period ended June 30,
1997. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.

In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Megabios Corp. as of June
30, 1996 and 1997, and the results of its operations and its cash flows for
each of the three years in the period ended June 30, 1997, in conformity with
generally accepted accounting principles.

ERNST & YOUNG LLP
Palo Alto, California

August 4, 1997, except for Note 11,
as to which the date is September 8, 1997

F-2

MEGABIOS CORP.

BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)

PRO FORMA
SHAREHOLDERS'
JUNE 30, EQUITY AT
------------------ JUNE 30,
1996 1997 1997
-------- -------- -------------
(UNAUDITED)

ASSETS
Current assets:
Cash and cash equivalents.................. $ 5,253 $ 9,044
Short-term investments..................... -- 15,225
Other receivables.......................... 16 238
Prepaid expenses and other current assets.. 275 390
-------- --------
Total current assets....................... 5,544 24,897
Property and equipment, net.................. 4,091 4,733
Other receivables............................ 35 27
Deposits and other assets.................... 286 321
-------- --------
$ 9,956 $ 29,978
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable........................... $ 148 $ 694
Accrued compensation....................... 133 170
Accrued construction-in-progress........... -- 249
Other accrued liabilities.................. 95 35
Deferred revenue........................... 531 887
Current portion of long-term debt.......... 1,069 1,233
-------- --------
Total current liabilities.............. 1,976 3,268
Long-term debt............................... 1,894 1,487
Commitments
Shareholders' equity:
Preferred stock, no par value, issuable in
series; 11,333,333 shares authorized;
5,754,069 and 8,420,720 convertible shares
issued and outstanding at June 30, 1996
and 1997, respectively; aggregate
liquidation preference of $51,200 at June
30, 1997 (no shares outstanding pro
forma).................................... 20,905 44,700 $ --
Common stock, no par value, 15,000,000
shares authorized; 1,368,148 and 1,567,727
shares issued and outstanding at June 30,
1996 and 1997, respectively (9,722,506
shares outstanding pro forma)............. 442 1,410 46,110
Deferred compensation, net of amortization. -- (679) (679)
Accumulated deficit........................ (15,261) (20,208) (20,208)
-------- -------- --------
Total shareholders' equity............. 6,086 25,223 $ 25,223
-------- -------- ========
$ 9,956 $ 29,978
======== ========

See accompanying notes.

F-3

MEGABIOS CORP.

STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

YEAR ENDED JUNE 30,
-------------------------
1995 1996 1997
------- ------- -------

Collaborative research and development revenue...... $ 1,157 $ 1,890 $ 5,793
Operating expenses:
Research and development.......................... 4,691 6,487 8,598
General and administrative........................ 1,811 2,169 2,417
------- ------- -------
Total operating expenses........................ 6,502 8,656 11,015
------- ------- -------
Loss from operations................................ (5,345) (6,766) (5,222)
Interest income..................................... 56 230 656
Interest expense.................................... (140) (365) (381)
------- ------- -------
Net loss............................................ $(5,429) $(6,901) $(4,947)
======= ======= =======
Pro forma net loss per share........................ $ (0.50)
=======
Shares used in computing pro forma net loss per
share.............................................. 9,926
=======

See accompanying notes.

F-4

MEGABIOS CORP.

STATEMENT OF SHAREHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)

PREFERRED STOCK COMMON STOCK TOTAL
----------------- ----------------- DEFERRED ACCUMULATED SHAREHOLDERS'
SHARES AMOUNT SHARES AMOUNT COMPENSATION DEFICIT EQUITY
--------- ------- --------- ------ ------------ ----------- -------------

Balances at June 30,
1994................... 2,084,970 $ 5,150 613,941 $ 217 $ -- $ (2,931) $ 2,436
Exercise of stock
options................ -- -- 68,164 20 -- -- 20
Issuance of Series C
convertible preferred
stock, net of issuance
costs of $76........... 1,292,089 4,942 -- -- -- -- 4,942
Conversion of notes
payable of $250 into
Series C convertible
preferred stock........ 64,442 250 -- -- -- -- 250
Net loss................ -- -- -- -- (5,429) (5,429)
--------- ------- --------- ------ ----- -------- -------
Balances at June 30,
1995................... 3,441,501 10,342 682,105 237 -- (8,360) 2,219
Issuance of Series C
convertible preferred
stock, net of issuance
costs of $36........... 1,827,871 7,063 -- -- -- -- 7,063
Issuance of Series D
convertible preferred
stock.................. 484,697 3,500 -- -- -- -- 3,500
Exercise of stock
options................ -- -- 693,543 208 -- -- 208
Repurchase of common
stock from employee.... -- -- (7,500) (3) -- -- (3)
Net loss................ -- -- -- -- -- (6,901) (6,901)
--------- ------- --------- ------ ----- -------- -------
Balance at June 30,
1996................... 5,754,069 20,905 1,368,148 442 -- (15,261) 6,086
Issuance of Series E
convertible preferred
stock, net of issuance
costs of $15........... 1,333,325 9,985 -- -- -- -- 9,985
Issuance of Series F
convertible preferred
stock, net of issuance
costs of $11........... 1,333,326 13,989 -- -- -- -- 13,989
Issuance of common stock
in lieu of cash payment
of Series E and F stock
offering commissions... -- (179) 119,046 179 -- -- --
Exercise of stock
options................ -- -- 116,517 56 -- -- 56
Repurchase of common
stock from employees... -- -- (35,984) (17) -- -- (17)
Deferred compensation
related to grant of
certain stock options,
net of amortization.... -- -- -- 750 (750) -- --
Amortization of deferred
compensation........... -- -- -- -- 71 -- 71
Net loss................ -- -- -- -- -- (4,947) (4,947)
--------- ------- --------- ------ ----- -------- -------
Balance at June 30,
1997................... 8,420,720 $44,700 1,567,727 $1,410 $(679) $(20,208) $25,223
========= ======= ========= ====== ===== ======== =======

See accompanying notes.

F-5

MEGABIOS CORP.

STATEMENTS OF CASH FLOWS
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (IN THOUSANDS)

YEAR ENDED JUNE 30,
-------------------------
1995 1996 1997
------- ------- -------

Cash flows from operating activities
Net loss........................................... $(5,429) $(6,901) $(4,947)
Adjustments to reconcile net loss to net cash used
in operations:
Depreciation...................................... 732 1,101 1,294
Amortization of deferred compensation............. -- -- 71
Changes in operating assets and liabilities:
Other receivables................................ (85) 93 (214)
Prepaid expenses and other assets................ 163 (87) (115)
Deferred revenue................................. 250 281 356
Accounts payable................................. (334) (33) 546
Accrued liabilities.............................. (736) 95 (23)
------- ------- -------
Net cash used in operating activities........... (5,439) (5,451) (3,032)
------- ------- -------
Cash flow from investing activities
Purchase of property and equipment................. (2,829) (1,111) (1,687)
Deposits and other assets.......................... (210) (12) (35)
Purchases of short-term investments................ -- -- (15,725)
Maturities of short-term investments............... -- -- 500
------- ------- -------
Net cash used in investing activities........... (3,039) (1,123) (16,947)
------- ------- -------
Cash flows from financing activities
Proceeds from issuance of notes payable -.......... 250 -- --
Proceeds from issuance of long-term debt........... 1,894 1,683 894
Payments on long-term debt......................... (232) (906) (1,137)
Proceeds from issuance of convertible preferred
stock, net of issuance costs...................... 4,942 10,563 23,974
Proceeds from issuance of common stock, net of
purchases......................................... 20 205 39
------- ------- -------
Net cash provided by financing activities....... 6,874 11,545 23,770
------- ------- -------
Net increase (decrease) in cash and cash
equivalents........................................ (1,604) 4,971 3,791
Cash and cash equivalents, beginning of period...... 1,886 282 5,253
------- ------- -------
Cash and cash equivalents, end of period............ $ 282 $ 5,253 $ 9,044
======= ======= =======
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Interest paid....................................... $ 158 $ 357 $ 381
======= ======= =======
Schedule of noncash transactions
Conversion of notes payable and related accrued
interest into convertible preferred stock......... $ 250 $ -- $ --
======= ======= =======
Construction-in-progress included in accrued
liabilities....................................... $ -- $ -- $ 249
======= ======= =======

See accompanying notes.

F-6

MEGABIOS CORP.

NOTES TO FINANCIAL STATEMENTS

JUNE 30, 1997

1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization and Basis of Presentation

Megabios Corp. ("Megabios" or the "Company") develops proprietary gene
delivery systems and provides preclinical development expertise to create
gene-based therapeutics designed for the treatment or prevention of genetic
and acquired diseases. The Company has developed several in vivo, non-viral
gene delivery systems to address a number of potential therapeutic
applications using a variety of therapeutic genes. The Company's clinical
development and commercialization strategy is to enter into collaborative
research and development agreements or "corporate partnerships" with
pharmaceutical and biotechnology companies.

Through June 30, 1995, the Company was in the development stage. During
fiscal 1996, the Company recognized significant revenues associated with its
collaborative agreements and expects to receive significant revenues under
these agreements in the future. Consequently, the Company is no longer
considered to be in the development stage. The Company will require additional
financial resources to complete development and commercialization of its
products. Management plans to continue to finance the Company primarily
through issuances of equity securities, collaborative research and development
arrangements and debt financing. If the financing arrangements contemplated by
management are not consummated, the Company may have to seek other sources of
capital or reevaluate its operating plans.

Revenue Recognition

Revenue related to collaborative research agreements with the Company's
corporate partners are recognized over the related funding periods for each
contract. The Company is required to perform research and development
activities as specified in each respective agreement on a best-efforts basis.
The Company is reimbursed based on the costs associated with the number of
full time equivalent employees working on each specific contract, which is
generally on a ratable basis over the term of the agreement. Research and
development expenses under the collaborative research agreements approximate
the revenue recognized under such agreements over the term of the respective
agreements. Deferred revenue may result when the Company does not incur the
required level of effort during a specific period in comparison to funds
received under the respective contracts. Milestone payments, if any, will be
recognized pursuant to collaborative agreements upon the achievement of
specified milestones, such as the filing of Investigational New Drug
Applications, commencement of clinical trials or receipt of regulatory
approvals. No milestone payments have been earned or recognized to date.

Research and Development Expenses

Research and development expenses consist of costs incurred for independent
and collaborative research and development. These costs include direct and
research-related overhead expenses.

Cash and Cash Equivalents

Cash equivalents consist of highly liquid investments with maturities from
date of purchase of 90 days or less. At June 30, 1996 and 1997, the Company
had approximately $5,022,000 and $8,041,000, respectively, in a money market
mutual fund which invests in various U.S. government securities including
Treasury bills, notes and bonds. In addition, at June 30, 1997, the Company
had approximately $1,000,000 in a corporate note (none in fiscal 1996). These
amounts are included in cash and cash equivalents. The Company has not
recognized any gains or losses on the sale of cash equivalents and any
unrecognized gains and losses at June 30, 1996 and June 30, 1997 are not
material.

F-7

MEGABIOS CORP.

NOTES TO FINANCIAL STATEMENTS--(CONTINUED)

Depreciation and Amortization

Property and equipment are stated at cost, less accumulated depreciation.
Depreciation is provided using the straight-line method over the estimated
useful lives of the respective assets (generally five years). Leasehold
improvements are amortized over five years which is the lease term and the
estimated useful life of the assets.

Long-Lived Assets

The Company has adopted Statement of Financial Accounting Standards No. 121,
Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets
to be Disposed of ("Statement 121"), and in accordance with Statement 121
identifies and records impairment losses, as circumstances dictate, on long-
lived assets used in operations when events and circumstances indicate that
the assets might be impaired and the undiscounted cash flows estimated to be
generated by those assets are less than the carrying amounts of those assets.
No such events have occurred with respect to the Company's long-lived assets,
which consist primarily of machinery and equipment and leasehold improvements.
The adoption of Statement 121 did not have a material impact on the financial
position, results of operations or cash flows of the Company.

Stock-Based Compensation

The Company generally grants stock options to employees for a fixed number
of shares with an exercise price equal to the fair value of the shares at the
date of grant. In accordance with the provisions of Statements of Financial
Accounting Standards No. 123, Accounting for Stock-Based Compensation ("SFAS
123"), the Company has elected to follow Accounting Principles Board Opinion
No. 25, Accounting for Stock Issued to Employees ("APB 25"), and related
interpretations in accounting for option grants to employees under its
employee stock option plan and to adopt the pro forma disclosure alternative
as described in SFAS 123 (see Note 9). Option grants to all others are
accounted for using the fair value method prescribed by SFAS 123.

Use of Estimates

The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.

Net Loss Per Share

Except as noted below, net loss per share is computed using the weighted
average number of common shares outstanding. Common equivalent shares are
excluded from the computation as their effect is antidilutive, except that,
pursuant to the Securities and Exchange Commission ("SEC") Staff Accounting
Bulletins, common and common equivalent shares (stock options, warrants and
convertible preferred stock) issued during the period commencing 12 months
prior to the initial filing of a proposed public offering at prices below the
assumed public offering price have been included in the calculation as if they
were outstanding for all periods presented (using the treasury stock method
for stock options and warrants and the if-converted method of preferred
stock). Per share information calculated on the above noted basis is as
follows:

YEAR ENDED JUNE 30,
----------------------
1995 1996 1997
------ ------ ------

Net loss per share..................................... $(1.49) $(1.81) $(1.11)
====== ====== ======
Shares used in calculating net loss per share (in
thousands)............................................ 3,638 3,812 4,438
====== ====== ======

Pro forma net loss per share has been computed as described above and also
gives effect, pursuant to SEC policy, to common equivalent shares from
convertible preferred stock issued more than 12 months prior to the initial
filing of the proposed initial public offering (using the if-converted method)
from the original date of issuance.

F-8

MEGABIOS CORP.

NOTES TO FINANCIAL STATEMENTS--(CONTINUED)

In 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128, Earnings Per Share ("SFAS 128"). SFAS
128 requires that Company's present two measures of earnings per share, basic
and diluted. Basic earnings per share is computed by dividing the net loss
available to common shareholders by the weighted-average number of common
shares outstanding for the period while diluted earnings per share reflects
the potential dilution of securities that could share in the earnings of the
Company. SFAS 128 is effective for interim and annual periods ending after
December 15, 1997. The Company does not believe the adoption of SFAS 128 will
have a material impact on its loss per share calculations.

Fair Values of Financial Instruments

The following methods and assumptions were used by the Company in estimating
its fair value disclosures for financial instruments:

Cash and Cash Equivalents

The carrying amount reported in the balance sheet for cash and cash
equivalents approximates its fair value.

Investments

The Company determines fair values based on quoted market values.

Long- and Short-Term Debt

The carrying amounts of the Company's borrowings under its term loan
and equipment financing agreements approximate their fair value. The
fair values of the Company's long-term debt are estimated using
discounted cash flow analyses, based on the Company's current
incremental borrowing rates for similar types of borrowing
arrangements.

2. COLLABORATIVE AGREEMENTS

Glaxo Wellcome plc

In April 1994, the Company entered into a five-year collaborative agreement
with Glaxo Wellcome plc ("Glaxo Wellcome") to develop a gene-based therapeutic
for the treatment of cystic fibrosis. In May 1996, the agreement was amended
such that it expired as of April 1, 1997. The agreement provided for quarterly
nonrefundable research and development fees. The Company has completed all of
its obligations under the Glaxo Wellcome agreement and will receive future
payments, if any, only through the achievement of a certain clinical milestone
and the payment of royalties. Revenue for research and development was
recorded as earned in accordance with the agreement. Revenue recognized under
agreement with Glaxo Wellcome was $1,157,000, $1,625,000 and $1,971,000 for
the years ended June 30, 1995, 1996 and 1997, respectively. These amounts
represent 100%, 86% and 34% of total collaborative research and development
funding recognized by the Company during the years ended June 30, 1995, 1996
and 1997, respectively.

Pfizer Inc

In May 1996, the Company entered into a four-year collaborative research
agreement, as well as a license and royalty agreement, with Pfizer Inc
("Pfizer") to develop a gene-based therapeutic for the treatment of solid
tumors via angiogenesis inhibition. Under the terms of the collaborative
research agreement, the Company is

F-9

MEGABIOS CORP.

NOTES TO FINANCIAL STATEMENTS--(CONTINUED)

conducting research and preclinical development activities and will receive
funding for such activities through at least June 1998. However, Pfizer can,
at its option, terminate the program after June 1998 upon six months prior
notice to the Company. The agreements also provide for royalty and milestone
payments to the Company upon the occurrence of specified events as set forth
in the agreements. Pfizer will be responsible for clinical development and
regulatory functions, as well as large scale clinical and commercial
manufacturing and sales and marketing. Pfizer has worldwide marketing rights
to any products resulting from the collaboration. Revenue recognized under the
collaborative research agreement with Pfizer was $265,000 (14% of total
revenues) and $3,352,000 (58% of total revenues) for the year ended June 30,
1996 and 1997, respectively. Deferred revenue of $735,000 as of June 30, 1997
represents payment for research to be performed in the following quarter.

In May 1996, in connection with the above agreements, Pfizer purchased
484,697 shares of the Company's Series D convertible preferred stock at $7.22
per share. Furthermore, should Pfizer decide to extend the research term
beyond two years, it will be required, prior to January 1998 to commit to
purchase within 60 days $10,000,000 of the Company's common stock at a premium
to the then current market value.

Eli Lilly and Company

In May 1997, the Company entered into a two-year collaborative research
agreement with Eli Lilly and Company ("Lilly") to develop gene-based
therapeutics using BRCA1, a gene which has been identified as a putative tumor
suppressor. The agreement provides for research and development funding fees
as well as funding to support manufacturing and process development efforts.
Lilly has the option to extend the initial term of the agreement by up to two
years. However, after 21 months from the commencement date of the
collaborative research agreement, Lilly can, at its option, extend the
collaborative research agreement upon three-months advance notice to the
Company. The agreement provides for certain royalty and milestone payments to
the Company upon the occurrence of specified events as set forth in the
agreement. Lilly will be responsible for clinical development and regulatory
functions, as well as large-scale clinical and commercial manufacturing and
sales and marketing. Revenue recognized under the collaborative research
agreement with Lilly was $270,000 (5% of total revenues) for the year ended
June 30, 1997. Deferred revenue of $152,000 as of June 30, 1997 represents
payment for research to be performed in the following quarter.

In June 1997, in connection with the Lilly agreement, Lilly purchased
285,714 shares of the Company's Series F convertible preferred stock at $10.50
per share.

3. SPONSORED UNIVERSITY RESEARCH

The Company has entered into several research agreements with universities.
These agreements are generally cancelable by either party upon written notice
and may be extended by mutual consent of both parties. Research and
development expenses are recognized as the related services are performed,
generally ratably over the period of service. Expenses under these agreements
were approximately $865,000, $1,100,000, and $496,000 for the years ended June
30, 1995, 1996 and 1997, respectively.

4. INVESTMENTS

Short-term investments consist of corporate notes with remaining maturities
at the date of purchase of greater than 90 days but less than one year.

The Company accounts for marketable investments in accordance with Statement
of Financial Accounting Standards No. 115, Accounting for Certain Investments
in Debt and Equity Securities ("Statement 115"). Under Statement 115,
management determines the appropriate classification of debt securities at the
time of purchase

F-10

MEGABIOS CORP.

NOTES TO FINANCIAL STATEMENTS--(CONTINUED)

and reevaluates such designation as of each balance sheet date. To date, all
marketable securities have been classified as held to maturity and are carried
at amortized cost. The amortized cost of debt securities in this category is
adjusted for amortization of premiums and accretion of discounts to maturity.
Such amortization is included in interest income. The cost of securities sold
is based on the specific identification method. Interest earned on securities
are included in interest income.

A summary of the Company's investments at June 30, 1997 follows (in
thousands).

GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- -------

Short-term investments:
Corporate notes.................... $15,225 $ 2 $(10) $15,217
======= === ==== =======

The Company held no such investments at June 30, 1995 or 1996. There have
been no realized gains or losses on short-term investments.

5. PROPERTY AND EQUIPMENT

Property and equipment consist of the following (in thousands):

JUNE 30,
---------------
1996 1997
------- ------

Machinery and equipment..................................... $ 2,493 $3,239
Furniture and fixtures...................................... 250 481
Leasehold improvements...................................... 3,230 3,235
Construction-in-progress.................................... -- 954
------- ------
5,973 7,909
Less accumulated depreciation............................... (1,882) (3,176)
------- ------
Property and equipment, net................................. $ 4,091 $4,733
======= ======

6. LONG-TERM DEBT

Term Loan

In 1995, the Company established a line of credit for $1,500,000 with a
commercial bank. As of June 30, 1995, the Company had drawn down $510,000
under the line of credit. In July and August 1995, the Company drew down the
remaining $990,000 available line of credit, and in accordance with the terms
of the agreement, the Company elected to convert the entire balance to a term
loan bearing interest at prime plus 2% (10.25% and 10.75% at June 30, 1996 and
1997, respectively) due in 36 equal monthly installments. The loan is secured
by all tangible personal property, accounts receivable and funds on deposit,
other than the assets securing the equipment financing. As a condition of the
term loan, the Company must maintain a minimum net worth of $3,000,000 and is
prohibited from paying dividends. In conjunction with this financing
arrangement, the Company issued the bank a warrant to purchase 24,140 shares
of the Company's Series C convertible preferred stock at $3.88 per share (see
Note 9).

F-11

MEGABIOS CORP.

NOTES TO FINANCIAL STATEMENTS--(CONTINUED)

Equipment Financing

In December 1993, the Company entered into an equipment financing agreement
for up to $2,300,000 with a financing company. As of June 30, 1996 and 1997,
the Company had financed $1,922,000 in equipment purchases under this
agreement structured as loans. The equipment loans are to be repaid over 42
months at interest rates ranging from 13.8% to 16.2% and are secured by the
related equipment. In conjunction with the original agreement, the Company
issued the financing company a warrant to purchase 21,630 shares of Company's
Series B convertible preferred stock at $3.88 per share (see Note 9).

In May 1996, the Company entered into an equipment financing agreement for
up to $2,700,000 with another financing company. As of June 30, 1996 and 1997,
the Company had financed $693,000 and $1,587,000, respectively, in equipment
purchases under this agreement structured as loans. The equipment loans are to
be repaid over 48 months at interest rates ranging from 15.2% to 16.2% and are
secured by the related equipment. In conjunction with this equipment financing
agreement, the Company issued a warrant to purchase 38,238 shares of Series C
convertible preferred stock at $3.88 per share (see Note 9).

Following is a schedule of future minimum principal payments under the term
loan and equipment financing arrangements at June 30, 1997 (in thousands):

Year ended June 30,
1998................................................................ $1,233
1999................................................................ 603
2000................................................................ 536
2001................................................................ 315
2002................................................................ 33
------
$2,720
======

7. FACILITY LEASE

The Company leases its facility under operating leases. These leases expire
in November 2004 and October 2007 with renewal options at the end of the
initial terms of the leases. Minimal annual rental commitments under the
operating leases at June 30, 1997 are as follows (in thousands):

Year ended June 30,
1998................................................................ $ 459
1999................................................................ 496
2000................................................................ 521
2001................................................................ 537
2002................................................................ 540
Thereafter.......................................................... 2,085
------
$4,638
======

Rent expense for the years ended June 30, 1995, 1996 and 1997 was
approximately $221,000, $273,000, and $295,000, respectively.

8. RELATED PARTY TRANSACTIONS

The Company has issued loans to certain employees, of which $27,500 was
outstanding at June 30, 1997 ($46,000 as of June 30, 1996). These loans,
classified as other receivables on the balance sheet, bear interest at
approximately 4.8% to 6.0% per annum.

F-12

MEGABIOS CORP.

NOTES TO FINANCIAL STATEMENTS--(CONTINUED)

9. SHAREHOLDERS' EQUITY

Convertible Preferred Stock

The following table describes information with respect to the various series
of convertible preferred stock outstanding as of June 30, 1997:

SHARES AGGREGATE
SHARES ISSUED AND ISSUANCE PRICE LIQUIDATION
AUTHORIZED OUTSTANDING PER SHARE PREFERENCE
---------- ----------- -------------- --------------
(IN THOUSANDS)

Series A................ 1,029,222 1,029,222 $ 1.05 $ 1,050
Series B................ 1,089,083 1,055,748 $ 3.88 4,100
Series C................ 3,700,000 3,184,402 $ 3.88 18,550
Series D................ 2,515,028 484,697 $ 7.22 3,500
Series E................ 1,333,333 1,333,325 $ 7.50 10,000
Series F................ 1,333,333 1,333,326 $10.50 14,000
Undesignated............ 333,334 -- -- --
---------- --------- -------
Total................... 11,333,333 8,420,720 $51,200
========== ========= =======

Series A, B, C, D, E and F convertible preferred shareholders are entitled
to noncumulative annual dividends, when and if declared by the board of
directors, of $0.0612, $0.2331, $0.2331, $0.2331, $0.2331 and $0.2331 per
share, respectively, payable in preference to common stock dividends. No
dividends have been declared or paid by the Company.

Series A, B, C, D, E and F convertible preferred shares have a liquidation
preference of $1.0203, $3.8835, $5.8254, $7.2210, $7.50 and $10.50 per share,
respectively, plus all declared but unpaid dividends. Upon liquidation, after
payment of the full liquidation preference has been made to the Series A, B,
C, D, E and F shareholders, the remaining assets of the Company, if any, shall
be distributed ratably among the common shareholders and Series C convertible
preferred shareholders.

Preferred stock is convertible at any time at the option of the shareholder.
Each share of Series A convertible preferred stock is convertible into 0.74161
shares of common stock plus any accumulated and unpaid dividends. Each share
of Series B, C, D, E and F convertible stock is convertible into one share of
common stock plus any accumulated and unpaid dividends. While the conversion
ratios are subject to adjustment, based upon certain events including the
issuance of additional shares of common stock, to date no such adjustment has
occurred. Each share of Series A, B, C, D, E and F convertible preferred stock
automatically converts into common stock at the then effective conversion rate
(noted above) in the event of an underwritten public offering of the Company's
common stock at an offering price of not less than $7.50 per share and with
aggregate net proceeds to the Company, after deduction of underwriting
commissions and expenses, of at least $7,500,000. Each share of convertible
preferred stock votes equally with shares of common stock on an "if-converted"
basis.

In December 1996, in connection with the Series E preferred stock financing,
the board of directors approved the issuance of 66,666 shares of common stock
as commissions to certain financial advisors. The common stock was issued in
February 1997. Also, in May 1997, in connection with the Series F preferred
stock financing, the Company issued 52,380 shares of common stock as
commissions to certain financial advisors. Total offering costs of $179,000
associated with these issuances was recorded based on the fair value of the
common stock at the time of issuance.

F-13

MEGABIOS CORP.

NOTES TO FINANCIAL STATEMENTS--(CONTINUED)

Warrants

In connection with the equipment financing agreement entered into in
December 1993, the Company issued a warrant to purchase 21,630 shares of
Series B convertible preferred stock at an exercise price of $3.88 per share.
The warrant expires on the earliest of May 13, 2000, or the day prior to the
effectiveness of a registration statement covering an underwritten offering of
the Company's securities with aggregate proceeds of $7,500,000, or a merger or
sale of substantially all of the Company's assets. The warrant is exercisable
immediately.

The Company issued a warrant to purchase 28,969 shares of Series C
convertible stock at $3.88 per share to the commercial bank providing the line
of credit to the Company. In accordance with the terms of the warrant, the
number of shares subject to the warrant was reduced from 28,969 to 24,140 in
July 1995. The warrant provided for a reduction in the number of shares upon
securing a commitment of at least $7,000,000 in sales of Series C preferred
stock. The warrant is exercisable immediately and expires at the earlier of
June 1, 2000, or in the event of a merger or sale of substantially all of the
assets of the Company.

In connection with the equipment financing agreement in May 1996, the
Company issued a warrant to purchase 38,238 shares of Series C convertible
preferred stock at $3.88 per share. The warrant is exercisable immediately and
expires at the earlier of ten years from the date of issuance or five years
after an initial public offering of the Company's common stock.

The value ascribed to warrants issued by the Company as noted above, both
individually and in the aggregate, was immaterial.

Stock Option Plan

On October 14, 1993, the board of directors approved a stock option plan
(the "Plan"). As of June 30, 1997, the Company had reserved 1,440,000 shares
of common stock for issuance under the plan. Under the plan, incentive stock
options may be granted to employees, and nonstatutory stock options may be
granted to employees, directors, and consultants. Options are granted at an
exercise price of not less than the fair value per share of the common stock
on the date of grant and expire no later than ten years from the date of
grant. The options may be exercised immediately upon grant, however, the
shares issuable upon exercise of the options are subject to repurchase by the
Company. Options under the Plan generally vest 25% one year after the date of
grant and on a pro rata basis over the following 36 months. An aggregate of
344,654 shares are subject to repurchase at an aggregate repurchase price of
$120,000 as of June 30, 1997. Such repurchase rights will lapse at a minimum
rate of 20% per annum and over a period of time not to exceed five years from
the date the option was granted.

In October 1994, the Company offered all option holders with per share
exercise prices above $0.30, the fair value on the date of the offer, the
opportunity to reprice their options to the fair value as determined by the
board of directors on the date of the offer. The new unvested options have a
vesting period three months longer than the original vesting terms under the
previous option. In response to the offer, options on 143,546 shares were
returned by employees and canceled, and a similar number of new options were
regranted with an exercise price of $0.30 per share.

The Company has elected to follow APB 25 and related interpretations in
accounting for its employee stock options because, as discussed below, the
alternative fair value accounting provided for under SFAS 123 requires use of
valuation models that were not developed for use in valuing employee stock
options. Under APB 25, because the exercise price of the Company's stock
options equal the price set by the Company's Board of Directors for the
underlying stock as of the grant date, no compensation expense is recognized.

F-14

MEGABIOS CORP.

NOTES TO FINANCIAL STATEMENTS--(CONTINUED)

The fair value option valuation model was developed for use in estimating
the fair value of traded options which have no vesting restrictions and are
fully transferable. In addition, option valuation models require the input of
highly speculative assumptions including the expected stock price volatility.
Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in
the subjective input assumptions can materially affect the fair value
estimate, in management's opinion, the existing models do not necessarily
provide a reliable single measure of the fair value of its employee stock
options.

Pro forma information regarding net earnings and earnings per share is
required by SFAS 123 which also requires that the information be determined as
if the Company had accounted for its employee stock options granted subsequent
to December 31, 1994 under the fair value method of that statement. The fair
value of these options was estimated at the date of grant using a minimum
value option pricing model, with the following assumptions: risk-free interest
rates from 4.8% to 6.4% and from 5.7% to 6.5% for grants in fiscal 1996 and
1997, respectively; a weighted-average expected life of the option from grant
date of 2.5 years; and a dividend yield of zero. The effect of applying the
minimum value model to the stock option activity did not result in pro forma
net loss and loss per share that are materially different from historical
amounts reported. Therefore, such pro forma information is not separately
presented herein. Future pro forma net income or loss and earnings or loss per
share may be materially different from actual amounts reported. The Company
will not use the minimum value option pricing model once the Company becomes a
publicly traded company.

Activity under the plan was as follows:

OUTSTANDING STOCK OPTIONS
SHARES ---------------------------- WEIGHTED-
AVAILABLE NUMBER OF PRICE AVERAGE
FOR GRANT SHARES PER SHARE EXERCISE PRICE
--------- ------------ -------------- --------------

Balance at June 30,
1994................... 221,340 111,994 $1.11 $1.11
Additional
authorization........ 433,333 -- -- --
Options granted....... (666,870) 666,870 $0.30-$1.11 $0.34
Options exercised..... -- (68,164) $0.30 $0.30
Options canceled...... 153,879 (153,879) $0.30-$1.11 $1.07
-------- ----------- -------------- -----
Balance at June 30,
1995................... 141,682 556,821 $0.30 $0.30
Additional
authorization........ 320,000 -- -- --
Options granted....... (387,329) 387,329 $0.30 $0.30
Options exercised..... -- (693,543) $0.30 $0.30
Options canceled...... 16,582 (16,582) $0.30 $0.30
Options underlying
shares repurchased... 7,500 -- $0.30 $0.30
-------- ----------- -------------- -----
Balance at June 30,
1996................... 98,435 234,025 $0.30 $0.30
Additional
authorization........ 353,333 -- -- --
Options granted....... (388,680) 388,680 $1.50 $1.50
Options exercised..... -- (116,517) $0.30-$1.50 $0.45
Options canceled...... 26,566 (26,566) $0.30-$1.50 $0.51
Options underlying
shares repurchased... 32,045 -- $0.30-$1.50 $0.39
-------- ----------- -------------- -----
Balance at June 30,
1997................... 121,699 479,622 $0.30-$1.50 $1.22
======== =========== ============== =====

F-15

MEGABIOS CORP.

NOTES TO FINANCIAL STATEMENTS--(CONTINUED)

The options outstanding and exercisable at June 30, 1997 have been
segregated into ranges for additional disclosure as follows:

OPTIONS
OUTSTANDING WEIGHTED WEIGHTED
EXERCISE AND EXERCISABLE AVERAGE AVERAGE
PRICE AT REMAINING EXERCISE
PER SHARE JUNE 30, 1997 CONTRACTUAL LIFE PRICE
--------- --------------- ---------------- --------
(IN YEARS)

$0.30 110,421 8.26 $0.30
$1.50 369,201 9.65 $1.50
------- -----
479,622 9.33 $1.22
======= =====

The weighted average fair value of options granted in fiscal 1996 and 1997
was $0.037 and $0.199 respectively. There were 61,025 shares vested and
unexercised at June 30, 1997 at a weighted average exercise price of $0.42.

In December 1996, the Company increased the shares reserved for issuance
under the stock option plan to 1,440,000 shares.

Through the year ended June 30, 1997, options to purchase 359,700 shares of
common stock, net of cancellations, were granted at $1.50 per share. Deferred
compensation of $750,000 was recorded on these options based on the deemed
fair value of the common stock at the dates of grant at prices ranging from
$1.50 to $3.75 per share, respectively. The Company recognized expense of
$71,000 in the period ended June 30, 1997 related to these options. In July
and August 1997, the Company granted options to purchase a total of 59,949
shares at exercise prices ranging from $2.70 to $2.88 per share. Additional
deferred compensation of approximately $390,000 is expected to be recorded
based on the deemed fair values of common stock ranging from $9.00 to $9.60
per share. The deferred compensation is being amortized to expense over the
vesting period of the options, generally four years.

Common Stock Reserved for Future Issuance

At June 30, 1997, the Company had reserved shares of common stock for future
issuance as follows:

Conversion of convertible preferred stock......................... 8,154,779
1993 Stock Option Plan............................................ 601,321
Exercise of Series B convertible preferred stock purchase warrants
convertible into common shares................................... 21,630
Exercise of Series C convertible preferred stock purchase warrants
convertible into common shares................................... 62,378
---------
8,840,108
=========

10. INCOME TAXES

As of June 30, 1997, the Company had federal net operating loss
carryforwards and federal research credit carryforwards of approximately
$15,637,000 and $379,000, respectively. The net operating loss and credit
carryforwards will expire at various dates beginning in 2007 through 2012, if
not utilized.

Utilization of the net operating losses and credits may be subject to a
substantial annual limitation due to the "change in ownership" provisions of
the Internal Revenue Code of 1986. The annual limitation may result in the
expiration of net operating losses and credits before utilization.

F-16

MEGABIOS CORP.

NOTES TO FINANCIAL STATEMENTS--(CONTINUED)

Significant components of the Company's deferred tax assets and liabilities
for federal income taxes as of June 30 are as follows (in thousands):

1996 1997
------- -------

Net operating loss carryforwards........................... $ 4,101 $ 5,425
Research and development credits........................... 429 625
Capitalized research and development....................... 775 724
Depreciation............................................... 460 840
Other, net................................................. 311 467
------- -------
Net deferred tax assets.................................... 6,076 8,081
Valuation allowance........................................ (6,076) (8,081)
------- -------
$ -- $ --
======= =======

The net valuation allowance increased by $2,077,000 and $2,769,000 during
the years ended June 30, 1995 and 1996, respectively.

11. SUBSEQUENT EVENTS

In July 1997, the board of directors authorized management of the Company to
file a registration statement with the SEC permitting the Company to sell up
to 2,875,000 shares of Common Stock to the public (the "Offering"). In
connection with the Offering, the board of directors approved, subject to
shareholder approval, a one-for-three reverse stock split covering each class
and series of the Company's capital stock, options and warrants outstanding.
The reverse stock split, which was approved by the shareholders, was effected
on September 8, 1997. All share and per share amounts, as well as the dividend
and liquidation preferences for Series A, B, C, D, E and F convertible
preferred stock, included in the accompanying financial statements have been
retroactively adjusted to reflect the reverse stock split. If the Offering is
completed under the terms currently contemplated, 8,420,720 shares of
outstanding Series A, B, C, D, E and F convertible preferred stock will
convert into 8,154,779 shares of common stock. In conjunction with the
Offering, the board of directors authorized, subject to shareholder approval,
the reincorporation of the Company into Delaware. In connection with the
reincorporation the Company will adopt an Amended and Restated Certificate of
Incorporation which provides that the Company will be authorized to issue
10,000,000 shares of $0.001 par value preferred stock and 30,000,000 shares of
$0.001 par value common stock.

In July 1997, the board of directors also adopted, subject to shareholder
approval, the Company's 1997 Equity Incentive Plan (the "Incentive Plan") as
an amendment and restatement of the Company's 1993 stock option plan. There
are currently 2,100,000 shares of common stock authorized for issuance under
the Incentive Plan. Also in July 1997, the board of directors adopted, subject
to shareholder approval, the Company's Employee Stock Purchase Plan (the
"Purchase Plan") covering an aggregate of 200,000 shares of common stock.
Under the Purchase Plan, the board of directors may authorize participation by
eligible employees, including officers, in periodic offerings following the
adoption of the Purchase Plan.

Unaudited pro forma shareholders' equity, as adjusted for the assumed
conversion of the Series A, B, C, D, E and F convertible preferred stock, is
set forth on the accompanying balance sheet.

F-17

===============================================================================

No dealer, sales representative or any other person has been authorized to
give any information or to make any representations in connection with this
offering other than those contained in this Prospectus and, if given or made,
such information or representations must not be relied upon as having been
authorized by the Company or any of the Underwriters. This Prospectus does not
constitute an offer to sell or a solicitation of an offer to buy any
securities other than the shares of Common Stock to which it relates, or an
offer to, or a solicitation of, any person in any jurisdiction where such an
offer or solicitation would be unlawful. Neither the delivery of this
Prospectus nor any sale made hereunder shall, under any circumstances, create
an implication that there has been no change in the affairs of the Company
since the date hereof or that the information contained herein is correct as
of any time subsequent to the date hereof.

--------------------

TABLE OF CONTENTS

--------------------

Page
----

Prospectus Summary........................................................ 3
Risk Factors.............................................................. 6
Special Note Regarding Forward-Looking Statements......................... 15
Use of Proceeds........................................................... 16
Dividend Policy........................................................... 16
Capitalization............................................................ 17
Dilution.................................................................. 18
Selected Financial Data................................................... 19
Management's Discussion and Analysis of Financial Condition and Results of
Operations............................................................... 20
Business.................................................................. 24
Management................................................................ 42
Certain Transactions...................................................... 51
Principal Stockholders.................................................... 52
Description of Capital Stock.............................................. 54
Shares Eligible for Future Sale........................................... 56
Underwriting.............................................................. 58
Legal Matters............................................................. 60
Experts................................................................... 60
Additional Information.................................................... 60
Index to Financial Statements............................................. F-1

--------------------

Until , 1997 (25 days after the date of this Prospectus), all dealers
effecting transactions in the Common Stock, whether or not participating in
this distribution, may be required to deliver a Prospectus. This is in
addition to the obligation of dealers to deliver a Prospectus when acting as
underwriters and with respect to their unsold allotments or subscriptions.

================================================================================

2,500,000 SHARES
[LOGO OF MEGABIOS]

COMMON STOCK

-----------------

PROSPECTUS

-----------------

MONTGOMERY SECURITIES

HAMBRECHT & QUIST

, 1997

===============================================================================

PART II

INFORMATION NOT REQUIRED IN PROSPECTUS

ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION

The following table sets forth the costs and expenses, other than
underwriting discounts and commissions, payable by the registrant in
connection with the distribution of the Common Stock being registered. All
amounts are estimated, except the SEC Registration Fee, the NASD Filing Fee
and the Nasdaq National Market Filing Fee:

SEC Registration Fee............................................... 11,325
NASD Filing Fee.................................................... 4,240
Nasdaq National Market Filing Fee.................................. 48,065
Blue Sky Fees and Expenses......................................... 5,000
Accounting Fees.................................................... 125,000
Legal Fees and Expenses............................................ 250,000
Transfer Agent and Registrar Fees.................................. 15,000
Printing and Engraving............................................. 125,000
Miscellaneous...................................................... 16,370
--------
Total............................................................ $600,000
========

ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS

The Registrant's Certificate of Incorporation provides that directors of the
Registrant shall not be personally liable to the Registrant or its
stockholders for monetary damages for breach of fiduciary duty as a director,
to the fullest extent permitted by the General Corporation Law of the State of
Delaware. The Registrant's Bylaws provide for indemnification of officers and
directors to the full extent and in the manner permitted by Delaware law.
Section 145 of the Delaware General Corporation Law makes provision for such
indemnification in terms sufficiently broad to cover officers and directors
under certain circumstances for liabilities arising under the Securities Act
of 1933, as amended (the "Securities Act").

The Registrant intends to enter into indemnification agreements with each
director and certain officers which provide indemnification under certain
circumstances for acts and omissions which may not be covered by any
directors' and officers' liability insurance.

The form of Underwriting Agreement, filed as Exhibit 1.1 to the Registration
Statement, provides for indemnification of the Registrant and its controlling
persons against certain liabilities under the Securities Act.

ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES

Since April 1, 1994, the Company has sold and issued the following
unregistered securities (share and dollar amounts do not reflect the 1 for 3
reverse stock split assumed elsewhere in this registration statement).

(1) Since inception to June 30, 1997, the Registrant has granted stock
incentive stock options and nonstatutory stock options to employees, directors
and consultants under its 1993 Stock Option Plan covering an aggregate of
4,664,795 shares of the Registrant's Common Stock, at an average exercise
price of $0.225 per share. Options to purchase 591,127 shares of Common Stock
have been canceled or have lapsed without being exercised, and 118,643 shares
of Common Stock have been repurchased by the Registrant.

(2) In May 1994, the Registrant issued a warrant exercisable for 64,890
shares of Series B Preferred Stock, convertible into 64,890 shares of Common
Stock, at an exercise price of $1.2945 per share to an accredited investor.

II-1

(3) Between September 1994 and October 1995, the Registrant issued and sold
9,553,274 shares of Series C Preferred Stock, convertible into 9,553,274
shares of Common Stock, to a total of 37 accredited investors, including one
officer, for cash in the aggregate amount of $12,366,711.

(4) In June 1995, the Registrant issued a warrant exercisable for 115,875
shares, which number was subsequently adjusted to 72,422 shares by agreement
of the parties, of Series C Preferred Stock, convertible into 72,422 shares of
Common Stock, at an exercise price of $1.2945 per share to an accredited
investor.

(5) In April 1996, the Registrant issued a warrant exercisable for 114,716
shares of Series C Preferred Stock, convertible into 114,716 shares of Common
Stock, at an exercise price of $1.2945 per share to an accredited investor.

(6) In May 1996, the Registrant issued and sold 1,454,092 shares of Series D
Preferred Stock, convertible into 1,454,092 shares of Common Stock, to an
accredited investor for cash in the amount of $3,500,000.

(7) In October 1996, the Registrant issued and sold 4,000,000 shares of
Series E Preferred Stock, convertible into 4,000,000 shares of Common Stock to
24 investors for cash in the aggregate amount of $10,000,000. In connection
with the private placement, the Registrant issued 200,000 shares of Common
Stock to the placement agents equal in value to the aggregate amount of
$100,000.

(8) In May and June 1997, the Registrant issued and sold 3,999,998 shares of
Series F Preferred Stock, convertible into 3,999,998 shares of Common Stock to
17 investors, for cash in the aggregate amount $14,000,000. In connection with
the private placement, the Registrant issued 157,142 shares of Common Stock to
the placement agents equal in value to the aggregate amount of $78,571.

The sales and issuances of securities in the transactions described in
paragraph (1) above were deemed to be exempt from registration under the
Securities Act by virtue of Rule 701 promulgated thereunder in that they were
offered and sold either pursuant to a written compensatory benefit plan or
pursuant to a written contract relating to compensation, as provided by Rule
701.

The sales and issuances of securities in the transactions described in
paragraphs (2) through (8) above were deemed to be exempt from registration
under the Securities Act by virtue of Section 4(2), Regulation D or Regulation
S promulgated thereunder. The purchasers in each case represented their
intention to acquire the securities for investment only and not with a view to
the distribution thereof. Appropriate legends are affixed to the stock
certificates issued in such transactions. Similar legends were imposed in
connection with any subsequent sales of any such securities. All recipients
received either received adequate information about the Registrant or had
access, through employment or other relationships, to such information.

ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

(a) EXHIBITS.

II-2

10.1 1997 Equity Incentive Plan(1)
10.2 Form of Incentive Stock Option Grant(1)
10.3 Form of Non-Incentive Stock Option Grant(1)
10.4 1997 Employee Stock Purchase Plan(1)
10.5 1997 Employee Stock Purchase Offering(1)
10.6 Form of Indemnification Agreement between the Registrant and its
directors and executive officers(1)
10.7 Amended and Restated Investor Rights Agreement, dated as of May 23,
1997 among the Registrant and the investors named therein(1)
10.8 Letter Agreement between the Registrant and Benjamin F. McGraw, III,
Pharm.D.(1)
10.9 Letter Agreement between the Registrant and Patrick G. Enright(1)
10.10 Letter Agreement between the Registrant and Rodney Pearlman, Ph.D.(1)
10.11 Lease Agreement between the Registrant and Provident Life and
Accident Insurance Company ("Provident"), dated December 21, 1993(1)
10.12 First Amendment to Lease Agreement between the Registrant and SFO
Associates LLC (successor in interest to Provident)(1)
10.13 Lease Agreement between the Registrant and SFO Associates LLC, dated
March 18, 1997(1)
10.14 Credit Agreement between the Registrant and Imperial Bank, dated as
of August 31, 1995(1)
10.15 Lease Agreement between the Registrant and LMSI, dated May 13, 1994,
as amended as of May 13, 1994(1)
10.16 Senior Loan and Security Agreement No. L0016 between the Registrant
and Phoenix Leasing Incorporated, dated as of April 22, 1996(1)
10.17* Research and License Agreement between the Registrant and Glaxo
Wellcome Group Limited, dated April 11, 1994, as amended as of May
31, 1996
10.18* Collaborative Research Agreement between the Registrant and Pfizer
Inc, dated May 31, 1996(1)
10.19* License and Royalty Agreement between Registrant and Pfizer Inc,
dated June 1, 1996
10.20 Stock Purchase Agreement between Registrant and Pfizer Inc, dated May
30, 1996(1)
10.21* Exclusive License Agreement between the Registrant and the Regents of
the University of California, dated May 9, 1996 as amended May 15,
1997
10.22* Research and License Agreement between the Registrant and Eli Lilly
and Company, effective May 23, 1997
10.23 Preferred Stock Warrant issued to Lease Management Services, Inc.,
dated May 13, 1994(1)
10.24 Preferred Stock Warrant issued to Imperial Bank, dated June 1,
1995(1)
10.25 Series C Preferred Stock Warrant issued to Phoenix Leasing
Incorporated, dated April 30, 1996(1)
11.1 Statement re computation of net loss per share(1)
23.1 Consent of Ernst & Young LLP, Independent Auditors (see page II-6)
23.2 Consent of Cooley Godward LLP (included in Exhibit 5.1)(1)
23.3 Consent of McDonnell, Boehnen, Hulbert, Berghoff, Ltd.(1)
24.1 Power of Attorney (see page II-5)(1)
27.1 Financial Data Schedule(1)

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* Confidential treatment being sought for portions of this document. A
separate filing setting forth the Registrant's application for confidential
treatment has been made with the Commission.
(1) Previously filed.

(B) FINANCIAL STATEMENT SCHEDULES

Schedules are omitted because they are not applicable, or because the
information is included in the Financial Statements or the Notes thereto.

II-3

ITEM 17. UNDERTAKINGS.

A. The Registrant hereby undertakes to provide to the underwriters at the
closing specified in the underwriting agreement certificates in such
denominations and registered in such names as required by the underwriters to
permit prompt delivery to each purchaser.

B. Insofar as indemnification for liabilities arising under the Securities
Act may be permitted to directors, officers, and controlling persons of the
Registrant pursuant to the provisions described in Item 14 above, or
otherwise, the Registrant has been advised that in the opinion of the
Securities and Exchange Commission such indemnification is against public
policy as expressed in the Securities Act and is, therefore, unenforceable. In
the event that a claim for indemnification against such liabilities (other
than the payment by the Registrant of expenses incurred or paid by a director,
officer or controlling person of the Registrant in the successful defense of
any action, suit or proceeding) is asserted by such director, officer or
controlling person in connection with the securities being registered, the
Registrant will, unless in the opinion of its counsel the matter has been
settled by controlling precedent, submit to a court of appropriate
jurisdiction the question of whether such indemnification by it is against
public policy as expressed in the Securities Act and will be governed by the
final adjudication of such issue.

C. The Registrant hereby undertakes that:

(1) For purposes of determining any liability under the Securities Act,
the information omitted from the form of prospectus filed as part of this
registration statement in reliance upon Rule 430A and contained in a form
of prospectus filed by the Registrant pursuant to Rule 424(b)(1) or (4) or
497(h) under the Securities Act shall be deemed to be part of this
registration statement as of the time it was declared effective.

(2) For purposes of determining any liability under the Securities Act,
each post-effective amendment that contains a form of prospectus shall be
deemed to be a new registration statement relating to the securities
offered therein, and the offering of such securities at that time shall be
deemed to be the initial bona fide offering thereof.

II-4

SIGNATURES

PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, MEGABIOS CORP.
HAS DULY CAUSED THIS AMENDMENT NUMBER 3 TO REGISTRATION STATEMENT TO BE SIGNED
ON ITS BEHALF, BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED, IN THE CITY OF
BURLINGAME, COUNTY OF SAN MATEO, STATE OF CALIFORNIA, ON SEPTEMBER 11, 1997.

Megabios Corp.

/s/ Benjamin F. McGraw, III
By: _________________________________
BENJAMIN F. MCGRAW III, PHARM.D.
CHAIRMAN, CHIEF EXECUTIVE OFFICER
AND PRESIDENT

PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THIS AMENDMENT
NUMBER 3 TO REGISTRATION STATEMENT HAS BEEN SIGNED BY THE FOLLOWING PERSONS IN
THE CAPACITIES AND ON THE DATES INDICATED.

SIGNATURE TITLE DATE

/s/ Benjamin F. McGraw, III Chairman, Chief September 11, 1997
- ------------------------------------- Executive Officer
BENJAMIN F. MCGRAW III, PHARM.D. and President
(Principal
Executive Officer)

/s/ Patrick G. Enright Chief Financial September 11, 1997
- ------------------------------------- Officer and Vice
PATRICK G. ENRIGHT President
(Principal
Financial and
Accounting Officer)

* Director September 11, 1997
- -------------------------------------
FRANK J. CAUFIELD

* Director September 11, 1997
- -------------------------------------
EDWARD L. ERICKSON

* Director September 11, 1997
- -------------------------------------
A. GRANT HEIDRICH

* Director September 11, 1997
- -------------------------------------
RUSSELL C. HIRSCH, M.D., PH.D.

* Director September 11, 1997
- -------------------------------------
RAJU KUCHERLAPATI, PH.D.

/s/ Benjamin F. McGraw, III
*By: ________________________________
BENJAMIN F. MCGRAW III, PHARM.D.
ATTORNEY-IN-FACT

/s/ Patrick G. Enright
*By: ________________________________
PATRICK G. ENRIGHT
ATTORNEY-IN-FACT

II-5

CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

We consent to the references to our firm under the captions "Selected
Financial Data" and "Experts" and to the use of our report dated August 4,
1997, for Note 11, as to which the date is September 8, 1997, in Amendment
No. 3 to the Registration Statement (Form S-1, No. 333-32593) and related
Prospectus of Megabios Corporation for the registration of 2,875,000 shares of
its common stock.

/s/ ERNST & YOUNG LLP

Palo Alto, California

September 10, 1997

II-6

EXHIBIT INDEX

SEQUENTIAL
EXHIBIT PAGE
NUMBER DOCUMENT DESCRIPTION NUMBER
------- -------------------- ----------

1.1 Underwriting Agreement(1)
3.1 Fifth Amended and Restated Articles of Incorporation of
the Registrant as filed May 14, 1997(1)
3.2 Certificate of Correction of Fifth Amended and Restated
Articles of Incorporation as filed July 25, 1997(1)
3.3 Bylaws of the Registrant(1)
3.4 Certificate of Incorporation to be effective upon closing
of the offering(1)
3.5 Bylaws of the Registrant to be effective upon the closing
of the offering(1)
4.1 Specimen Common Stock Certificate(1)
5.1 Opinion of Cooley Godward llp as to legality of the
Common Stock(1)
10.1 1997 Equity Incentive Plan(1)
10.2 Form of Incentive Stock Option Grant(1)
10.3 Form of Non-Incentive Stock Option Grant(1)
10.4 1997 Employee Stock Purchase Plan(1)
10.5 1997 Employee Stock Purchase Offering(1)
10.6 Form of Indemnification Agreement between the Registrant
and its directors and executive officers(1)
10.7 Amended and Restated Investor Rights Agreement, dated as
of May 23, 1997 among the Registrant and the investors
named therein(1)
10.8 Letter Agreement between the Registrant and Benjamin F.
McGraw, III, Pharm.D.(1)
10.9 Letter Agreement between the Registrant and Patrick G.
Enright(1)
10.10 Letter Agreement between the Registrant and Rodney
Pearlman, Ph.D.(1)
10.11 Lease Agreement between the Registrant and Provident Life
and Accident Insurance Company ("Provident"), dated
December 21, 1993(1)
10.12 First Amendment to Lease Agreement between the Registrant
and SFO Associates LLC (successor in interest to
Provident)(1)
10.13 Lease Agreement between the Registrant and SFO Associates
LLC, dated March 18, 1997(1)
10.14 Credit Agreement between the Registrant and Imperial
Bank, dated as of August 31, 1995(1)
10.15 Lease Agreement between the Registrant and LMSI, dated
May 13, 1994, as amended as of May 13, 1994(1)
10.16 Senior Loan and Security Agreement No. L0016 between the
Registrant and Phoenix Leasing Incorporated, dated as of
April 22, 1996(1)
10.17* Research and License Agreement between the Registrant and
Glaxo Wellcome Group Limited, dated April 11, 1994, as
amended as of May 31, 1996
10.18* Collaborative Research Agreement between the Registrant
and Pfizer Inc, dated May 31, 1996(1)
10.19* License and Royalty Agreement between Registrant and
Pfizer Inc, dated June 1, 1996

SEQUENTIAL
EXHIBIT PAGE
NUMBER DOCUMENT DESCRIPTION NUMBER
------- -------------------- ----------

10.20 Stock Purchase Agreement between Registrant and Pfizer
Inc, dated May 30, 1996(1)
10.21* Exclusive License Agreement between the Registrant and
the Regents of the University of California, dated May
9, 1996 as amended May 15, 1997
10.22* Research and License Agreement between the Registrant
and Eli Lilly and Company, effective May 23, 1997
10.23 Preferred Stock Warrant issued to Lease Management
Services, Inc., dated May 13, 1994(1)
10.24 Preferred Stock Warrant issued to Imperial Bank, dated
June 1, 1995(1)
10.25 Series C Preferred Stock Warrant issued to Phoenix
Leasing Incorporated, dated April 30, 1996(1)
11.1 Statement re computation of net loss per share(1)
23.1 Consent of Ernst & Young LLP, Independent Auditors (see
page II-6)
23.2 Consent of Cooley Godward LLP (included in Exhibit 5.1)(1)
23.3 Consent of McDonnell, Boehnen, Hulbert, Berghoff,
Ltd.(1)
24.1 Power of Attorney (see page II-5)(1)
27.1 Financial Data Schedule(1)

- --------