10-K405

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                                      UNITED STATES
                            SECURITIES AND EXCHANGE COMMISSION
                                  WASHINGTON, D.C. 20549

                                        FORM 10-K

[X]      ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
         EXCHANGE ACT OF 1934 [NO FEE REQUIRED]

               For the fiscal year ended            DECEMBER 31, 1997
                                          ----------------------------

[ ]      TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
         EXCHANGE ACT OF 1934 [NO FEE REQUIRED]

          For the transition period from ____________ to ____________

                         Commission file number 0-24274

                         LA JOLLA PHARMACEUTICAL COMPANY
             (Exact name of registrant as specified in its charter)


             DELAWARE                                        33-0361285
  (State or other jurisdiction of                         (I.R.S. Employer
   incorporation of organization)                         Identification No.)

                   6455 NANCY RIDGE DRIVE, SAN DIEGO, CA 92121
                    (Address of principal executive offices)

       Registrant's telephone number, including area code: (619) 452-6600

Securities registered pursuant to Section 12(b) of the Act:      None
                                                           --------------------

Securities registered pursuant to Section 12(g) of the Act: Common Stock, par
                                                            value $0.01 
                                                            Warrants

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

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

        The aggregate market value of the voting stock held by non-affiliates of
the Registrant, computed by reference to the closing price of such stock on the
Nasdaq Stock Market on March 17, 1998, was $51,158,734. The number of shares of
the Registrant's common stock, $.01 par value, outstanding at March 17, 1998 was
18,159,807.

                       DOCUMENTS INCORPORATED BY REFERENCE

        Part III incorporates certain information by reference from the
Registrant's definitive proxy statement for its annual meeting of stockholders
to be held on May 13, 1998, which proxy statement will be filed on or about
March 31, 1998.


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                           FORWARD-LOOKING STATEMENTS

        This Report includes forward-looking statements, including without
limitation those dealing with the Company's drug development plans and clinical
trials, its relationship with Abbott Laboratories ("Abbott"), and other matters
described in terms of the Company's plans and expectations. The forward-looking
statements in this Report involve risks and uncertainties, and a number of
factors, both foreseen and unforeseen, could cause actual results to differ from
the Company's current expectations. The Company's ongoing Phase II/III clinical
trial of LJP 394, the Company's drug candidate for the treatment of lupus, could
result in a finding that LJP 394 is not effective in producing a sustained
reduction of double-stranded DNA ("dsDNA") antibodies in large patient
populations or does not provide a meaningful clinical benefit. The Company's
other potential drug candidates are at earlier stages of development and involve
comparable risks. Payments by Abbott to the Company are contingent upon progress
of clinical trials and the Company's achievement of certain other milestones
that might not be met. The relationship with Abbott could be terminated by
either party for various reasons. Clinical trials could be delayed and could
have negative or inconclusive results. Additional risk factors include the
uncertainty of future revenue from product sales or other sources such as
collaborative relationships, the uncertainty of future profitability, the need
for additional financing, the Company's dependence on patents and other
proprietary rights, the Company's limited manufacturing capabilities and the
Company's lack of marketing experience. Readers are cautioned not to place undue
reliance upon forward-looking statements, which speak only as of the date
hereof, and the Company undertakes no obligation to update forward-looking
statements to reflect events or circumstances occurring after the date hereof.
Interested parties are urged to review the risks described below under the
heading "Certain Risk Factors" and elsewhere in this Report and in other reports
and registration statements of the Company filed with the Securities and
Exchange Commission ("SEC") from time to time.


                                     PART I

ITEM 1.  BUSINESS.

OVERVIEW

        La Jolla Pharmaceutical Company is a biopharmaceutical company focused
on the research and development of highly specific therapeutics for the
treatment of certain life-threatening antibody-mediated diseases. These
diseases, including autoimmune conditions such as lupus and antibody-mediated
stroke, are caused by abnormal B cell production of antibodies that attack
healthy tissues. Current therapies for these autoimmune disorders only address
symptoms of the disease or nonspecifically suppress the normal operation of the
immune system, which often results in severe, adverse side effects and
hospitalization. The Company believes that its drug candidates, called
Toleragens, will treat the underlying cause of many antibody-mediated diseases
without these severe, adverse side effects. The Company is currently conducting
a Phase II/III clinical trial initiated in December 1996 for its lupus drug
candidate, LJP 394.


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ANTIBODY-MEDIATED DISEASES

        The immune system is the major biological defense mechanism responsible
for recognizing and fighting disease. The immune system identifies antigens,
such as bacteria, viruses and other disease-causing substances, and seeks to rid
the body of these antigens. There are two fundamental types of immune responses:
cell-mediated and antibody-mediated. Cell-mediated immunity is primarily
responsible for ridding the body of cells that have become infected.
Antibody-mediated immunity is primarily responsible for eliminating circulating
antigens. These immune responses are controlled by the activities of white blood
cells called T cells and B cells. T cells provide cell-mediated immunity and
regulate B cells. B cells produce antibodies that recognize and help to
eliminate antigens.

        Each B cell produces antibodies against a specific structure on the
antigen's surface called an epitope. The B cell is triggered to produce
antibodies when the specific epitope is recognized by and binds to the antibody
receptors on the surface of the B cell and only when the B cell receives an
appropriate signal from a T cell. When an epitope binds to the B cell with no
corresponding T cell signal, the B cell may become "tolerized" and cease to
produce antibodies.

        A properly functioning immune system distinguishes between antigens and
the body's healthy tissues. In a malfunctioning immune system, healthy tissue
may trigger an immune response that causes B cells to produce disease-causing
antibodies, resulting in antibody-mediated autoimmune disease. For example, B
cells can produce disease-causing antibodies that are associated with the
destruction of the kidneys in lupus and the wasting of muscles in myasthenia
gravis. Other antibody-mediated disorders include antibody-mediated stroke,
heart attacks, deep vein thrombosis, recurrent fetal loss, Rh hemolytic disease
of the newborn and Graves' disease.

        Current therapies for antibody-mediated diseases have significant
shortcomings, including severe side effects and a lack of specificity. Mild
forms of antibody-mediated diseases are generally treated with drugs that
address only the disease symptoms and fail to suppress disease progression
because they do not control the production of disease-causing antibodies. Severe
antibody-mediated diseases are generally treated with high levels of steroids
and immunosuppressive therapy (primarily anti-cancer drugs) which broadly
suppress the normal function of the entire immune system. These therapies can
leave patients susceptible to potentially life-threatening infections that may
require hospitalization. Repeated dosing with steroids may cause other serious
conditions, including diabetes, hypertension, cataracts, osteoporosis and
psychosis, that may limit the use of this therapy. The use of chemotherapy may
lead to acute problems, including weight loss and nausea, and long-term adverse
effects, including sterility and an increased risk of malignancies.

LJP'S TOLERANCE TECHNOLOGY PROGRAM

        The Company's Tolerance Technology program focuses on the discovery and
development of proprietary therapeutics, called Toleragens, which target and
suppress the production of specific disease-causing antibodies without affecting
the protective functions of the immune system. The Company believes that its
Toleragens will treat the underlying causes of antibody-mediated diseases, and
that its Tolerance Technology can be applied broadly wherever antibodies are
involved in the disease process.


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        Toleragens are composed of disease-specific epitopes and a carrier
platform, which are proprietary chemical structures developed and synthesized by
the Company. To mimic the unique epitopes on an antigen's surface, LJP
identifies and synthesizes epitopes specific to particular antibody-mediated
diseases and attaches or conjugates these epitopes to the carrier platform,
which serves as a vehicle for presenting the epitopes to the antibody receptors
on the targeted B cell. When the epitope binds to the antibody receptors on the
B cell in the absence of a T cell signal, the B cell may become tolerized and
cease to produce disease-causing antibodies. The Company believes that the
Toleragen carrier platform, or a modification thereof, can be used with epitopes
specific to various diseases to create therapeutics targeted at different
antibody-mediated diseases.

        The Company designs its Toleragens to bind selectively to
disease-causing B cells without affecting the function of disease-fighting B
cells. This process involves: (i) collecting and purifying the disease-causing
antibodies from patients with the targeted disease; (ii) generating and
selecting an epitope that strongly binds to the purified antibodies; (iii)
modifying the epitope's structure to maximize its binding properties
(optimization) and (iv) linking the optimized epitope to the carrier platform.
The Company believes this process enables the Company to create Toleragens that
will preferentially tolerize and shut down B cells that generate antibodies with
the highest binding affinity, which are believed to be the most harmful. To
achieve this process, the Company utilizes advanced technologies in order to
identify suitable epitopes that will bind to targeted disease-causing B cells.
These technologies include:

        Combinatorial Epitope Libraries. Since 1991, the Company has been
developing epitope libraries to provide a large and diverse pool of epitope
candidates for screening. Each library is a collection of billions of different
epitopes that are created by introducing random sequences of DNA into bacterial
viruses. These DNA sequences direct the viruses to express a wide variety of
epitopes on their surfaces. LJP has used these libraries in the development of
drug candidates for lupus, antibody-mediated stroke, heart attack, deep vein
thrombosis, recurrent fetal loss, Rh hemolytic disease and myasthenia gravis.

        Molecular Modeling Capabilities. The Company uses nuclear magnetic
resonance spectroscopy (NMR) and molecular modeling software to determine and
analyze important three-dimensional structural features of epitopes and the
related disease-causing antibodies. These capabilities permit further
optimization of epitopes to increase their binding to targeted B cells.

        Disease-Specific Screening Methods and Assays. The Company clones and
expresses receptors that are associated with the targeted disease to screen the
disease-causing antibodies from patient blood. After screening, these antibodies
are presented to the epitope libraries through a series of assays in order to
identify suitable epitope candidates. Using these methods, the Company more
rapidly and efficiently selects lead epitope candidates with the highest
antibody binding affinity.

        Chemical Optimization Expertise. The Company optimizes each lead epitope
candidate by changing its chemical structure. These changes to the molecule
increase its binding affinity and stability. The Company then attaches multiple
copies of the lead epitope to the carrier platform to create a Toleragen. The
Company's carrier platform technology provides a stable presentation of multiple
copies of the epitope in an optimal configuration that increases binding
affinity and thus tolerization of B cells.


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BUSINESS STRATEGY

        The Company's objective is to become the leading developer of highly
specific therapeutics for the treatment of life-threatening, antibody-mediated
disorders such as lupus, antibody-mediated stroke, recurrent fetal loss, deep
vein thrombosis, Rh hemolytic disease of the newborn, myasthenia gravis, heart
attack and Graves' disease. The Company's strategy includes the following key
elements:

        Complete Clinical Development of LJP 394. The Company's primary
near-term goal is to complete development of LJP 394 to treat lupus. The Company
is conducting a Phase II/III clinical trial to evaluate the safety and efficacy
of the drug in a large population of patients.

        Apply Tolerance Technology to Life-threatening Antibody-mediated
Diseases. The Company is focusing on chronic, life-threatening,
antibody-mediated diseases, such as lupus, for which there are no existing
treatments or for which current therapeutics have significant limitations. The
Company intends to use its Tolerance Technology to design therapeutics that
specifically address other targeted antibody-mediated diseases without adversely
affecting normal immune system function.

        Utilize Strategic Collaborations to Develop and Commercialize Product
Candidates. The Company has a collaborative agreement with Abbott for the
worldwide development and commercialization of LJP 394, and intends to seek
appropriate collaborations with other pharmaceutical companies to provide
support for its research programs and the clinical development and
commercialization of other drug candidates.

        Exploit Proprietary Manufacturing Technology. Through the production of
LJP 394 for clinical trials, the Company has developed proprietary synthesis and
conjugation technologies that are being used in the development of its other
Toleragen candidates. The Company intends to further develop these technologies
in order to increase manufacturing efficiencies and to apply its know-how to the
development and manufacture of other potential products.

        Expand Intellectual Property Leadership Position. The Company owns 53
issued patents and has 55 pending patent applications covering the Company's
Tolerance Technology and its lupus and antibody-mediated stroke drug candidates.
The Company plans to broaden this position with further discoveries and patent
filings.

PRODUCTS UNDER DEVELOPMENT

        The Lupus Program

        Lupus is a life-threatening, antibody-mediated disease in which
disease-causing antibodies damage various tissues. According to recent
information compiled by the Lupus Foundation of America and other sources and
epidemiological studies conducted in the 1970s, the number of lupus patients in
the United States is between 250,000 and 1,000,000, with 16,000 new cases
diagnosed each year. Approximately nine out of 10 lupus patients are women, who
usually develop the disease during their childbearing years. Lupus is
characterized by a number of symptoms, including chronic kidney inflammation,
which can lead to kidney failure, and serious episodes of cardiac and central
nervous system inflammation, as well as arthritis and 


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rashes. Approximately 80% of patients will progress to more serious disease
symptoms, and approximately 50% of lupus patients have renal involvement.

        Antibodies to dsDNA can be detected in approximately 90% of untreated
lupus patients, and are widely believed to cause kidney disease (nephritis),
often resulting in morbidity and mortality in lupus patients. These antibodies
are also associated with episodes of potentially life-threatening inflammation
called flares, which may occur more than once per year and usually require
intensive care hospitalization. Significant kidney destruction occurs during
flares. Lupus nephritis can lead to deterioration of kidney function and
end-stage kidney disease, requiring long-term renal dialysis or kidney
transplantation.

        Current treatments for lupus patients with kidney disease and other
serious symptoms usually include repeated administration of steroids, often at
high levels that can have toxic effects when used as a chronic treatment
regimen. Many patients with advanced disease are also treated with
immunosuppressive therapy, including anti-cancer drugs, that have a general
suppressive effect on the immune system and may be carcinogenic. This
immunosuppressive treatment leaves the patient vulnerable to serious infection
and is a significant cause of morbidity and mortality.

        The Company has designed LJP 394 to suppress the production of
antibodies to dsDNA in lupus patients without suppressing the normal function of
the immune system. The design of LJP 394 is based upon scientific evidence of
the role of antibodies to dsDNA in lupus. A recent study indicated that a rise
in the level of antibodies to dsDNA may be predictive of flares in lupus
patients with renal involvement, and that suppressing antibodies to dsDNA by
treating these patients with steroids that non-specifically lower antibody
levels prevents relapses in a majority of patients. In a mouse model of lupus
nephritis that generates elevated levels of antibodies to dsDNA, administration
of LJP 394 reduced the production of antibodies to dsDNA, reduced the number of
antibody-forming cells, and reduced kidney disease while extending the life of
the animals. The Company believes that its own and other studies provide
evidence that inhibiting antibodies to dsDNA may provide an effective therapy
for lupus nephritis.

        Certain studies of lupus patients indicate that antibodies to dsDNA with
the highest binding affinity are associated with the most damage to the kidneys.
The Company believes that its Tolerance Technology process preferentially
targets these antibodies.

        Results of Clinical Trials

        Based on its preclinical findings, the Company filed an Investigational
New Drug ("IND") application for LJP 394 with the United States Food and Drug
Administration ("FDA") in August 1994. In a double-blind, placebo-controlled
Phase I clinical trial in December 1994, healthy volunteers received LJP 394 and
displayed no significant drug-related adverse effects and no immune reaction to
the drug.

        The Company's Phase II clinical trials included a single-dose trial, a
repeat escalating-dose trial, and a dose-ranging trial. The single-dose clinical
trial evaluated the safety of a single, 100 mg intravenous dose of LJP 394 in
four female lupus patients by monitoring antibody levels, blood chemistry, vital
signs and complement (inflammation-promoting proteins) levels for 28 days after
dosing. LJP 394 was well tolerated by all four patients, with no drug-related
adverse clinical symptoms and no clinically significant complement level
changes. In addition, no clinically significant immune complex formation
(inflammation-promoting accumulation of 


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antibodies and antigens) was observed, indicating the absence of an adverse
immune response to LJP 394. A transient reduction in dsDNA antibody levels was
also observed. These results were presented at the American College of
Rheumatology Conference in October 1996.

        The repeat escalating-dose clinical trial involved two female patients,
each receiving doses of 10, 10, 50, 50, 100 and 100 mg of LJP 394 at two-week
intervals. After the 10-week dosing regimen, patients were followed for six
weeks. LJP 394 was well tolerated with no drug-related adverse clinical
symptoms, no clinically significant complement changes, and no significant
immune complex formation. Six weeks after the last dose, the antibody levels in
both patients remained suppressed below baseline levels.

        The dose-ranging trial evaluated 58 patients with mild lupus symptoms
(53 females and five males). All patients were clinically stable and had dsDNA
antibody levels exceeding those generally found in healthy individuals. The
patients were organized into nine treatment groups at three dose levels (1 mg,
10 mg and 50 mg), and three frequencies (once per week, once every two weeks and
once every four weeks). Patients were randomized to one of the nine treatment
groups so that at each dose and frequency, four to seven patients received LJP
394 and one patient received a placebo.

        Patients in the weekly treatment groups showed a dose-response
correlation between increasing doses of LJP 394 and reductions of levels of
dsDNA antibodies. In patients treated weekly with 10 mg or 50 mg doses of LJP
394, antibodies to dsDNA were reduced by statistically significant levels and
remained suppressed in certain patients for up to two months after the last
dose. In the patient group treated weekly with 50 mg, the reductions in median
levels of dsDNA antibodies were accompanied by increases in median levels of two
important inflammation-related complement proteins, C3 and C4, which normally
decrease during active lupus renal disease and increase with clinical
improvement. These study data suggest that complement levels and antibody levels
were normalizing in parallel.

        Throughout the dose-ranging trial, the drug was well tolerated with no
clinically significant dose-related adverse reactions observed. Three patients
who began the study experienced lupus flares, and three other patients were
hospitalized as a result of transient adverse events that the treating
clinicians believed were unrelated to the underlying disease or LJP 394. Two of
the patients with flares withdrew from the study, as did four patients who
experienced exacerbations of lupus and one patient with herpes rash. However, no
relationship was observed between the development of an adverse event and the
dose or frequency of administration of LJP 394.

        In December 1996, the Company initiated a multicenter Phase II/III
clinical trial of LJP 394. The purpose of the trial is to evaluate the safety of
the drug and its potential to prevent renal flares, reduce disease severity and
the need for immunosuppressive steroids/chemotherapy drugs and hospitalization,
and improve patients' quality of life. The trial is being conducted in
collaboration with Abbott and will be completed when the last patient enrolled
completes the 18-month period of treatment currently estimated to be some time
in year 2000. This is a double-blind trial and the Company does not expect to
announce interim efficacy results. The trial and the development of LJP 394 in
general involve many risks and uncertainties, and there can be no assurance that
any interim clinical results can be replicated in further clinical testing or
that LJP 394 will be effective in inducing and sustaining antibody suppression,
will prove to be clinically safe or effective, or will receive required
regulatory approvals. If the Phase II/III trial produces 


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negative or inconclusive results, the Company's business and financial condition
will be adversely affected and it may be difficult or impossible for the Company
to survive.

        Antibody-Mediated Thrombosis, Including Stroke, Heart Attack, Deep Vein
Thrombosis and Recurrent Fetal Loss

        Researchers believe that anticardiolipin antibodies promote arterial and
venous blood clots, which can cause a variety of life-threatening medical
problems. For example, blood clots that lodge in the brain may cause stroke and
those that lodge in the legs may cause deep vein thrombosis. There are multiple
conditions associated with these antibodies: antibody-mediated stroke, heart
attack, recurrent fetal loss, thrombocytopenia (platelet deficiencies), deep
vein thrombosis, and complications following cardiovascular surgery. The
Company's program to develop a Toleragen to treat anticardiolipin antibodies
targets stroke, myocardial infarction, deep vein thrombosis, post operative
complications, and recurrent fetal loss. These antibodies are associated with
the formation of blood clots leading to multiple, recurring, and potentially
life threatening conditions. The Company estimates that there are greater than
500,000 patients world wide with antibody-mediated thrombosis.

        Stroke is a leading cause of death in the United States. In 1994, there
were approximately two million stroke patients in the United States,
approximately 500,000 new episodes occurred and approximately 150,000 people
died from stroke. This debilitating condition results from acute neurological
injury caused by the blockage or rupture of blood vessels in the brain. Many of
the blockages are caused by thromboses (blood clots), which clinicians believe
may be caused by a number of factors including a class of antibodies called
anticardiolipin antibodies, which can be identified and measured by a clinical
laboratory assay. It is estimated that 5 to 10% of the strokes in the United
States (affecting 100,000 to 200,000 patients) are caused by these antibodies.
Antibody-mediated stroke is thought to occur in younger individuals and with
greater frequency than non-antibody-mediated stroke. The cost of treatment for a
survivor of a serious stroke is approximately $30,000 per year for life,
consisting of hospitalization and home nursing care costs.

        Anticardiolipin antibodies are also associated with recurrent fetal
loss, a syndrome of repeated miscarriage. Published clinical reports estimate
that many women with elevated anticardiolipin antibody levels experience
multiple miscarriages, delayed fetal development or premature childbirth. Recent
academic research suggests that elevated levels of anticardiolipin antibodies
are also found in approximately 10 to 30% of patients with other clotting
disorders, including myocardial infarction (heart attack), deep vein thrombosis,
thrombocytopenia (platelet deficiency), cardiac valve lesion as well as in
approximately 30% of lupus patients. In myocardial infarction, recent research
suggests the relative risk of having an event or death is twice as high in
people with high anticardiolipin antibodies and this risk is independent of
other risk factors. In deep vein thrombosis, research indicates anticardiolipin
antibody-positive patients have recurring deep vein thromboses twice as often as
anticardiolipin antibody-negative patients.

        Current treatments for antibody-mediated thrombosis involve the use of
steroids and chronic, potentially life-long anticoagulant therapy with drugs
such as heparin or warfarin to prevent the formation of blood clots. Patients
must be carefully monitored to minimize serious bleeding episodes which can
occur because of the therapy. If patients are removed from anticoagulant
therapy, they are at an increased risk of stroke or another thrombotic episode.


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Warfarin is not recommended in the treatment of recurrent fetal loss because it
is toxic to the developing fetus.

        The Company believes that a Toleragen that binds to B cells producing
anticardiolipin antibodies may suppress antibody production and prevent or
reduce antibody-associated blood clots. To develop such a Toleragen, the Company
established a supply of blood samples from representative stroke and recurrent
fetal loss patients and purified antibodies from these samples. The Company has
used these blood samples to identify several epitopes that react with a subset
of patients. LJP scientists believe they have localized the epitope to one
antibody-binding region of the antigen and will continue to optimize this and
other cross-reactive epitopes prior to developing a potential Toleragen
candidate.

        Rh Hemolytic Disease of the Newborn

        Rh hemolytic disease of the newborn is a life-threatening fetal
condition characterized by the hemolysis (destruction) of fetal red blood cells.
This condition occurs in Rh incompatible pregnancies in which maternal
antibodies to Rh cross the placenta, bind to fetal red blood cells and cause
their destruction. Rh is a family of proteins on the surface of red blood cells.
When the most common form of these proteins is present, the blood type is Rh(+),
and when it is absent, the blood type is Rh(-). A pregnancy is "Rh incompatible"
when the fetus is Rh(+) and the mother is Rh(-).

        Each year approximately 500,000 women in the United States have Rh
incompatible pregnancies. Despite current treatments that attempt to control
maternal immune systems with immunoglobulin, approximately 5,000 of these women
each year begin producing antibodies against fetal red blood cells and therefore
become part of the existing pool of patients who are at risk of developing Rh
hemolytic disease in a subsequent pregnancy. Every year approximately 5,000
women from this pool of patients have pregnancies that result in severe cases of
Rh hemolytic disease, which can result in loss of the fetus. This condition is
treated by intrauterine fetal blood transfusions and associated amniocentesis
procedures, which are usually repeated several times prior to birth, are risky
to the fetus and mother, and can cost more than $30,000 during the course of a
pregnancy. The Company believes that these women, as well as others who produce
Rh antibodies and avoid pregnancy altogether, could be treated with an Rh
Toleragen.

        The Company believes that a Toleragen that binds to the appropriate
maternal B cells will suppress Rh antibody production, and that once the level
of antibodies to Rh(+) red blood cells is reduced, the risk of life-threatening
hemolysis will be eliminated. LJP has purified antibodies to Rh from blood
samples taken from sensitized patients and has identified several epitopes bound
by antibodies to Rh. LJP identified a potentially broadly cross-reactive peptide
epitope candidate that binds to antibodies from patients with Rh hemolytic
disease, blood donors specifically immunized to Rh and several known pathogenic
monoclonal Rh antibodies. The Company is currently optimizing this epitope while
continuing to evaluate other potentially cross-reactive candidate epitopes, with
the expectation of using it to synthesize lead Toleragens.

        Xenotransplantation

        Xenotransplantation, the use of animals as a source of donor organs for
human transplantation, has become an area of great interest due to the worldwide
shortage of human 


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organs available for transplantation. According to the American Society of
Transplant Physicians, approximately 100,000 patients in the United States are
on waiting lists for organ transplants. More than 100,000 patients die annually,
many of whom are too sick to qualify for waiting lists. A typical organ
transplant can cost more than $100,000.

        Hyperacute rejection, or the immediate destruction of the transplanted
animal organ by the recipient's antibodies, is a major barrier to
xenotransplantation. Human antibodies recognize and bind to an epitope called
di-galactose found on the tissues of transplanted animal organs. This binding
causes massive blood clots that block the blood supply to the transplanted
organ, destroying it within minutes.

        LJP has synthesized the di-galactose epitope and attached it to several
proprietary platforms to create new Toleragen candidates. During 1997, the
Company conducted in vitro studies that indicated that an appropriate Toleragen
candidate could have the potential to bind to the antibodies responsible for
hyperacute rejection following xenotransplantation. The Company has initiated
the testing of a series of Toleragen candidates in primates to assess their
potential to arrest the production of antibodies responsible for hyperacute
rejection in xenotransplantation. In a first primate study of a single Toleragen
candidate, the drug was well tolerated. LJP is now evaluating other candidates
and is working to improve the Toleragen's potency. The Company plans to
institute additional primate studies of these improved compounds in 1998.

        Other Antibody-Mediated Diseases

        The Company believes its Tolerance Technology may be applicable to
additional diseases and conditions caused by the production of disease-causing
antibodies, including myasthenia gravis and Graves' disease. Myasthenia gravis
is a form of muscular paralysis in which neuromuscular receptors are attacked by
antibodies, which can lead to a wasting of muscles, progressive loss of strength
and life-threatening respiratory arrest. This disease affected an estimated
20,000 people in the United States in 1994. The Company is engaged in the
development of antibody libraries derived from myasthenia gravis patients. These
libraries may provide antibodies that can be screened against the Company's
epitope libraries in order to identify potential epitope mimics. These mimics
may be useful as Toleragens to specifically suppress the disease causing
antibodies in myasthenia gravis.

        Graves' disease is caused by antibodies that bind to the
thyroid-stimulating hormone receptor and stimulate excessive production of
thyroid hormones, which results in hyperthyroidism (including potentially
life-threatening increases in heart rate, blood pressure and body temperature).
Graves' disease affected more than 2.5 million people in the United States in
1994. The Company's scientists have been engaged in the cloning of the
thyroid-stimulating hormone in anticipation of future development activities in
this area.

COLLABORATIVE ARRANGEMENTS

        As part of its business strategy, the Company pursues collaborations
with pharmaceutical companies in an effort to access their research, drug
development, manufacturing, marketing and financial resources. In December 1996,
the Company entered into a collaborative relationship with Abbott for worldwide
development and commercialization of LJP 394. Under the terms of a license and
supply agreement between Abbott and the Company, Abbott obtained the exclusive
right to market and sell LJP 394 throughout the world, and the Company retained
manufacturing 


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rights and ownership of all of its patents relating to the drug. Abbott will pay
escalating royalties to the Company on sales of LJP 394, with additional
premiums payable if specified sales levels are achieved. Abbott will also
purchase the drug in bulk form from the Company at prices calculated as a
percentage of Abbott's net sales.

        Abbott will pay future clinical development costs and is responsible for
obtaining worldwide regulatory approvals. Pending regulatory approval, Abbott
and the Company will cooperate in development and clinical trials for the drug,
and Abbott will pay development costs incurred by the Company in accordance with
a development plan and budgets to be mutually agreed upon. Abbott will handle
marketing activities throughout the world, with cooperation and assistance from
the Company. The Company is obligated to develop appropriate manufacturing
capabilities and conduct patent prosecution in the major markets of the world.

        Concurrently with the formation of the collaborative relationship,
Abbott made an initial $4 million license payment to the Company and purchased
1,000,050 shares of LJP's common stock for gross proceeds of $4.0 million.
Abbott also purchased 831,152 shares of LJP's common stock in September 1997 for
gross proceeds of $4.0 million. The Company has the right to require Abbott to
purchase up to $4.0 million of additional shares of the Company's common stock
at market value in 1998. Abbott is obligated to make milestone payments upon the
attainment of various performance and regulatory objectives. Both Abbott and the
Company have the right to terminate the agreement under certain circumstances.

        The Company intends to pursue collaborative arrangements with other
pharmaceutical companies to assist in its research programs and the clinical
development and commercialization of other drug candidates. There can be no
assurance that the Company will be able to negotiate arrangements with any other
collaborative partners on acceptable terms, if at all, and any additional
collaborative relationships are likely to include contingencies comparable to
those affecting the Abbott relationship. Once a collaborative relationship is
established, there can be no assurance that the collaborative partner will
continue funding any particular program or will not pursue alternative
technologies or develop alternative drug candidates, either individually or in
collaboration with others, including the Company's competitors, as a means for
developing treatments for the diseases targeted by the Company. Furthermore,
competing products, either developed by a collaborative partner or to which a
collaborative partner has rights, may result in the withdrawal of support by the
collaborative partner with respect to all or a portion of the Company's
technology.

        Failure to establish or maintain collaborative arrangements will require
the Company to fund its own research and development activities, resulting in
accelerated depletion of the Company's capital, and will require the Company to
develop its own marketing capabilities for any drug candidate that may receive
regulatory approval. The failure of any collaborative partner to continue
funding any particular program of the Company or to commercialize successfully
any product could delay or halt the development or commercialization of any
products involved in such program. As a result, failure to establish or maintain
collaborative arrangements could have a material adverse effect on the Company's
business, financial condition and results of operations.


                                       11


   12
MANUFACTURING

        The Company has constructed and is currently operating a pilot
production facility for the manufacture of LJP 394 which is large enough to
exceed its anticipated research and clinical trial needs for LJP 394. Through
internal development programs and external collaborations, the Company has made
several improvements to the manufacturing process for LJP 394 that have reduced
costs and increased capacity. The Company has developed proprietary synthesis
and conjugation technologies that are being used in the development of its other
Toleragen candidates. The Company intends to further develop these technologies
in order to increase manufacturing efficiencies and apply its know-how to the
development and manufacture of other potential products.

        However, the Company's current facilities are not yet adequate for
commercial production. In order to meet its obligations to supply all LJP 394 in
bulk form to Abbott for packaging and commercial resale, the Company will be
required to invest substantial amounts of capital in the expansion of its
facilities. The manufacture of the Company's potential products for clinical
trials and the manufacture of any resulting products for commercial purposes is
subject to current Good Manufacturing Practices ("cGMP") as defined by the FDA.
The Company has never operated an FDA-approved manufacturing facility, and there
can be no assurance that it will obtain the necessary approvals. The Company has
limited manufacturing experience, and no assurance can be given that it will be
able to make the transition to commercial production successfully. The Company
may enter into arrangements with contract manufacturers to expand its own
production capacity in order to meet requirements for its products, or to
attempt to improve manufacturing efficiency. If the Company chooses to contract
for manufacturing services and encounters delays or difficulties in establishing
relationships with manufacturers to produce, package and distribute its finished
products, clinical trials, market introduction and subsequent sales of such
products would be adversely affected. Moreover, contract manufacturers must
operate in compliance with the FDA's cGMP requirements. The Company's potential
dependence upon third parties for the manufacture of its products may adversely
affect the Company's profit margins and its ability to develop and deliver such
products on a timely and competitive basis.

MARKETING AND SALES

        In order to commercialize any drug candidate approved by the FDA, the
Company must either develop a marketing and sales force or enter into marketing
arrangements with third parties. Such arrangements may be exclusive or
nonexclusive and may provide for marketing rights worldwide or in a specific
market. Abbott has agreed to be responsible for worldwide marketing of LJP 394,
but the Abbott agreement may terminate under certain circumstances and the
Company has no arrangements with third parties for marketing of any other drug
candidates. There can be no assurance that the Company will be able to enter
into any additional marketing agreements on terms favorable to the Company, if
at all, or that any such agreements that the Company may enter into will result
in payments to the Company. Under the Abbott agreement and any co-promotion or
other marketing and sales arrangements that may be entered into with other
companies, any revenues to be received by the Company will be dependent on the
efforts of others and there can be no assurance that such efforts will be
successful. To the extent that the Company chooses to attempt to develop its own
marketing and sales capability, it will compete with other companies that
currently have experienced and well-funded marketing and sales operations.
Furthermore, there can be no assurance that the Company or any collaborative


                                       12


   13
partner will be able to establish sales and distribution capabilities without
undue delays or expenditures or gain market acceptance for any of the Company's
drug candidates.

PATENTS AND PROPRIETARY TECHNOLOGIES

        The Company files patent applications in the United States and in
foreign countries, as it deems appropriate, for protection of its proprietary
technologies and drug candidates. The Company owns 53 issued patents and has 55
pending patent applications covering its Tolerance Technology and its lupus and
antibody-mediated stroke drug candidates. The Company's issued patents include
four issued United States patents, one issued Australian patent and one granted
European patent which has been unbundled as thirteen European national patents
concerning its lupus Toleragens (expiring in 2009, 2011, 2013, 2014 and 2011,
respectively), two issued United States patents, two issued Australian patents,
one granted European patent which has been unbundled as fifteen European
national patents and one granted Japanese patent concerning its overall
Tolerance Technology (expiring in 2010, 2014, 2012, 2014, 2012 and 2012,
respectively) and two issued United States patents and one issued Australian
patent (expiring in 2012, 2015 and 2012, respectively) on linkage chemistries
for its Toleragens. The Company has received a Notice of Allowance from the
United States Patent Office for two additional applications for linkage
chemistries for its Toleragens. The Company also has an option to obtain the
exclusive license to several issued United States patents and related technology
concerning compounds that may be used in the potential treatment of myasthenia
gravis or muscular dystrophies. The Company's decision to exercise the option,
which will require payment of a nonrefundable advance against future royalties
of $100,000, will be made based upon the results of future studies of this
technology.

        The Company's success will depend upon its ability to obtain patent
protection for its therapeutic approaches and for any developed products, to
preserve its trade secrets and to operate without infringing the proprietary
rights of third parties. While the Company has received patents covering certain
aspects of its technology, there can be no assurance that any additional patents
will be issued, that the scope of any patent protection will be sufficient, or
that any current or future issued patents will be held valid if subsequently
challenged.

        There is a substantial backlog of biotechnology patent applications at
the United States Patent and Trademark Office ("USPTO") that may delay the
review and issuance of any patents. The patent position of biotechnology firms
generally is highly uncertain and involves complex legal and factual questions,
and no consistent policy has emerged regarding the breadth of claims covered in
biotechnology patents or protection afforded by such patents. To date, the
Company has rights to certain United States and foreign issued patents and has
filed or participated as a licensee in the filing of a number of patent
applications in the United States relating to the Company's technology, as well
as foreign counterparts of certain of these applications in certain 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, or that claims allowed under issued
patents 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, or to file patent applications for,
such technology. Competitors may have filed applications for, or may have
received patents and may obtain additional patents and proprietary rights
relating to, compounds or processes that block or compete with those of the
Company.


                                       13


   14
        A number of pharmaceutical and biotechnology companies and research and
academic institutions have filed or may file patent applications, and have
received or may receive patents in the fields being pursued by the Company.
Certain of these applications or patents may be competitive with the Company's
applications or conflict in certain respects with claims made under the
Company's applications. In particular, the Company is aware of one currently
pending United States patent application that, if allowed, may contain claims
covering subject matter that may be competitive or conflicting with the
Company's patents and patent applications. In addition, the Company is aware of
a United States patent that has been issued to a third party that contains
claims that may adversely affect the ability of the Company to pursue one of its
projects. Any conflict between the Company's patents and patent applications and
patents or patent applications of third parties could result in a significant
reduction of the coverage of the Company's existing patents or any future
patents that may be issued. In addition, to determine the priority of
inventions, the Company may have to participate in interference proceedings
declared by the USPTO or in opposition, nullity or other proceedings before
foreign agencies with respect to any of its existing patents or patent
applications or any future patents or applications, which could result in
substantial cost to the Company. Further, the Company may have to participate at
substantial cost in International Trade Commission proceedings to abate
importation of goods which would compete unfairly with products of the Company.
If patents containing competitive or conflicting claims are issued to other
parties and such claims are ultimately determined to be valid, there can be no
assurance that the Company would be able to obtain licenses to these patents at
a reasonable cost, if at all, or be able to develop or obtain alternative
technology.

        The Company also relies upon unpatented trade secrets and improvements,
unpatented know-how and continuing technological innovation to develop and
maintain its competitive position, which it seeks to protect, in part, by
confidentiality agreements with its commercial partners, collaborators,
employees and consultants. The Company also has invention or patent assignment
agreements with its employees and certain consultants. There can be no assurance
that relevant inventions will not be developed by a person not bound by an
invention assignment agreement, or that binding agreements will not be breached,
that the Company will have adequate remedies for any breach, or that the
Company's trade secrets will not otherwise become known or be independently
discovered by competitors. In addition, the Company could incur substantial
costs in defending against suits brought against it by others for infringement
of intellectual property rights or in prosecuting suits which the Company might
bring against other parties to protect its intellectual property rights.

COMPETITION

        The biotechnology and pharmaceutical industries are subject to rapid
technological change. Competition from domestic and foreign biotechnology
companies, large pharmaceutical companies and other institutions is intense and
expected to increase. A number of companies are pursuing the development of
pharmaceuticals in the Company's targeted areas. These include companies which
are conducting clinical trials and preclinical studies for the treatment of
lupus.

        In addition, there are many academic institutions, both public and
private, engaged in activities relating to research and development of
therapeutics for autoimmune, inflammatory and other diseases. Most of these
companies and institutions have substantially greater facilities, resources,
research and development capabilities, regulatory compliance expertise, and
manufacturing and marketing capabilities than the Company. In addition, other
technologies 


                                       14


   15
may in the future be the basis of competitive products. There can be no
assurance that the Company's competitors will not develop or obtain regulatory
approval for products more rapidly than the Company, or develop and market
technologies and products that are more effective than those being developed by
the Company or that would render the Company's technology and proposed products
obsolete or noncompetitive.

        The Company believes that its ability to compete successfully will
depend upon its ability to attract and retain experienced scientists, develop
patented or proprietary technologies and products, obtain regulatory approvals,
manufacture and market products either alone or through third parties, and
secure additional capital resources to fund anticipated net losses for at least
the next several years. The Company expects that competition among products
approved for marketing will be based in large part upon product safety,
efficacy, reliability, availability, price and patent position.

GOVERNMENT REGULATION

        The Company's research and development activities and the future
manufacturing and marketing of any products developed by the Company are subject
to significant regulation by numerous government authorities in the United
States and other countries. In the United States, the Federal Food, Drug and
Cosmetic Act and the Public Health Service Act govern the testing, manufacture,
safety, efficacy, labeling, storage, record keeping, approval, advertising and
promotion of any products the Company may develop. In addition to FDA
regulations, the Company is subject to other federal, state and local
regulations such as the Occupational Safety and Health Act and the Environmental
Protection Act as well as regulations governing the handling, use and disposal
of radioactive and other hazardous materials used by the Company in its research
activities. Product development and approval within this regulatory framework
takes a number of years and involves the expenditure of substantial resources.
In addition, this regulatory framework is subject to changes that may affect
approval, delay an application or require additional expenditures by the
Company.

        The steps required before a pharmaceutical compound may be marketed in
the United States include (i) preclinical laboratory and animal testing, (ii)
submission to the FDA of an IND application, which must become effective before
clinical trials may commence, (iii) adequate and well-controlled clinical trials
to establish the safety and efficacy of the drug, (iv) submission to the FDA of
a New Drug Application ("NDA") and (v) FDA approval of the NDA prior to any
commercial sale or shipment of the drug. In addition to obtaining FDA approval
for each product, each domestic drug manufacturing establishment must be
registered with, and approved by, the FDA. Drug product manufacturing
establishments located in California also must be licensed by the State of
California in compliance with separate regulatory requirements.

        Preclinical testing includes laboratory evaluation of product chemistry
and animal studies to assess the safety and efficacy of the product and its
formulation. The results of preclinical testing are submitted to the FDA as part
of an IND and, unless the FDA objects, the IND will become effective 30 days
following its receipt by the FDA.

        Clinical trials involve administration of the drug to healthy volunteers
or to patients diagnosed with the condition for which the drug is being tested
under the supervision of a qualified clinical investigator. Clinical trials are
conducted in accordance with protocols that detail the objectives of the study,
the parameters to be used to monitor safety and the efficacy 


                                       15


   16
criteria to be evaluated. Each protocol is submitted to the FDA as part of the
IND. Each clinical trial is conducted under the auspices of an independent
Institutional Review Board (the "IRB"). The IRB will consider, among other
matters, ethical factors, the safety of human subjects and the possible
liability of the institution.

        Clinical trials are typically conducted in three sequential phases, but
the phases may overlap. In Phase I, the initial introduction of the drug into
healthy human subjects, the drug is tested for safety (adverse effects), dosage
tolerance, metabolism, distribution, excretion and clinical pharmacology. Phase
II involves trials in a limited patient population to (i) characterize the
actions of the drug in targeted indications, (ii) determine drug tolerance and
optimal dosage and (iii) identify possible adverse side effects and safety
risks. When a compound is found to be effective and to have an acceptable safety
profile in Phase II clinical trials, Phase III clinical trials are undertaken to
further evaluate and confirm clinical efficacy and safety within an expanded
patient population at multiple clinical trial sites. The FDA reviews both the
clinical plans and the results of the trials and may discontinue the trials at
any time if significant safety issues arise.

        The results of preclinical testing and clinical trials are submitted to
the FDA in the form of an NDA or Product License Application for marketing
approval. The testing and approval process is likely to require substantial time
and effort and there can be no assurance that any approval will be granted on a
timely basis, if at all. In addition, the Company will be required to obtain
separate regulatory approval for each indicated use of a drug. The approval
process is affected by a number of factors, including the severity of the
disease, the availability of alternative treatments and the risks and benefits
demonstrated in clinical trials.

        Additional preclinical testing or clinical trials may be requested
during the FDA review period and may delay marketing approval. After FDA
approval for the initial indications, further clinical trials may be necessary
to gain approval for the use of the product for additional indications. The FDA
mandates that adverse effects be reported to the FDA and may also require
post-marketing testing to monitor for adverse effects, which can involve
significant expense.

        Among the conditions for FDA approval is the requirement that the
prospective manufacturer's quality control and manufacturing procedures conform
to the FDA's cGMP requirements. Domestic manufacturing facilities are subject to
biennial FDA inspections and foreign manufacturing facilities are subject to
periodic inspections by the FDA or foreign regulatory authorities.

        The Company is also subject to numerous and varying foreign regulatory
requirements governing the design and conduct of clinical trials and marketing
approval for pharmaceutical products to be marketed outside of the United
States. The approval procedure varies among countries and can involve additional
testing, and the time required to obtain approval may differ from that required
to obtain FDA approval. The foreign regulatory approval process includes all of
the risks associated with obtaining FDA approval, and approval by the FDA does
not ensure approval by the health authorities of any other country.


                                       16


   17
EMPLOYEES

        The Company has 101 full-time employees (including 24 Ph.D.s and
M.D.s), 83 of whom are involved full-time in research, development and
manufacturing scale-up activities. All of the Company's management have had
prior experience with pharmaceutical, biotechnology or medical product
companies. The Company believes that it has been successful in attracting
skilled and experienced scientific personnel, but competition for such personnel
is intense and there can be no assurance that the Company will be able to
attract and retain the individuals needed. None of the Company's employees are
covered by collective bargaining agreements, and management considers relations
with the Company's employees to be good.

LEGAL PROCEEDINGS

        The Company is not a party to any legal proceedings.



                              CERTAIN RISK FACTORS

        The Company's business is subject to a number of risks, including but
not limited to the following. Additional risks related to the Company are
described in the preceding sections of this Report and in the section entitled
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."

UNCERTAINTIES RELATED TO CLINICAL TRIALS

        The Company must demonstrate that LJP 394, the Company's only drug
candidate in clinical trials, is safe and effective for use in each target
indication prior to applying for any regulatory approvals in any market. The
results from preclinical testing and clinical trials of LJP 394 conducted to
date may not be indicative of results that may be obtained in further clinical
trials. A number of companies in the biopharmaceutical industry have suffered
significant setbacks in advanced clinical trials, even after promising results
in earlier trials. The rate of completion of the Company's clinical trials may
be delayed by many factors, including slower than anticipated patient
enrollment, a slower timetable as determined by the Company or a collaborative
partner, or any other adverse event. During the course of clinical trials,
patients can die or suffer other adverse medical effects for reasons that may
not be related to the pharmaceutical agent being tested but which can
nevertheless affect clinical trial results. There can be no assurance that the
Company will be permitted by regulatory authorities in the United States or any
other country to undertake additional clinical trials of LJP 394 or to initiate
clinical trials of any other drug candidates, or that any clinical trials
undertaken by the Company will be completed successfully within any particular
time period, if at all. Any delays in, or termination of, the Company's clinical
trial efforts would have a material adverse effect on the Company's business,
financial condition and results of operations. There also can be no assurance
that LJP 394 or any other drug candidate of the Company will prove to be safe or
effective in clinical trials, that LJP 394 or any other drug candidate of the
Company will receive regulatory approval in any market for any indication, or
that any clinical trials undertaken by the Company will result in marketable
products. If LJP 394 is not shown to be safe and effective in clinical trials,
the resulting delays in developing any other drug candidate and conducting
related preclinical testing and clinical trials, as well as the need for
additional financing, would have a material adverse


                                       17


   18
effect on the Company's business, financial condition and results of operations.
See "Business -- Products Under Development -- Results of Clinical Trials."

EARLY STAGE OF PRODUCT DEVELOPMENT; TECHNOLOGICAL UNCERTAINTIES

        All of the Company's product development efforts are based upon unproven
technologies and therapeutic approaches that have not been widely tested or
used. To date, the Company's Tolerance Technology has been used only in the
preclinical tests and clinical trials of LJP 394 conducted by the Company.
Application of Tolerance Technology to antibody-mediated diseases other than
lupus is in earlier discovery or preclinical research stages. LJP 394 and any
other potential drug candidates of the Company will require significant
additional research and development and are subject to significant risks.
Potential products that appear to be promising at early stages of development
may be ineffective or cause harmful side effects during preclinical testing or
clinical trials, fail to receive necessary regulatory approvals, be difficult to
manufacture, be uneconomical to produce (particularly if high doses are
required), fail to achieve market acceptance or be precluded from
commercialization by proprietary rights of third parties. There can be no
assurance that the Company's product development efforts with respect to LJP 394
or any other drug candidate will be successfully completed, that required
regulatory approvals will be obtained or that any product, if introduced, will
be successfully marketed or achieve commercial acceptance.

        The mechanism of action utilized by LJP 394 is unproven in humans, and
to date, no therapeutic products have been developed that target the activity of
specific B cells. There can be no assurance that LJP 394 will reliably induce or
sustain suppression of disease-causing antibodies, or that LJP 394 will prove to
be safe or effective. Furthermore, clinical trials of LJP 394 may be viewed as a
test of the Company's entire Tolerance Technology approach. If these clinical
trials encounter problems or are otherwise unsuccessful, the applicability of
the Company's Tolerance Technology to other antibody-mediated diseases will be
highly uncertain. Therefore, there is significant risk that the Company's
therapeutic approaches will not prove to be successful, and there can be no
assurance that the Company's drug discovery technologies will result in any
commercially successful products. See "Business -- Products Under Development."

UNCERTAINTY OF COLLABORATIVE ARRANGEMENTS

        As part of its business strategy, the Company pursues collaborations
with pharmaceutical companies in an effort to access their research, drug
development, manufacturing, marketing and financial resources. In December 1996
the Company entered into a collaborative agreement with Abbott pursuant to which
Abbott obtained the exclusive right to market and sell LJP 394 throughout the
world in exchange for royalties on sales, development financing, and certain
milestone payments. Abbott's obligations to make payments to the Company and to
conduct development activities are contingent upon the progress of clinical
trials and the attainment of certain milestones related to regulatory approvals
and sales levels. There can be no assurance that these contingencies will be
met. Furthermore, Abbott has the right to terminate the relationship at any time
based on documented safety or efficacy issues, and without cause within 90 days
of receipt of the results of the pending Phase II/III clinical trial that was
initiated in December 1996 and is expected to be completed some time in 2000.


                                       18


   19
        The Company intends to pursue collaborative arrangements with other
pharmaceutical companies to assist in its research programs and the clinical
development and commercialization of its other drug candidates. There can be no
assurance that the Company will be able to negotiate arrangements with any other
collaborative partners on acceptable terms, if at all, and any additional
collaborative relationships are likely to include contingencies comparable to
those affecting the Abbott arrangement. Once a collaborative arrangement is
established, there can be no assurance that the collaborative partner will
continue funding any particular program or will not pursue alternative
technologies or develop alternative drug candidates, either individually or in
collaboration with others, including the Company's competitors, as a means for
developing treatments for the diseases targeted by the Company. Furthermore,
competing products, either developed by a collaborative partner or to which a
collaborative partner has rights, may result in the withdrawal of support by the
collaborative partner with respect to all or a portion of the Company's
technology.

        Failure to establish or maintain collaborative arrangements will require
the Company to fund its own research and development activities, resulting in
accelerated depletion of the Company's capital, and will require the Company to
develop its own marketing capabilities for any drug candidate that may receive
regulatory approval. The failure of any collaborative partner to continue
funding any particular program of the Company or to commercialize successfully
any product could delay or halt the development or commercialization of any
products involved in such program. As a result, failure to establish or maintain
collaborative arrangements would have a material adverse effect on the Company's
business, financial condition and results of operations. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
"Business -- Collaborative Arrangements."

NEED FOR ADDITIONAL FUNDING; UNCERTAIN ACCESS TO CAPITAL

        The Company's operations to date have consumed substantial capital
resources, and LJP will continue to require substantial and increasing amounts
of capital to support research, product development, preclinical testing and
clinical trials of its drug candidates, to establish commercial-scale
manufacturing capabilities, and to market its potential products. The Company's
future capital requirements will depend on many factors, including continued
scientific progress in its research and development programs, the size and
complexity of these programs, the scope and results of preclinical testing and
clinical trials, the time and costs involved in applying for regulatory
approvals, the costs involved in preparing, filing, prosecuting, maintaining and
enforcing patent claims, competing technological and market developments, the
ability of the Company to establish and maintain collaborative research and
development arrangements and the cost of manufacturing scale-up and effective
commercialization activities and arrangements. The Company expects financing
provided by Abbott for development, commercialization and marketing of LJP 394
to reduce the Company's rate of consumption of its own funds in the short term.
However, Abbott's financing is subject to various conditions and may be
unavailable if conditions and milestones are not met or if Abbott decides not to
pursue development of LJP 394 after the results of the pending Phase II/III
clinical trial are reviewed. In addition, initiation and progress of additional
drug development programs is expected to result in increased expenditures of the
Company's funds. Accordingly, the Company expects to incur significant losses
each year for at least the next several years as its clinical trial, research,
development and manufacturing scale-up activities increase, and losses may
exceed those experienced in prior years if the scope of the Company's programs
reaches expected levels, if Abbott does not provide all financing currently
anticipated for development of 


                                       19


   20
LJP 394, or if the Company is not successful in establishing additional
collaborative relationships to help finance other drug discovery programs. The
Company expects its existing capital resources, together with anticipated
financing from Abbott, to be sufficient to fund the Company's activities, as
currently planned, through 1999. However, the amounts expended by the Company
for various purposes may vary significantly and Abbott's financial support for
development of LJP 394 may terminate under certain circumstances. It is
therefore possible that the Company's cash requirements will exceed current
projections and that the Company will therefore need additional financing sooner
than currently expected. There can be no assurance that the Company will have
adequate resources to support its existing or future business activities.

        The Company actively seeks additional funding, including through
collaborative arrangements and public and private financings. The Company's
choice of financing alternatives may vary from time to time depending upon
various factors, including the market price of the Company's securities,
conditions in the financial markets, and the interest of other entities in
strategic transactions with the Company. There can be no assurance that
additional financing will be available on acceptable terms, if at all, whether
through collaborative arrangement, issuance of securities, or otherwise. If
adequate funds are not available, the Company may be required to delay, scale
back or eliminate one or more of its research and development programs or obtain
funds through arrangements with collaborative partners or others that may
require the Company to relinquish rights to certain of its technologies or
potential products, which could have a material adverse effect on the Company's
business, financial condition and results of operations. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."

HISTORY OF OPERATING LOSSES; UNCERTAINTY OF FUTURE PROFITABILITY

        The Company has incurred operating losses each year since its inception
in 1989 and had an accumulated deficit of approximately $54.7 million as of
December 31, 1997. The continued development of the Company's products will
require the commitment of substantial resources to conduct expanded research and
preclinical and clinical development programs, to enhance manufacturing
capabilities, and to establish additional quality control, regulatory,
administrative and marketing and sales capabilities. The Company expects to
incur significant losses each year for at least the next several years as its
research, development, clinical trial and manufacturing scale-up activities
increase, and losses may exceed those experienced in prior years if the scope of
the Company's programs reaches expected levels, if Abbott does not provide all
financing currently anticipated for development of LJP 394, or if the Company is
not successful in establishing additional collaborative relationships to help
finance other drug discovery programs. To achieve profitability the Company
must, among other things, complete development of its products, obtain
regulatory approvals and establish commercial manufacturing and marketing
capabilities. The amount of net losses and the time required by the Company to
reach sustained profitability are highly uncertain, and the Company does not
expect to generate revenues from the sale of products, if any, for at least
several years. There can be no assurance that the Company will obtain required
regulatory approvals, or successfully develop, manufacture, commercialize and
market products or that the Company will ever achieve product revenues or
profitability. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations."


                                       20


   21
GOVERNMENT REGULATION; NO ASSURANCE OF REGULATORY APPROVAL

        Prior to marketing, any potential product developed by the Company must
undergo an extensive regulatory approval process that includes preclinical
testing and clinical trials and may include post-marketing surveillance of each
compound to establish its safety and efficacy. This regulatory process can take
many years and require the expenditure of substantial resources. Data obtained
from the Company's preclinical and clinical activities are susceptible to
varying interpretations which could delay, limit or prevent regulatory approval.
In addition, delays or rejections may be encountered based upon changes in
policies of the United States FDA for drug approval during the period of product
development and FDA regulatory review of each submitted NDA. Similar delays may
also be encountered in foreign countries. Regulatory approval for a drug may
entail limitations on its indicated uses. In addition, the Company will be
required to obtain separate regulatory approval for each indicated use of a
drug. Even if regulatory approval is obtained, a marketed drug and its
manufacturer are subject to continuing review, and discovery of previously
unknown problems with a product or manufacturer may have adverse effects on the
Company's business, financial condition and results of operations, including
withdrawal of the product from the market. Violations of regulatory requirements
at any stage, including preclinical testing and clinical trials, the approval
process or post-approval surveillance, may result in various adverse
consequences including the FDA's delay in approving or its refusal to approve a
product, withdrawal of an approved product from the market and the imposition of
criminal penalties against the manufacturer and NDA holder. The Company has not
submitted any IND application for any drug candidate other than LJP 394, and
none of the Company's drug candidates has been approved for commercialization in
the United States or elsewhere. There can be no assurance that regulatory
approval will be obtained for any drugs developed by the Company. Failure to
obtain requisite government approvals or approvals of the scope requested would
delay or preclude the Company or any licensees or marketing partners from
marketing the Company's potential products or limit the commercial use of such
products and will have a material adverse effect on the Company's business,
financial condition and results of operations. The Company is also subject to
numerous and varying foreign regulatory requirements governing the design and
conduct of clinical trials and marketing approval for pharmaceutical products to
be marketed outside of the United States. The regulatory procedures vary among
countries and can involve additional testing, and the time required to obtain
approval may differ from that required to obtain FDA approval. The foreign
regulatory approval process includes all of the risks associated with obtaining
FDA approval, and if approval by the FDA were granted, such approval does not
ensure approval by the health authorities of any other country. See "Business --
Government Regulation."

PATENTS AND PROPRIETARY TECHNOLOGY

        The Company's success will depend heavily upon its ability to obtain
patent protection for its therapeutic approaches and for any developed products,
to preserve its trade secrets and to operate without infringing the proprietary
rights of third parties. While the Company has received patents covering certain
aspects of its technology, there can be no assurance that any additional patents
will be issued, that the scope of any patent protection will be sufficient, or
that any current or future issued patents will be held valid if subsequently
challenged. There is a substantial backlog of biotechnology patent applications
at the USPTO that may delay the review and issuance of any patents. The patent
position of biotechnology firms generally is 


                                       21


   22
highly uncertain and involves complex legal and factual questions, and no
consistent policy has emerged regarding the breadth of claims covered in
biotechnology patents or protection afforded by such patents. To date, the
Company has rights to certain United States and foreign issued patents and has
filed or participated as a licensee in the filing of a number of patent
applications in the United States relating to the Company's technology, as well
as foreign counterparts of certain of these applications in certain 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, or that claims allowed under issued
patents 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, or to file patent applications for,
such technology. Competitors may have filed applications for, or may have
received patents and may obtain additional patents and proprietary rights
relating to, compounds or processes that block or compete with those of the
Company.

        A number of pharmaceutical and biotechnology companies and research and
academic institutions have filed or may file patent applications, and have
received or may receive patents, in the fields being pursued by the Company.
Certain of these applications or patents may be competitive with the Company's
applications or conflict in certain respects with claims made under the
Company's applications. In particular, the Company is aware of one currently
pending United States patent application that, if allowed, may contain claims
covering subject matter that may be competitive or conflicting with the
Company's patents and patent applications. In addition, the Company is aware of
a United States patent that has been issued to a third party that contains
claims that may adversely affect the ability of the Company to pursue one of its
projects. Any conflict between the Company's patents and patent applications,
and patents or patent applications of third parties could result in a
significant reduction of the coverage of the Company's existing patents or any
future patents that may be issued. In addition, to determine the priority of
inventions, the Company may have to participate in interference proceedings
declared by the USPTO or in opposition, nullity or other proceedings before
foreign agencies with respect to any of its existing patents or patent
applications or any future patents or applications, which could result in
substantial cost to the Company. Further, the Company may have to participate at
substantial cost in International Trade Commission proceedings to abate
importation of goods which would compete unfairly with products of the Company.
If patents containing competitive or conflicting claims are issued to other
parties and such claims are ultimately determined to be valid, there can be no
assurance that the Company would be able to obtain licenses to these patents at
a reasonable cost, if at all, or be able to develop or obtain alternative
technology.

        The Company also relies upon unpatented trade secrets and improvements,
unpatented know-how and continuing technological innovation to develop and
maintain its competitive position, which it seeks to protect, in part, by
confidentiality agreements with its commercial partners, collaborators,
employees and consultants. The Company also has invention or patent assignment
agreements with its employees and certain consultants. There can be no assurance
that relevant inventions will not be developed by a person not bound by an
invention assignment agreement, or that binding agreements will not be breached,
that the Company will have adequate remedies for any breach, or that the
Company's trade secrets will not otherwise become known or be independently
discovered by competitors. In addition, the Company could incur substantial
costs in defending against suits brought against it by others for infringement
of intellectual property rights or in prosecuting suits which the Company might
bring against other 


                                       22


   23
parties to protect its intellectual property rights. See "Business -- Patents
and Proprietary Technologies."

COMPETITION AND TECHNOLOGICAL CHANGE

        The biotechnology and pharmaceutical industries are subject to rapid
technological change. Competition from domestic and foreign biotechnology
companies, large pharmaceutical companies and other institutions is intense and
expected to increase. A number of companies are pursuing the development of
pharmaceuticals in the Company's targeted areas. These include companies which
are conducting clinical trials and preclinical studies for the treatment of
lupus.

        In addition, there are many academic institutions, both public and
private, engaged in activities relating to research and development of
therapeutics for autoimmune, inflammatory and other diseases. Most of these
companies and institutions have substantially greater facilities, resources,
research and development capabilities, regulatory compliance expertise, and
manufacturing and marketing capabilities than the Company. In addition, other
technologies may in the future be the basis of competitive products. There can
be no assurance that the Company's competitors will not develop or obtain
regulatory approval for products more rapidly than the Company, or develop and
market technologies and products that are more effective than those being
developed by the Company or that would render the Company's technology and
proposed products obsolete or noncompetitive. See "Business -- Competition."

LIMITED MANUFACTURING CAPABILITIES

        The manufacture of the Company's potential products for clinical trials
and the manufacture of any resulting products for commercial purposes is subject
to cGMP as defined by the FDA. While the Company is producing limited quantities
of LJP 394 for clinical trials, its current facilities are not adequate for
commercial production of its potential products. Pursuant to its agreement with
Abbott, the Company is responsible for manufacturing LJP 394 and selling it in
bulk form to Abbott for packaging and commercial resale. Substantial capital
investment in the expansion and build-out of the Company's manufacturing
facilities will be required to enable manufacture of any products in commercial
quantities. The Company has never operated an FDA-approved manufacturing
facility, and there can be no assurance that it will obtain necessary approvals.
The Company has limited manufacturing experience, and no assurance can be given
that it will be able to make the transition to commercial production
successfully. The Company may enter into arrangements with contract
manufacturing companies to expand its own production capacity in order to meet
requirements for its products, or to attempt to improve manufacturing
efficiency. If the Company chooses to contract for manufacturing services and
encounters delays or difficulties in establishing relationships with
manufacturers to produce, package and distribute its finished products, clinical
trials, market introduction and subsequent sales of such products would be
adversely affected. Moreover, contract manufacturers must operate in compliance
with the FDA's cGMP requirements. The Company's potential dependence upon third
parties for the manufacture of its products may adversely affect the Company's
profit margins and its ability to develop and deliver such products on a timely
and competitive basis. See "Business -- Manufacturing."


                                       23


   24
LACK OF MARKETING EXPERIENCE

        In order to commercialize any drug candidate approved by the FDA, the
Company must either develop a marketing and sales force or enter into marketing
arrangements with third parties. Abbott has agreed to be responsible for
worldwide marketing of LJP 394, but the Abbott agreement may terminate under
certain circumstances, and the Company has no arrangements with third parties
for marketing of any of its other drug candidates. There can be no assurance
that the Company will be able to enter into any additional marketing agreements
on terms favorable to the Company, if at all, or that any such agreements that
the Company may enter into will result in payments to the Company. Under the
Abbott agreement and any co-promotion or other marketing and sales arrangements
that may be entered into with other companies, any revenues to be received by
the Company will be dependent on the efforts of others and there can be no
assurance that such efforts will be successful. To the extent that the Company
chooses to attempt to develop its own marketing and sales capabilities, it will
compete with other companies that currently have experienced and well-funded
marketing and sales operations. Furthermore, there can be no assurance that the
Company or any collaborative partner will be able to establish sales and
distribution capabilities without undue delays or expenditures or gain market
acceptance for any of the Company's drug candidates. See "Business -- Marketing
and Sales."

UNCERTAINTIES RELATED TO PHARMACEUTICAL PRICING AND REIMBURSEMENT

        The continuing efforts of government and third-party payers to contain
or reduce the costs of health care through various means may have a material
adverse effect on the Company's business, financial condition and results of
operations. For example, in certain foreign markets, pricing and/or
profitability of prescription pharmaceuticals are subject to government control.
In the United States, the Company expects that there will continue to be a
number of federal and state proposals to implement similar government control.
In addition, increasing emphasis on managed care in the United States will
continue to put pressure on pharmaceutical pricing. Cost control initiatives
could decrease the price that the Company receives for any products it may
develop and sell in the future and have a material adverse effect on the
Company's business, financial condition and results of operations. Further, to
the extent that cost control initiatives have a material adverse effect on the
Company's commercial partners, the Company's ability to commercialize its
products may be adversely affected.

        The Company's ability to commercialize pharmaceutical products may
depend in part on the extent to which reimbursement for the products will be
available from government health administration authorities, private health
insurers and other third-party payers. Significant uncertainty exists as to the
reimbursement status of newly approved health-care products, and third-party
payers, including Medicare, are increasingly challenging the prices charged for
medical products and services. There can be no assurance that any third-party
insurance coverage will be available to patients for any products developed by
the Company. Government and other third-party payers are increasingly attempting
to contain health care costs by limiting both coverage and the level of
reimbursement for new therapeutic products and by refusing in some cases to
provide coverage for uses of approved products for disease indications for which
the FDA has not granted labeling approval. If adequate coverage and
reimbursement levels are not provided by government and other third-party payers
for the Company's products, the market acceptance of these products would be
adversely affected.


                                       24


   25
POTENTIAL PRODUCT LIABILITY; UNCERTAINTIES RELATED TO INSURANCE

        The Company has not received marketing approval from the FDA for any of
its drug candidates and currently uses LJP 394 only in clinical trials. The use
of LJP 394 or any of the Company's other potential products in such clinical
trials and the sale of any approved products may expose the Company to liability
claims resulting from the use of products or product candidates and associated
negative publicity. These claims might be made directly by consumers,
pharmaceutical companies or others. The Company maintains product liability
insurance coverage for claims arising from the use of its products in clinical
trials in the amount of $5.0 million. However, coverage is becoming increasingly
expensive, and there can be no assurance that the Company will be able to
maintain insurance or, if maintained, that insurance can be acquired at a
reasonable cost or in sufficient amounts to protect the Company against losses
due to liability that could have a material adverse effect on the Company's
business, financial condition and results of operations. There can be no
assurance that the Company will be able to obtain product liability insurance on
commercially reasonable terms for any product approved for marketing in the
future or that insurance coverage and the resources of the Company would be
sufficient to satisfy any liability resulting from product liability claims. A
successful product liability claim or series of claims brought against the
Company could have a material adverse effect on its business, financial
condition and results of operations.

DEPENDENCE UPON KEY EMPLOYEES AND CONSULTANTS

        The Company is highly dependent upon the principal members of its
scientific and management staff, the loss of whose services would delay the
achievement of its research and development objectives. The Company's
anticipated growth and expansion into areas and activities requiring additional
expertise, such as clinical trials, government approvals, manufacturing, and
marketing, are expected to place increased demands on the Company's resources
and require the addition of new management personnel as well as the development
of additional expertise by existing management personnel. Retaining the
Company's current key employees and recruiting additional qualified scientific
personnel to perform research and development work in the future will also be
critical to the Company's success. Because competition for experienced
scientists among numerous pharmaceutical and biotechnology companies and
research and academic institutions is intense, there can be no assurance that
the Company will be able to attract and retain such personnel.

        In addition, the Company relies upon consultants and advisors to assist
the Company in formulating its research and development, clinical, regulatory
and manufacturing strategies. All of the Company's consultants and advisors are
employed outside the Company and may have commitments or consulting or advisory
contracts with other entities that may affect their ability to contribute to the
Company.

ENVIRONMENTAL MATTERS AND HAZARDOUS MATERIALS

        Due to the nature of its manufacturing processes, the Company is subject
to stringent federal, state and local laws, rules, regulations and policies
governing the use, generation, manufacture, storage, air emission, effluent
discharge, handling and disposal of certain materials and wastes. There can be
no assurance that the Company will not be required to incur significant costs to
comply with environmental regulations as manufacturing is increased to
commercial volumes, or that the operations, business or assets of the Company
will not be materially and 


                                       25


   26
adversely affected by current or future environmental laws, rules, regulations
and policies or by any releases or discharges of hazardous material.

        In its research activities, the Company utilizes radioactive and other
materials that could be hazardous to human health, safety or the environment.
These materials and various wastes resulting from their use are stored at the
Company's facility pending ultimate use and disposal. The risk of accidental
injury or contamination from these materials cannot be eliminated. In the event
of such an accident, the Company could be held liable for any resulting damages,
and any such liability could exceed the Company's resources.

VOLATILITY OF COMMON STOCK PRICE

        The market prices for securities of biotechnology and pharmaceutical
companies, including the Company, have historically been highly volatile, and
the market has from time to time experienced significant price and volume
fluctuations that are unrelated to the operating performance of particular
companies. Factors such as fluctuations in the Company's operating results,
announcements of technological innovations or new therapeutic products by the
Company or others, clinical trial results, developments concerning agreements
with collaborators, government regulation, developments in patent or other
proprietary rights, public concern as to the safety of drugs discovered or
developed by the Company or others, future sales of substantial amounts of
Common Stock by existing stockholders, comments by securities analysts and
general market conditions can have an adverse effect on the market price of the
Common Stock. The realization of any of the risks described in these "Risk
Factors" could have an adverse effect on market price of the Company's Common
Stock. See "Market for Registrant's Common Equity and Related Stockholder
Matters."

POTENTIAL ADVERSE EFFECTS OF SHARES ELIGIBLE FOR FUTURE SALE

        Sales of the Company's Common Stock in the public market, or the
perception that such sales could occur, could adversely affect the prevailing
market price of the Company's securities and impair the Company's ability to
complete equity financings. The Company has outstanding approximately 9,000,000
shares of Common Stock that have been issued in registered public offerings,
pursuant to the Company's Employee Stock Purchase Plan, upon exercise of stock
options or sold in the public market pursuant to Rule 144 under the Securities
Act of 1933, as amended (the "Securities Act"), and are freely tradable in the
public markets, and up to approximately 5,000,000 shares of Common Stock
currently are eligible for resale in the public market pursuant to Rule 144
under the Securities Act. An additional 2,000,000 shares issued to an overseas
investor pursuant to Regulation S under the Securities Act may also be resold.
An additional 1,831,202 shares issued to Abbott may also be resold pursuant to
Rule 144 at various times. In addition, an aggregate of 4,418,832 shares of
Common Stock are issuable upon exercise of warrants and stock options
outstanding as of December 31, 1997, as follows: (i) 1,494,550 shares issuable
upon exercise of the Company's publicly traded Redeemable Common Stock Purchase
Warrants at an exercise price of $6.00 per share; (ii) 961,219 shares issuable
upon exercise of various privately held warrants and options at a weighted
average exercise price of $6.54 per share, and (iii) 1,963,063 shares issuable
upon exercise of stock options outstanding under the Company's various stock
option plans at a weighted average exercise price of $3.25 per share. The
Company has in effect or intends to file registration statements under the
Securities Act registering approximately 2,954,000 shares of Common Stock
reserved under its employee stock option and purchase plans, up to 1,494,550
shares of Common Stock reserved 


                                       26


   27
for issuance upon exercise of the Company's publicly traded Redeemable Common
Stock Purchase Warrants, and resale of approximately 701,219 shares of Common
Stock issuable upon exercise of privately held warrants. Up to approximately
931,465 shares of Common Stock issuable upon future exercise of outstanding
stock options will be available for public resale under Rule 144 pursuant to
Rule 701 under the Securities Act. The Company is unable to estimate the number
of shares of Common Stock that may actually be resold in the public market
because this will depend upon the market price for the Common Stock, the
individual circumstances of the sellers and other factors. The Company has a
number of institutional stockholders that own significant blocks of the
Company's Common Stock. If such stockholders sell large portions of their
holdings in a relatively short time, for liquidity or other reasons, the
prevailing market price of the Company's Common Stock could be negatively
affected.

ANTI-TAKEOVER PROVISIONS; POSSIBLE ISSUANCES OF PREFERRED STOCK

        Certain provisions of the Delaware General Corporation Law may have the
effect of deterring hostile takeovers or delaying or preventing changes in the
control or management of the Company, including transactions in which
stockholders might otherwise receive a premium for their shares over
then-current market prices. The Company may also issue shares of Preferred Stock
without stockholder approval and upon such terms as the Company's Board of
Directors may determine. The issuance of Preferred Stock could have the effect
of making it more difficult for a third party to acquire a majority of the
Company's outstanding stock, and the holders of such Preferred Stock could have
voting, dividend, liquidation and other rights superior to those of holders of
the Common Stock.

ABSENCE OF DIVIDENDS

        The Company has not paid any cash dividends since its inception and does
not anticipate paying any cash dividends in the foreseeable future.


ITEM 2. PROPERTIES.


        The Company leases two adjacent buildings in San Diego, California for a
total of approximately 54,000 square feet. Each building is subject to a lease,
one that expires in 2001 and one that expires in 2004. Each lease includes an
option exercisable by the Company to extend the term of the agreement for an
additional five years and is subject to escalation clauses that provide for
annual rent increases based on the consumer price index. The Company believes
that these facilities will be adequate to meet its needs for the near term. Over
the longer term, management believes additional space can be secured at
commercially reasonable rates.


ITEM 3. LEGAL PROCEEDINGS.


        The Company is not a party to any legal proceedings.


                                       27


   28
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

        No matters were submitted to a vote of the Company's security holders
during the fourth quarter of the year ended December 31, 1997.

EXECUTIVE OFFICERS OF THE REGISTRANT

        The executive officers and key employees of the Company and their ages
are set forth below.


                              
Steven B. Engle                43   Chairman of the Board, Chief Executive Officer, and
                                    Assistant Secretary

Stephen M. Coutts, Ph.D.       57   Executive Vice President of Research and Development

Peter G. Ulrich                45   Executive Vice President

Bonnie Hepburn, M.D.           57   Vice President of Clinical Development

Mark T. Edgar, Ph.D.           47   Vice President of Operations

Wood C. Erwin, C.P.A.          47   Vice President of Finance, Chief Financial Officer
                                    and Secretary

Andrew Wiseman, Ph.D.          49   Director of Business Development




               STEVEN B. ENGLE, Chairman of the Board and Chief Executive
Officer, joined the Company as Executive Vice President and Chief Operating
Officer in 1993, became President and a Director in 1994, Chief Executive
Officer in 1995 and Chairman of the Board in 1997. From 1991 to 1993, Mr. Engle
served as Vice President of Marketing, Acting Vice President of Manufacturing
and Acting Chief Executive Officer for Cygnus Inc., a publicly held company that
develops drug delivery systems. From 1987 to 1991, he was Chief Executive
Officer of Quantum Management Company, a management consulting firm serving the
pharmaceutical and biotechnology industry. From 1984 to 1987, he was Vice
President of Marketing and Divisional General Manager for Micro Power Systems
Inc., a privately held company that manufactures high technology products
including medical devices. He holds an M.S.E.E. and a B.S.E.E. in Biomedical
Engineering from the University of Texas.

        STEPHEN M. COUTTS, Ph.D. has served as the Executive Vice President of
Research and Development of the Company since its formation in May 1989. From
1987 until 1989, Dr. Coutts was Vice President of Therapeutics Research &
Development for Quidel Corporation, a publicly held company that markets human
diagnostic kits. From 1986 to 1987 he served as Executive Director of Scientific
Research of the Purdue Frederick Company, a pharmaceutical company, and from
1976 to 1986 he held various positions with the Revlon Health Care Group,
including Director of Revlon's Department of Immunobiology. From 1968 to 1976,
Dr. Coutts held academic research and teaching positions at The Institute for
Molecular Biology 


                                       28


   29
(Braunschweig, Germany) and Princeton University. Dr. Coutts holds an M.B.A.
from New York University and a Ph.D. in Biochemistry from Harvard University.

        PETER G. ULRICH, Executive Vice President, joined the Company in
December 1995 as Senior Vice President of Corporate Development and Marketing.
Mr. Ulrich has served as President and Chief Executive Officer of three
biotechnology companies: MedClone, Inc., a biotechnology company developing
therapeutics for autoimmune diseases from 1991 to 1994, LipoGen, Inc. from 1988
to 1990, and BIOTX from 1985 to 1988. From 1982 to 1985, he was the Vice
President of Marketing at Analytical Luminescence Laboratory, and from 1974 to
1982 he held various positions with Baxter Travenol Laboratories, including
International Marketing Manager and National Sales Manager. Before joining the
Company, Mr. Ulrich served for one year as Assistant Vice President of
Technology Development for the University of Alabama at Birmingham. Mr. Ulrich
holds a B.A. from the University of Texas at Austin and a Masters Degree in
International Business Administration from the University of Dallas.

        BONNIE HEPBURN, M.D., a practicing rheumatologist, joined the Company in
April 1996 as Vice President of Clinical Development. Prior to joining the
Company, from 1994 to 1995, Dr. Hepburn served as Director of Immunology
Clinical Research for Centocor. From 1987 to 1994, Dr. Hepburn held several
positions with Ciba-Geigy Ltd., including Head of Inflammation/Bone/Allergy
Clinical Research, Executive Director of Anti-Inflammatory/Pulmonary Clinical
Research, and Director of Regulatory Affairs. She served as a member and
chairman of the FDA Arthritis Advisory Committee from 1980 to 1983 and also on
the Committee for Revision of FDA Antirheumatic Drug Guidelines. Dr. Hepburn is
a Clinical Professor of Medicine at the University of California, San Diego. Dr.
Hepburn received her B.A. from Wellesley College and her M.D. from the
University of Pennsylvania School of Medicine, and completed her medical
residency and fellowship in rheumatology at the Mayo Clinic.

        MARK T. EDGAR, Ph.D., Vice President of Operations, joined the Company
in May 1995 as Vice President of Manufacturing. Prior to joining the Company,
Dr. Edgar was with Syntex Corp. for 15 years, during which time he served in a
variety of capacities, including as Vice President and Director of the CNTF
Program Management Team at Syntex Development Research from 1993 to 1995;
Director of Operations at Syntex Bahamas Chemical from 1990 to 1993; and
Director of Manufacturing Engineering and Materials at Syntex Laboratories, Inc.
from 1987 to 1990. Dr. Edgar holds a Ph.D. in organic chemistry from Arizona
State University and an M.B.A. from the University of Colorado.

        WOOD C. ERWIN joined the Company as Vice President of Finance and Chief
Financial Officer in January 1996. Before joining the Company, Mr. Erwin served
during 1995 as Vice President of Finance and Chief Financial Officer of Resource
Optimization, Inc., a software company. From 1992 to 1995 he served as Chief
Financial Officer of MedClone, Inc., a biotechnology company developing
therapeutics for autoimmune diseases. From 1991 to 1992, Mr. Erwin served as
Vice President of Finance and Chief Financial Officer of Med Images, Inc., a
provider of computerized services to hospitals; and from 1986 to 1991 as Chief
Financial Officer and Director of Operations of LipoGen, Inc., a biotechnology
company. Mr. Erwin was also the Controller of Plasti-Line, Inc., a publicly
traded manufacturer of illuminated signs; Vice President of Finance of Kusan,
Inc., a subsidiary of Bethlehem Steel Corp.; and Cost Analyst for Oscar Mayer
Company. Mr. Erwin holds B.S. and M.B.A. degrees from the University of
Tennessee and is a Certified Public Accountant and Certified Management
Accountant.


                                       29


   30
        ANDREW WISEMAN, Ph.D. has served as Director of Business Development for
the Company since its formation in May 1989. From 1983 to 1989, Dr. Wiseman held
several positions with Quidel Corporation, including Senior Research Scientist,
Project Manager in Diagnostic Research and Development and Manager of Business
Development. Dr. Wiseman was an Associate Member (Professor) at the Medical
Biology Institute and an Assistant Member at the Scripps Clinic and Research
Foundation and holds a Ph.D. in Genetics from Duke University.



                                     PART II


ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.

        The Company's Common Stock trades on the Nasdaq National Market under
the symbol "LJPC." Set forth below are the high and low sales prices for the
Company's Common Stock for each full quarterly period within the two most recent
fiscal years.




                                                     Prices
Year Ended December 31, 1997                High                  Low
                                           ------               -------
                                                          
          First Quarter                    6                    4-31/64
          Second Quarter                   5-5/8                3-7/8
          Third Quarter                    5-1/2                3-7/8
          Fourth Quarter                   5-7/8                4-1/8

Year Ended December 31, 1996

          First Quarter                    9-3/8                4-7/8
          Second Quarter                   8-7/8                5-1/8
          Third Quarter                    6-7/16               3-7/8
          Fourth Quarter                   6-5/16               3-1/2



        The Company has not paid dividends on its Common Stock and does not
anticipate paying dividends in the foreseeable future.

        The approximate number of record holders of the Company's Common Stock
as of March 17, 1998, was 314.

        In September 1997, the Company sold 831,152 shares of its Common Stock
to Abbott for an aggregate price of $4.0 million. The sale was a privately
negotiated sale to a single buyer and was exempt from registration under Section
4(2) of the Securities Act of 1933, as amended, and there were no underwriters
involved.


                                       30


   31
ITEM 6. SELECTED FINANCIAL DATA.

        The following Selected Financial Data should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" included in Item 7 below and the financial statements of the Company
and related notes thereto beginning at page F-1 of this Report.




                                                      Years Ended December 31,
                             ----------------------------------------------------------------------------
                               1993             1994             1995             1996             1997
                             --------         --------         --------         --------         --------
                                                 (In thousands, except per share data)
                                                                                       
STATEMENT OF OPERATIONS
DATA:

Revenue from
 collaborative
 agreements                  $     --         $     --         $  3,000         $  4,000         $  9,860

Expenses:
  Research and
     development                6,737            8,499            9,804           11,663           14,676
  General and
     administrative             1,386            2,049            2,390            2,920            2,937
                             --------         --------         --------         --------         --------
Loss from operations           (8,123)         (10,548)          (9,194)         (10,583)          (7,753)

Interest expense                 (145)            (364)            (301)            (183)             (56)
Interest income                   321              599              941            1,170            1,441
                             --------         --------         --------         --------         --------

Net loss                     $ (7,947)        $(10,313)        $ (8,554)        $ (9,596)        $ (6,368)
                             ========         ========         ========         ========         ========

Basic and diluted net
 loss per share(1)          $  (1.68)        $  (1.44)        $   (.79)        $   (.63)        $   (.36)
                             ========         ========         ========         ========         ========

Shares used in
 computing basic and
 diluted net loss per
 share(1)                      4,718            7,137           10,883           15,150           17,547
                             ========         ========         ========         ========         ========

BALANCE SHEET DATA:

Working capital              $  6,314         $ 12,643         $ 21,949         $ 25,886         $ 23,713
Total assets                 $ 10,102         $ 17,094         $ 26,375         $ 31,687         $ 29,646
Noncurrent portion of
 obligations under
 capital leases              $  1,595         $  1,628         $    892         $    168         $      8
Stockholders' equity         $  6,938         $ 13,810         $ 23,568         $ 27,938         $ 25,715



(1) The loss per share information was computed applying the requirements of
recently effective Statement of Financial Accounting Standard No. 128 and SEC
Staff Accounting Bulletin No. 98. See Note 1 of Notes to Financial Statements
for an explanation of the computation of per share data.


                                       31


   32
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS.

        Since its inception in May 1989, the Company has devoted substantially
all of its resources to the research and development of technology and potential
drugs to treat antibody-mediated diseases. The Company has never generated any
revenue from product sales and has relied upon private and public investors,
revenue from collaborative agreements, equipment lease financings and interest
income on invested cash balances for its working capital. The Company has been
unprofitable since inception and expects to incur substantial additional
expenses and net operating losses for at least the next several years as it
increases its manufacturing scale-up activities including the production of LJP
394 for clinical trials, and increases its research and development expenditures
on additional drug candidates, and general and administrative expenditures to
support increased research and development and manufacturing scale-up
activities. The Company's activities to date are not as broad in depth or scope
as the activities it must undertake in the future and the Company's historical
operations and the financial information included in this Report are not
indicative of its future operating results or financial condition.

        The Company expects that losses will fluctuate from quarter to quarter
as a result of differences in the timing of expenses incurred and potential
revenues from collaborative arrangements. Some of these fluctuations may be
significant. As of December 31, 1997, the Company's accumulated deficit was
approximately $54.7 million.

        The Company's business is subject to significant risks including, but
not limited to, the risks inherent in its research and development efforts,
including clinical trials, uncertainties associated with both obtaining and
enforcing its patents and with the patent rights of others, the lengthy,
expensive and uncertain process of seeking regulatory approvals, uncertainties
regarding government reforms and of product pricing and reimbursement levels,
technological change and competition, manufacturing uncertainties and dependence
on its collaborative relationship with Abbott, a related party. Even if the
Company's product candidates appear promising at an early stage of development,
they may not reach the market for numerous reasons. Such reasons include the
possibilities that the products will be ineffective or unsafe during clinical
trials, will fail to receive necessary regulatory approvals, will be difficult
to manufacture on a large scale, will be uneconomical to market or will be
precluded from commercialization by proprietary rights of third parties.

RESULTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995

        Revenue. The Company had revenue of $9.9 million, $4.0 million and $3.0
million in the years ended December 31, 1997, 1996 and 1995, respectively. In
December 1996 the Company entered into a collaborative agreement with Abbott for
the worldwide development and commercialization of LJP 394, the Company's lupus
drug candidate. Revenue in 1997 was attributable to the funding from Abbott for
the development of LJP 394. Revenue in 1996 was attributable solely to an
up-front license fee upon the signing of the Company's collaborative agreement
with Abbott. Revenue in 1995 was attributable solely to a one-time initial
license fee under a prior collaborative agreement which was terminated in May
1996. The collaborative agreement with Abbott obligates Abbott to make further
development funding and milestone 


                                       32


   33
payments, however both Abbott and the Company have the right to terminate the
agreement under certain circumstances. Accordingly, there is no assurance that
the Company will realize any further revenue from this arrangement or any other
collaborative arrangement.

        Research and Development Expenses. The Company's research and
development expenses increased to $14.7 million for the year ended December 31,
1997 from $11.7 million in 1996 and $9.8 million in 1995. Several factors
contributed to the increase from 1996 to 1997, including manufacturing scale-up
activities, expansion of the Company's research and development programs and
increased facilities expenditures. The increase in research and development
expense from 1995 to 1996 was primarily attributable to additions to research
and development personnel, expansion of the Company's research and development
programs, manufacturing scale-up activities, conduct of the Company's clinical
and toxicology programs including Phase II/III clinical trial of LJP 394 and
increased facilities expenditures. The Company's research and development
expenses are expected to increase significantly in the future as manufacturing
scale-up activities including the production of LJP 394 for clinical trials are
increased, efforts to develop additional drug candidates are intensified and
potential products progress into and through clinical trials.

        General and Administrative Expenses. The Company's general and
administrative expenses of $2.9 million for the year ended December 31, 1997
remained comparable to the expenses in 1996 of $2.9 million and increased from
$2.4 million in 1995. Several factors contributed to this increase from 1995,
including increased personnel to support increased research and development and
clinical activities, increased facilities expenditures and expanded business
development activities. The Company expects general and administrative expenses
to increase significantly in the future in order to support increased
manufacturing scale-up and research and development activities.

        Interest Income and Expense. The Company's interest income increased to
$1.4 million for the year ended December 31, 1997 from $1.2 million in 1996 and
$941,000 in 1995. The increase in interest income in 1997 as compared to 1996
was due to the investment of the proceeds from the Company's additional stock
issuance to Abbott in September 1997 and from the development funding received
from Abbott throughout 1997. The increase in interest income in 1996 as compared
to 1995 was due to the investment of the proceeds from the Company's additional
public offering in July and August 1996. Interest expense decreased to $56,000
for the year ended December 31, 1997 from $183,000 in 1996 and $301,000 in 1995.
The decreases in interest expense were the result of decreases in the Company's
capital lease obligations.

        Net Operating Loss Carryforwards. At December 31, 1997, the Company had
available net operating loss carryforwards and research tax credit carryforwards
of approximately $51.8 million and $2.3 million, respectively, for federal
income tax purposes, which will begin to expire in 2004 unless previously
utilized. Because of "change in ownership" provisions of the Tax Reform Act of
1986, the Company's net operating loss and tax credit carryforwards will be
subject to an annual limitation regarding utilization against taxable income in
future periods. The Company believes that such limitation will not have a
material impact on the benefits that may arise out of its net operating loss and
tax credit carryforwards, but there can be no assurance that additional
limitations arising from any future changes in ownership will not have a
material impact on the Company. For more information concerning the provision
for income taxes, see Note 7 of the Notes to Financial Statements.


                                       33


   34
LIQUIDITY AND CAPITAL RESOURCES

        From inception through December 31, 1997, the Company had incurred a
cumulative net loss of approximately $54.7 million and financed its operations
through private and public offerings of its securities, revenues from
collaborative agreements, capital and operating lease transactions and interest
income on its invested cash balances. As of December 31, 1997, the Company had
raised $79.5 million in net proceeds since inception from sales of equity
securities.

        At December 31, 1997, the Company had $27.0 million in cash, cash
equivalents and short-term investments, as compared to $24.2 million at December
31, 1996. The Company's working capital at December 31, 1997 was $23.7 million,
as compared to $25.9 million at December 31, 1996. The increase in cash, cash
equivalents and short-term investments resulted from $11.1 million of funding
received from Abbott for the development of LJP 394, $4.0 million for the
up-front license fee upon the signing of its collaborative agreement with Abbott
in 1996 which was received in 1997 and net proceeds of $3.9 million from the
sale of stock to Abbott in September 1997, partially offset by the continued use
of the Company's cash toward expenses of ongoing research and development and
clinical programs and related general and administrative expenses. The decrease
in working capital is primarily due to use of cash for net operating expenses in
1997 offset by the net proceeds received from the sale of stock to Abbott in
September 1997. The Company invests its cash in corporate and United States
Government-backed debt instruments.

        As of December 31, 1997, the Company had acquired an aggregate of $4.1
million in property and equipment, of which approximately $956,000 of total
fixed assets costs is financed under capital lease obligations. In addition, the
Company leases its office and laboratory facilities and certain equipment under
operating leases. The Company has no material commitments for the acquisition of
property and equipment but anticipates increasing investment in property and
equipment in connection with the enhancement of its research and development and
manufacturing facilities and capabilities.

        The Company intends to use its financial resources to fund manufacturing
scale-up activities including the production of LJP 394 for clinical trials,
research and development efforts, and for working capital and other general
corporate purposes. The amounts actually expended for each purpose may vary
significantly depending upon numerous factors, including the results of clinical
trials, the timing of regulatory applications and approvals, and technological
developments. Expenditures will also depend upon the establishment and progress
of collaborative arrangements, contract research and the availability of other
financings. There can be no assurance that these funds will be available on
acceptable terms, if at all.

        The Company anticipates that its existing capital and interest earned
thereon and anticipated funding from the Abbott collaboration will be sufficient
to fund the Company's operations as currently planned through 1999. The
Company's future capital requirements will depend on many factors, including
continued scientific progress in its research and development programs, the size
and complexity of these programs, the scope and results of clinical trials, the
time and costs involved in applying for regulatory approvals, the costs involved
in preparing, filing, prosecuting, maintaining and enforcing patent claims,
competing technological and market developments, the ability of the Company to
maintain its collaborative arrangement with Abbott and to establish and maintain
additional collaborative relationships, and the cost of manufacturing scale-up
and effective commercialization activities and arrangements. The 


                                       34


   35
Company expects to incur significant net operating losses each year for at least
the next several years as it expands its current research and development
programs and increases its general and administrative expenses to support a
larger, more complex organization. It is possible that the Company's cash
requirements will exceed current projections and that the Company will therefore
need additional financing sooner than currently expected.

        The Company has no current means of generating cash flow from operations
and its lead drug candidate, LJP 394, will not generate revenues, if at all,
until it has been proven safe and effective, has received regulatory approval
and has been successfully commercialized, a process that is expected to take at
least the next several years. The Company's other drug candidates are much less
developed than LJP 394. There can be no assurance that the Company's product
development efforts with respect to LJP 394 or any other drug candidate will be
successfully completed, that required regulatory approvals will be obtained, or
that any product, if introduced, will be successfully marketed or achieve
commercial acceptance. Accordingly, the Company must continue to rely upon
outside sources of financing to meet its capital needs for the foreseeable
future.

        Abbott's funding of the development costs for LJP 394 and milestone
payments are expected to continue to enhance the Company's short-term liquidity
by minimizing the expenditure of the Company's own funds on further development
of LJP 394. However, the Company anticipates increasing expenditures on the
development of other drug candidates and over time, the Company's consumption of
cash will necessitate additional sources of financing. Furthermore, the Company
has no internal sources of liquidity and termination of the Abbott arrangement
would have a serious adverse effect on the Company's ability to generate
sufficient cash to meet its needs.

        The Company will continue to seek capital through any appropriate means,
including issuance of its securities and establishment of additional
collaborative arrangements. However, there can be no assurance that additional
financing will be available on acceptable terms and the Company's negotiating
position in its capital-raising efforts may worsen as it continues to use its
existing resources. Financing through collaborative arrangements is uncertain
because payments under the Company's collaborative agreement with Abbott are
subject to certain termination rights, including those related to progress in
clinical trials for LJP 394, and there is no assurance that the Company will be
able to enter into further collaborative relationships.

IMPACT OF YEAR 2000

        The "Year 2000 Issue" is the result of computer programs written in the
past that used two digits rather than four to define the applicable year. As a
result, these computer programs may not properly recognize calendar dates
beginning in the year 2000. This problem may cause systems to fail or
miscalculate causing disruptions of operations, including a temporary inability
to process transactions or engage in similar normal business activities.

        The Company believes that its total internal Year 2000 Issue costs will
be minimal and that its Year 2000 conversion requirements will be achieved
through routine upgrades to its software programs. The Company expects these
upgrades to be completed by the end of 1998. These costs and the expected
completion date are based on management's best estimates; there can be no
assurance that these estimates will be achieved and actual results could differ
materially from those anticipated. The Company has also initiated communications
with all of 


                                       35


   36
its significant suppliers to determine the extent to which the Company's systems
are vulnerable to those third parties' failure to remediate their own Year 2000
Issues. There can be no assurance that the systems of other companies on which
the Company's systems rely will be timely converted and will not have an adverse
effect on the Company's systems.


ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

        The financial statements and supplementary data required by this item
are at the end of this Report beginning on page F-1.


ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
        FINANCIAL DISCLOSURE.

        None.



                                    PART III


ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

        Information concerning the Company's executive officers is included
under the caption "Executive Officers" following Part I, Item 4 of this Report.
Other information for Item 10 is incorporated by reference from the portions of
the Registrant's definitive proxy statement for its annual meeting of
stockholders to be held on May 13, 1998 entitled "Proposal 1 - Election of
Directors" and "Section 16(a) Beneficial Ownership Reporting Compliance."


ITEM 11. EXECUTIVE COMPENSATION.

        Information for Item 11 is incorporated by reference from the portions
of the Registrant's definitive proxy statement for its annual meeting of
stockholders to be held on May 13, 1998 entitled "Executive Compensation and
Other Information," "Report of the Compensation Committee on Executive
Compensation," "Compensation Committee Interlocks and Insider Participation,"
and "Stock Performance Graph."


ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.

        Information for Item 12 is incorporated by reference from the portion of
the Registrant's definitive proxy statement for its annual meeting of
stockholders to be held on May 13, 1998 entitled "Security Ownership of Certain
Beneficial Owners and Management."


ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

        No disclosures are required.


                                       36


   37
                                     PART IV


ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.

         (a) Documents filed as part of this Report:

               1. Financial Statements.

                  The following financial statements of La Jolla Pharmaceutical
                  Company are included in Item 8:


                                                                                       
                      Report of Ernst & Young LLP, Independent
                      Auditors ....................................................        F-1

                      Balance Sheets at December 31, 1997 and
                      1996 ........................................................        F-2

                      Statements of Operations for each of the three years in the
                      period ended December 31, 1997, 1996 and 1995 ...............        F-3

                      Statements of Stockholders' Equity for each of the three 
                      years in the period ended December 31, 1997, 1996 and 1995 ..        F-4

                      Statements of Cash Flows for each of the three years in the
                      period ended December 31, 1997, 1996 and 1995 ...............        F-5

                      Notes to Financial
                      Statements ..................................................        F-6
                      
                      


               2. Financial Statement Schedules.

                      No financial statement schedules are required.




                                       37


   38
                3. Exhibits.



Exhibit
Number          Description
- ------          -----------
             
3.1             Intentionally omitted

3.2             Bylaws of the Company(1)

3.3             Restated Certificate of Incorporation of the Company(3)

10.1            Intentionally omitted

10.2            Stock Option Agreement dated February 4, 1993 entitling Joseph Stemler
                to purchase 35,000 shares of Common Stock(1) *

10.3            Letter regarding terms of employment and potential severance of Stephen
                M. Coutts(1) and the modification to this letter(10) *

10.4            Intentionally omitted

10.5            Intentionally omitted

10.6            Steven B. Engle Employment Agreement(1) and Amendment No. 1(10) *

10.7            Form of Directors and Officers Indemnification Agreement(1)

10.8            Intentionally omitted

10.9            Exclusive License Agreement dated September 1, 1991 regarding PLA2
                inhibition technology between the Company and the Regents of the
                University of California(1)

10.10           Option and Collaborative Research Agreement dated June 10, 1991
                regarding certain compounds for potential treatment of muscular
                dystrophies or myasthenia gravis between the Company and CepTor
                Corporation(1)

10.11           Consulting Agreement dated September 1, 1991 between the Company and Dr.
                Edward A. Dennis(1)

10.12           Agreement dated September 1, 1991 regarding stock purchase between the
                Company and Dr. Edward A. Dennis(1)

10.13           Form of Employee Invention and Confidential Information Agreement(1)

10.14           Industrial Real Estate Lease(1)

10.15           Intentionally omitted

10.16           Master Lease Agreement dated June 22, 1993 with Aberlyn Capital
                Management Limited Partnership ("ACM") and related Agreements to Issue
                Warrant with Warrants issued to ACM and Aberlyn Holding Company, Inc.(1)

10.17           La Jolla Pharmaceutical Company 1989 Incentive Stock Option Plan and
                1989 Nonstatutory Stock Option Plan(1) *

10.18           Form of Stock Option Agreement under the 1989 Nonstatutory Stock Option
                Plan(1)

10.19           La Jolla Pharmaceutical Company 1994 Incentive Stock Option Plan(1) *

10.20           Intentionally omitted

10.21           Letter Agreement dated June 7, 1993 between the Company and Vector
                Securities International regarding Vector's engagement as
                financial advisor to the Company with respect to potential
                corporate strategic alliances(1)

10.22           Intentionally omitted



                                       38


   39



Exhibit
Number          Description
- ------          -----------
             
10.23           Intentionally omitted

10.24           Intentionally omitted

10.25           Second Amendment to Lease dated June 30, 1994 by and between the Company
                and BRE Properties, Inc.(2)

10.26           Intentionally omitted

10.27           Third Amendment to Lease dated January 26, 1995 by and between the
                Company and BRE Properties, Inc.(4)

10.28           Intentionally omitted

10.29           Master Lease Agreement dated September 13, 1995 by and between the
                Company and Comdisco Electronics Group(5)

10.30           Intentionally omitted

10.31           Agreement dated September 22, 1995 between the Company and
                Joseph Stemler regarding option vesting (6)*

10.32           Consulting Agreement dated January 1, 1996 between the Company and
                Joseph Stemler(6)*

10.33           Building Lease Agreement effective November 1, 1996 by and between the
                Company and WCB II-S BRD Limited Partnership(7)

10.34           Master Lease Agreement dated December 20, 1996 by and between
                the Company and Transamerica Business Credit Corporation(9)

10.35           License and Supply Agreement dated December 23, 1996  by and between the
                Company and Abbott Laboratories(8),(9)

10.36           Stock Purchase Agreement dated December 23, 1996 by and between the
                Company and Abbott Laboratories(9)

10.37           Option Amendment Agreement dated November 3, 1997 between the Company
                and Peter G. Ulrich(11) *

23.1            Consent of Ernst & Young LLP, Independent Auditors

27              Financial Data Schedule



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

*       This exhibit is a management contract or compensatory plan or
        arrangement.

(1)     Previously filed with the Company's Registration Statement on Form S-1
        (No. 33-76480) as declared effective by the Securities and Exchange
        Commission on June 3, 1994.

(2)     Previously filed with the Company's quarterly report on Form 10-Q for
        the quarter ended June 30, 1994 and incorporated by reference herein.

(3)     Previously filed with the Company's annual report on Form 10-K for the
        fiscal year ended December 31, 1994 and incorporated by reference
        herein.

(4)     Previously filed with the Company's quarterly report on Form 10-Q for
        the quarter ended March 31, 1995 and incorporated by reference herein.

(5)     Previously filed with the Company's quarterly report on Form 10-Q for
        the quarter ended September 30, 1995 and incorporated by reference
        herein.

(6)     Previously filed with the Company's annual report on Form 10-K for the
        fiscal year ended December 31, 1995 and incorporated by reference
        herein.

(7)     Previously filed with the Company's quarterly report on Form 10-Q for
        the quarter ended September 30, 1996 and incorporated by reference
        herein.


                                       39


   40
(8)     Portions of the Exhibit 10.35 have been omitted and filed separately
        with the Securities and Exchange Commission pursuant to a request for
        confidential treatment under Rule 24b-2 of the Securities Exchange Act
        of 1934.

(9)     Previously filed with the Company's annual report on Form 10-K for the
        fiscal year ended December 31, 1996 and incorporated by reference
        herein.

(10)    Previously filed with the Company's quarterly report on Form 10-Q for
        the quarter ended June 30, 1997 and incorporated by reference herein.

(11)    Previously filed with the Company's quarterly report on Form 10-Q for
        the quarter ended September 30, 1997 and incorporated by reference
        herein.



         (b) Reports on Form 8-K:

             The Company did not file any reports on Form 8-K during the three
             months ended December 31, 1997.


                                       40


   41
                Report of Ernst & Young LLP, Independent Auditors



The Board of Directors and Stockholders
La Jolla Pharmaceutical Company

We have audited the accompanying balance sheets of La Jolla Pharmaceutical
Company as of December 31, 1997 and 1996, and the related statements of
operations, stockholders' equity and cash flows for each of the three years in
the period ended December 31, 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 La Jolla Pharmaceutical Company
at December 31, 1997 and 1996, and the results of its operations and its cash
flows for each of the three years in the period ended December 31, 1997, in
conformity with generally accepted accounting principles.




                               /s/ ERNST & YOUNG LLP


San Diego, California
January 30, 1998


                                       F-1


   42
                         La Jolla Pharmaceutical Company

                                 Balance Sheets

                 (In thousands, except share and per share data)




                                                                       DECEMBER 31,
                                                                 -------------------------
                                                                   1997             1996
                                                                 --------         --------
                                                                                 
ASSETS
Current assets:
  Cash and cash equivalents                                      $ 11,999         $  6,613
  Short-term investments                                           14,979           17,621
  Receivable - related party                                           --            4,000
  Other current assets                                                658            1,233
                                                                 --------         --------
    Total current assets                                           27,636           29,467

Property and equipment, net                                           946            1,361

Patent costs and other assets, net                                  1,064              859
                                                                 --------         --------
                                                                 $ 29,646         $ 31,687
                                                                 ========         ========

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
  Accounts payable                                               $  1,256         $  1,539
  Accrued expenses                                                    880            1,106
  Accrued payroll and related expenses                                377              294
  Deferred revenue - related party                                  1,277               --
  Current portion of obligations under capital leases                 133              642
                                                                 --------         --------
    Total current liabilities                                       3,923            3,581

Noncurrent portion of obligations under capital leases                  8              168

Commitments

Stockholders' equity:
  Common stock, $.01 par value; 32,000,000 shares
    authorized, 18,159,807 and 17,279,195 shares
    issued and outstanding at December 31, 1997                       182              173
    and 1996, respectively
  Additional paid-in capital                                       80,304           76,307
  Deferred compensation                                               (30)            (169)
  Accumulated deficit                                             (54,741)         (48,373)
                                                                 --------         --------
    Total stockholders' equity                                     25,715           27,938
                                                                 --------         --------
                                                                 $ 29,646         $ 31,687
                                                                 ========         ========



See accompanying notes.


                                      F-2


   43
                         La Jolla Pharmaceutical Company

                            Statements of Operations

                      (In thousands, except per share data)




                                                          YEARS ENDED DECEMBER 31,
                                                  ------------------------------------------
                                                    1997             1996             1995
                                                  --------         --------         --------
                                                                                
Revenues:
  Revenue from collaborative agreement -
    related party                                 $  9,860         $  4,000         $     --
  Revenue from collaborative agreement                  --               --            3,000
                                                  --------         --------         --------
    Total revenues                                   9,860            4,000            3,000


Expenses:
  Research and development                          14,676           11,663            9,804
  General and administrative                         2,937            2,920            2,390
                                                  --------         --------         --------
    Total expenses                                  17,613           14,583           12,194
                                                  --------         --------         --------
Loss from operations                                (7,753)         (10,583)          (9,194)

Interest expense                                       (56)            (183)            (301)
Interest income                                      1,441            1,170              941
                                                  --------         --------         --------
Net loss                                          $ (6,368)        $ (9,596)        $ (8,554)
                                                  ========         ========         ========
Basic and diluted net loss per share              $   (.36)        $   (.63)        $   (.79)
                                                  ========         ========         ========
Shares used in computing basic and diluted
  net loss per share                                17,547           15,150           10,883
                                                  ========         ========         ========



See accompanying notes.


                                      F-3


   44
                         La Jolla Pharmaceutical Company


                       Statements of Stockholders' Equity

              For the years ended December 31, 1995, 1996 and 1997




                                                                            NOTE     
(In thousands)                              COMMON STOCK     ADDITIONAL  RECEIVABLE                                   TOTAL   
                                        -------------------   PAID-IN       FROM         DEFERRED     ACCUMULATED  STOCKHOLDERS'
                                         SHARES     AMOUNT    CAPITAL    STOCKHOLDER   COMPENSATION     DEFICIT      EQUITY
                                        --------   --------   --------    --------       --------       --------    --------
                                                                                              
Balance at December 31, 1994               8,616   $     86   $ 44,690    $    (27)      $   (716)      $(30,223)   $ 13,810
  Issuance of common stock upon                                                                       
    secondary public offering,
    net of issuance costs                  3,400         34      9,852          --             --             --       9,886
  Issuance of common stock                 2,000         20      8,120          --             --             --       8,140
  Exercise of stock options                   31         --         30          --             --             --          30
  Payment on note receivable                  --         --         --          13             --             --          13
  Amortization of deferred
    compensation                              --         --         --          --            243             --         243
  Adjustment to deferred compensation                                                                 
    for terminations                          --         --        (45)         --             45             --          --
  Net loss                                    --         --         --          --             --         (8,554)     (8,554)
                                        --------   --------   --------    --------       --------       --------    --------
Balance at December 31, 1995              14,047        140     62,647         (14)          (428)       (38,777)     23,568
  Issuance of common stock upon                                                                       
    additional public offering, 
    net of issuance costs                  2,140         21      9,753          --             --             --       9,774
  Issuance of common stock                 1,000         10      3,790          --             --             --       3,800
  Issuance of common stock under                                                                      
    Employee Stock Purchase Plan              27          1         97          --             --             --          98
  Exercise of stock options and
    warrants                                  65          1         85          --             --             --          86
  Payment on note receivable                  --         --         --          14             --             --          14
  Amortization of deferred
    compensation                              --         --         --          --            194             --         194
  Adjustment to deferred compensation                                                                 
     for terminations                         --         --        (65)         --             65             --          --
  Net loss                                    --         --         --          --             --         (9,596)     (9,596)
                                        --------   --------   --------    --------       --------       --------    --------
Balance at December 31, 1996              17,279        173     76,307          --           (169)       (48,373)     27,938
  Issuance of common stock                   831          8      3,852          --             --             --       3,860
  Issuance of common stock under                                                                      
    Employee Stock Purchase Plan              41          1        150          --             --             --         151
  Exercise of stock options                    9         --         11          --             --             --          11
  Amortization of deferred
    compensation                              --         --         --          --            123             --         123
  Adjustment to deferred compensation                                                                 
     for terminations                         --         --        (16)         --             16             --          --
  Net loss                                    --         --         --          --             --         (6,368)     (6,368)
                                        --------   --------   --------    --------       --------       --------    --------
Balance at December 31, 1997              18,160   $    182   $ 80,304    $     --       $    (30)      $(54,741)   $ 25,715
                                        ========   ========   ========    ========       ========       ========    ========



See accompanying notes.


                                      F-4


   45
                         La Jolla Pharmaceutical Company

                            Statements of Cash Flows

                                 (In thousands)




                                                            YEARS ENDED DECEMBER 31,
                                                        --------------------------------
                                                          1997        1996        1995
                                                        --------    --------    --------
                                                                             
OPERATING ACTIVITIES
Net loss                                                $ (6,368)   $ (9,596)   $ (8,554)
Adjustments to reconcile net loss to net cash used
  for operating activities:
    Write-off of patent costs                                  7          89          --
    Write-off of fixed assets                                 76          --          --
    Depreciation and amortization                            642         754         784
    Deferred compensation amortization                       123         194         243
    Changes in operating assets and liabilities:
      Receivable - related party                           4,000      (4,000)         --
      Other current assets                                   434      (1,020)         89
      Accounts payable and accrued expenses                 (509)      1,819           3
      Accrued payroll and related expenses                    83         (16)        145
      Deferred revenue - related party                     1,277          --          --
                                                        --------    --------    --------
         Net cash used for operating activities             (235)    (11,776)     (7,290)

INVESTING ACTIVITIES
Purchases of short-term investments                      (21,842)    (22,649)    (73,467)
Sales of short-term investments                            5,493       5,028      65,616
Maturities of short-term investments                      18,991       3,847       6,547
Additions to property and equipment                         (124)       (161)       (248)
Increase in patent costs and other assets                   (250)       (391)        (83)
                                                        --------    --------    --------
         Net cash provided by (used for) investing         2,268     (14,326)     (1,635)
         activities

FINANCING ACTIVITIES
Payment on note receivable from stockholder                   --          14          13
Net proceeds from issuance of common stock                   162       9,958      18,056
Net proceeds from issuance of common stock to related
  party                                                    3,860       3,800          --
Payments on obligations under capital leases                (669)       (861)       (757)
                                                        --------    --------    --------
         Net cash provided by financing activities         3,353      12,911      17,312

                                                        --------    --------    --------
Increase (decrease) in cash and cash equivalents           5,386     (13,191)      8,387
Cash and cash equivalents at beginning of period           6,613      19,804      11,417
                                                        ========    ========    ========
Cash and cash equivalents at end of period              $ 11,999    $  6,613    $ 19,804
                                                        ========    ========    ========

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid                                           $     56    $    183    $    301
                                                        ========    ========    ========

SUPPLEMENTAL SCHEDULE OF NONCASH FINANCING
ACTIVITIES:
Capital lease obligations incurred for property and
  equipment                                             $     --    $     --    $    132
                                                        ========    ========    ========
Adjustment to deferred compensation for terminations    $     16    $     65    $     45
                                                        ========    ========    ========



See accompanying notes.


                                      F-5


   46
                         La Jolla Pharmaceutical Company
                          Notes to Financial Statements


1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

ORGANIZATION AND BUSINESS ACTIVITY

La Jolla Pharmaceutical Company (the "Company") is a biopharmaceutical company
focused on the research and development of highly specific therapeutics for the
treatment of certain life-threatening antibody-mediated diseases. These
diseases, including autoimmune conditions such as systemic lupus erythematosus
("lupus") and antibody-mediated stroke, are caused by abnormal B cell production
of antibodies that attack healthy tissues. In the fourth quarter of 1996, the
Company initiated a Phase II/III clinical trial for its lupus drug candidate,
LJP 394.

All of the Company's revenues to date have been derived from its recent
collaborative agreement with Abbott Laboratories ("Abbott"), a related party,
signed in December 1996 and its former collaborative agreement with Leo
Pharmaceutical Products Ltd., a Danish company ("Leo Pharmaceutical") (See Note
2). As part of its planned business operations, the Company pursues
collaborations with pharmaceutical companies in an effort to access their
research, drug development, manufacturing and financial resources. Prior to
generating product revenues, the Company must complete the development of its
products, including several years of clinical testing, and receive regulatory
approvals prior to selling these products commercially. There can be no
assurance that the Company's product development efforts with respect to LJP 394
or any other drug candidate will be successfully completed, that required
regulatory approvals will be obtained, or that any product, if introduced, will
be successfully marketed or achieve commercial acceptance. In addition, there
can be no assurance that the Company can successfully manufacture and market any
such products at prices that would permit the Company to operate profitably.

The Company actively seeks additional financing to fund its research and
development efforts and commercialize its technologies. There is no assurance
such financing will be available to the Company when required or that such
financing would be available under favorable terms.

The Company believes that patents and other proprietary rights are important to
its business. The Company's policy is to file patent applications to protect
technology, inventions and improvements to its inventions that are considered
important to the development of its business. The patent positions of
biotechnology firms, including the Company, are uncertain and involve complex
legal and factual questions for which important legal principles are largely
unresolved. There can be no assurance that any additional patents will be
issued, or that the scope of any patent protection will be sufficient, or that
any current or future issued patent will be held valid if subsequently
challenged.

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 disclosures made in
the accompanying notes to the financial statements. Actual results could differ
from those estimates.


                                      F-6


   47
                         La Jolla Pharmaceutical Company
                          Notes to Financial Statements

1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

RECLASSIFICATION

Certain amounts in the 1996 and 1995 financial statements have been reclassified
to conform with the December 31, 1997 presentation.

REVENUE RECOGNITION

Revenue from collaborative agreements typically consists of nonrefundable
up-front fees, ongoing research and development funding and milestone, royalty
and other payments. Revenue from nonrefundable up-front fees is recognized upon
signing of the agreement. Revenue from ongoing research and development funding
is recorded as the expenses are incurred. Revenue from milestone, royalty and
other payments will be recognized as earned. Payments received in advance under
these agreements are recorded as deferred revenue until earned.

COMPREHENSIVE INCOME

In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 130, "Reporting Comprehensive Income" ("SFAS
130"). SFAS 130 requires that all components of comprehensive income, including
net income, be reported in the financial statements in the period in which they
are recognized. Comprehensive income is defined as the change in equity during
the period from transactions and other events and circumstances from non-owner
sources. Net income and other comprehensive income, including unrealized gains
and losses on investments, shall be reported, net of their related tax effect,
to arrive at comprehensive income. SFAS 130 is effective for fiscal years
beginning after December 15, 1997. The adoption of this statement is not
expected to have a material impact on the financial statements.

SEGMENT INFORMATION

In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard No. 131, "Segment Information" ("SFAS 131"). SFAS
131 redefines segments and requires companies to report financial and
descriptive information about their operating segments. Historically, the
Company has operated in one business segment. The Company has not determined how
operating segments will be defined for disclosure purposes or which segments
will meet the quantitative requirements for disclosure. SFAS 131 is effective
for fiscal years beginning after December 15, 1997. The adoption of this
statement will have no impact on the Company's future results of operations or
financial position.

NET LOSS PER SHARE

Net loss per share is computed using the weighted-average number of common
shares outstanding during the periods. In February 1997, the Financial
Accounting Standards Board issued Statement of Financial Accounting Standard No.
128, "Earnings per Share" ("SFAS 128"). SFAS 128 replaced the previously
reported "primary earnings per share" with "basic earnings per share" which
excludes any dilutive effects of options and warrants and is based on
weighted-average common shares outstanding for the period. The adoption of this
statement did not have a material impact as the Company has incurred a net loss
for all years presented and therefore stock options and warrants are not
included in the computation of earnings per share since their effect is
anti-dilutive.


                                      F-7


   48
                         La Jolla Pharmaceutical Company
                          Notes to Financial Statements

1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

CASH, CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS

Cash and cash equivalents consist of cash and highly liquid investments which
include debt securities with remaining maturities when acquired of three months
or less and are stated at market. Short-term investments mainly consist of debt
securities with maturities greater than three months. Management has classified
the Company's cash equivalents and short-term investments as available-for-sale
securities in the accompanying financial statements. Available-for-sale
securities are carried at fair value, with unrealized gains and losses reported
as a separate component of stockholders' equity. Realized gains and losses and
declines in value judged to be other-than-temporary on available-for-sale
securities are included in investment income. The cost of securities sold is
based on the specific identification method. Interest and dividends on
securities classified as available-for-sale are included in investment income.

CONCENTRATION OF CREDIT RISK

Cash, cash equivalents and short-term investments are financial instruments
which potentially subject the Company to concentrations of credit risk. The
Company deposits its cash in financial institutions. At times, such deposits may
be in excess of insured limits. The Company invests its excess cash in United
States Government securities and debt instruments of financial institutions and
corporations with strong credit ratings. The Company has established guidelines
relative to diversification of its cash investments and their maturities in an
effort to maintain safety and liquidity. These guidelines are periodically
reviewed and modified to take advantage of trends in yields and interest rates.
To date, the Company has not experienced any losses on its cash, cash
equivalents and short-term investments.

PROPERTY AND EQUIPMENT

Property and equipment is stated at cost and depreciated using the straight-line
method over the estimated useful lives of the assets (primarily five years).
Leasehold improvements are stated at cost and amortized on a straignt-line basis
over the shorter of the estimated useful life or the lease term. Equipment under
capital leases is amortized over the estimated useful life of the assets and
such amortization is included in depreciation in the accompanying financial
statements.

Property and equipment is comprised of the following (in thousands):




                                                      DECEMBER 31,
                                                   ------------------
                                                    1997       1996
                                                   -------    -------
                                                            
Laboratory equipment                               $ 2,943    $ 3,384
Computer equipment                                     263        511
Furniture and fixtures                                 111        597
Leasehold improvements                                 751         55
                                                   -------    -------
                                                     4,068      4,547
Less:  accumulated depreciation and amortization    (3,122)    (3,186)
                                                   -------    -------
                                                   $   946    $ 1,361
                                                   =======    =======



                                      F-8


   49
                         La Jolla Pharmaceutical Company
                          Notes to Financial Statements

1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

IMPAIRMENT OF LONG-LIVED ASSETS

The Company records impairment losses on long-lived assets used in operations
when events and circumstances indicate that assets might be impaired and the
undiscounted cash flows estimated to be generated by those assets are less than
the carrying amount of those assets. The Company also records the assets to be
disposed of at the lower of their carrying amount or fair value less cost to
sell. To date, the Company has not experienced any impairment losses on its long
lived assets used in operations.

PATENTS

The Company has filed several patent applications in the United States Patent
and Trademark Office and in foreign countries. Legal costs and expenses incurred
in connection with pending patent applications have been deferred. Costs related
to successful patent applications are amortized using the straight-line method
over the lesser of the remaining useful life of the related technology or the
remaining patent life, commencing on the date the patent is issued. Accumulated
amortization at December 31, 1997 and 1996 was $87,000 and $49,000,
respectively. Deferred costs related to patent applications are charged to
operations at the time a determination is made not to pursue such applications.

STOCK OPTIONS

As allowed under Statement of Financial Accounting Standard No. 123, "Accounting
and Disclosure of Stock-Based Compensation" ("SFAS 123"), the Company has
elected to continue to account for stock option grants in accordance with
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" ("APB 25") and related interpretations. The Company generally grants
stock options for a fixed number of shares to employees with an exercise price
equal to the fair value of the shares at the date of grant and, under APB 25,
recognizes no compensation expense for such stock option grants.

2.  COLLABORATIVE AGREEMENTS

In December 1996, the Company entered into a collaborative agreement with
Abbott, a diversified healthcare company. Under this agreement, in exchange for
an exclusive, worldwide license to market and sell LJP 394, Abbott agreed to pay
an initial license fee of $4,000,000 upon signing, and agreed to fund the
development of the Company's lupus drug candidate, LJP 394, and to make certain
payments to the Company upon the attainment of specific milestones. In addition,
Abbott has agreed to make royalty and sales incentive payments to the Company on
sales of LJP 394 while the Company retains worldwide manufacturing rights and
ownership rights of all of its patents relating to the drug. Abbott also
purchased common stock of the Company in December 1996 for an aggregate purchase
price of $4,000,000 and again in September 1997 for an aggregate purchase price
of $4,000,000. The Company has the right to require Abbott to purchase up to
$4,000,000 of additional shares of the Company's common stock over the next
year. Both Abbott and the Company have the right to terminate the agreement
under certain circumstances.


                                      F-9


   50
                         La Jolla Pharmaceutical Company
                          Notes to Financial Statements

2.  COLLABORATIVE AGREEMENTS (CONTINUED)

Under the collaborative agreement with Abbott, the Company incurred research and
development costs of approximately $9,860,000 during the year ended December 31,
1997 for the development of LJP 394. In 1997, the Company received $11,137,000
from Abbott for the development of LJP 394, of which $9,860,000 was recorded as
revenue.

The $3,000,000 of revenue recorded in 1995 relates to a collaborative agreement
with Leo Pharmaceutical which was terminated due to the parties inability to
reach agreement regarding the timing and allocation of resources with respect to
further clinical trials of LJP 394.

3. CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS

The following is a summary of the estimated fair value of available-for-sale
securities (in thousands):




                                                    DECEMBER 31,
                                                  -----------------
                                                   1997      1996
                                                  -------   -------
                                                          
Money market accounts                             $ 8,424   $   460
United States corporate debt securities             9,202    10,901
Government asset backed securities                  7,611    10,999
United States Treasury securities and 
    obligations of the United States
    government agencies                               249       249
                                                  -------   -------
                                                  $25,486   $22,609
                                                  =======   =======



As of December 31, 1997 and 1996, the difference between cost and estimated fair
value of available-for-sale securities was not significant. Included in cash and
cash equivalents at December 31, 1997 and 1996 were $10,507,000 and $4,988,000,
respectively, of securities classified as available-for-sale. As of December 31,
1997, available-for-sale securities of $24,236,000 are due in one year or less
and $1,250,000 are due after one year through two years.

4. COMMITMENTS

LEASES

In July 1992, the Company entered into a non-cancellable operating lease for the
rental of its office and research and development facilities which expires in
July 2004. The lease is subject to an escalation clause that provides for annual
increases based on the consumer price index (CPI). The lease also contains an
option to extend the lease term for an additional five years and a one-time
cancellation option effective any time after August 1, 1998 with the payment of
certain penalties. The lease also contains a construction allowance in the
amount of $1,434,000 for approved tenant improvements to the facility.


                                      F-10


   51
                         La Jolla Pharmaceutical Company
                          Notes to Financial Statements

4. COMMITMENTS (CONTINUED)

In October 1996, the Company entered into a non-cancellable operating lease for
the rental of office and research and development facilities which expires in
October 2001. The lease contains a provision for scheduled annual rent increases
and an option to extend the lease term for an additional five years. The lease
also contains a construction allowance in the amount of $168,000 for approved
tenant improvements to the facility.

The Company leases certain equipment under a capital lease. The total amount of
equipment originally financed under this capital lease was $3,188,000 of which
approximately $956,000 of fixed assets costs was remaining under this capital
lease as of December 31, 1997.

The Company leases certain other equipment and leasehold improvements under
operating leases. As of December 31, 1997, the total amount of equipment and
leasehold improvements financed under these operating leases was $4,643,000.

Annual future minimum lease payments as of December 31, 1997, which include
$1,030,000 for the effect of exercising the facility operating lease
cancellation option, are as follows (in thousands):




                                                 OPERATING   CAPITAL
YEARS ENDED DECEMBER 31,                          LEASES     LEASES
                                                  -------    -------
                                                           
1998                                              $ 1,870    $   139
1999                                                2,309          9
2000                                                1,224         --
2001                                                  567         --
2002                                                   --         --
                                                  -------    -------
Total                                             $ 5,970        148
                                                  =======    =======
Less amount representing interest                                 (7)
                                                             -------
Present value of net minimum lease payments                      141
Less current portion                                            (133)
                                                             -------
Noncurrent portion of capital lease obligations              $     8
                                                             =======



Rent expense under all operating leases totaled $1,853,000, $952,000, and
$545,000 for the years ended December 31, 1997, 1996 and 1995, respectively.
Equipment acquired under capital leases included in property and equipment
totaled $290,000 and $1,201,000 (net of accumulated amortization of $666,000 and
$2,021,000) at December 31, 1997 and 1996, respectively.

5. STOCKHOLDERS' EQUITY

PREFERRED STOCK

As of December 31, 1997, the Company is authorized to issue 8,000,000 shares of
preferred stock, in one or more series.


                                      F-11


   52
                         La Jolla Pharmaceutical Company
                          Notes to Financial Statements

5. STOCKHOLDERS' EQUITY (CONTINUED)

COMMON STOCK

In September 1997, the Company issued an additional 831,152 shares of common
stock to Abbott for net proceeds of $3,860,000. (See Note 2.)

WARRANTS

In connection with the Company's initial public offering ("IPO") in June 1994,
including the conversion of the principal and accrued interest on stockholder
bridge notes, the Company issued 3,823,517 redeemable warrants. The redeemable
warrant holders are entitled to purchase one-half of one share of common stock
for each warrant at an exercise price of $3.00 per one-half share. The warrants
are exercisable at any time until June 3, 1999. The Company is entitled to
redeem the warrants on not less than 30 days written notice at $0.05 per warrant
if the average closing bid price of the common stock exceeds 150% of the
then-effective warrant exercise price for one share of common stock, over a
period of 20 consecutive trading days, ending within 15 days of the date of
notice of redemption. At December 31, 1997, 3,822,617 redeemable warrants were
outstanding.

The terms of the shareholder bridge notes also provided for the granting of
additional warrants to the holders. Those additional warrants permit the holders
to purchase 166,697 shares of common stock at $5.00 per share until June 3,
1999. At December 31, 1997, warrants to purchase 154,460 shares of common stock
were outstanding.

Also in connection with the IPO, the Underwriter was granted the option to
purchase up to 260,000 additional shares of common stock and 260,000 redeemable
warrants to purchase one-half of one share of common stock at an exercise price
of $3.60 per one-half share. The purchase option expires on June 3, 1999. At
December 31, 1997, warrants to purchase 130,000 shares of common stock were
outstanding.

As of December 31, 1997, 4,237,077 warrants were outstanding and 2,195,769
shares of common stock are reserved for issuance upon exercise of warrants.

STOCK OPTION PLANS

In May 1989, the Company adopted the 1989 Stock Option Plan and the 1989
Nonstatutory Stock Option Plan (the "1989 Plan"), under which 904,000 shares of
common stock have been authorized for issuance upon exercise of options granted
by the Company.

In June 1994, the Company adopted the 1994 Stock Incentive Plan (the "1994
Plan"), under which 1,750,000 shares of common stock have been authorized for
issuance upon exercise of options granted by the Company. The 1994 Plan provides
for the grant of incentive and non-qualified stock options, as well as other
stock based awards, to employees, consultants and advisors of the Company with
various vesting periods as determined by the compensation committee, as well as
automatic fixed grants to non-employee directors of the Company.


                                      F-12


   53
                         La Jolla Pharmaceutical Company
                          Notes to Financial Statements

5. STOCKHOLDERS' EQUITY (CONTINUED)

A summary of the Company's stock option activity, and related data follows:




                                                                     OUTSTANDING OPTIONS
                                                                -------------------------------
                                             OPTIONS
                                            AVAILABLE           NUMBER OF           PRICE PER
                                            FOR GRANT            SHARES               SHARE
                                             -------            ---------           -----------
                                                                           
Balance at December 31, 1994                 425,015            1,200,874           $1.00-$5.25
    Granted                                 (336,195)             336,195           $2.25-$4.31
    Exercised                                     --              (30,541)          $      1.00
    Cancelled                                 44,490              (44,490)          $1.00-$4.13
                                             -------            ---------
Balance at December 31, 1995                 133,310            1,462,038           $1.00-$5.25
    Additional shares authorized             500,000                   --                    --
    Granted                                 (426,750)             426,750           $3.75-$8.31
    Exercised                                     --              (52,722)          $1.00-$5.03
    Cancelled                                120,982             (120,982)          $1.00-$7.88
                                             -------            ---------
Balance at December 31, 1996                 327,542            1,715,084           $1.00-$8.31
    Additional shares authorized             500,000                   --                    --
    Granted                                 (312,700)             312,700           $4.00-$5.38
    Exercised                                     --               (8,620)          $1.00-$4.31
    Cancelled                                 56,101              (56,101)          $1.00-$7.88
                                             -------            ---------
Balance at December 31, 1997                 570,943            1,963,063           $1.00-$8.31
                                             =======            =========





                                                            YEARS ENDED DECEMBER 31,
                              --------------------------------------------------------------------------------------------
                                         1997                           1996                              1995
                              --------------------------      --------------------------       --------------------------
                                               WEIGHTED-                      WEIGHTED-                         WEIGHTED- 
                                               AVERAGE                        AVERAGE                           AVERAGE
                                               EXERCISE                       EXERCISE                          EXERCISE
                               OPTIONS          PRICE          OPTIONS          PRICE           OPTIONS           PRICE    
                              ---------      -----------      ---------      -----------       ---------       -----------
                                                                                                     
Outstanding -
  beginning of year           1,715,084      $      3.00      1,462,038      $      2.40       1,200,874       $      1.92
Granted                         312,700      $      4.82        426,750      $      4.91         336,195       $      3.94
Exercised                        (8,620)     $      1.38        (52,722)     $      1.58         (30,541)      $      1.00
Forfeited                       (56,101)     $      4.55       (120,982)     $      2.98         (44,490)      $      2.26
                              ---------                       ---------                        ---------
Outstanding - end of
  year                        1,963,063      $      3.25      1,715,084      $      3.00       1,462,038       $      2.40
                              =========                       =========                        =========
Exercisable at end of
  year                        1,171,376                         931,465                          720,588

Weighted-average fair
  value of options
  granted during the
  year                        $    2.72                      $     3.08                       $     2.48



                                      F-13


   54
                         La Jolla Pharmaceutical Company
                          Notes to Financial Statements

5. STOCKHOLDERS' EQUITY (CONTINUED)

Exercise prices and weighted-average remaining contractual lives for the options
outstanding as of December 31, 1997 follows:




                                          WEIGHTED-
                                           AVERAGE        WEIGHTED-                       WEIGHTED- 
                                          REMAINING       AVERAGE                          AVERAGE
      OPTIONS           RANGE OF         CONTRACTUAL      EXERCISE          OPTIONS        EXERCISE
    OUTSTANDING     EXERCISE PRICES          LIFE          PRICE          EXERCISABLE        PRICE
      -------        -------------           ----         --------         ---------        --------
                                                                                
      702,765        $        1.00           4.37         $   1.00           690,142        $   1.00
      508,100        $2.00 - $4.31           7.84         $   3.63           217,528        $   3.52
      495,700        $4.38 - $5.03           8.58         $   4.74           158,408        $   4.93
      256,498        $5.13 - $8.31           8.11         $   5.82           105,298        $   5.79
      -------                                                              ---------
    1,963,063        $1.00 - $8.31           6.82         $   3.25         1,171,376        $   2.43
      =======                                                              =========



At December 31, 1997, the Company has reserved 2,534,006 shares of common stock
for future issuance under the 1989 and 1994 Plans.

For certain options granted, the Company recognizes as compensation expense the
excess of the deemed value for accounting purposes of the common stock issuable
upon exercise over the aggregate exercise price of such options. Compensation
expense is amortized ratably over the vesting period of each option.

EMPLOYEE STOCK PURCHASE PLAN

Effective August 1, 1995, the Company adopted the 1995 Employee Stock Purchase
Plan (the "Purchase Plan") which was amended in July 1996. Under the amended
Purchase Plan, a total of 300,000 shares of common stock are reserved for sale
to full-time employees with six months of service. Employees may purchase common
stock under the Purchase Plan every six months (up to but not exceeding 10% of
each employee's earnings) over the offering period at 85% of the fair market
value of the common stock at certain specified dates. The offering period may
not exceed 24 months. For the year ended December 31, 1997, 40,840 shares of
common stock had been issued under the Purchase Plan (27,658 shares for the year
ended December 31, 1996). To date, 68,498 shares of common stock had been issued
under the Purchase Plan and 231,502 shares of common stock are available for
issuance.


                                      F-14


   55
                         La Jolla Pharmaceutical Company
                          Notes to Financial Statements

5. STOCKHOLDERS' EQUITY (CONTINUED)

STOCK-BASED COMPENSATION

Pro forma information regarding net loss and net loss per share is required by
SFAS 123, which also requires that the information be determined as if the
Company has accounted for its employee stock options granted after December 31,
1994 under the fair value method of that statement. The fair value for these
options was estimated at the date of grant using a Black-Scholes option pricing
model with the following weighted-average assumptions for 1995, 1996 and 1997,
respectively: risk-free interest rate of 6.0%, 6.0% and 5.5%; volatility factor
of the expected market price of the Company's common stock of .70, .70 and .60;
and a dividend yield of 0% and a weighted-average expected life of the option of
five years for all three years presented.

The Black-Scholes 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
subjective 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.

For purposes of pro forma disclosures, the estimated fair value of the options
is amortized to expense over the options' vesting period. The Company's pro
forma information follows (in thousands except for net loss per share
information):




                                              YEARS ENDED DECEMBER 31,
                                    ---------------------------------------------
                                      1997              1996              1995
                                    ---------         ---------         ---------
                                                                      
Pro forma net loss                  $  (6,873)        $  (9,970)        $  (8,613)
                                    =========         =========         =========
Pro forma net loss per share        $    (.39)        $    (.66)        $    (.79)
                                    =========         =========         =========



The effects of applying SFAS 123 for either recognizing compensation expense or
providing pro forma disclosures are not likely to be representative of the
effects on reported net loss for future years.

6.  401(K) PLAN

The Company has established a 401(k) defined contribution retirement plan (the
"401(k) Plan"), which was amended in July 1997, to cover all employees with six
months of service. The Plan provides for voluntary employee contributions up to
20% of annual compensation (as defined). The Company does not match employee
contributions or otherwise contribute to the Plan.


                                      F-15


   56
                         La Jolla Pharmaceutical Company
                          Notes to Financial Statements

7. INCOME TAXES

At December 31, 1997, the Company had federal and California income tax net
operating loss carryforwards of approximately $51,750,000 and $3,207,000,
respectively. The difference between the federal and California tax loss
carryforwards is primarily attributable to the capitalization of research and
development expenses for California income tax purposes and the 50% percent
limitation on California loss carryforwards. The Company also had federal and
California research tax credit carryforwards of $2,339,000 and $1,069,000,
respectively. The federal net operating loss and tax credit carryforwards will
begin to expire in 2004 unless previously utilized, while the California net
operating loss of $353,000 expired in 1997, and will continue to expire
beginning in 1998.

In accordance with certain provisions of the Internal Revenue Code, a change in
ownership of greater than 50% within a three-year period will place an annual
limitation on the Company's ability to utilize its existing net operating loss
and tax credit carryforwards. Due to the completion of the initial public
offering in June 1994, the Company is subject to these annual limitations.
However, the annual limitations are not expected to have a material effect on
the Company's ability to utilize its net operating loss and tax credit
carryforwards.

Significant components of the Company's deferred tax assets are shown below (in
thousands):




                                                         DECEMBER 31,
                                                   -------------------------
                                                     1997             1996
                                                   --------         --------
                                                                   
Deferred tax assets:
  Net operating loss carryforwards                 $ 18,000         $ 16,000
  Research and development credits                    3,000            3,000
  Capitalized research and development                3,000            2,000
                                                   --------         --------
Total deferred tax assets                            24,000           21,000
Valuation allowance for deferred tax assets         (24,000)         (21,000)
                                                   --------         --------
Net deferred tax assets                            $     --         $     --
                                                   ========         ========



A valuation allowance of $24,000,000 has been recognized to offset the deferred
tax assets as realization of such assets is uncertain.


                                      F-16


   57
                                   SIGNATURES

        Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.

                                   LA JOLLA PHARMACEUTICAL COMPANY


                                   By: /s/ Steven B. Engle
                                     -------------------------------
                                   Name: Steven B. Engle
                                        ----------------------------
                                   Title:  Chairman of the Board and
                                         ---------------------------
                                           Chief Executive Officer
                                         ---------------------------

March 27, 1998

        Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.




                   Signature                                  Title                       Date
                   ---------                                  -----                       ----
                                                                            
PRINCIPAL EXECUTIVE OFFICER AND DIRECTOR:

  /s/ Steven B. Engle                             Chairman of the Board and       March   27, 1998
- -----------------------------------               Chief Executive Officer
Steven B. Engle                                   


PRINCIPAL FINANCIAL AND ACCOUNTING OFFICER:

  /s/ Wood C. Erwin                               Chief Financial Officer and     March   27, 1998
- -----------------------------------               Secretary
Wood C. Erwin                                     


  /s/ Joseph Stemler                              Director                        March   27, 1998
- -----------------------------------
Joseph Stemler


  /s/ Thomas H. Adams                             Director                        March   27, 1998
- -----------------------------------
Thomas H. Adams, Ph.D.


  /s/ William E. Engbers                          Director                        March   27, 1998
- -----------------------------------
William E. Engbers


  /s/ Robert A. Fildes                            Director                        March   27, 1998
- -----------------------------------
Robert A Fildes, Ph.D.


  /s/ W. Leigh Thompson                           Director                        March   27, 1998
- -----------------------------------
W. Leigh Thompson, M.D., Ph.D.



                                       41


   58
                         La Jolla Pharmaceutical Company

                                  Exhibit Index





Exhibit Number                              Description
- --------------                              -----------
                     
23.1                    Consent of Ernst & Young LLP, Independent Auditors
27                      Financial Data Schedule



                                       42

EX-23.1

   1
                                                                    EXHIBIT 23.1


               CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

We consent to the incorporation by reference in (i) the Registration Statement
(Form S-8 No. 33-82664) pertaining to the 1994 Stock Incentive Plan, (ii) the
Registration Statement (Form S-8 No. 33-94830) pertaining to the 1995 Employee
Stock Purchase Plan, and (iii) the Registration Statement (Form S-8 No.
333-14285) pertaining to the 1994 Stock Incentive Plan of La Jolla
Pharmaceutical Company of our report dated January 30, 1998 with respect to the
financial statements of La Jolla Pharmaceutical Company included in this Annual
Report (Form 10-K) for the year ended December 31, 1997.



                                                   ERNST & YOUNG LLP

San Diego, California
March 27, 1998


                                       44

EX-27

 

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