CELLEGY PHARMACEUTICALS INC, S-1/A, 1997-11-19

CELLEGY PHARMACEUTICALS INC
S-1/A, 1997-11-19
PHARMACEUTICAL PREPARATIONS

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<PAGE> 1

AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON NOVEMBER 19, 1997

REGISTRATION NO. 333-38179
================================================================================

SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------

AMENDMENT NO. 2 TO

FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
------------------------

CELLEGY PHARMACEUTICALS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

<TABLE>
<S> <C> <C>
CALIFORNIA 2834 82-0429727
(STATE OR OTHER JURISDICTION OF (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER IDENTIFICATION
INCORPORATION OR ORGANIZATION) CLASSIFICATION CODE NUMBER) NO.)
</TABLE>

1065 E. HILLSDALE BLVD., SUITE 418
FOSTER CITY, CALIFORNIA 94404
(650) 524-1600
(ADDRESS AND TELEPHONE NUMBER OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES)

K. MICHAEL FORREST
PRESIDENT AND CHIEF EXECUTIVE OFFICER
CELLEGY PHARMACEUTICALS, INC.
1065 E. HILLSDALE BLVD., SUITE 418
FOSTER CITY, CALIFORNIA 94404
(650) 524-1600
(NAME, ADDRESS AND TELEPHONE NUMBER OF AGENT FOR SERVICE)

COPIES TO:

<TABLE>
<S> <C>
C. KEVIN KELSO, ESQ. BRIAN C. CUNNINGHAM, ESQ.
FENWICK & WEST LLP LANA K. HAWKINS, ESQ.
TWO PALO ALTO SQUARE COOLEY GODWARD LLP
PALO ALTO, CALIFORNIA 94306 5 PALO ALTO SQUARE
(650) 494-0600 PALO ALTO, CALIFORNIA 94304-2155
(650) 843-5000
</TABLE>

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

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

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

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

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

CALCULATION OF REGISTRATION FEE
- --------------------------------------------------------------------------------

<TABLE>
<S> <C> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------------
PROPOSED MAXIMUM PROPOSED MAXIMUM
TITLE OF EACH CLASS OF AMOUNT TO BE OFFERING PRICE AGGREGATE AMOUNT OF
SECURITIES TO BE REGISTERED REGISTERED(1) PER SHARE(2) OFFERING PRICE(2) REGISTRATION FEE(3)
- ------------------------------------------------------------------------------------------------------------
Common Stock, no par value
per share................. 2,012,500 shares $8.625 $22,317,188 $6,763
============================================================================================================
</TABLE>

(1) Includes 262,500 shares that the Underwriter has the option to purchase to
cover over-allotments, if any.

(2) Estimated pursuant to Rule 457(c) solely for the purpose of calculating the
amount of the registration fee.

(3) Previously paid.

THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A),
MAY DETERMINE.
================================================================================
<PAGE> 2

1,750,000 SHARES

LOGO

COMMON STOCK
------------------------

All of the shares of Common Stock offered hereby are being sold by Cellegy
Pharmaceuticals, Inc. ("Cellegy" or the "Company"). Prior to this Offering, the
Company's Common Stock was listed on the Nasdaq SmallCap Market under the symbol
"CLGY." On November 18, 1997, the last reported sale price of the Common Stock
was $9.1875 per share. The Company's Common Stock has been approved for
quotation on the Nasdaq National Market under the symbol "CLGY."

THE COMMON STOCK OFFERED HEREBY INVOLVES A HIGH DEGREE OF RISK.
SEE "RISK FACTORS" BEGINNING ON PAGE 7.
------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION, NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.

<TABLE>
<CAPTION>
=================================================================================================
PRICE TO PROCEEDS TO
PUBLIC UNDERWRITING COMPANY(2)
DISCOUNT(1)
- -------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Per Share......................... $7.50 $0.45 $7.05
Total(3).......................... $13,125,000 $787,500 $12,337,500
============================================================================================
</TABLE>

(1) Excludes the issuance of a warrant to the Underwriter (the "Underwriter
Warrant") to purchase up to 125,000 shares of Common Stock, exercisable for
a period of four years commencing one year following the closing of this
Offering, at an exercise price of 130% of the public offering price set
forth above. The Underwriter has been granted certain registration rights
under the Securities Act of 1933, as amended, with respect to the Common
Stock issuable upon exercise of the Underwriter Warrant. The Company has
agreed to indemnify the Underwriter against certain liabilities, including
liabilities under the Securities Act of 1933, as amended. See
"Underwriting."

(2) Before deducting expenses of the offering payable by the Company estimated
at $466,000.

(3) The Company has granted the Underwriter an option, exercisable within 30
days of the date hereof, to purchase up to 262,500 additional shares of
Common Stock at the Price to Public per share, less the Underwriting
Discount, for the purpose of covering over-allotments, if any. If the
Underwriter exercises such option in full, the total Price to Public,
Underwriting Discount and Proceeds to Company will be $15,093,750, $905,625
and $14,188,125, respectively. See "Underwriting."

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

The shares of Common Stock are offered by the Underwriter when, as and if
delivered to and accepted by it, subject to its right to withdraw, cancel or
reject orders in whole or in part and subject to certain other conditions. It is
expected that delivery of the certificates representing the shares will be made
against payment on or about November 24, 1997 at the office of CIBC Oppenheimer
Corp., CIBC Oppenheimer Tower, One World Financial Center, New York, New York
10281.

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

LOGO

The date of this Prospectus is November 19, 1997.

<PAGE> 3

PRODUCTS UNDER DEVELOPMENT

The following table summarizes certain information concerning Cellegy's
clinical and preclinical product candidates and is qualified in its entirety by
the more detailed information appearing elsewhere in this Prospectus. The
development and commercialization of the Company's product development
candidates are subject to numerous risks and uncertainties. See "Risk Factors"
and "Recent Developments."
- --------------------------------------------------------------------------------

<TABLE>
<CAPTION>
DEVELOPMENT TECHNOLOGIES
PRODUCTS INDICATIONS STATUS UTILIZED
------------------------ ------------------------ ------------------------ ------------
<S> <C> <C> <C>
PRESCRIPTION TOPICAL THERAPEUTICS
Glylorin Non-bullous congenital Phase III trials in Proprietary
ichthyosiform progress
erythroderma
Ichthyosis vulgaris Phase II trials planned Proprietary
Anogesic* Anal fissures Phase III trials planned CELLEDIRM
Hemorrhoids Phase III trials planned CELLEDIRM
PRESCRIPTION PRODUCTS USING TRANSDERMAL DRUG DELIVERY TECHNOLOGY
Testosterone gel Hypogonadism (hormone Pilot studies in humans CELLEDIRM
therapy for male planned for late 1997
andropause)
Testosterone gel Female hormone therapy Preclinical evaluation CELLEDIRM
Estrogen-testosterone Female hormone therapy Research PERMEATE
gel
CELLEDIRM
Immunosuppressive drug Psoriasis Research PERMEATE
CELLEDIRM
COSMECEUTICAL PRODUCTS
Anti-wrinkling Photodamaged and aging In human testing CELLEDIRM
products** skin
Anti-irritant cream Irritated, red, itchy Formulation development CELLEDIRM
skin
Other skin care products Dry and disrupted skin Formulations complete; CELLEDIRM
ready for marketing
</TABLE>

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

* The Company has signed a legally binding letter of intent to acquire the
Anogesic product. See "Recent Developments."

** References in this Prospectus to "anti-wrinkling," "anti-wrinkling products"
or the "anti-wrinkling market" are intended to refer to a cosmeceutical
product category that the Company believes is generally understood in the
marketplace, and are not intended to describe any claims that the Company's
cosmeceutical products act in any way other than as cosmetics as defined
under applicable laws. The term "cosmeceuticals" refers to products that, if
they satisfy the definition of a cosmetic under applicable federal laws and
if they are not also drugs under those laws, are not subject to the same
requirements as drug products. See "Risk Factors -- Possible FDA Regulation
of Cosmeceutical Products as Drugs" and "Business -- Government Regulation."

IN CONNECTION WITH THIS OFFERING, THE UNDERWRITER MAY OVER-ALLOT OR EFFECT
TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE COMPANY'S
COMMON STOCK AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN
MARKET. SUCH TRANSACTIONS MAY BE EFFECTED ON THE NASDAQ NATIONAL MARKET, OR
OTHERWISE. SUCH STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME.

IN CONNECTION WITH THIS OFFERING, THE UNDERWRITER MAY ENGAGE IN PASSIVE
MARKET MAKING TRANSACTIONS IN THE COMPANY'S COMMON STOCK ON THE NASDAQ NATIONAL
MARKET IN ACCORDANCE WITH RULE 103 OF REGULATION M. SEE "UNDERWRITING."
<PAGE> 4

PROSPECTUS SUMMARY

The following summary is qualified in its entirety by the more detailed
information and the financial statements (and notes thereto) appearing elsewhere
in this Prospectus. Except as otherwise noted herein, information in this
Prospectus assumes no exercise of the Underwriter's over-allotment option. An
investment in the shares of Common Stock offered hereby involves a high degree
of risk. Prospective investors should consider carefully the information
provided under "Risk Factors."

The term "cosmeceuticals" is not defined by the U.S. Food and Drug
Administration (the "FDA") but refers to products that, depending on several
factors, may not be subject to the same requirements as drug products. See "Risk
Factors -- Possible FDA Regulation of Cosmeceutical Products as Drugs" and
"Business -- Government Regulation."

Cellegy is a biopharmaceutical company engaged in the development of
prescription drugs and cosmeceuticals to address a variety of diseases and
conditions utilizing its patented transdermal and topical delivery technologies.
Cellegy's first prescription drug, Glylorin, is a novel treatment for certain
forms of ichthyosis, a family of incurable skin diseases. Glylorin has been
licensed by Cellegy to Glaxo Wellcome, Inc. ("Glaxo") and is currently in Phase
III clinical trials in the United States. Cellegy is also evaluating several
prescription drugs including a transdermal testosterone gel for the treatment of
hypogonadism, a condition that frequently results in lethargy and reduced libido
in men above the age of 40. In addition to its prescription drugs, Cellegy is
testing and developing a line of anti-wrinkling cosmeceutical products which the
Company believes will address the skin care needs of an affluent and aging
population.

The Company's principal technologies consist of PERMEATE and CELLEDIRM.
PERMEATE is a patented topical drug delivery system which has been found in
preclinical evaluations to permit delivery of larger or insoluble drugs into the
blood stream or into the skin itself. These drugs include peptides that to the
Company's knowledge are not deliverable using methods employed in currently
approved transdermal products. CELLEDIRM (Cellegy's Dermal Inflammatory Response
Modulators) is a group of compounds identified by Cellegy's scientists that have
been found in preclinical evaluations to reduce or eliminate irritation caused
by many substances that come into contact with the skin. The Company's CELLEDIRM
technology is being developed as an adjunct to the PERMEATE technology to
mitigate the skin irritation problems associated with transdermal drug delivery,
and to improve existing prescription drugs and cosmeceutical products.

Glylorin, the Company's most advanced topical prescription candidate, is
currently in Phase III clinical trials for non-bullous congenital ichthyosiform
erythroderma ("n-CIE"). n-CIE is a severe form of congenital primary ichthyosis
("CPI"), a group of incurable skin conditions for which there is currently no
satisfactory treatment. Ichthyosis is a family of related skin diseases
characterized by a severe scaling of the skin that frequently affects large
areas of the body. In all forms of ichthyosis, skin cells form a rigid, thick
surface layer of scales that often discolor and crack. Many of the most severely
afflicted infants die shortly after birth from dehydration, hypothermia and
microbes, which enter through the damaged epidermis. Approximately 100,000
people in the United States, and at least an equal number of persons outside the
United States, are afflicted with CPI.

Based on Phase I and II clinical studies conducted by the Company, Glylorin
appears to be safe and effective in the treatment of n-CIE. The results from the
Company's Phase II clinical studies produced statistically significant
improvements in scaling, induration (swelling) and erythema (redness). After
developing the product through early Phase III clinical trials, Cellegy licensed
Glylorin to Glaxo in November 1996. Glaxo has completed patient enrollment for
the Phase III trial.

The Company's most advanced transdermal drug delivery candidate is a
testosterone gel. Based on preclinical studies to date, the Company believes its
proprietary gel product will be capable of providing therapeutic levels of
testosterone in a once-a-day topical application to a small area of the body.
Furthermore, by using CELLEDIRM, the Company believes its testosterone gel will
have a lower incidence of local skin irritation and other adverse skin reactions
than current patch products.

3
<PAGE> 5

The Company's most advanced cosmeceutical is an anti-wrinkling product
designed to mitigate the visible effects of photoaging and skin wrinkling.
Cellegy's anti-wrinkling product will be included in a line of products that the
Company expects to produce greater improvement to the skin's appearance and
cause less irritation than current market leading products. Cellegy commenced
human evaluation of this product line during the second quarter of 1997 and
expects to begin commercial sales during 1998.

Cellegy intends to utilize its delivery technologies (i) to produce
transdermal versions of existing FDA approved drugs, (ii) to develop topical or
transdermal formulations of new chemical entities in partnership with innovator
pharmaceutical or biotechnology companies and (iii) to develop high performance
cosmeceuticals. The Company plans to establish corporate partnerships to support
development and marketing of many of these products. Whenever possible, the
Company plans to retain certain marketing rights to products it develops for the
dermatology market, and Cellegy intends ultimately to build or acquire a sales
force to serve this market. Although Cellegy is focusing primarily on the
development of its own products and technologies, the Company may acquire
products, technologies or businesses consistent with its commercial objectives.

Cellegy's principal executive offices are located at 1065 E. Hillsdale
Blvd., Suite 418, Foster City, California 94404, and its telephone number is
(650) 524-1600. In this Prospectus, the term "Cellegy" or the "Company" refers
to Cellegy Pharmaceuticals, Inc., a California corporation, unless the context
otherwise requires.

RECENT DEVELOPMENTS

On November 3, 1997, the Company signed a legally binding letter of intent
(the "Anogesic Agreement") with Neptune Pharmaceutical Corporation ("Neptune")
to acquire all patent and other intellectual property rights relating to
"Anogesic" (the "Anogesic Acquisition"), a topical product candidate for the
treatment of anal fissures and hemorrhoids. Unlike currently available drugs,
which provide only partial symptomatic relief, based on clinical studies to date
Anogesic appears to heal anal fissures and hemorrhoids. As a result, Anogesic
represents a potential alternative to surgical intervention. Clinical studies of
Anogesic have been completed on over 400 patients to date, and the Company plans
to commence Phase III trials during 1998.

The closing of the Anogesic Acquisition is subject to the satisfaction of
certain conditions, and there can be no assurance that the Company will conclude
the Anogesic Acquisition. See "Recent Developments."

Cellegy is a registered trademark of the Company. Glylorin is a registered
trademark that the Company has transferred to Glaxo. CELLEDIRM and PERMEATE are
trademarks of the Company. This Prospectus also includes trademarks of companies
other than the Company.

4
<PAGE> 6

THE OFFERING

<TABLE>
<S> <C>
Common Stock offered by the Company....... 1,750,000 shares

Common Stock to be outstanding after the
offering................................ 9,344,959 shares(1)

Use of proceeds........................... To fund clinical trials and research and
development expenses, and for general corporate
purposes, including working capital. See "Use of
Proceeds."

Nasdaq National Market symbol............. CLGY(2)
</TABLE>

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

<TABLE>
<CAPTION>
NINE MONTHS
ENDED
YEARS ENDED DECEMBER 31, SEPTEMBER 30,
--------------------------- -----------------
1994 1995 1996 1996 1997
------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues.......................................... $ -- $ 1,000 $ 648 $ 15 $ 643
Total operating expenses.......................... 2,542 2,535 4,346 3,037 3,455
------- ------- ------- ------- -------
Operating loss.................................... (2,542) (1,535) (3,698) (3,022) (2,812)
Net loss applicable to common shareholders........ (2,543) (2,152) (4,782) (4,119) (2,493)
======= ======= ======= ======= =======
Pro forma net loss per share applicable to common
shareholders(3)................................. $ (0.76) $ (0.67) $ (1.11) $ (1.02) $ (0.41)
======= ======= ======= ======= =======
Shares used in computing pro forma net loss per
share(3)........................................ 3,344 3,206 4,307 4,050 6,076
</TABLE>

<TABLE>
<CAPTION>
SEPTEMBER 30, 1997
--------------------------
ACTUAL AS ADJUSTED(4)
------- --------------
<S> <C> <C>
BALANCE SHEET DATA:
Cash, cash equivalents and investments............................... $ 9,377 $ 21,249
Total assets......................................................... 9,841 21,713
Long-term obligations................................................ -- --
Deficit accumulated during the development stage..................... (17,431) (17,431)
Total shareholders' equity........................................... 9,114 20,986
</TABLE>

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

(1) Based on the number of shares outstanding as of September 30, 1997. Excludes
1,061,447 shares of Common Stock issuable upon the exercise of outstanding
stock options at a weighted average exercise price of $4.19 per share,
661,250 shares of Common Stock issuable upon the exercise of publicly traded
warrants issued in the Company's initial public offering (the "IPO
Warrants") at an exercise price of $9.375 per share, 832,061 shares of
Common Stock issuable upon the exercise of other outstanding warrants at a
weighted average exercise price of $7.79 per share, up to 125,000 shares of
Common Stock issuable upon exercise of the Underwriter Warrant, 33,057
shares of Common Stock that were issued in connection with the Anogesic
Acquisition and 429,752 shares of Common Stock that are issuable at the
closing of the Anogesic Acquisition. See "Description of Capital Stock" and
"Recent Developments."

(2) Prior to this Offering, the Common Stock and IPO Warrants were traded on the
Nasdaq SmallCap Market under the symbols "CLGY" and "CLGYW," respectively.
The Common Stock and the IPO Warrants have been approved for quotation on
the Nasdaq National Market under the symbols "CLGY" and "CLGYW,"
respectively.

(3) See Note 1 of Notes to the financial statements of the Company appearing
elsewhere herein (the "Financial Statements") for an explanation of the
determination of the number of pro forma shares used in per share
calculations.

(4) Adjusted to reflect the sale of 1,750,000 shares of Common Stock offered
hereby and the application of the net proceeds therefrom at a public
offering price of $7.50 per share. See "Use of Proceeds" and
"Capitalization."

5
<PAGE> 7

RECENT DEVELOPMENTS

On November 3, 1997, the Company signed the Anogesic Agreement with Neptune
to acquire all patent and other intellectual property rights relating to
"Anogesic," a topical product candidate for the treatment of anal fissures and
hemorrhoids, and certain other related intellectual property of Neptune. Unlike
currently available drugs, which provide only partial symptomatic relief, based
on clinical studies to date Anogesic appears to heal anal fissures and
hemorrhoids. As a result, Anogesic represents a potential alternative to
surgical intervention. Clinical studies of Anogesic have been completed on over
400 patients to date, and the Company plans to commence Phase III trials during
1998.

Anal fissures are painful tears or slits in the tissue of the anus and are
common conditions affecting men and women of all age groups. Of the
approximately 200,000 new cases of anal fissures each year, more than half
require painful and expensive surgical intervention to treat these conditions. A
thrombosed external hemorrhoid is a dilated, swollen vein at the margin of the
anus, resulting from clotting blood formed within the dilated external
hemorrhoidal veins. In the United States alone, approximately nine million
patients seek treatment from physicians for hemorrhoids each year, and the
Company believes that a significant number of additional people suffering from
this condition do not seek medical treatment.

Current drug therapies include anesthetics and anti-inflammatory agents
that only partially relieve the symptoms of the conditions. Even though current
treatments are only partially effective, sales of products currently used to
treat anal fissures and hemorrhoids are estimated to be more than $500 million
in the United States, Europe and Japan. Surgical procedures represent
substantial additional expenditures related to these conditions.

The patented Anogesic product will be administered intra-anally in a
proprietary formulation that includes nitroglycerin, a drug that has been used
for many years in the treatment of certain heart diseases. Once administered,
nitroglycerin results in relaxation of the sphincter muscles, which rapidly
relieves pain and promotes the healing of the anal fissure or hemorrhoid.
Anogesic will incorporate the Company's proprietary CELLEDIRM technology to
assist in mitigating the inflammation present in these conditions.

Clinical studies published in the New England Journal of Medicine and The
Lancet have shown that nitroglycerin promotes healing and is capable of rapidly
relieving intense anal pain. In the study published in The Lancet, 80 patients
with anal fissures were randomized to receive treatments with topical 0.2
percent nitroglycerin ointment or placebo. After eight weeks, healing was
observed in 26 out of 38 (68%) of the patients treated with nitroglycerin and in
3 out of 39 (8%) of the patients treated with placebo (p < 0.0001).

The Company issued 33,057 shares of Common Stock to Neptune upon signing
the Anogesic Agreement. At the closing, the Company will deliver to Neptune an
additional 429,752 shares of Common Stock. In addition, the Anogesic Agreement
calls for a series of additional payments, aggregating up to $5.5 million and
payable in shares of Common Stock. The additional payments are subject to
successful completion of certain late stage clinical trials and regulatory
milestones which, if achieved, would occur over the next several years. An
additional payment of $5 million, also payable in shares of Common Stock, will
be made if in the future the Company applies for and receives FDA approval for
the sale of Anogesic in the over-the-counter (non-prescription) market for the
treatment of hemorrhoids. The Anogesic Agreement does not provide for the
payment by Cellegy of any future product royalties in connection with sales of
Anogesic.

The Company currently expects to conclude the Anogesic Acquisition by
December 31, 1997. The Anogesic Agreement includes several representations,
warranties and covenants of Neptune and Cellegy, indemnification of the Company
by Neptune and its shareholders for, among other things, breaches of Neptune's
representations, warranties and covenants, and indemnification of Neptune and
its shareholders by Cellegy for breaches of Cellegy's representations,
warranties and covenants or claims based solely on Cellegy's conduct after the
closing date. The closing of the Anogesic Acquisition is subject to a number of
closing conditions, including the satisfactory completion of Cellegy's due
diligence of Neptune, the absence of material adverse changes in Neptune's or
Cellegy's business between the date of the Anogesic Agreement and the closing
date, the approval of the transaction by Neptune's shareholders and the absence
of litigation or claims relating to the transaction or Anogesic. There can be no
assurance that the Company will complete the Anogesic Acquisition. Failure to
complete the Anogesic Acquisition may have a material adverse effect on the
market price of the Common Stock but would not, the Company believes, have a
material adverse effect on its business or financial condition.

6
<PAGE> 8

RISK FACTORS

An investment in the shares of Common Stock offered hereby is speculative
in nature and involves a high degree of risk. In addition to the information
contained in this Prospectus, the following factors should be considered
carefully in evaluating the Company and its business before purchasing the
shares of Common Stock offered hereby. This Prospectus contains forward-looking
statements which involve risks and uncertainties, including but not limited to
statements concerning the commencement and completion of clinical trials, the
commencement of commercial sales of the Company's products, the timing of
planned regulatory filings, the applicability to the Company's products of drug
and cosmetic laws and regulations, the Company's intent to enter into
collaborative arrangements and the planned activities of collaborative partners,
the Company's strategic plans, the scope of the Company's patent coverage,
anticipated expenditures and the need for additional funds. Discussions
containing such forward-looking statements may be found in the material set
forth under "Risk Factors," "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and "Business" as well as in the Prospectus
generally. Actual events or results may differ materially from those discussed
in this Prospectus.

History of Losses; Future Profitability Uncertain. The Company has a
history of operating losses and expects to incur substantial additional expenses
with resulting quarterly losses over at least the next several years as it
continues to develop its potential products and to devote significant resources
to preclinical studies, clinical trials and manufacturing. As of September 30,
1997, the Company had accumulated net losses of approximately $17.4 million. To
date, the Company has not sought regulatory approval to distribute any products.
The time and resource commitment required to achieve market success for any
individual product is extensive and uncertain. No assurance can be given that
the Company's product development efforts will be successful, that required
regulatory approvals can be obtained, that potential products can be
manufactured at an acceptable cost and with appropriate quality or that any
approved products can be successfully marketed.

The Company has not generated any significant revenues from product sales
or royalties from licenses of the Company's technology, and most of the
potential products that may be marketed by the Company, if any, are not expected
to be marketed or approved for marketing for at least the next several years.
Moreover, the Company anticipates that its operating expenses will continue to
increase significantly as the Company increases its research and development,
preclinical, clinical, administrative and patent activities. Accordingly, in the
absence of substantial revenues from new corporate collaborations, royalties on
product sales or other sources, the Company expects to incur substantial and
increased operating losses in the foreseeable future as certain of its earlier
stage potential products move into clinical development, as additional potential
products are selected as clinical candidates for further development, as the
Company invests in additional facilities or capacity, and as the Company invests
in research or acquires additional technologies, product candidates or
businesses. The amount of net losses and the time required to reach sustained
profitability are highly uncertain. To achieve sustained profitable operations,
the Company, alone or with its collaborative partners, must successfully
discover, develop, obtain regulatory approvals for and market its potential
pharmaceutical products. No assurances can be given that the Company will be
able to achieve or sustain profitability, and results are expected to fluctuate
from quarter to quarter.

Uncertainty of Clinical Trial Results. Before obtaining regulatory approval
for the commercial sale of many of its potential drug products, the Company must
demonstrate through preclinical studies and clinical trials that the product is
safe and efficacious for use in the clinical indication for which approval is
sought. There can be no assurance that the Company will be permitted to
undertake or continue clinical trials for any of its potential products or, if
such trials are permitted, that such products will be demonstrated to be safe
and efficacious. Moreover, the results from preclinical studies and early
clinical trials may not be predictive of results that will be obtained in
later-stage clinical trials, such as the Phase III trials being conducted by
Glaxo relating to Glylorin and the planned Phase III clinical trials relating to
Anogesic. Thus, there can be no assurance that the Company's present or future
clinical trials will demonstrate the safety and efficacy of any potential
products or will result in approval to market products.

The Company's most advanced topical prescription candidate, Glylorin, has
been licensed by Cellegy to Glaxo and is currently in Phase III clinical trials
in the United States. There can be no assurance that the outcome of the current
Phase III clinical trial will be favorable, that further clinical studies will
not be needed

7
<PAGE> 9

for Glylorin, that the FDA will approve Glylorin for marketing or that current
or future clinical trials of any of the Company's other product candidates,
including Anogesic, will be successfully completed or lead to FDA approval. The
failure of Glylorin to successfully complete its current Phase III or any future
clinical testing, including toxicology studies, could have a material adverse
effect on the Company.

The evaluation of animal and human clinical test results involves making
judgments about data and other information that often are not conclusive. Later
testing may show those judgments to have been erroneous. For example, the
Company's beliefs regarding the potential comparative therapeutic benefits of
its products compared to currently marketed products may be erroneous, or the
FDA may not agree with the Company's conclusions regarding such matters.
Furthermore, due to the independent and blind nature of certain human clinical
testing, there will be extended periods during the testing process when the
Company will have only limited, or no, access to information about the status or
results of the tests. Other pharmaceutical companies have believed that their
products performed satisfactorily in early tests, only to find their performance
in later tests, including Phase III clinical trials, to be inadequate or
unsatisfactory, or that FDA Advisory Committees have declined to recommend
approval of the drugs, or that the FDA itself refused approval, with the result
that such companies' stock prices have fallen precipitously.

Early Stage of Product Development. With the exception of certain skin care
cosmeceutical products, Cellegy has not yet completed the development of its
proposed products or sought regulatory approval for the marketing of drug
products and has not begun to market or generate revenues from the
commercialization of products. Development of most of the Company's products
will require significant additional research and development. All of the
Company's product development efforts are based upon technologies and
therapeutic approaches that have not been widely tested or used. Moreover, the
Company's beliefs regarding the therapeutic and commercial potential for its
products are based on studies conducted to date, and later studies may not
support the Company's current beliefs. In addition, results of the Company's
studies have not been published in medical journals or reviewed by independent
third parties, and as a result have not been subjected to the same degree of
scrutiny as results that have been published or subjected to review by
independent parties.

The Company's potential products are subject to the risks of failure
inherent in the development of products based on new technologies. These risks
include the possibilities that the Company's therapeutic approaches will not be
successful; that the results from future clinical trials may not correlate with
any safety or effectiveness results from prior clinical studies conducted by the
Company or others; that some or all of the Company's potential products will not
be successfully developed or will not be found to be safe and effective by the
FDA, or otherwise will fail to meet applicable regulatory standards or receive
necessary regulatory clearances; that the products, if safe and effective, will
be difficult to manufacture in commercial quantities at reasonable costs or will
be uneconomical to market; that proprietary rights of third parties will
preclude the Company from commercializing such products; or that third parties
will market superior or equivalent products. There can be no assurance the
Company's research and development activities will result in any commercially
viable products.

Possible FDA Regulation of Cosmeceutical Products as Drugs. The Company
intends to introduce products that will compete in the cosmeceutical market.
"Cosmeceuticals" are not defined in the federal Food, Drug and Cosmetic Act (the
"FD&C Act"). The FDA has not defined the term by regulation and may consider use
of the term to imply drug-like qualities. Cosmeceuticals (a hybrid of the words
"cosmetics" and "pharmaceuticals") are products that contain active ingredients
which, when applied to the skin, will enhance appearance. Cosmeceuticals which
satisfy the definition of a cosmetic under the FD&C Act and which are not also
drugs under that statute are not subject to the same FDA requirements as drug
products. For example, cosmeceutical products that constitute cosmetics (but not
drugs as well) as defined by applicable federal laws may be marketed to
consumers without prior approval by the FDA, and without requiring a
prescription from a physician. The Company intends to develop a number of
cosmeceutical products, including a product that will compete in what is
generally referred to as the "anti-wrinkling" market.

The FDA has at times in the past contended, and may in the future contend,
that one or more cosmeceutical products, including the Company's or competitors'
anti-wrinkling products that are currently

8
<PAGE> 10

marketed or may in the future be marketed, are not cosmetics but instead are
subject to regulation as drugs. Even if the FDA were not ultimately to prevail
with regard to such a contention, such a claim by the FDA could have a material
adverse effect on the Company's ability to market its proposed cosmeceutical
products and could significantly delay or prohibit marketing of such products.
The extent to which different kinds of current or future cosmeceutical products
of the Company or its competitors are subject to FDA regulation as drugs, and
the extent to which the FDA will seek to become more active in regulating
cosmeceutical products, such as products that compete in the "anti-wrinkling"
market, is uncertain, but will depend in part on the claims made for the
cosmeceuticals by their manufacturers and marketers. See "Business -- Government
Regulation." The inability of the Company to market its proposed cosmeceutical
products as cosmetics without prior FDA approval could have a material adverse
effect on the Company's business and financial condition.

Competition and Technological Change. The pharmaceutical industry is
subject to rapid and significant technological change. In the development and
marketing of topical prescription drugs, skin care and other cosmeceutical
products and drug delivery systems, Cellegy faces intense competition.
Competitors of the Company in the United States and abroad are numerous and
include, among others, major pharmaceutical, chemical, cosmetic, consumer
product, and biotechnology companies, specialized firms, universities and other
research institutions. There can be no assurance that the Company's competitors
will not succeed in developing technologies and products that are more effective
than any which are being developed by the Company or that would render the
Company's technology and potential products obsolete and noncompetitive. Many of
these competitors have substantially greater financial and technical resources,
production and marketing capabilities and regulatory experience than the
Company. In addition, many of the Company's competitors have significantly
greater experience than the Company in preclinical testing and human clinical
trials of pharmaceutical products and in obtaining FDA and other regulatory
approvals of products for use in health care. There can be no assurance that the
Company's products under development will be able to compete successfully with
existing products or products under development by other companies, universities
and other institutions or that they will obtain regulatory approval in the
United States or elsewhere. The Company also competes with universities
developing drug delivery technologies and with several companies which have been
formed to develop unique delivery systems. In addition, these companies and
academic and research institutions compete with Cellegy in recruiting and
retaining highly qualified scientific and management personnel.

Patents and Proprietary Technology. The Company's success depends, in part,
on its ability to obtain patent protection for its products and methods, both in
the United States and in other countries. Several of the Company's products are
based on existing compounds with a history of use in humans but which are being
developed by the Company for new therapeutic use in skin diseases unrelated to
the systemic diseases for which the compounds were previously approved. The
Company cannot obtain composition patent claims on the compound itself, and will
instead need to rely on patent claims, if any, directed to use of the compound
to treat certain conditions or to specific formulations. The Company may not be
able to prevent a competitor from using that formulation or compound for a
different purpose. No assurance can be given that any additional patents will be
issued to the Company, that the protection of any patents issued in the future
will be significant or that current or future patents will be held valid if
subsequently challenged.

The patent position of companies engaged in businesses such as the
Company's business generally is uncertain and involves complex legal and factual
questions. There is a substantial backlog of patent applications at the United
States Patent and Trademark Office ( "USPTO"). Further, issued patents can later
be held invalid by the patent office issuing the patent or by a court. There can
be no assurance that any patent applications relating to the Company's products
or methods will issue as patents, or, if issued, that the patents will not be
challenged, invalidated or circumvented or that the rights granted thereunder
will provide a competitive advantage to the Company. In addition, many other
entities are engaged in research and product development efforts in drug
delivery, skin biology and cosmeceutical fields that may overlap with the
Company's currently anticipated and future products, and such other entities may
currently have, or may obtain in the future, legally blocking proprietary
rights, including patent rights, in one or more products or methods under
development or consideration by the Company. These rights may prevent the
Company from commercializing technology, or may require the Company to obtain a
license from the entity to practice the

9
<PAGE> 11

technology. There can be no assurance that the Company will be able to obtain
any such licenses that may be required on commercially reasonable terms, if at
all, or that the patents underlying any such licenses will be valid or
enforceable. Moreover, the laws of certain foreign countries do not protect
intellectual property rights relating to United States patents as extensively as
those rights are protected in the United States. As with other companies in the
pharmaceutical industry, the Company is subject to the risk that persons located
in such countries will engage in development, marketing or sales activities of
products that would infringe the Company's patent rights if such activities were
in the United States.

The agreements with the University of California pursuant to which the
Company has exclusive license rights to certain drug delivery and other
technology contain certain development and performance milestones which the
Company must satisfy in order to retain such rights. While the Company currently
believes it will be able to satisfy the milestone dates, a loss of rights to
these technologies could have a material adverse effect on the Company.

Dependence on Collaborative Partners. In view of the early stage of the
Company and its research and development programs, the Company has restricted
hiring to research and development scientists and a small administrative staff
and has made limited or no investment in marketing, product sales and regulatory
compliance resources. The Company has granted to Glaxo certain exclusive rights
to commercialize Glylorin for the indications covered by the Company's agreement
with Glaxo, and may in the future enter into agreements with certain of its
collaborative partners granting similar rights with respect to other products.
The Company has other collaborative agreements with certain third party
companies or academic institutions, and intends to enter into other
collaborative agreements in the future, relating to the research, development,
manufacture and marketing of certain potential products. In some cases, the
Company is relying, and in the future will rely, on its collaborative partners
to conduct clinical trials, to compile and analyze the data received from such
trials, to obtain regulatory approvals and, if approved, to manufacture and
market these products. As a result, the Company may have little or no control
over the development of these potential products and little or no opportunity to
review clinical data before or after public announcement. There can be no
assurance that the Company will be able to establish any such collaborative
arrangements or that they will be successful. Failure to enter into any such
arrangements that in the future might be necessary could have a material adverse
effect on the Company's business and financial condition.

Government Regulation and Drug Product Approvals. The research,
development, testing, manufacture, labeling, distribution, marketing and
advertising of products such as the Company's products and its ongoing research
and development activities are subject to extensive regulation by governmental
regulatory authorities in the United States and other countries. The extensive
preclinical and clinical testing requirements and regulatory approval process of
the FDA in the United States and of certain foreign regulatory authorities
require a number of years and the expenditure of substantial resources. There
can be no assurance that the Company will be able to obtain the necessary
approvals for clinical testing or for the marketing of products on a timely
basis or at all. Moreover, additional government regulations may be established
that could prevent or delay regulatory approval of the Company's products.
Delays in obtaining regulatory approvals could have a material adverse effect on
the Company's business and results of operations. Even if regulatory approval of
a product is granted, such approval may include significant limitations on the
indicated uses of the product or the manner in which or conditions under which
the product may be marketed. For example, even if the Company seeks FDA approval
of a product for non-prescription consumer sales, the FDA could instead require
that the product be distributed by means of a prescription before considering
approval for distribution as a non-prescription product. Prescription only
approval, which the Company believes is common where a company seeks approval
for a product involving a new compound or a compound previously approved for
other uses, could delay for several years, or indefinitely, distribution through
the non-prescription channel of the Company's products which are subject to
premarket review and approval by the FDA. Moreover, failure to comply with
regulatory requirements for marketing drugs, or if the Company's cosmeceutical
products are deemed to be drugs by the FDA, could subject the Company to
regulatory or judicial enforcement actions, including, but not limited to,
product recalls or seizures, injunctions against production, distribution, sales
and marketing, civil penalties, criminal prosecution of the Company, its
officers or employees, refusals to approve new products and suspensions and
withdrawals of existing approvals, as well as potentially increased product

10
<PAGE> 12

liability exposure. Sales of the Company's products outside the United States
will be subject to regulatory requirements governing clinical trials and
marketing approval. These requirements vary widely from country to country and
could delay introduction of the Company's products in those countries. See
"Business -- Government Regulation."

Limited Experience with Clinical Trials. The Company has conducted only a
limited number of clinical trials to date. There can be no assurance that the
Company will be able to successfully commence and complete all of its planned
clinical trials without significant additional resources and expertise. In
addition, there can be no assurance that the Company will meet its contemplated
development schedule for any of its potential products. The inability of the
Company or its existing or any future collaborative partners to commence or
continue clinical trials as currently planned, to complete the clinical trials
on a timely basis or to demonstrate the safety and efficacy or its potential
products, would have a material adverse effect on the business and the financial
condition of the Company.

Future Capital Needs; Uncertainty of Additional Funding. The Company's
operations to date have consumed substantial amounts of cash. The Company's cash
needs are expected to continue to increase significantly over at least the next
several years in order to fund the additional expenses the Company will incur as
it expands its current research and development programs, particularly in the
drug delivery, prescription pharmaceutical and cosmeceutical product areas. The
Company has no current source of significant ongoing revenues or capital beyond
existing cash, the net proceeds of this Offering and payments, if any, that may
be received pursuant to the existing licensing agreements with Glaxo. In order
to complete the research and development and other activities necessary to
commercialize its products, additional financing may be required. The Company's
future expenditures and capital requirements depend on numerous factors,
including without limitation the progress of its research and development
programs, the progress of preclinical and clinical testing, the time and costs
involved in obtaining regulatory approvals and complying with pre- and
post-regulatory approval requirements, the costs of filing, prosecuting,
defending and enforcing any patent claims and other intellectual property
rights, competing technological and market developments, changes in the
Company's existing research relationships, the ability of the Company to
establish collaborative arrangements, the development of commercialization
activities and arrangements, the purchase of capital equipment and any funding
that may be received from third parties pursuant to license, development or
other agreements that the Company may enter into in the future and the level of
royalties or revenues, if any, from commercial product sales.

As a result, the Company may seek private or public equity investments and
future collaborative arrangements with third parties to help fund its future
cash needs. There is no assurance that such funding will be available on
acceptable terms, if at all. Insufficient funding may require the Company to
delay, reduce or eliminate some or all of its research and development
activities, planned clinical trials and administrative programs. The Company
believes that available cash resources, the net proceeds of this Offering and
the interest thereon will be adequate to satisfy its capital needs through at
least December 31, 1999. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations."

Limited Sales and Marketing Experience. The Company may market certain of
its products, if successfully developed and approved, through a direct sales
force in the United States and through sales and marketing partnership
arrangements or distribution arrangements outside the United States. The Company
has no history or experience in sales, marketing or distribution. To market its
products directly, the Company must either establish a marketing group and
direct sales force or obtain the assistance of one or more third parties. There
can be no assurance that the Company will be able to establish sales and
distribution capabilities or succeed in gaining market acceptance for its
products. If the Company enters into marketing or licensing arrangements with
established pharmaceutical companies, the Company's revenues will be subject to
the payment provisions of such arrangements and will be dependent on the efforts
of third parties. There can be no assurance that the Company will be able to
successfully establish a direct sales force or that its collaborators will
effectively market any of the Company's potential products, and the inability of
the Company or its collaborators to do so could have a material adverse effect
on the business and financial condition of the Company.

11
<PAGE> 13

Manufacturing Limitations; Suppliers. The Company has no experience in
manufacturing commercial quantities of its potential products and currently does
not have any capacity to manufacture potential products on a commercial scale
itself. The Company currently relies on a third party to manufacture unprocessed
compounds into therapeutic products. Although the Company believes that there
will be adequate third party manufacturers, there can be no assurance that the
Company will be able to enter into acceptable agreements with third party
manufacturers, and the Company is and will be dependent upon third party
contract manufacturers for such production. There can be no assurance that the
Company will continue to be able to obtain contract manufacturing on
commercially acceptable terms for compounds or products and quantities currently
obtainable. There can be no assurance that manufacturing or quality control
problems will not arise at the manufacturing plants of the Company's contract
manufacturers or that such manufacturers will be able to maintain the compliance
with the FDA's current good manufacturing practice requirements necessary to
continue manufacturing the Company's products.

Broad Management Discretion Over Use of Proceeds. The primary purposes of
the Offering are to increase the Company's working capital and funds available
for general corporate purposes, preclinical and clinical development, research
activities, including investigation of new technologies and potential
acquisition of complementary technologies, product candidates or businesses. The
Company has not designated specific amounts of the net proceeds for particular
purposes. Management of the Company will have broad discretion with respect to
the use of proceeds derived from the Offering.

Uncertainty Related to Health Care Industry. The health care industry is
subject to changing political, economic and regulatory influences that may
significantly affect the purchasing practices and pricing of human therapeutics.
Cost containment measures, whether instituted by health care providers or
enacted as a result of government health administration regulators or new
regulations, such as pricing limitations or formulating eligibility for
dispensation by medical providers, could result in greater selectivity in the
availability of treatments. Such selectivity could have an adverse effect on the
Company's ability to sell its prescription products and there can be no
assurance that adequate third party coverage will be available for the Company
to maintain price levels sufficient to generate an appropriate return on its
investment in product development. Third-party payors are increasingly focusing
on the cost-benefit profile of alternative therapies and prescription drugs and
challenging the prices charged for such products and services. Also, the trend
towards managed health care in the United States and the concurrent growth of
organizations such as health maintenance organizations which could control or
significantly influence the purchase of health care services and products, as
well as legislative proposals to reform health care or reduce government
insurance programs, may all result in lower prices or proposals to reform health
care or reduce government insurance programs or result in lower prices or
reduced markets for the Company's products. The cost containment measures and
reforms that government institutions and third party payors are considering
instituting could result in significant and unpredictable changes to the
marketing, pricing and reimbursement practices of prescription drugs marketed by
bio-pharmaceutical companies such as the Company. The adoption of any such
measures or reforms could have a material adverse effect on the business and
financial condition of the Company. However, cosmeceutical products generally
are not reimbursed by third party payors.

Dependence Upon Key Employees. The success of the Company is dependent upon
the efforts of its senior management team, including Dr. Carl R. Thornfeldt,
Chairman of the Board of Directors and Medical Director of the Company, and K.
Michael Forrest, Chief Executive Officer of the Company. A change in the
association of these individuals or other officers and directors of the Company
could adversely affect the Company if suitable replacement personnel could not
be employed. The success of the Company also depends upon its ability to
continue to attract and retain qualified scientific and technical personnel.
There is intense competition for qualified personnel in the areas of the
Company's activities, and there can be no assurance that the Company will be
able to continue to attract and retain the qualified personnel necessary for the
development or expansion of its business.

Environmental Regulation. The Company is subject to federal, state and
local laws and regulations governing the use, generation, manufacture, storage,
discharge, handling and disposal of certain materials and wastes used in its
operations, some of which are classified as "hazardous." There can be no
assurance that the Company will not be required to incur significant costs to
comply with environmental laws, the Occupational

12
<PAGE> 14

Safety and Health Act, and state, local and foreign counterparts to such laws,
rules and regulations as its activities are increased or that the operations,
business and future profitability of the Company will not be adversely affected
by current or future laws, rules and regulations. The risk of accidental
contamination or injury from hazardous materials cannot be eliminated. In the
event of such an accident, the Company could be held liable for any damages that
result and any such liability could exceed the resources of the Company. In any
event, the cost of defending claims arising from such contamination or injury
could be substantial. In addition, the Company cannot predict the extent of the
adverse effect on its business or the financial and other costs that might
result from any new government requirements arising out of future legislative,
administrative or judicial actions.

Risk of Product Liability; Limited Product Liability Insurance. The
testing, marketing and sale of human health care products entails an inherent
risk of allegations of product liability. There can be no assurance that
substantial product liability claims will not be asserted against the Company.
The Company has obtained limited amounts of insurance relating to its clinical
trials. There can be no assurance that the Company will be able to obtain or
maintain insurance on acceptable terms for its clinical and commercial
activities or that any insurance obtained will provide adequate protection
against potential liabilities.

Anti-Takeover Provisions. Certain provisions of the Company's Amended and
Restated Articles of Incorporation, as well as the California General
Corporation Law, could discourage a third party from attempting to acquire, or
make it more difficult for a third party to acquire, control of the Company
without approval of the Company's Board of Directors. Such provisions could also
limit the price that certain investors might be willing to pay in the future for
shares of the Common Stock. Certain of such provisions allow the Board of
Directors to authorize the issuance of preferred stock with rights superior to
those of the Common Stock. The rights of the holders of Common Stock will be
subject to, and may be adversely affected by, the rights of the holders of any
preferred stock that may be issued in the future. The issuance of preferred
stock could adversely affect the voting power of holders of Common Stock and the
likelihood that such holders will receive dividend payments and payments upon
liquidation. The Company has no current plans to issue shares of preferred
stock. The Company is also subject to the provisions of Section 1203 of the
California General Corporation Law which requires that a fairness opinion be
provided to the Company's shareholders in connection with their consideration of
any proposed "interested party" reorganization transaction.

Volatility of Stock Price. The stock market has from time to time
experienced significant price and volume fluctuations that may be unrelated to
the operating performance of particular companies. In addition, the market price
of the Common Stock, like the stock prices of many publicly-traded
pharmaceutical, chemical, consumer, and biotechnology companies, may prove to be
highly volatile. Announcements of technological innovations or new commercial
products by the Company or its competitors, developments or disputes concerning
patent or proprietary rights, publicity regarding actual or potential medical
results relating to products under development by the Company or its
competitors, regulatory developments in both the United States and foreign
countries, public concern as to the safety of pharmaceutical products, sales of
a large number of shares of Common Stock in the market and economic and other
external factors, as well as period-to-period fluctuations in financial results,
among other factors, may have a significant impact on the market price of the
Common Stock.

13
<PAGE> 15

USE OF PROCEEDS

The net proceeds to be received by the Company from the sale of the
1,750,000 shares of Common Stock offered hereby are estimated to be
approximately $11.9 million (approximately $13.7 million if the Underwriter's
over-allotment option is exercised in full), at a public offering price of $7.50
per share and after deducting underwriting discounts and commissions and
estimated offering expenses.

The Company intends to use a substantial portion of the net proceeds to
conduct clinical trials and fund its research and development programs and
research facilities and for general corporate purposes, including working
capital. Although Cellegy is focusing primarily on the development of its own
products, a portion of the net proceeds may also be used to acquire products,
technologies or businesses consistent with its commercial objectives. Other than
the Anogesic Agreement, the Company is not currently a party to any agreements
with respect to such acquisitions or investments.

The amounts and timing of expenditures for each purpose may vary
significantly depending on numerous factors including, without limitation, the
progress of the Company's research and development programs, the progress and
results of the Company's clinical trials and preclinical studies, the time and
costs involved in obtaining regulatory approvals, the costs of filing,
prosecuting, defending and enforcing any patent claims and other intellectual
property rights, competing technological and market developments, changes in the
Company's existing research relationships, the ability of the Company to
establish collaborative arrangements, the initiation of commercialization
activities, the purchase of capital equipment and the availability of other
financing. The Company believes that its available cash resources, the net
proceeds from this offering and the interest thereon will be adequate to satisfy
its capital needs at least through December 31, 1999.

Pending such uses, the net proceeds of this Offering will be invested in
short-term, interest-bearing, investment grade securities.

PRICE RANGE OF COMMON STOCK

Cellegy's Common Stock has been traded on the Nasdaq SmallCap Market under
the symbol "CLGY" since the Company's initial public offering in August 1995.
The Company's Common Stock has been approved for quotation on the Nasdaq
National Market under the symbol "CLGY." The following table sets forth the
range of high and low sale prices for the Common Stock as reported on the Nasdaq
SmallCap Market for the periods indicated below.

<TABLE>
<CAPTION>
1995 HIGH LOW
- ----------------------------------------------------------------------------- ----- -----
<S> <C> <C>
Third Quarter................................................................ $7.25 $4.88
Fourth Quarter............................................................... 6.25 4.00
1996
- -----------------------------------------------------------------------------
First Quarter................................................................ 7.13 5.00
Second Quarter............................................................... 10.13 5.50
Third Quarter................................................................ 9.38 4.75
Fourth Quarter............................................................... 6.00 4.38
1997
- -----------------------------------------------------------------------------
First Quarter................................................................ 5.13 4.13
Second Quarter............................................................... 4.50 2.38
Third Quarter................................................................ 6.56 2.44
Fourth Quarter (through November 18, 1997)................................... 9.44 6.25
</TABLE>

As of October 10, 1997, there were approximately 96 shareholders of record.
The Company believes that the actual number of shareholders of the Common Stock
substantially exceeds this number.

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<PAGE> 16

CAPITALIZATION

The following table sets forth the actual capitalization of the Company as
of September 30, 1997, and as adjusted to reflect the sale of the 1,750,000
shares of Common Stock offered hereby at an offering price of $7.50 per share,
and the receipt of the estimated net proceeds therefrom.

<TABLE>
<CAPTION>
SEPTEMBER 30, 1997
------------------------
ACTUAL AS ADJUSTED
-------- -----------
(IN THOUSANDS)
<S> <C> <C>
Shareholders' equity:
Preferred Stock, no par value: 5,000,000 shares authorized; no
shares issued and outstanding.................................... $ -- $ --
Common Stock, no par value: 20,000,000 shares authorized; 7,594,959
shares issued and outstanding actual, 9,344,959 shares issued and
outstanding as adjusted(1)....................................... 26,497 38,369
Unrealized gain on investments...................................... 48 48
Deficit accumulated during the development stage.................... (17,431) (17,431)
-------- --------
Total shareholders' equity..................................... 9,114 20,986
-------- --------
Total capitalization........................................ $ 9,114 $ 20,986
======== ========
</TABLE>

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

DIVIDEND POLICY

The Company has never paid dividends on its Common Stock and does not
anticipate paying dividends on its Common Stock in the foreseeable future.

15
<PAGE> 17

DILUTION

As of September 30, 1997, the net tangible book value of the Company's
Common Stock was $9,114,000 or $1.20 per share of Common Stock. "Net tangible
book value" per share represents the amount of total tangible assets of the
Company reduced by the total liabilities and divided by the number of shares of
Common Stock outstanding. After giving effect to the sale by the Company of
1,750,000 shares of Common Stock offered hereby, less underwriting discount and
estimated offering expenses payable by the Company, the Company's pro forma net
tangible book value as of September 30, 1997 would have been $20,986,000, or
$2.25 per share of Common Stock. This represents an immediate increase in pro
forma net tangible book value of $1.05 per share to existing holders of Common
Stock and an immediate dilution per share of $5.25 to new investors purchasing
shares of Common Stock in this Offering. "Dilution per share to new investors"
represents the difference between the price per share of Common Stock paid for
the shares issued in this Offering and the pro forma net tangible book value per
share at September 30, 1997, as adjusted to give effect to this Offering.

<TABLE>
<S> <C> <C>
Public offering price per share(1).......................... $ 7.50
Pro forma net tangible book value per share before
offering............................................... $1.20
Increase per share attributable to new investors.......... 1.05
-----
Pro forma net tangible book value per share after
offering.................................................. 2.25
------
5.25
Dilution per share to new investors............... ======
</TABLE>

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

(1) Before deduction of underwriting discount and estimated offering expenses
payable by the Company.

The above computations assume no exercise of outstanding options and
warrants. At September 30, 1997, a total of 1,061,447 shares of Common Stock
were subject to outstanding options at a weighted average exercise price of
$4.19 per share, 661,250 shares of Common Stock issuable upon the exercise of
the IPO Warrants at an exercise price of $9.375 per share, 832,061 shares of
Common Stock issuable upon the exercise of other outstanding warrants at a
weighted average exercise price of $7.79 per share and up to 125,000 shares of
Common Stock issuable upon the exercise of the Underwriter Warrant. Any exercise
of such options or warrants may result in further dilution to new investors.

16
<PAGE> 18

SELECTED FINANCIAL DATA

The following balance sheet data as of December 31, 1995 and 1996 and the
statement of operations data for the three years ended December 31, 1996 are
derived from the Company's audited financial statements that are included
elsewhere in this Prospectus. The balance sheet data set forth below as of
December 31, 1992, 1993 and 1994 and the statement of operations data for the
years ended December 31, 1992 and 1993, are derived from the Company's audited
financial statements which are not included herein. The balance sheet data at
September 30, 1997 and the statement of operations data for the nine months
ended September 30, 1996 and 1997, are derived from the Company's unaudited
financial statements. In the opinion of management of the Company, the unaudited
financial statements have been prepared on the same basis as the audited
financial statements and include all adjustments, consisting only of normal
recurring adjustments, necessary for a fair presentation of the Company's
financial position and results of operations for these periods. Operating
results for the nine months ended September 30, 1997 are not necessarily
indicative of the results that may be expected for the entire year ending
December 31, 1997. The data set forth below should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the Financial Statements.

<TABLE>
<CAPTION>
PERIOD FROM
NINE MONTHS ENDED JUNE 26, 1989
(INCEPTION)
YEARS ENDED DECEMBER 31, SEPTEMBER 30, THROUGH
----------------------------------------------- ----------------- SEPTEMBER 30,
1992 1993 1994 1995 1996 1996 1997 1997
------- ------- ------- ------- ------- ------- ------- --------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues................................. $ 44 $ 86 $ -- $ 1,000 $ 648 $ 15 $ 643 $ 2,422
Expenses:
Research and development............... 828 1,798 1,510 1,225 2,712 1,866 2,389 11,511
General and administrative............. 1,069 723 1,032 1,310 1,634 1,171 1,066 7,248
------- ------- ------- ------- ------- ------- ------- --------------
Total expenses................... 1,897 2,521 2,542 2,535 4,346 3,037 3,455 18,759

Loss from operations..................... (1,853) (2,435) (2,542) (1,535) (3,698) (3,022) (2,812) (16,337)
Interest expense....................... -- -- (5) (752) -- -- -- (864)
Interest income and other, net......... 178 156 4 135 330 271 354 1,219
------- ------- ------- ------- ------- ------- ------- --------------

Net loss................................. (1,675) (2,279) (2,543) (2,152) (3,368) (2,751) (2,458) (15,982)

Non-cash preferred dividends............. -- -- -- -- 1,414 1,368 35 1,449
------- ------- ------- ------- ------- ------- ------- --------------

Net loss applicable to common
shareholders........................... $(1,675) $(2,279) $(2,543) $(2,152) $(4,782) $(4,119) $(2,493) $(17,431)
======= ======= ======= ======= ======= ======= ======= =============

Pro forma net loss per share(1).......... $ (0.76) $ (0.67) $ (1.11) $ (1.02) $ (0.41)
======= ======= ======= ======= =======

Shares used in computing pro forma net
loss per share(1)...................... 3,344 3,206 4,307 4,050 6,076
</TABLE>

<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------------------------- SEPTEMBER 30,
1992 1993 1994 1995 1996 1997
------- ------- ------- ------- ------- -------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash, cash equivalents and investments.................... $ 3,276 $ 1,099 $ 402 $ 3,820 $ 7,315 $ 9,377
Total assets.............................................. 3,558 1,280 555 4,028 7,696 9,841
Deficit accumulated during the development stage.......... (3,181) (5,460) (8,004) (10,155) (14,937) (17,431)
Total shareholders' equity (deficit)...................... 3,325 1,168 (1,374) 3,648 7,387 9,114
</TABLE>

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

(1) See Note 1 of Notes to the Financial Statements for an explanation of the
determination of the number of pro forma shares used in per share
calculations.

17
<PAGE> 19

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

This Prospectus contains forward-looking statements which involve risks and
uncertainties, including but not limited to statements concerning the
commencement and completion of clinical trials, the timing of planned regulatory
filings, the applicability of drug and cosmetic laws and regulations to the
Company's products, planned activities of collaborative partners, the Company's
strategic plans, the scope of the Company's patent coverage, anticipated
expenditures and the need for additional funds. Discussions containing such
forward-looking statements may be found in the material set forth under "Risk
Factors," "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and "Business" as well as in the Prospectus generally.
Actual events or results may differ materially from those discussed in this
Prospectus.

Cellegy is a biopharmaceutical company engaged in the development of
prescription drugs and cosmeceuticals to address a variety of diseases and
conditions utilizing its patented transdermal and topical delivery technologies.
Cellegy's first prescription drug, Glylorin, is a novel treatment for certain
forms of ichthyosis, a family of incurable skin diseases. Glylorin has been
licensed by Cellegy to Glaxo and is currently in Phase III clinical trials in
the United States. Cellegy is also evaluating several prescription drugs
including a transdermal testosterone gel for the treatment of hypogonadism, a
condition that frequently results in lethargy and reduced libido in men above
the age of 40. In addition to its prescription drugs, Cellegy is testing and
developing a line of anti-wrinkling cosmeceutical products which the Company
believes will address the skin care needs of an affluent and aging population.

Since its inception in 1989, the Company has engaged only in research and
development activities, and intends to continue research, development and
testing of its drug delivery systems and pharmaceutical and cosmeceutical
products.

On November 3, 1997, the Company signed the Anogesic Agreement with Neptune
to acquire all patent and other intellectual property rights relating to
Anogesic, a topical product candidate for the treatment of anal fissures and
hemorrhoids. The closing of the Anogesic Acquisition is subject to the
satisfaction or waiver of certain conditions, and there can be no assurance that
the Company will conclude the Anogesic Acquisition. See "Recent Developments."
If the Company completes the Anogesic Acquisition, the Company's expenses
relating to product development and clinical trials are expected to increase
during 1998 and thereafter as a result of expenses relating to Anogesic. The
Company expects to record a material charge to operations for in-process
technology upon completion of the Anogesic Acquisition.

In July 1997, the Company reacquired rights to skin repair technology that
had been licensed in April 1992 to Neutrogena Corporation ("Neutrogena"), a
subsidiary of Johnson & Johnson. Pursuant to this licensing agreement, Cellegy
has received development funding and other amounts from Neutrogena over the last
several years. The Company will not receive additional development funding under
this agreement.

In November 1996, the Company entered into a licensing agreement with Glaxo
for Cellegy's most advanced topical prescription drug candidate, Glylorin. The
license agreement provides for milestone payments, certain development funding
and royalty payments on net sales assuming successful completion of product
development and market launch.

In September 1996, the Company received an Orphan Drug grant from the FDA
to cover certain of the Company's Phase III study costs for Glylorin over a two
year period.

RESULTS OF OPERATIONS

NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1996

Revenues. The Company had revenues of $643,000 for the nine months ended
September 30, 1997, compared with revenues of $15,000 for the same period last
year. Revenues for the nine months ended September 30, 1997, consisted of
$442,000 for development funding associated with the Glaxo license agreement,
$126,000 from an FDA Orphan Drug grant relating to Glylorin and $75,000 from
Neutrogena for

18
<PAGE> 20

the reimbursement of patent expenses incurred by Cellegy related to a license
agreement with Neutrogena. Revenues of $15,000 for the nine months ended
September 30, 1996, were associated with the Neutrogena licensing agreement. The
Company expects to receive additional development funding and milestones from
Glaxo over the next several quarters and is pursuing other licensing and product
supply agreements which, if entered into, may result in additional contract
revenues or product sales. There can be no assurances regarding when, or if,
such revenues will occur.

Research and Development Expenses. Research and development expenses were
$2,389,000 for the nine months ended September 30, 1997, compared with
$1,866,000 for the same period last year. This increase was primarily due to
salary costs associated with the addition of scientific personnel, as well as
increased contract research expenses. Cellegy's research expenses are expected
to increase during the fourth quarter of 1997 and throughout 1998 as preclinical
and clinical trial activity associated with its testosterone and anti-wrinkling
programs increases and as it continues to focus on the identification and
testing of compounds using the Company's drug delivery technologies. The Company
plans to selectively add personnel in research and development in order to
accomplish its goals.

General and Administrative Expenses. General and administrative expenses
were $1,066,000 for the nine months ended September 30, 1997, compared with
$1,171,000 for the same period last year. Higher expenses during the 1996 period
resulted primarily from administrative costs associated with a Series A
Preferred Stock financing and subsequent preparation and filing of registration
statements. The Company's general and administrative expenses are expected to
increase in the future in support of its research and product commercialization
efforts. However, the rate of increase in general and administrative expenses is
expected to be lower than the growth rate of research and development spending.

Interest Income and Expense. Interest income was $354,000 for the nine
months ended September 30, 1997, compared with $271,000 for the same period last
year. The additional interest income earned during 1997 was due to higher
average investment balances during that period.

Net Loss. The net loss applicable to common shareholders was $2,493,000 or
$0.41 per share for the nine months ended September 30, 1997, compared with
$4,119,000 or $1.02 per share for the same period last year. The Company's net
loss during 1996 was impacted by significant non-cash preferred dividend charges
reflecting primarily a 15% discount to the common stock variable conversion
price of the Series A Preferred Stock issued in April 1996. The impact of these
dividends was $35,000 and $1,368,000, for the nine months ended September 30,
1997 and 1996, respectively.

YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994

Revenues. The Company had revenues of $648,000 and $1,000,000 in 1996 and
1995, respectively. No revenues were recorded for 1994. In 1996, revenues
consisted primarily of approximately $560,000 associated with the Glaxo license
agreement and approximately $74,000 from FDA Orphan Drug grant payments.
Revenues in 1995 of $1,000,000 were associated with the expiration in May 1995
of Cellegy's option to reacquire rights to a prescription product that was
originally purchased by Neutrogena in 1994.

Research and Development Expenses. Research and development expenses were
$2,712,000 in 1996, compared with $1,225,000 in 1995 and $1,510,000 in 1994. The
increase of $1,487,000 in 1996 was primarily due to clinical trial expenses
related to Glylorin. Other factors contributing to the increase in expenses were
personnel costs associated with the hiring of additional scientists, and costs
of contract research work related to the Company's drug delivery technology.
Additionally, the Company occupied and equipped a new laboratory in San Carlos,
California during the first half of 1996. The decrease of $285,000 in 1995 was
primarily due to a reduction in formulation activity associated with products
entering the clinical phase.

Although the Company's expenses related to Glylorin are expected to
decrease significantly as Glaxo is obligated to pay for product development
costs under the Company's agreement with Glaxo, Cellegy's total research
expenses are expected to increase in the future as preclinical and clinical
trial activity associated with other research programs increase. The Company has
increased its research spending in 1997 and expects to

19
<PAGE> 21

increase its research spending again during 1998 as a result of its efforts to
identify, develop and test compounds using the Company's PERMEATE and CELLEDIRM
technologies.

General and Administrative Expenses. General and administrative expenses
were $1,634,000 in 1996, compared with $1,310,000 in 1995 and $1,032,000 in
1994. The increase of $324,000 in 1996 was primarily due to increased
professional fees, as well as increases in personnel and related expenses. The
increase of $278,000 in 1995 was primarily due to increased salaries. The
Company's general and administrative expenses are expected to continue to
increase in the future in support of its research and product commercialization
efforts.

Interest Income and Expense. The Company recognized $330,000 in interest
income for 1996, compared with $135,000 for 1995. Interest income in 1994 was
not significant. The additional interest income earned in 1996 was due to a
higher investment balance during the 1996 period resulting from proceeds
associated with the Series A Preferred Stock financing transaction completed in
April 1996. The Company incurred no interest expense during 1996. In 1995,
interest expense was $752,000 which reflected the interest and amortization of
the discount on the notes issued in connection with a bridge financing
transaction, which were repaid in August 1995. Interest expense in 1994 was not
significant.

Net Loss. The net loss applicable to common shareholders was $4,782,000 or
$1.11 per share in 1996, compared with a net loss of $2,152,000 or $0.67 per
share in 1995 and a net loss of $2,543,000 or $0.76 per share in 1994. The net
loss applicable to common shareholders in 1996 was impacted by two significant
non-cash items. Total operating expenses in 1996 included a total of $268,000
associated with the extension of certain stock option exercise periods. In
addition, there was a non-cash preferred dividend charge of $1,414,000 due to a
one-time conversion discount of 15% and an ongoing dividend rate of 8%
associated with the issuance of Series A Preferred Stock.

LIQUIDITY AND CAPITAL RESOURCES

The Company has experienced net losses and negative cash flow from
operations each year since its inception. Through September 30, 1997, the
Company had incurred an accumulated deficit of $17.4 million and had consumed
cash from operations of $14.3 million. The Company raised approximately $6.4
million in net proceeds from its initial public offering in August 1995 and
approximately $6.8 million in net proceeds from a preferred stock financing in
April 1996. An additional approximately $3.8 million was raised in a private
placement of Common Stock in July 1997.

The Company's cash and investments were $9.4 million at September 30, 1997,
compared with $7.3 million at December 31, 1996. The increase of $2.1 million
during the first nine months of 1997 was principally due to additional funds
received in the private placement completed in July 1997, offset by net cash
used in operating activities.

The Company's operations to date have consumed substantial amounts of cash.
The Company has no current source of significant ongoing revenues or capital
beyond existing cash and investments, the net proceeds of this Offering and
payments if any, that may be received pursuant to existing licensing agreements
with third parties. In order to complete the research and development and other
activities necessary to commercialize its products, additional financing may be
required. The Company's future expenditures and capital requirements depend on
numerous factors including, without limitation, the progress and focus of its
research and development programs, the progress and results of preclinical and
clinical testing, the time and costs involved in obtaining regulatory approvals
and complying with pre- and post-approval regulatory requirements, the costs of
filing, prosecuting, defending and enforcing any patent claims and other
intellectual property rights, competing technological and market developments,
changes in the Company's existing research relationships, the ability of the
Company to establish collaborative arrangements, the initiation of
commercialization activities, the purchase of capital equipment and the
availability of other financing.

In the course of its development activities, the Company has incurred
significant losses and expects to incur substantial additional development
costs. As a result, the Company will require additional funds to finance
operations and may seek private or public equity investments and future
collaborative arrangements

20
<PAGE> 22

with third parties to meet such needs. There is no assurance that such funding
will be available for the Company to finance its operations on acceptable terms,
if at all. Insufficient funding may require the Company to delay, reduce or
eliminate some or all of its research and development activities, planned
clinical trials and administrative programs. The Company believes that available
cash resources, the net proceeds of this Offering and the interest thereon will
be adequate to satisfy its capital needs through at least December 31, 1999.

As of December 31, 1996, the Company had federal and state income tax net
operating loss carryforwards of approximately $12.8 million and $4.7 million,
respectively, which expire between 2004-2011 and 1997-2001, respectively. The
Company also had federal and state research tax credit carryforwards of
approximately $262,000 and $95,000, respectively. The federal credits expire
between 2006 and 2011; the state credits have no expiration date.

21
<PAGE> 23

BUSINESS

OVERVIEW

Cellegy is a biopharmaceutical company engaged in the development of
prescription drugs and cosmeceuticals to address a variety of diseases and
conditions utilizing its patented transdermal and topical delivery technologies.
Cellegy's first prescription drug, Glylorin, is a novel treatment for certain
forms of ichthyosis, a family of incurable skin diseases. Glylorin has been
licensed by Cellegy to Glaxo and is currently in Phase III clinical trials in
the United States. Cellegy is also evaluating several prescription drugs
including a transdermal testosterone gel for the treatment of hypogonadism, a
condition that frequently results in lethargy and reduced libido in men above
the age of 40. In addition to its prescription drugs, Cellegy is testing and
developing a line of anti-wrinkling cosmeceutical products which the Company
believes will address the skin care needs of an affluent and aging population.

The Company's principal technologies consist of PERMEATE and CELLEDIRM.
PERMEATE is a patented topical drug delivery system which has been found in
preclinical evaluations to permit delivery of larger or insoluble drugs into the
blood stream or into the skin itself. These drugs include peptides that to the
Company's knowledge are not deliverable using methods employed in currently
approved transdermal products. CELLEDIRM is a group of compounds identified by
Cellegy's scientists which have been found in preclinical evaluations to reduce
or eliminate irritation caused by many substances that come into contact with
the skin. The Company's CELLEDIRM technology is being developed as an adjunct to
the PERMEATE technology to mitigate skin irritation problems associated with
transdermal drug delivery, and to improve existing prescription drugs and
cosmeceutical products.

Based on Phase I and II clinical trials conducted by the Company, Glylorin
appears to be safe and effective in the treatment of n-CIE. The results from the
Company's Phase II clinical trials showed statistically significant improvements
in scaling, induration (swelling) and erythema (redness). After developing the
product through early Phase III clinical trials, Cellegy licensed Glylorin to
Glaxo in November 1996. Glaxo has completed patient enrollment for the Phase III
trial.

RECENT DEVELOPMENTS

On November 3, 1997, the Company signed the Anogesic Agreement with Neptune
to acquire all patent and other intellectual property rights relating to
Anogesic, a topical product candidate for the treatment of anal fissures and
hemorrhoids. Unlike currently available drugs which provide only partial
symptomatic relief, based on clinical studies to date Anogesic appears to heal
anal fissures and hemorrhoids. As a result, Anogesic represents a potential
alternative to surgical intervention. Clinical studies of Anogesic have been
completed on over 400 patients to date, and the Company plans to commence Phase
III trials during 1998. The closing of the Anogesic Acquisition is subject to
the satisfaction or waiver of certain conditions, and there can be no assurance
that the Company will conclude the Anogesic Acquisition. See "Recent
Developments."

22
<PAGE> 24

STRATEGY

Cellegy intends to become a leader in the field of transdermal drug
delivery and in the development and marketing of specialty pharmaceutical and
cosmeceutical products that are applied to the skin. Key elements of its
business and commercialization strategy include the following:

Lower Risk Strategy for Selecting Product Candidates for Development. The
Company does not intend to focus its product development efforts on development
of new chemical entities. Instead, the Company will focus on applying its
proprietary technologies in the following three areas:

(1) development of improved topical and transdermal formulations of
FDA approved pharmaceutical compounds for which marketing exclusivity or
patent rights have expired or are near expiration;

(2) development of topical or transdermal formulations of new
chemical entities in partnership with innovator pharmaceutical or
biotechnology companies; and

(3) development of new, high performance cosmeceutical products
that address the skin care needs of an increasing number of affluent
middle-aged and older people.

Leveraging of Corporate Alliances. Cellegy plans to enter into strategic
alliances with established pharmaceutical companies for the development of
certain products. These alliances generally will provide research or clinical
funding and other support during the product development process. Cellegy's
partners generally will provide established and trained marketing and sales
forces to sell the products.

Internal Focus on the Dermatology Market. Cellegy plans to retain exclusive
or co-marketing/co-promotion rights in the United States to dermatological and
related uses of the products it develops, while out-licensing rights for other
uses. Similarly, whenever possible, it will attempt to retain commercial rights
to dermatological and other specialty pharmaceutical uses of products developed
under partner sponsored research collaborations. The Company ultimately plans to
market the dermatologic and cosmeceutical products it develops, either through
the utilization of contract sales representatives or through the establishment
of its own sales force.

Acquisition of Complementary Products, Technologies or Businesses. Although
Cellegy is focusing primarily on the development of its own products and
technologies, the Company may opportunistically acquire products, technologies
or companies with products and distribution capabilities consistent with its
commercial objectives.

BACKGROUND

Skin Biology

Cellegy's technologies and products have been developed based on an expert
knowledge of the biology and physical function of the skin, particularly the
epidermis. The epidermis is comprised mainly of cells known as keratinocytes
which are continually regenerated and move toward the skin surface where they
flatten, loose their nucleus and become the outermost layer of the epidermis,
the stratum corneum. The stratum corneum acts as a protective barrier against
physical injuries and disease, and regulates the loss of moisture from the

23
<PAGE> 25

body. It consists of an array of flattened cells suspended in highly organized
lipid structures, similar conceptually to a brick and mortar arrangement. Most
importantly, these lipids regulate the permeability properties of the skin and,
therefore, the movement of topically applied drugs into the body.

(Figure depicts the epidermis showing the various layers thereof, including the
stratum corneum.)

In addition to its physical role as barrier, the epidermis is biologically
active, capable of initiating a full inflammatory reaction (characterized by
redness and swelling). Normally, this process is a protective reaction in
response to various noxious stimuli such as sunlight, poison ivy or cuts and
bruises. The same reaction, however, can result following the topical
application of many drugs.

Similarly, certain dermatologic diseases can also be linked to
environmental influences. Psoriasis, for example, which is characterized by
inflammation and accelerated growth of the epidermis, can sometimes be triggered
by a simple cut or abrasion to the skin. Nonetheless, despite material
differences in appearance and symptoms, this disease and the other inflammatory
reactions described above all share fundamental similarities in the underlying
biological processes mediated by the epidermis.

Transdermal Drug Delivery

Transdermal delivery involves the topical administration of drugs to the
skin for the treatment of systemic diseases or localized skin conditions,
generally using patches. This method of drug delivery is well suited for drugs
that are targeted to the skin itself, or for drugs that are degraded either in
the intestinal tract or the liver if taken orally, such that only a small
fraction of the total administered dose is actually absorbed into the
bloodstream. Attempts to overcome this problem by increasing the dosage can
result in harmful side effects.

Transdermal delivery systems may offer significant advantages over many
conventional oral dosage forms and most parenteral (injectable) dosage forms.
Those advantages include increased convenience, less pain (compared to
injections), improved patient compliance and potentially reduced side effects.
Transdermal delivery systems can also offer certain advantages to pharmaceutical
companies, including brand extension, further product differentiation and
additional patent protection.

Transdermal delivery has historically been limited to those drugs which are
small in size, highly potent and can easily penetrate the skin due to their
physical and chemical characteristics. Specifically, the Company believes that
drugs with molecular weights larger than 400, or drugs that require daily doses
greater than five milligrams or that are too lipid soluble, will be difficult to
deliver transdermally. Although many companies have experimented with different
methods of facilitating the delivery of drugs through the skin barrier, to date
they have enjoyed only limited success. Of all the prescription drugs in the
United States, less than ten systemically-active drugs are currently approved by
the FDA for transdermal administration. Although this reflects a reasonably
successful history relative to other non-oral routes of novel drug
administration (for example, nasal, implants or liposomal-based systems),
transdermal delivery has proved more difficult than initially anticipated.

24
<PAGE> 26

There are many reasons for the limited number of transdermal product
offerings. The principal reason relates to irritation caused by solvents and
other conventional permeation enhancers designed to ease the passage of drugs
through the skin. These solvents dissolve the lipid-rich stratum corneum,
permitting the passage of the therapeutic agent into the lower levels of the
skin, where it can be absorbed into the bloodstream. However, the interaction of
the solvents with the metabolically active stratum corneum and the resulting
inflammatory responses have been greater than anticipated. Several of the
currently marketed transdermal patches utilize these solvents, often in
concentrations exceeding the drug itself. The table below summarizes the
incidence of skin irritation, as determined in certain clinical studies,
associated with certain FDA-approved transdermal products.

<TABLE>
<CAPTION>
INCIDENCE OF ADVERSE
TRANSDERMAL DRUG SKIN REACTIONS* PRINCIPAL SKIN REACTIONS
- ---------------- -------------------- ---------------------------------
<S> <C> <C>
Scopolamine 10% Allergic contact dermatitis
Clonidine 5 - 30% Irritant and allergic contact
dermatitis
Estradiol 17% Erythema (redness)
Nitroglycerin 5 - 16% Erythema
Fentanyl 39% Erythema
9% Pruritis (itching)
Nicotine 38% Pruritis
Testosterone 37% Pruritis
12% Blistering
7% Erythema
</TABLE>

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

* Ranges reflect differing results achieved when more than one study was
conducted.

Recent efforts to expand the number and type of drugs delivered
transdermally include the use of iontophoresis (mild electrical charges) or
ultrasound waves in order to help drive the drug through the stratum corneum.
While these approaches may prove successful for a few drugs, the Company
believes that the resulting inflammatory skin reactions and higher product costs
are likely to limit the use of these techniques.

With the advent of biotechnology, the discovery and development of larger
molecular size drugs (including proteins, peptides and oligonucleotides) has
increased significantly. As many of these potentially breakthrough new drugs are
amenable only to injectable administration, the Company believes that
transdermal methods to deliver these products represent an increasingly large
commercial opportunity. Thus, the need to find new methods to expand the type
and number of therapeutic agents deliverable by transdermal methods, while at
the same time minimizing the incidence of adverse skin reactions, has assumed
greater importance. Cellegy's approach to this challenge has been to develop
novel technologies which (i) do not rely on solvent permeation enhancers, (ii)
increase the size of molecules deliverable through the skin and (iii)
significantly mitigate skin irritation.

CELLEGY'S PROPRIETARY TECHNOLOGIES

Cellegy's focus on the biological functioning of the skin has permitted
development of two novel technologies: (i) PERMEATE, which appears to be capable
of enhancing the delivery of drugs applied to the skin for systemic delivery or
for the treatment of local skin conditions, and (ii) CELLEDIRM, which appears to
be capable of mitigating the irritation and inflammation caused when drugs,
solvents and other substances come into contact with the skin.

PERMEATE Drug Delivery Technology

PERMEATE is a patented technology which employs bioactive permeation
enhancers to permit the passage of larger molecule drugs into or through the
skin. This technology represents a variety of methods to manipulate the three
primary lipids which dictate the barrier properties of the stratum corneum:
cholesterol, ceramides and free fatty acids. Normal barrier function requires a
specific critical ratio of these three lipids. The Company has shown that its
newly identified enhancers can alter these lipid ratios to increase the

25
<PAGE> 27

permeability of the skin by inhibiting specific enzymes responsible for the
synthesis or processing of these lipids, or by inducing defects in the rigid
lipid structures of the stratum corneum.

Cellegy's PERMEATE system has the potential of being able to open the
stratum corneum barrier wider than believed possible before, and to keep it open
longer than conventional solvent approaches. This has been found in preclinical
studies to facilitate the permeation of larger or more insoluble drugs into the
skin or into the bloodstream. Further, Cellegy's PERMEATE technology potentially
enables transdermal delivery of such drugs without using energy dependent
systems, such as iontophoresis, electroporation, ultrasound or laser. Cellegy's
studies to date have also shown that these enhancers can exert their effect when
formulated as topical creams or gels or in conventional transdermal patches.

The Company's research findings include the evaluation of selected PERMEATE
systems in conjunction with the following drugs: testosterone, vasopressin,
luteinizing hormone releasing hormone ("LHRH"), lidocaine, cimetidine,
hydrocortisone and caffeine. Experimental findings with these drugs indicated
that PERMEATE was capable in animal models of delivering up to ten times more
drug than attainable using conventional solvent approaches. Further, two of
these compounds (LHRH and vasopressin) delivered using the Company's PERMEATE
technology are peptides which, to the Company's knowledge, have never before
been delivered transdermally using conventional solvent technologies. The
molecular weights of LHRH and vasopressin (approximately 1000 and 1200,
respectively) are significantly greater than the molecular weights of drugs
delivered using currently approved transdermal patches (no more than
approximately 400 molecular weight).

CELLEDIRM Technology

CELLEDIRM is a group of compounds identified by Cellegy's scientists which
have in preclinical evaluations been found to be capable of reducing the
inflammation associated with the topical application of drugs, solvents or other
physiologically active substances. These compounds consist of specially
processed or purified excipients that have been shown in preclinical studies to
significantly reduce skin inflammation following challenge with a number of
irritating or allergenic substances.

The Company has conducted a number of research studies investigating the
utility of CELLEDIRM in mitigating the symptoms of skin inflammation. These
compounds have been shown to reduce inflammation by up to 40% in animal models
challenged with either a potent irritant or an allergen. These effects are
comparable to those achieved with topical corticosteroids. The ability of
CELLEDIRM to reduce the inflammation caused by irritants also has been confirmed
in humans using a standard soap chamber test.

The Company expects its proprietary CELLEDIRM technology to complement its
PERMEATE drug delivery system and to provide a unique platform for the
development of novel topical products which could benefit from the
anti-inflammatory or anti-allergic activities of CELLEDIRM. Since the active
ingredients within CELLEDIRM are either GRAS (generally regarded as safe) or
used as excipients in various pharmaceutical or cosmetic products, the Company
believes the use of these compounds will not lengthen the FDA review process of
therapeutic drug products in which they are used. Accordingly, the Company plans
to utilize these compounds in the near-term development of its testosterone and
other prescription products.

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PRODUCTS UNDER DEVELOPMENT

The following table summarizes certain information concerning Cellegy's
clinical and preclinical prescription product candidates.

<TABLE>
<CAPTION>
PROPRIETARY
DEVELOPMENT TECHNOLOGIES
PRODUCTS INDICATIONS STATUS UTILIZED
- ----------------------- ----------------------- ----------------------- ------------
<S> <C> <C> <C>
PRESCRIPTION TOPICAL THERAPEUTICS

Glylorin n-CIE Phase III trials in Proprietary
progress

Ichthyosis vulgaris Phase II trials planned Proprietary

PRESCRIPTION PRODUCTS USING TRANSDERMAL DRUG DELIVERY TECHNOLOGY

Testosterone gel Hypogonadism (hormone Pilot studies in humans CELLEDIRM
therapy for male planned for late 1997
andropause)

Testosterone gel Female hormone therapy Preclinical evaluation CELLEDIRM

Estrogen-testosterone Female hormone therapy Research PERMEATE
gel CELLEDIRM

Immunosuppressive drug Psoriasis Research PERMEATE
CELLEDIRM
</TABLE>

PRESCRIPTION TOPICAL THERAPEUTICS

Glylorin (congenital primary ichthyosis: n-CIE)

Glylorin, the Company's most advanced topical prescription candidate, is
currently in Phase III clinical trials for the treatment of n-CIE. n-CIE is a
severe form of CPI, a group of incurable skin conditions for which there is
currently no satisfactory treatment. After successfully completing Phase II
clinical trials and commencing Phase III clinical trials in January 1996,
Cellegy licensed Glylorin to Glaxo in November 1996. Glaxo is one of the world's
largest pharmaceutical companies and a leader in the field of dermatology.

Ichthyosis is a family of related incurable skin diseases characterized by
a severe scaling of the skin that frequently affects large areas of the body. In
all forms of ichthyoses, skin cells form a rigid, thick surface layer of scales
that often discolor and crack. CPI is a group of the most severe and
debilitating forms of ichthyosis, affecting all age and ethnic groups. Many of
the most severely afflicted infants die shortly after birth from dehydration,
hypothermia and microbes, which enter through the damaged epidermis. Victims of
the disease are currently treated with greases, emollients and Lac-Hydrin (not
indicated for treatment of CPI), which provide only limited benefits, or with
oral and topical retinoids, which have a risk of significant toxicity.
Approximately 100,000 people in the United States and at least an equal number
of persons outside the United States are afflicted with CPI.

Data from preclinical and clinical studies conducted to date have indicated
that Glylorin inhibits the scaling, as well as itching and other symptoms of
ichthyosis. It is a single medication with apparent multiple mechanisms of
action having the potential to:

- reverse skin barrier disruption and scaling by replenishing key barrier
membrane lipids;

- inhibit functioning of the white blood cells which invade the skin,
causing inflammation;

- kill a wide spectrum of bacteria, yeasts and fungi that are present in
scaling skin; and

- relieve itching and burning by reforming the barrier over exposed nerves.

In three Company-sponsored double-blind Phase II clinical studies on a
total of 27 patients, Glylorin appeared to effectively treat the two types of
CPI studied, n-CIE and neutral lipid storage disease. The studies showed that
Glylorin reduced the debilitating symptoms of the disease, including scaling,
induration

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<PAGE> 29

(swelling) and erythema (redness) to a significantly greater degree than the
placebo. In the Phase II dose ranging study, which was conducted at University
of California, San Francisco and Yale University, different formulation
concentrations of Glylorin were tested twice daily over a six week period to
defined localized areas. Results with 15% Glylorin produced statistically
significant improvement in scaling (p=0.016), induration (p=0.006) and erythema
(p=0.047).

In January 1996, the Company commenced a double-blind, placebo controlled
Phase III clinical trial to evaluate the effectiveness of Glylorin in n-CIE,
which is one of the most severe forms of CPI. The study is being conducted at 23
clinical sites in the United States. The study protocol includes a four week
wash out followed by a twelve week blinded application of 15% Glylorin or
placebo to the entire body. After completion of the blinded phase of the study,
there is a nine month whole body open label application of 15% Glylorin for
safety analysis. After an interim safety analysis of the first ten patients, the
FDA permitted the subsequent enrollment of pediatric patients into the study. In
June 1997, Glaxo enrolled the last of 80 patients in the study.

Glylorin (other indications)

Glaxo, the Company's corporate partner for Glylorin, intends to conduct
clinical trials for the potential commercialization of Glylorin for other
disease indications. The second disease target is ichthyosis vulgaris, a milder
form of ichthyosis, affecting approximately one million people in the United
States. The disease is characterized by severe dry skin and scaling (although
not as thick as the scaling present in CPI). Lac-Hydrin, the only currently
approved prescription product for the treatment of ichthyosis vulgaris, has
certain side effects including irritation and stinging on thinner skin areas
such as the face. In addition, the product is not indicated for pediatric use.

The third disease to be targeted is seborrheic dermatitis. This condition,
characterized by skin redness, flaking and itching, is most commonly found on
the scalp. Seborrheic dermatitis afflicts approximately seven million people in
the United States, primarily among the very young and the elderly.

PRESCRIPTION PRODUCTS USING TRANSDERMAL DRUG DELIVERY TECHNOLOGIES

Testosterone Gel (male hormone replacement therapy)

The Company's most advanced transdermal drug delivery candidate is a
transdermal testosterone gel. The product will address a condition increasingly
referred to as "male andropause" which results from an age-related decline in
the body's production of the sex hormone testosterone. Low levels of
testosterone can result in such clinical symptoms as lethargy, depression and a
decline in libido. In severely deficient cases, loss of muscle and bone mass can
occur. Approximately 5 million men in the United States, primarily in the aging
(over 40) male population group, have lower than normal levels of testosterone,
a condition known as hypogonadism.

There are a number of companies currently marketing testosterone in several
different product forms in domestic and certain international markets. Cellegy
believes that a major market opportunity exists for an improved product as the
side effects and patient inconveniences associated with the currently marketed
products has limited their use to less than 5% of potential patients. Major
current product forms include:

Orals. Oral testosterone products are inconvenient since they must be
taken three to four times per day. Prolonged use can cause liver toxicity
due to interference with hepatic enzyme activity.

Injectables. The large volume, oil-based testosterone injections that
are currently marketed can cause pain and inflammation at the injection
site. In addition, frequent doctor visits are inconvenient, and injections
can produce fluctuations in blood testosterone levels which can result in
unwanted mood and energy swings.

Transdermal Patches. Two companies have FDA-approved patch products
which have captured a large portion of the existing United States market
since their introduction in 1995. Although the patches alleviated a number
of the shortcomings of the orals and injectables, solvents used to enhance
delivery of

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<PAGE> 30

testosterone across the skin frequently cause skin irritation. In addition,
one of the patches marketed is applied to the scrotum, which has proved to
be highly inconvenient for the patient.

Cellegy is developing a patchless testosterone gel which will incorporate
the Company's CELLEDIRM technology. The gel product is expected to permit a
once-a-day application of a metered dose to a small area of the skin without the
irritation associated with current patch products. The gel is expected to be
transparent, rapid drying and non-staining. Based on preclinical studies to
date, the Company believes its proprietary transdermal gel formulation is
capable of delivering therapeutic levels of testosterone with reduced side
effects and in a more convenient dosage form compared with other currently
marketed products. The preclinical studies demonstrated transdermal testosterone
delivery into the blood stream at levels comparable to a leading patch product.

The Company plans to commence a human safety and pharmacokinetic study
using various testosterone gel formulations before the end of 1997. If the study
is successful, additional human trials are planned for 1998. The Company
believes that due to well documented toxicology and efficacy data regarding the
use of testosterone, regulatory approval of its transdermal testosterone gel may
be achieved more quickly than would normally be associated with a new chemical
entity.

Testosterone Gel (female hormone replacement therapy)

In women, the ovaries and adrenal glands continue to synthesize
testosterone after menopause, although the rate of production may diminished by
as much as 50%. Normal blood concentrations of testosterone in women range from
10 to 20 times less than that of men. Nevertheless, in both sexes, testosterone
plays a key role in building muscle or bone tissue, and the maintenance of
sexual drive.

Cellegy's testosterone gel product (for the treatment of hypogonadism) has
been designed so that the dose can be readily reduced and customized to restore
normal testosterone levels in women. The Company believes that this change may
be accomplished by reducing the amount of gel delivered via a metered dose
without a significant change in the product formulation. Thus, the Company
believes that the same formulation can be developed and tested for use in both
hypogonadism and menopause. Clinical studies for this indication are planned to
commence once the initial studies in hypogonadal males are completed. This study
will focus on the evaluation of oophorectomized women, or women with clinically
deficient testosterone levels. The study will also consider the effects on
sexual function or bone loss.

Estrogen-Testosterone Gel (female hormone replacement therapy)

Currently, there are more than 20 million postmenopausal or menopausal
women in the United States suffering from low hormone levels, which number is
expected to increase given the aging trend of the female population. The current
market size for female hormone replacement products exceeds $2 billion in sales
on a worldwide basis. These products include natural and synthetic estrogen and
progestin therapies.

Cellegy's third planned product in the area of hormone replacement therapy
will be a combination estrogentestosterone gel utilizing the Company's
proprietary PERMEATE and CELLEDIRM technologies, designed to simultaneously
restore the natural levels of both hormones in elderly or menopausal women. The
Company believes that this product will offer significant advantages over the
patches under development in terms of reduced side effects and patient
convenience. It will provide women with an easy to use, transparent alternative
for topical hormone replacement. The combination formulation is in the research
stage with clinical trials planned following development of the mono-therapy
testosterone products.

Immunosuppressive Drug (psoriasis)

Cellegy is developing a product for the treatment of psoriasis that is
expected to employ an FDA-approved immunosuppressive drug in a topical
formulation designed specifically for local delivery into psoriatic lesions.
This product will utilize the Company's proprietary PERMEATE technology to keep
the barrier of psoriatic lesions open for delivery of the therapeutic agent,
potentially leading to a final

29
<PAGE> 31

normalization of epidermis function. If successfully developed, healing will be
accomplished with minimal systemic effect and without the toxicities generally
associated with immunosuppressive drugs.

Psoriasis is a relatively common disease affecting approximately four
million individuals in the United States. This intractable condition is
characterized by inflammation and accelerated growth of the epidermis resulting
in dull red, scaly plaques distributed on the scalp, knees, elbows, hands, feet
and buttocks. The disease can be activated by infection and barrier damage. The
total annual cost to the health care system for this disease is estimated to be
greater than $3 billion. A large percentage of patients on extant therapies are
not satisfactorily relieved of psoriatic symptoms and are constantly seeking
more effective therapy.

COSMECEUTICAL PRODUCTS

Cosmeceuticals (a hybrid of the words cosmetics and pharmaceuticals) are
products that contain active ingredients which when applied to the skin will
enhance appearance. Cosmeceuticals that satisfy the legal definition of a
cosmetic under the FD&C Act, and that are not also drugs under that statute, are
not subject to the same FDA regulations as drug products. Such cosmeceuticals
may be marketed to consumers without prior approval by the FDA and without
requiring a prescription from a physician.

The anti-wrinkling segment of the cosmeceutical market in the United States
is split approximately equally among mass merchandisers, department and
specialty stores and professional groups. Sales through professional groups are
currently made predominantly by dermatologists, plastic surgeons and medical
aestheticians, who frequently see patients with specific or special skin care
needs. Dermatologists and plastic surgeons are increasingly purchasing
cosmeceutical products for resale to their patients from their own clinics to
supplement their revenue.

The total cosmeceutical market in the United States was estimated to be
approximately $2.5 billion in annual sales for 1996 and is expected to increase
to approximately $3.3 billion by the year 2000. Cellegy expects that the demand
for cosmeceutical products will continue to increase because of the aging of the
American population.

Cellegy intends to develop high performance cosmeceutical products
incorporating its CELLEDIRM technology. Based on studies conducted to date,
CELLEDIRM appears to have the ability to prevent or reduce the irritation
frequently caused by the active ingredients that are included in certain
cosmetic products. The Company intends to market its cosmeceutical products to
physicians and other professionals, including dermatologists, plastic surgeons
and medical aestheticians. Cellegy plans to demonstrate the quality and
superiority of its cosmeceutical products over competitive offerings through a
rigorous scientific and human testing program.

The following table summarizes certain information concerning Cellegy's
cosmeceutical product candidates.

Anti-irritant cream Irritated, red, itchy Formulation development CELLEDIRM
skin

Other skin care Dry and disrupted skin Formulations complete; CELLEDIRM
products............. ready for marketing
</TABLE>

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

* References in this Prospectus to "anti-wrinkling," "anti-wrinkling products"
or the "anti-wrinkling market" are intended to refer to a product category
that the Company believes is generally understood in the marketplace or to
products in that category, and are not intended to describe any claims that
the Company's cosmeceutical products act in any way other than as cosmetics as
defined under applicable laws. The term "cosmeceuticals" refers to products
that, if they satisfy the definition of a cosmetic under applicable federal
laws and if they are not also drugs under those laws, are not subject to the
same requirements as drug products. See "Risk Factors -- Possible FDA
Regulation of Cosmeceutical Products as Drugs" and "Business -- Government
Regulation."

30
<PAGE> 32

Anti-Wrinkling Products

Cellegy's high performance anti-wrinkling line will consist of six to nine
complementary products, which together will constitute a complete system. The
system is expected to include facial creams and lotions, eye creams, a cleanser
and a moisturizer. The Company anticipates that subsequent line extensions will
be designed for specific ages, skin sites and skin types.

Signs of aging and photoaging usually become visible when people reach
their early thirties, with fine wrinkling, loss of suppleness and elasticity of
the skin becoming apparent. In subsequent decades, there is further
deterioration marked by coarse wrinkles, irregular increased pigmentation, and
thinning and fragility of the skin. Many of the skin changes associated with
aging are due to ultraviolet light exposure, referred to as "photoaging." At the
retail level, the non-prescription market for products which are used to
mitigate the effects of aging and photodamage upon the skin is estimated to be
in excess of $1 billion in annual sales in the United States and growing at
approximately 14% per year.

The current high performance cosmeceutical anti-wrinkling market in the
United States consists of four broad categories of products:

Retinoids are derived from vitamin A and related compounds and include
both prescription and cosmeceutical products. Retinoids increase the rate
of cell turnover and thereby reduce the appearance of wrinkles.

Alpha Hydroxy Acids ("AHAs") are a class of compounds which have been
used by professionals for years in chemical peels and were introduced at
the consumer level in lower concentrations in the early 1990s. AHAs promote
exfoliation and thereby reduce the appearance of wrinkles. Glycolic Acid is
the most widely used of the AHAs.

Beta Hydroxy Acids were recently introduced, with salicylic acid being
the first such compound. As with the AHAs, beta hydroxy acids promote
exfoliation and thereby reduce the appearance of wrinkles.

Anti-Oxidants such as Vitamin C and E (and their derivatives) applied
directly to the skin are believed to mitigate the effects of oxidative
stress, or damage caused by ultraviolet light exposure, ozone and other
damaging environmental factors.

Many of the currently marketed cosmeceutical products contain low
concentrations of one or more of the above active ingredients, and, to the
Company's knowledge, their efficacy has not generally been supported by clinical
studies. Low concentrations of the active ingredients are employed in order to
avoid side effects which can include stinging, redness and skin irritation, and
which generally increase with the concentration of active ingredient used.
However, the low concentrations of the active ingredient generally limit the
efficacy of the products.

Cellegy's high performance anti-wrinkling products incorporate CELLEDIRM,
together with an active ingredient having multi-action capability exhibiting
many of the attributes of the cosmeceutical products in the categories listed
above. Human studies planned for next year will provide comparative data versus
certain leading cosmeceutical products. If successfully developed, the Company
believes the product line could be available for launch during 1998. Cellegy
will focus its marketing efforts on the professional market segment,
capitalizing on the Company's research and human studies and its expertise in
skin biology.

Anti-Irritant Cream

Non-specific skin conditions, including various forms of dry, irritated,
itchy skin, have a significant economic impact. Dermatologists as a group rely
heavily on topical products. Cellegy's anti-irritant cream will be designed to
restore and soothe irritated, itchy skin. This product will incorporate natural
substances from the Company's CELLEDIRM technology with a proven use and safety
record. The product will be made

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<PAGE> 33

available to dermatologists as a high performance cosmeceutical alternative to
skin care products or lotions which are frequently used by these physicians to
restore irritated and itchy skin.

Other Skin Care Products

The Company has completed development of certain other consumer skin care
products, including moisturizers and body creams and is continuing to develop
formulations in other related skin care consumer product categories. These
products utilize certain of the Company's proprietary formulations. These
formulations were tested for their moisturizing properties in humans compared
with a leading commercial product. Results showed that the Cellegy formulations
had more than a 50% higher moisturization effect on untreated skin 12 hours
after application than the leading product tested. The Company expects to sell
these products to consumer products companies who will market them under their
own brand names through traditional, non-physician channels.

LICENSE AGREEMENTS

Glaxo. In November 1996, the Company entered into an agreement with Glaxo
for licensing rights to Glylorin, Cellegy's lipid compound for the treatment of
ichthyosis. Under the terms of the agreement, Cellegy provided Glaxo with an
exclusive license of patent rights and know-how covering Glylorin in most of the
world's major markets. In exchange for this license, Cellegy received from Glaxo
an initial license fee payment and could potentially receive future milestone
payments (upon achievement of the specified milestones) totaling, including the
initial payment, over $8.0 million, as well as a royalty on net sales assuming
successful completion of product development and market launch. There can be no
assurances, however, that the Company will receive any additional payments from
Glaxo. The agreement provides that Glaxo will assume responsibility for and the
associated costs of all future development and commercialization, including
certain development costs incurred prior to the date of the agreement. Through
September 30, 1997, the Company had recognized total revenues of approximately
$1.0 million relating to licensing fees and development funding under the
agreement.

University of California. In October 1993, the Company entered into a
license agreement with the University of California (the "Licensor") providing
for an exclusive, worldwide, royalty bearing license, subject to customary
government rights, for patent rights relating to barrier repair formulations
jointly held by the Licensor and the Company, in consideration of the issuance
to the Licensor of certain shares of preferred stock (which subsequently
converted into shares of Common Stock) and the payment by the Company of a
licensing fee. In March 1994, the Company entered into a second exclusive,
worldwide, royalty bearing license agreement with the Licensor for patent
rights, jointly held by the Licensor and Cellegy, relating to drug delivery
technologies, in consideration of the payment by the Company of a licensing fee,
and an annual maintenance fee payable each year until the Company is
commercially selling a licensed product. Both agreements require the Company to
pay the Licensor royalties based on net sales of consumer and prescription
products (with minimum annual royalty payment). The Company has the right to
grant sublicenses to third parties under both agreements. In May and October
1997, the Licensor and the Company amended these agreements. The amendments,
among other things, modified and extended certain development and
commercialization milestones contained in the original agreements. The revised
milestones are tied to the achievement of certain clinical, regulatory or
product commercialization goals over the next several years. Although there can
be no assurance that such goals will be achieved, the Company believes its
development programs in place will result in the satisfaction of such
milestones.

Neutrogena. In April 1992, the Company entered into the License Option
Agreement (the "License Option Agreement"), the Azelaic Acid OTC License
Agreement (the "Azelaic Acid Agreement") and the Metabolic Moisturizer OTC
License Agreement (the "Metabolic Moisturizer Agreement"), with Neutrogena. The
Azelaic Acid Agreement was terminated and replaced by the Patent License
Agreement effective June 1, 1994 (the "Patent License Agreement"). Pursuant to
the Patent License Agreement, Neutrogena paid the Company $1.0 million for an
exclusive, royalty-free license for certain azelaic acid uses for both
prescription and consumer products in most major markets of the world. In July
1997, Neutrogena and the Company terminated the Metabolic Moisturizer Agreement
and the License Option Agreement (except as it related to azelaic acid), and the
metabolic moisturizer technology that had been licensed to Neutrogena was
returned to the Company. The Company agreed to continue prosecution of patents
related to

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<PAGE> 34

azelaic acid on behalf of Neutrogena and will be reimbursed by Neutrogena for
legal costs, up to a certain limit.

PATENTS AND TRADE SECRETS

The Company's success depends, in part, on its ability to obtain patent
protection for its products and methods, both in the United States and in other
countries. The patent position of companies engaged in businesses such as the
Company's business generally is uncertain and involves complex legal and factual
questions. There is a substantial backlog of patent applications at the USPTO.
Patents in the United States are issued to the party that is first to invent the
claimed invention. Since patent applications in the United States are maintained
in secrecy until patents issue, the Company cannot be certain that it was the
first inventor of the invention covered by its pending patent applications or
patents or that it was the first to file patent applications for such
inventions. Further, issued patents can later be held invalid by the patent
office issuing the patent or by a court. There can be no assurance that any
patent applications relating to the Company's products or methods will issue as
patents, or, if issued, that the patents will not be challenged, invalidated, or
circumvented or that the rights granted thereunder will provide a competitive
advantage to the Company. In addition, many other entities are engaged in
research and product development efforts in drug delivery, skin biology and
cosmeceutical fields that may overlap with the Company's currently anticipated
and future products. A substantial number of patents have been issued to such
companies, and such companies may have filed applications for, or may have been
issued patents or may obtain additional patents and proprietary rights relating
to, products or processes competitive with those of the Company. Such entities
may currently have, or may obtain in the future, legally blocking proprietary
rights, including patent rights, in one or more products or methods under
development or consideration by the Company. These rights may prevent the
Company from commercializing technology, or may require the Company to obtain a
license from the entity to practice the technology. There can be no assurance
that the Company will be able to obtain any such licenses that may be required
on commercially reasonable terms, if at all, or that the patents underlying any
such licenses will be valid or enforceable. Moreover, the laws of certain
foreign countries do not protect intellectual property rights relating to United
States patents as extensively as those rights are protected in the United
States. The issuance of a patent in one country does not assure the issuance of
a patent with similar claims in another country, and claim interpretation and
infringement laws vary among countries, so the extent of any patent protection
is uncertain and may vary in different countries. As with other companies in the
pharmaceutical industry, the Company is subject to the risk that persons located
in such countries will engage in development, marketing or sales activities of
products that would infringe the Company's patent rights if such activities were
in the United States.

Several of the Company's products are based on existing compounds with a
history of use in humans but which are being developed by the Company for new
therapeutic use in skin diseases unrelated to the systemic diseases for which
the compounds were previously approved. The Company cannot obtain composition
patent claims on the compound itself, and will instead need to rely on patent
claims, if any, directed to use of the compound to treat certain conditions or
to specific formulations. The Company will not be able to prevent a competitor
from using that formulation or compound for a different purpose. No assurance
can be given that any additional patents will be issued to the Company, that the
protection of any patents that may be issued in the future will be significant,
or that current or future patents will be held valid if subsequently challenged.

The agreements with the University of California pursuant to which the
Company has exclusive license rights to certain barrier repair and drug delivery
and other technology contain certain development and performance milestones
which the Company must satisfy in order to retain such rights. While the Company
currently believes it will be able to satisfy the revised milestone dates, a
loss of rights to these technologies could have a material adverse effect on the
Company.

The Company has 10 issued and one allowed United States patents, many
issued foreign patents and pending patent applications for the use of certain
compounds to treat common or severe inflammatory dermatologic diseases including
dermatitis, psoriasis, rosacea and acne, as well as disorders such as various
ichthyoses, signs and symptoms of skin aging and premalignant actinic keratoses.
Three issued United States patents and more than 20 patent applications relate
to the Company's Glylorin product for the treatment of ichthyosis and certain
other skin diseases and conditions. One allowed United States patent and more
than 10

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<PAGE> 35

patent applications relate to the drug delivery technology licensed from the
University of California, and one issued United States patent and at least 10
patent applications relate to the barrier repair technology licensed from the
University of California. Additional patent applications are being prepared for
filing that will cover methods or products currently under development.
Corresponding patent applications for most of the Company's issued United States
patents have been filed in countries of importance to the Company located in
major world markets, including certain countries in Europe, Australia, South
Korea, Japan, Mexico and Canada.

Federal patent law provides that for any inventions that have been
developed with government funding that are the subject of a license, the
government has the right to require the assignor or the licensee to grant a
license to third parties upon the occurrence of certain events, such as if the
government determines that no effective steps have been taken to achieve
practical application of the invention, or if health or safety needs or
requirements for public use are not reasonably satisfied.

The Company's policy is to protect its technology by, among other things,
filing patent applications for technology that it considers important to the
development of its business. The Company intends to file additional patent
applications, when appropriate, relating to its technology, improvements to its
technology and to specific products that it develops. It is impossible to
anticipate the breadth or degree of protection that any such patents will
afford, or whether the Company can meaningfully protect its rights to its
unpatented trade secrets. The Company also relies upon unpatented trade secrets
and know-how, and no assurance can be given that others will not independently
develop substantially equivalent proprietary information and techniques, or
otherwise gain access to the Company's trade secrets or disclose such
technology, or that the Company can meaningfully protect its rights to its
unpatented trade secrets. It is the Company's policy to require its employees to
execute an invention assignment and confidentiality agreement upon employment.
Cellegy's consultants are required to execute a confidentiality agreement upon
the commencement of their consultancy to the Company. Each agreement provides
that all confidential information developed or made known to the employee or
consultant during the course of employment or consultancy will be kept
confidential and not disclosed to third parties except in specific
circumstances. The invention assignment generally provides that all inventions
conceived by the employee shall be the exclusive property of the Company. In
addition, it is the Company's policy to require the collaborators and potential
collaborators to enter into confidentiality agreements. There can be no
assurance, however, that these agreements will provide meaningful protection for
the Company's trade secrets.

GOVERNMENT REGULATION

FDA Requirements for Human Drugs. The research, testing, manufacturing,
labeling, distribution, and marketing of drug products are extensively regulated
by numerous governmental authorities in the United States and other countries.
In the United States, drugs are subject to rigorous FDA regulation. The FD&C Act
and the regulations promulgated thereunder, and other federal and state
regulations govern, among other things, the research, development, testing,
manufacture, distribution, storage, record keeping, labeling, advertising,
promotion and marketing of pharmaceutical products. The process of developing
and obtaining approval for a new pharmaceutical product within this regulatory
framework requires a number of years and the expenditure of substantial
resources. There can be no assurance that necessary approvals will be obtained
on a timely basis, if at all. Moreover, additional government regulations may be
established that could prevent or delay regulatory approval of the Company's
products. Delays in obtaining regulatory approvals could have a material adverse
effect on the Company. If the Company fails to comply with applicable regulatory
requirements for marketing drugs, or if the Company's cosmeceutical products are
deemed to be drugs by the FDA, the Company could be subject to administrative or
judicially imposed sanctions such as warning letters, fines, products recalls or
seizures, injunctions against production, distribution, sales, or marketing,
delays in obtaining marketing authorizations or the refusal of the government to
grant such approvals, suspensions and withdrawals of previously granted
approvals, civil penalties and criminal prosecution of the Company, its officers
or its employees.

The steps ordinarily required before a new pharmaceutical product may be
marketed in the United States include: (i) preclinical laboratory tests, animal
studies and formulation studies; (ii) the submission to the FDA of an
Investigational New Drug Application ("IND") , which must become effective
before clinical

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<PAGE> 36

testing may commence; (iii) adequate and well-controlled clinical trials to
establish the safety and efficacy of the product for its proposed indication;
(iv) the submission of a New Drug Application ("NDA") to the FDA; and (v) FDA
review and approval of the NDA prior to any commercial sale or shipment of the
drug. Preclinical tests include laboratory evaluation of product chemistry and
formulation, as well as animal studies to assess the potential safety and
functionality of the product. Compounds must be produced according to the FDA's
current Good Manufacturing Practice ("cGMP") requirements, and preclinical tests
must be conducted in compliance with the FDA's Good Laboratory Practice
regulations. The results of preclinical testing are submitted to the FDA as part
of an IND. A 30-day waiting period after the filing of each IND is required
prior to the commencement of clinical testing in humans. If the FDA has not
commented upon or questioned the IND within this 30-day period, clinical studies
may begin. If the FDA has comments or questions, the questions must be answered
to the satisfaction of the FDA before initial clinical testing can begin. In
addition, the FDA may, at any time, impose a clinical hold on ongoing clinical
trials. If the FDA imposes a clinical hold, clinical trials may not commence or
recommence without FDA authorization and then only under terms authorized by the
FDA. In some instances, the IND application process can result in substantial
delay and expense.

Clinical trials involve the administration of the investigational product
to healthy volunteers or patients under the supervision of a qualified
investigator. Clinical trials must be conducted in accordance with good clinical
practice ("GCP") requirements under protocols detailing the objectives of the
study, the parameters to be used in monitoring safety and the effectiveness
criteria to be evaluated. Each protocol must be submitted to the FDA as part of
the IND. Further, each clinical study must be conducted under the auspices of an
independent Institutional Review Board ("IRB") at the institution at which the
study will be conducted. The IRB will consider, among other things, ethical
issues, the safety of human subjects and the possible liability of the
institution. Clinical trials to support NDAs are typically conducted in three
sequential phases, which may overlap. In Phase I, the initial introduction of
the drug into healthy human subjects or patients, the drug generally is tested
to assess metabolism, pharmacokinetics, pharmacological action and safety,
including side effects associated with increasing doses, and if possible, to
gain early evidence on effectiveness. Phase II usually involves studies in a
limited patient population to (i) determine the efficacy of the drug for a
specific indication, (ii) determine dosage tolerance and optimal dosage and
(iii) identify possible short-term adverse effects and safety risks. If a
compound is found to be effective and to have an acceptable safety profile in
Phase II evaluations, Phase III trials are undertaken to further evaluate
clinical efficacy, usually (although not necessarily) in comparison with a
placebo or approved treatment and to further test for safety within an expanded
patient population at geographically dispersed clinical study sites. A clinical
trial may combine the elements of more than one phase, and typically two or more
Phase III studies are required. The designation of a clinical trial as being in
a particular phase is not necessarily indicative that such a trial will be
sufficient to satisfy the requirements of a particular phase. For example, no
assurance can be given that a Phase III clinical trial will be sufficient to
support an NDA without further clinical trials. There can be no assurance that
Phase I, Phase II or Phase III testing will be completed within any specific
time period, if at all, with respect to any of the Company's products subject to
such testing.

New and Abbreviated New Drug Applications. After completion of the
required clinical testing, generally an NDA is submitted. FDA approval of the
NDA (or, in the alternative, an Abbreviated New Drug Application ("ANDA"), as
described below) is required before marketing may begin in the United States.
The NDA must include the results of extensive clinical and other testing and the
compilation of data relating to the product's chemistry, pharmacology and
manufacture, the cost of all of which is substantial. The FDA reviews all NDAs
submitted before it accepts them for filing and may request additional
information rather than filing an NDA. In such an event, the NDA must be
resubmitted with the additional information and, again, is subject to review
before filing. Once the submission is accepted for filing, the FDA begins an
in-depth review of the NDA. Under the FD&C Act, the FDA has 180 days in which to
review the NDA and respond to the applicant, although in practice the process
generally takes longer. The review process is often extended significantly by
FDA requests for additional information or clarification. The FDA may refer the
application to the appropriate advisory committee, typically a panel of
clinicians, for review, evaluation and a recommendation as to whether the
application should be approved. The FDA is not bound by the recommendation of an
advisory committee. During the review process, the FDA generally will conduct an
inspection of the relevant

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<PAGE> 37

drug manufacturing facilities and clinical sites to ensure that the facilities
are in compliance with applicable cGMP and GCP requirements. If FDA evaluations
of the NDA application, manufacturing facilities, and clinical sites are
favorable, the FDA may issue either an approval letter or an approvable letter,
which contains a number of conditions that must be met in order to secure
approval of the NDA. When and if those conditions have been met to the FDA's
satisfaction, the FDA will issue an approval letter, authorizing commercial
marketing of the drug for certain specific indications. If the FDA's evaluation
of the NDA submission or manufacturing facilities is not favorable, the FDA may
refuse to approve the NDA or issue a not approvable letter, outlining the
deficiencies in the submission and often requiring additional testing or
information. Notwithstanding the submission of any requested additional data or
information in response to an approvable or not approvable letter, the FDA
ultimately may decide that the application does not satisfy the regulatory
criteria for approval. Even if FDA approval is obtained, a marketed drug product
and its manufacturer are subject to continual review and inspection, and later
discovery of previously unknown problems with the product or manufacturer may
result in restrictions or sanctions on such product or manufacturer, including
withdrawal of the product from the market, and other enforcement actions. The
FDA may also require postmarketing testing and surveillance programs to
continuously monitor the drug's usage and effects. Side effects resulting from
the use of drug products may prevent or limit the further marketing of products.

Certain of the Company's mid and late term products utilize its drug
delivery technology formulated with an active ingredient that is included in a
drug product that is already the subject of an NDA approved by the FDA. In
connection with obtaining FDA approval of such Company products which require an
NDA, it is possible in certain instances that clinical and preclinical testing
requirements may not be as extensive. Limited additional data about the safety
or effectiveness of the proposed new drug formulation, along with chemistry and
manufacturing information and public information about the active ingredient,
may be satisfactory for product approval. Consequently, the new product
formulation may receive marketing approval more rapidly than a traditional full
NDA, although there can be no assurance that a product will be granted such
treatment by the FDA.

Once patent and other statutory protections covering a drug approved under
an NDA have expired or have been demonstrated not to apply, a generic equivalent
to that drug may be approved under an ANDA. An ANDA is ordinarily based upon
bioequivalence data that demonstrate that the rate and extent of absorption of
the active drug ingredient of the generic drug, usually measured in the blood
stream, is equivalent to that of the drug approved under an NDA. The
demonstration of bioequivalence and, therefore, ANDA approval, generally
requires less time than safety and efficacy studies and NDA approval.

Until an NDA or ANDA is actually approved, there can be no assurance that
the information requested and submitted will be considered adequate by the FDA
to justify approval. It is impossible to anticipate the amount of time that will
be required to obtain approval from the FDA to market any product.

Orphan Drug Designation. Under the Orphan Drug Act, the FDA may grant
orphan drug designation to drugs intended to treat a "rare disease or
condition," which generally is a disease or condition that affects populations
of fewer than 200,000 individuals in the United States. Orphan drug designation
must be requested before submitting an NDA. After the FDA grants orphan drug
designation, the generic identity of the therapeutic agent and its potential
orphan use are publicized by the FDA. Under current law, orphan drug designation
confers upon the first company to receive FDA approval to market such designated
drug United States marketing exclusivity for the designated drug and indication
for a period of seven years following approval of the NDA, subject to certain
limitations.

Orphan drug designation does not convey any advantage in, or shorten the
duration of, the regulatory approval process. Although obtaining FDA approval to
market a product with an orphan drug designation can be advantageous, there can
be no assurance that the scope of protection or the seven years of market
exclusivity that is currently afforded by orphan drug designation and marketing
approval will remain in effect in the future.

Possible Regulation of Cosmeceutical Products as Drugs. "Cosmeceuticals"
are not defined in the FD&C Act. The FDA has not defined the term by regulation
and may consider use of the term to imply drug-like qualities. The FDA will
regulate a particular cosmeceutical product as a drug or a cosmetic (or both a

36
<PAGE> 38

drug and a cosmetic) depending primarily upon the manufacturer's intended use
for such product. Such intent may be determined from labeling, advertising,
promotional and marketing materials, and any other source attributable to the
manufacturer or its employees, representatives or agents. Under the FD&C Act,
drugs are articles intended for use in the diagnosis, cure, mitigation,
treatment or prevention of disease or to affect the structure or function of the
body. By comparison, cosmetic products are defined as articles intended to be
rubbed, poured, sprinkled or sprayed on, introduced into or otherwise applied to
the body for cleansing, beautifying, promoting attractiveness or altering its
appearance. Some products, however, may satisfy the definition of a drug and a
cosmetic, and the FDA has generally regulated as drugs products that are
intended to have a physiological effect on the body, for example, to alter the
skin in more than a temporary way. Unlike drugs, products that constitute
cosmetics (but not drugs as well) under the FD&C Act do not require premarket
review or approval of the FDA, but cosmetics must be safe under normal
conditions of use, and comply with FDA labeling and manufacturing requirements.
Furthermore, the Federal Trade Commission ("FTC"), as well as state and local
authorities, oversees the advertising of cosmetic products and prohibits false,
misleading, deceptive or unsubstantiated advertising. The FTC has the authority
to seek a number of remedies against a company that it believes fails to comply
with its requirements, including, but not limited to, preliminary injunctive
relief.

The Company plans to label, market, promote, advertise and distribute its
cosmeceutical products with claims intended to be within the statutory
definition of cosmetic. There can be no assurance, however, that the FDA will
not determine that some or all of the Company's cosmeceutical products are
drugs, and are therefore subject to more stringent regulatory oversight,
including premarket approval, based on their intended use or ingredients.

The FDA has at times in the past contended, and may in the future contend,
that one or more cosmeceutical products, including the Company's or competitors'
anti-wrinkling products that are currently marketed or may in the future be
marketed, are not cosmetics but instead are subject to regulation as drugs. Even
if the FDA were not ultimately to prevail with regard to such a contention, such
a claim by the FDA could have a material adverse effect on the Company's ability
to market its proposed cosmeceutical products and could significantly delay or
prohibit marketing of such products. The extent to which different kinds of
current or future cosmeceutical products of the Company or its competitors are
subject to FDA regulation as drugs, and the extent to which the FDA will seek to
become more active in regulating cosmeceutical products, such as products that
compete in the anti-wrinkling market, is uncertain, but will depend in part on
the claims made for the cosmeceuticals by their manufacturers and marketers. See
"Business -- Government Regulation." The inability of the Company to market its
proposed cosmeceutical products as cosmetics without prior FDA approval could
have a material adverse effect on the Company's business and financial
condition.

OTC Monograph. Most over the counter ("OTC") drug products marketed in the
United States are not subjected to the FD&C Act's premarket approval
requirements. In 1972, the FDA instituted the ongoing OTC Drug Review to
evaluate the safety and effectiveness of OTC drugs then on the market. Through
this process, the FDA issues monographs that set forth the specific active
ingredients, dosages, indications and labeling statements for OTC drugs that the
FDA will consider generally recognized as safe and effective and therefore not
subject to premarket approval. For certain categories of OTC drugs not yet
subject to a final monograph, the FDA usually will not take regulatory action
against such a product unless failure to do so poses a potential health hazard
to consumers. OTC drugs not covered by pending or final OTC monographs, however,
are subject to premarket review and approval by the FDA through the NDA/ANDA
mechanism. Even if the Company seeks FDA approval of a product for OTC consumer
sales, the FDA could instead require that the product be distributed by
prescription only. Such a requirement could delay for several years, or
indefinitely, distribution of the Company's products directly to consumers.

Manufacturing. Each domestic drug manufacturing facility must be
registered with the FDA. Domestic drug and, to a lesser extent, cosmetic
manufacturing establishments are subject to routine inspection by the FDA and
other regulatory authorities and must comply with cGMP requirements (albeit less
extensive ones for cosmetics than for drugs). Drug manufacturing facilities
located in California must be licensed by the State of California in compliance
with local regulatory requirements. The Company intends to use contract
manufacturers that operate in conformance with these requirements to produce its
compounds and finished

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<PAGE> 39

products in commercial quantities. There can be no assurance that manufacturing
or quality control problems will not arise at the manufacturing plants of the
Company's contract manufacturers or that such manufacturers will be able to
maintain the compliance with the FDA's cGMP requirements necessary to continue
manufacturing the Company's products.

Foreign Regulation of Drugs. Whether or not FDA approval has been
obtained, approval of a product by comparable regulatory authorities may be
necessary in foreign countries before the commencement of marketing of the
product in such countries. The approval procedure varies among countries, can
involve additional testing, and the time required may differ from that required
for FDA approval. Although there are some procedures for unified filings for
certain European countries, in general each country has its own procedures and
requirements, many of which are time consuming and expensive. Thus, there can be
substantial delays in obtaining required approvals from both the FDA and foreign
regulatory authorities after the relevant applications are filed. The Company
expects to rely principally on corporate partners, licensees and contract
research organizations, along with Company expertise, to obtain foreign
governmental approval in foreign countries of drug formulations utilizing its
compounds.

Other Government Regulation. In addition to regulations enforced by the
FDA, the Company also is subject to regulation under the Occupational Safety and
Health Act, the Environmental Protection Act, the Toxic Substances Control Act,
the Resource Conservation and Recovery Act and other similar federal and state
laws regarding, among other things, occupational safety, the use and handling of
radioisotopes, environmental protection and hazardous substance control. In
connection with its research and development activities and any manufacturing of
clinical trial materials in which the Company may engage, the Company is subject
to 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. Although the Company
believes that it has complied with these laws and regulations in all material
respects and has not been required to take any action to correct any
noncompliance, there can be no assurance that the Company will not be required
to incur significant costs to comply with environmental and health and safety
regulations in the future. The Company's research and development involves the
controlled use of hazardous materials, chemicals, and various radioactive
compounds. Although the Company believes that its safety procedures for handling
and disposing of such materials comply with the standards prescribed by state
and federal regulations, the risk of accidental contamination or injury from
these materials cannot be completely eliminated. In the event of such an
accident, the Company could be held liable for any damages that result and any
such liability could exceed the resources of the Company.

Health Care Reform. In the United States, there have been, and the Company
expects there will continue to be, a number of federal and state proposals to
implement cost controls and other health care regulatory measures. Future
legislation could result in a substantial restructuring of the health care
delivery system. Nevertheless, the Company believes that employer-driven reform
with managed care and capitation will continue even without government
intervention and may significantly affect health care delivery and costs. While
the Company cannot predict whether any legislative or regulatory proposals will
be adopted or the effect such proposals may have on its business, the
uncertainty of such proposals could have an adverse effect on the Company's
ability to raise capital and to identify and reach agreements with potential
partners, and the adoption of such proposals could have an adverse effect on the
Company. For example, such changes could have the effect of reducing the number
of independent practicing dermatologists, which might reduce the number of
prescriptions written for products such as some of the Company's potential
products. In addition, the Company believes that many high-volume purchasers and
consumers of health care are demanding changes in the pricing and delivery of
products and services. The effect of any such changes on the Company's business
are unpredictable. One of the Company's potential products, such as its drug
delivery products, might have the effect of reducing the overall cost of
delivering therapeutic compounds compared to existing delivery techniques, and
sales of such products might benefit from regulatory changes focusing on
controlling health care costs. Nevertheless, any such reform, if adopted, and
ongoing changes in the industry, could adversely affect the pricing of
therapeutic products in the United States or the amount of reimbursement
available from governmental agencies or third-party insurers, and consequently
could have a material adverse effect upon the Company. In both domestic and
foreign markets, sales of the Company's therapeutic products, if any, will

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<PAGE> 40

depend in part on the availability of reimbursement from third-party payors,
such as government and private insurance plans and other organizations.
Third-party payors and others increasingly are challenging the prices charged
for medical products and services. There can be no assurance that the Company's
products will be considered cost effective, that reimbursement will be available
or, if available, that the payor's reimbursement policies will not adversely
affect the Company's ability to sell its products on a profitable basis. Other
aspects of the business in which the Company is engaged could also be affected.
The Company cannot predict the outcome of any government or industry reform
initiatives or the impact thereof on the Company's financial position or results
of operations.

COMPETITION

The pharmaceutical industry is subject to rapid and significant
technological change. In the development and marketing of topical prescription
drugs, cosmeceutical and skin care products, and drug delivery systems, Cellegy
faces intense competition. Competitors of the Company in the United States and
abroad are numerous and include, among others, major pharmaceutical, cosmetic,
chemical, consumer product, and biotechnology companies, specialized firms,
universities and other research institutions. There can be no assurance that the
Company's competitors will not succeed in developing technologies and products
that are more effective than any which are being developed by the Company or
that would render the Company's technology and potential products obsolete and
noncompetitive. Many of these competitors have substantially greater financial
and technical resources, production and marketing capabilities and regulatory
experience than the Company. In addition, many of the Company's competitors have
significantly greater experience than the Company in preclinical testing and
human clinical trials of pharmaceutical products and in obtaining FDA and other
regulatory approvals of products for use in health care. The Company also
competes with universities developing drug delivery technologies and with
several companies which have been formed to develop unique delivery systems. In
addition, these companies and academic and research institutions compete with
Cellegy in recruiting and retaining highly qualified scientific and management
personnel.

Competition in the markets in which the Company expects to compete is
generally based on performance characteristics and, to a lesser extent, price.
There can be no assurance that the Company's products under development will be
able to compete successfully with existing or new commercial products.

EMPLOYEES

As of October 10, 1997, the Company had 13 full-time and three part-time
employees. Eleven of these employees, of whom three are M.D.s and another three
are Ph.D.s, are engaged in research and development. In addition, the Company
utilizes the services of several professional consultants, as well as contract
manufacturing and research organizations to supplement its internal staff's
activities. None of the Company's employees is represented by a labor union. The
Company has experienced no work stoppages and believes that its employee
relations are good.

PROPERTIES

The Company occupies approximately 4,300 square feet at its executive
offices in Foster City, California, located near San Francisco, California. The
Company's lease has a term expiring July 31, 2001. The Company also occupies
approximately 5,600 square feet of research and laboratory facilities in San
Carlos, California under a lease with a term expiring May 31, 1998. The Company
may extend the term for up to a six month period. The Company believes its
current facilities will be adequate for at least the next year, although if
acceptable space becomes available, the Company may attempt to consolidate its
laboratory and administrative operations into a single location.

LEGAL PROCEEDINGS

The Company is not a party to any legal proceedings.

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<PAGE> 41

MANAGEMENT

The executive officers, directors, and other significant employees of the
Company are as follows:

<TABLE>
<CAPTION>
NAME AGE POSITION
- ----------------------------- --- ---------------------------------------------------
<S> <C> <C>
K. Michael Forrest 54 President, Chief Executive Officer, and Director
Carl R. Thornfeldt, M.D. 45 Medical Director and Chairman of the Board
Daniel L. Azarnoff, M.D. 71 Vice President, Clinical and Regulatory Affairs
Michael L. Francoeur, Ph.D. 46 Vice President, Research and Development
A. Richard Juelis 49 Vice President, Finance and Chief Financial Officer
Vivien H.W. Mak, Ph.D. 40 Vice President, Cutaneous Research
Jack L. Bowman(1) 65 Director
Denis R. Burger, Ph.D.(2) 54 Director
Tobi B. Klar, M.D. 42 Director
Alan A. Steigrod(1) 60 Director
Larry J. Wells(2) 54 Director
</TABLE>

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

(1) Member of the Compensation Committee.
(2) Member of the Audit Committee.

K. Michael Forrest. Mr. Forrest became President, CEO, and a director in
December 1996. From January 1996 to November 1996, he served as a biotechnology
consultant. From November 1994 to December 1995, he served as President and CEO
of Mercator Genetics, a public biotechnology company. From March 1991 to June
1994, he served as President and CEO of Transkaryotic Therapies, Inc., a public
biotechnology company. From 1968 to 1991, Mr. Forrest held a series of positions
with Pfizer, Inc. and senior management positions with American Cyanamid,
including Vice President of the Lederle International Group. He is a director of
AlphaGene Inc.

Carl R. Thornfeldt, M.D. Dr. Thornfeldt is the Chairman of the Board of
Directors and a co-founder of the Company, as well as a physician, board
certified in dermatology. He has been Medical Director of the Company since its
inception. Dr. Thornfeldt served as acting CEO from July 1996 to December 1996.
In addition, Dr. Thornfeldt served as Vice President, Research and Development
from October 1994 until May 1996. Since 1983, Dr. Thornfeldt has maintained a
private dermatology practice and is an Assistant Clinical Professor in
Dermatology at the University of Oregon Health Sciences Center. Dr. Thornfeldt
received his M.D. from the University of Oregon.

Daniel L. Azarnoff, M.D. Dr. Azarnoff became Vice President, Clinical and
Regulatory Affairs in October 1997. Since January 1986, Dr. Azarnoff has been
President of D.L. Azarnoff Associates and will continue consulting to the
industry on a part-time basis. From August 1978 to December 1985, he served as
President of Research and Development at G.D. Searle and Co. From July 1967 to
August 1978, he was KUMC Distinguished Professor of Medicine and Pharmacology,
as well as the Director of the Clinical Pharmacology-Toxicology Center at the
University of Kansas Medical Center. Dr. Azarnoff has also served as a member of
advisory and expert committees within the Food and Drug Administration, World
Health Organization, American Medical Association, National Academy of Sciences
and National Institutes of Health. He received his M.D. from the University of
Kansas Medical School.

Michael L. Francoeur, Ph.D. Dr. Francoeur became Vice President, Research
and Development in June 1996. From March 1994 to May 1996, he was founder,
Chairman and Chief Technical Officer of De Novo, Inc., a dermal therapeutics
company. From September 1992 to March 1994, Dr. Francoeur held senior executive
positions with Pharmetrix, Inc., a drug delivery company, where he led research
and development. From February 1983 to August 1992, he was employed by Pfizer,
Inc., where he held various research and management positions in product
development, drug delivery, and drug discovery. Dr. Francoeur holds a Ph.D. in
pharmaceutical chemistry and a B.S. in pharmacy from the University of Kansas.

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<PAGE> 42

A. Richard Juelis. Mr. Juelis became Vice President, Finance and Chief
Financial Officer in March 1996. From November 1994 until March 1996, he worked
as a financial consultant to the Company, as well as to other companies. From
January 1993 to September 1994 he served as Vice President, Finance and Chief
Financial Officer for VIVUS, Inc., a publicly traded drug delivery company. From
October 1990 to December 1992, he served as Vice President, Finance and Chief
Financial Officer at XOMA Corporation, a public biotechnology company. Mr.
Juelis has also held domestic and international financial and general management
positions with Hoffmann-LaRoche from 1976 to 1982, and Schering-Plough from 1983
to 1990.

Vivien H.W. Mak, Ph.D. Dr. Mak became Vice President, Cutaneous Research
in January 1996, after joining the Company as a research consultant in October
1995. From January 1994 to September 1995, she served as Vice President,
Research for De Novo, Inc. From October 1992 to December 1993, she was Director
of Biopharmaceutical Sciences at Pharmetrix Corporation, a developer of drug
delivery systems. From January 1989 to September 1992 she held research
scientist positions in the Dermal Therapeutics Group of Pfizer, Inc. Dr. Mak
holds a Ph.D. in medicinal chemistry from Purdue University.

Jack L. Bowman. Mr. Bowman became a director in December 1996. He is
currently a consultant to various pharmaceutical and biotechnology industry
groups. From August 1987 to January 1994, he was Group Chairman at Johnson &
Johnson, where he managed its global pharmaceutical business. Before then, Mr.
Bowman held executive positions with CIBA-Geigy and American Cyanamid, where he
had responsibility for worldwide pharmaceutical, medical device, and consumer
product divisions. He is currently a director of NeoRx Corp., CytRx Corp., Cell
Therapeutics, Inc., Targeted Genetics, Inc. and Osiris Pharmaceuticals, Inc.

Denis R. Burger, Ph.D. Dr. Burger became a director in October 1995.
Currently, he serves as Chief Executive Officer of AntiVirals Inc., a
biotechnology company, and is a general partner of Sovereign Partners LLC, a
biotechnology consulting and merchant banking partnership. He is a director of
SuperGen, Inc. and Trinity Biotech, plc. He was a co-founder of Epitope, Inc.
and served as Chairman from 1981 to 1990. Dr. Burger has also served as a
research scientist and professor of microbiology and immunology at the Oregon
Health Sciences University. He holds an M.S. and Ph.D. degrees in microbiology
and immunology.

Tobi B. Klar, M.D. Dr. Klar became a director of the Company in June 1995.
She is a physician, board certified in dermatology. Since 1986, Dr. Klar has
maintained a private dermatology practice and has served as Co-Chairperson of
the Department of Dermatology at New Rochelle Hospital Medical Center, New
Rochelle, New York, and Associate Clinical Professor in dermatology at Albert
Einstein Medical Center in New York City. Dr. Klar holds an M.D. from the State
University of New York.

Alan A. Steigrod. Mr. Steigrod became a director in July 1996, and has
been a biotechnology industry consultant since December 1995. From March 1993 to
November 1995, he served as President and CEO of Cortex Pharmaceuticals, Inc.
From February 1991 to February 1993, he worked as a biotechnology consultant.
From March 1981 through February 1991, Mr. Steigrod held a series of executive
positions with Glaxo, Inc., serving as Chairman of Glaxo's operating committee,
as well as on its board of directors. As Executive Vice President, he managed
five divisions, including Glaxo Pharmaceuticals and Glaxo Dermatology Products.
Prior to Glaxo, Mr. Steigrod held a number of senior management positions with
Boehringer Ingelheim, Ltd. and Eli Lilly & Co. He is a director of Sepracor Inc.

Larry J. Wells. Mr. Wells became a director of the Company in 1989. For
the past five years, he has been a venture capitalist. He is the founder of
Sundance Venture Partners, L.P. ("Sundance"), a venture capital fund, and is the
Chairman of the managing entity of Sundance. Mr. Wells is a director of Identix,
Inc., Gateway Data Sciences and Telegen Corp.

Directors hold office until the next annual meeting of shareholders and
until their respective successors have been elected and qualified. Executive
officers are chosen by and serve at the discretion of the Board of Directors,
subject to any written employment agreements with the Company.

Standing committees of the Board include an Audit Committee and a
Compensation Committee. Dr. Burger and Mr. Wells are the current members of the
Audit Committee. The Audit Committee reviews the Company's accounting practices,
internal control systems and meets with the Company's outside auditors

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<PAGE> 43

concerning the scope and terms of their engagement and the results of their
audits. Messrs. Bowman and Steigrod are the current members of the Compensation
Committee. The Compensation Committee recommends compensation for officers and
employees of the Company, and grants options and stock awards under the
Company's employee benefit plans.

SCIENTIFIC ADVISORY BOARD

The Company has established relationships with a group of scientific
advisors with expertise in the fields of dermatology, drug delivery and skin
care. The Company's scientific advisors consult with management and key
scientific employees of the Company to assist the Company in identifying
scientific and product development opportunities, to review the progress of the
Company's specific projects, and to recruit and evaluate the Company's
scientific staff. The nature, scope and frequency of consultations between the
Company and each scientific advisor vary depending upon the Company's current
activities, the need for specific assistance and the individual scientific
advisor.

The Company's scientific advisors and consultants include:

Carl R. Thornfeldt, M.D. Dr. Thornfeldt is Co-Chairman of the Scientific
Advisory Board. See "Executive Officers and Directors."

Peter M. Elias, M.D. Dr. Elias is Co-Chairman of the Scientific Advisory
Board. Dr. Elias is a board certified dermatologist and served as a director of
the Company from April 1995 until October 1997. He is an expert in the stratum
corneum barrier, as well as epidermal structure, function and lipid metabolism.
Dr. Elias is currently the Vice-Chairman, Department of Dermatology, University
of California, San Francisco. He received his M.D. from University of
California, San Francisco, and performed his dermatology residency at Harvard
University Medical Center.

Bruce A. Beutler, M.D. Dr. Beutler is a Professor of Internal Medicine and
an Associate Investigator at the Howard Hughes Medical Institute at the
University of Texas Southwestern Medical Center in Dallas. He is best known for
his work related to tumor necrosis factor alpha (TNF) which he originally
isolated and demonstrated to be an essential mediator in shock and other
inflammatory diseases. Dr. Beutler has published numerous articles related to
these subjects, and has lectured extensively on TNF and the role of cytokines in
inflammation. He is an elected member of the American Society for Clinical
Research and the American Society for Hematology. He is also a member of the New
York Academy of Sciences and the American Federation for Clinical Research. He
has received numerous awards and honors including the Young Investigator Award
(American Society for Clinical Research) and the Alexander von Humboldt -
Stiftung Award. Dr. Beutler is also a Consulting and Advisory Editor for the
Journal of Experimental Medicine and the Journal of Clinical Investigation.

Kenneth R. Feingold, M.D. Dr. Feingold is a physician at the VAMC, San
Francisco and is also a professor of Medicine and Dermatology at the University
of California, San Francisco, School of Medicine. Dr. Feingold has performed
extensive research in metabolism, endocrinology and dermatology.

Richard H. Guy, Ph.D. Dr. Guy is the Directeur Scientifique of the Centre
Interuniversitaire de Recherche et d'enseignement (Pharmapeptides), and
Professeur Associe in the Faculte des Sciences at the Universite de Geneve. Dr.
Guy was formerly Professor of Biopharmaceutical Sciences and Pharmaceutical
Chemistry at the University of California, San Francisco, where he continues to
hold a position as Adjunct Professor. Dr. Guy is an elected fellow of the Royal
Society of Chemistry, the American Association of Pharmaceutical Scientists and
the American Association for the Advancement of Science, and serves on the
editorial advisory boards of Advanced Drug Delivery Reviews, the Journal of
Controlled Release, the Journal of Pharmacy & Pharmacology and the European
Journal of Pharmaceutics and Biopharmaceutics.

Kenneth L. Melmon, M.D. Dr. Melmon serves as the Professor of Medicine and
Pharmacology and Associate Dean for Postgraduate Medical Education at Stanford
University School of Medicine. He joined Stanford Medical School in 1978 where
he served as Chairman of the Department of Medicine. Dr. Melmon's work in
Clinical Pharmacology has resulted in the training of numerous fellows at the
University of California, San Francisco and Stanford University School of
Medicine. Dr. Melmon's area of research is directed at the

42
<PAGE> 44

pharmacology of the immune response, and in particular he has focused on the
molecular and cellular mechanisms by which mediators of inflammation modulate
and suppress the immune response.

Lester Mitscher, Ph.D. Dr. Mitscher is the University Distinguished
Professor, Department Medicinal Chemistry, University of Kansas, where he
previously served as Chairman. He also currently holds the positions of Adjunct
Professor of Medicinal Chemistry, University of Missouri (Kansas City) and
Adjunct Professor of Microbiology, University of Kansas. Dr. Mitscher is a
member of numerous organizations including the American Chemical Society, where
he served as Chairman of the Medical Chemistry Division, and the American
Society for Pharmacognosy, where he served as Chairman. Dr. Mitscher has
received several awards and honors, such as the Edward E. Smissman Award in the
Biomedical Sciences and is an Elected Fellow for the American Association for
the Advancement of Science. He has published or presented numerous research
papers, authored several books on drug synthesis, and holds twelve U.S. patents
and several foreign patents. His current research interests relate to the
chemistry and mechanisms of medicinals, including anti-oxidants, antibiotics and
anti-inflammatory drugs.

Jim E. Riviere, D.V.M., Ph.D. Dr. Riviere is the Burroughs Wellcome Fund
Distinguished Professor of Pharmacology and Director, Cutaneous Pharmacology and
Toxicology Center, College of Veterinary Medicine, North Carolina State
University. Dr. Riviere is a member of numerous organizations including the U.S.
Pharmacopeia General Committee of Revision, Society of Toxicology, American
Board of Forensic Examiners and the American Veterinary Medical Association. Dr.
Riviere has received the American Pharmaceutical Association's Ebert Prize, the
Harvey W. Wiley Medal and FDA Commissioner's Special Citation in 1997. He has
published or presented numerous research papers and is the holder of four U.S.
patents. His current research interests relate to pharmacokinetics, transdermal
drug delivery and pesticide dermal absorption and metabolism.

43
<PAGE> 45

EXECUTIVE COMPENSATION

The following table sets forth all compensation awarded, earned or paid for
services rendered in all capacities to the Company during fiscal years 1994,
1995 and 1996 to (i) each person who served as the Company's chief executive
officer during 1996, (ii) any other executive officers who were serving as
executive officers at the end of 1996 and whose total annual salary and bonus in
such year exceeded $100,000 and (iii) any person who was an executive officer
during a portion of 1996 whose total annual salary and bonus exceeded $100,000
(together, the "Named Officers").

SUMMARY COMPENSATION TABLE

<TABLE>
<CAPTION>
LONG TERM
ANNUAL COMPENSATION COMPENSATION
-------------------------------------------- SECURITIES
OTHER ANNUAL UNDERLYING ALL OTHER
NAME AND PRINCIPAL SALARY BONUS COMPENSATION OPTIONS COMPENSATION
POSITION YEAR ($) ($) ($) (#) ($)
- --------------------------- ---- ------- ------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
K. Michael Forrest......... 1996 23,103 50,000(2) -- 245,000 --
President and Chief 1995 -- -- -- -- --
Executive Officer(1) 1994 -- -- -- -- --
William E. Bliss........... 1996 154,583 -- -- -- --
President and Chief 1995 21,242 -- 89,512(4) 226,333 --
Executive Officer(3) 1994 -- -- -- -- --
Carl R. Thornfeldt, M.D.... 1996 107,962 -- -- 54,000 --
Medical Director and 1995 97,500 -- -- 70,422 --
Chairman of the Board 1994 76,098 -- -- 4,920 --
Michael L. Francoeur, 1996 147,042 -- -- 81,000 --
Ph.D.....................
VP, Research and 1995 -- -- -- -- --
Development 1994 -- -- -- -- --
A. Richard Juelis.......... 1996 131,830 -- -- 28,500 --
VP, Finance and 1995 103,670 -- -- 55,502 --
Chief Financial Officer 1994 11,108 --
Vivien H.W. Mak, Ph.D...... 1996 115,187 -- -- 40,000 --
VP, Cutaneous Research 1995 22,100 -- -- 7,810 --
1994 -- -- -- -- --
</TABLE>

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

(1) Mr. Forrest became President and Chief Executive Officer of the Company in
November 1996, following the death of William E. Bliss, President and Chief
Executive Officer.
(2) Consists of a bonus paid on January 31, 1997, in accordance with his
employment agreement. The bonus is being expensed during the period starting
December 1, 1996, and ending December 31, 1997.
(3) Mr. Bliss was President and Chief Executive Officer of the Company from
December 1995 until his death in July 1996.
(4) Consists of Mr. Bliss' relocation compensation accrued when he joined the
Company in December 1995 and paid during 1996.

44
<PAGE> 46

The following table sets forth information regarding individual grants of
options to acquire Common Stock during fiscal 1996 to each Named Officer.

OPTION GRANTS IN LAST FISCAL YEAR

<TABLE>
<CAPTION>
INDIVIDUAL GRANTS
-----------------------------------------------------------------------
NUMBER OF
SECURITIES
UNDERLYING % OF TOTAL OPTIONS EXERCISE OR
OPTIONS GRANTED TO EMPLOYEES BASE PRICE
NAME GRANTED (#) IN FISCAL YEAR ($/SH) EXPIRATION DATE
- --------------------------------- ----------- -------------------- ----------- ------------------
<S> <C> <C> <C> <C>
K. Michael Forrest(1)............ 245,000 47.2% $4.56 November 20, 2006
Carl R. Thornfeldt, M.D.(2)...... 45,000 8.7% $5.64 January 2, 2006
Carl R. Thornfeldt, M.D.......... 9,000 1.7% $4.56 November 20, 2006
Michael L. Francoeur, Ph.D.(3)... 75,000 14.4% $7.25 May 22, 2006
Michael L. Francoeur, Ph.D....... 6,000 1.2% $4.56 November 20, 2006
A. Richard Juelis(4)............. 19,500 3.8% $5.50 March 26, 2006
A. Richard Juelis................ 9,000 1.7% $4.56 November 20, 2006
Vivien H.W. Mak, Ph.D............ 18,000 3.5% $5.75 March 15, 2006
Vivien H.W. Mak, Ph.D.(5)........ 16,000 3.1% $7.25 May 22, 2006
Vivien H.W. Mak, Ph.D............ 6,000 1.2% $4.56 November 20, 2006
</TABLE>

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

(1) Of the shares subject to this option, 25,000 shares were exercisable at
grant, and 25,000 shares are exercisable after six months following the
grant date. An additional 150,000 shares become exercisable over four years
from the grant date vesting in four equal annual installments, if there has
been no employment termination. The remaining 45,000 shares will become
exercisable at the earlier of the accomplishment of certain milestones or
after five years from the date of grant. The option becomes exercisable in
full upon acquisition of the Company.
(2) Of the shares subject to this option, 22,500 shares were exercisable at
grant. The remaining 22,500 shares are exercisable over a four year period
at a rate of 1/48 per month.
(3) Of the shares subject to this option, 12,750 shares were exercisable at
grant. An additional 37,500 shares become exercisable over four years from
the grant date vesting in four equal annual installments, if there has been
no employment termination. The remaining 24,750 shares will become
exercisable at the earlier of the accomplishment of certain milestones or
after five years from the date of grant.
(4) Of the shares subject to this option, 4,875 shares were exercisable at
grant. The remaining 14,625 shares will become exercisable at the earlier of
the accomplishment of certain milestones or after five years from the date
of grant.
(5) Of the shares subject to this option, 4,000 shares were exercisable at
grant. The remaining 12,000 shares will become exercisable at the earlier of
the accomplishment of certain milestones or after five years from the date
of grant.

45
<PAGE> 47

The following table sets forth information with respect to the options
exercised during fiscal 1996 by the Named Officers during fiscal 1996.

AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND
FY-END OPTION/SAR VALUES

<TABLE>
<CAPTION>
NUMBER OF SECURITIES
UNDERLYING UNEXERCISED VALUE OF UNEXERCISED IN-THE-
OPTIONS/SARS AT MONEY OPTIONS AT
DECEMBER 31, 1996 (#) DECEMBER 31, 1996 ($)
NAME EXERCISABLE/UNEXERCISABLE EXERCISABLE/UNEXERCISABLE(1)
- ---------------------------------------------- ------------------------- -----------------------------
<S> <C> <C>
K. Michael Forrest............................ 25,000/220,000 --
Carl R. Thornfeldt, M.D....................... 27,656/17,344 --
Carl R. Thornfeldt, M.D....................... 0/9,000 --
Michael L. Francoeur, Ph.D.................... 12,750/75,000 --
Michael L. Francoeur, Ph.D.................... 0/6,000 --
A. Richard Juelis............................. 9,750/9,750 --
A. Richard Juelis............................. 0/9,000 --
Vivien H.W. Mak, Ph.D......................... 0/18,000 --
Vivien H.W. Mak, Ph.D......................... 4,000/12,000 --
Vivien H.W. Mak, Ph.D......................... 0/6,000 --
</TABLE>

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

(1) Based on the difference between the fair market value of the Common Stock at
December 31, 1996 ($4.50 per share) and the exercise price of options shown
in the table. The exercise prices of the options are higher than the fair
market value of the shares at December 31, 1996.

DIRECTOR COMPENSATION

Directors employed by the Company did not receive any monetary fees for
services performed for the Company during 1996. Outside directors are reimbursed
for their travel expenses related to Board meetings and receive a fee of $1,000
for each Board meeting attended in person.

Non-employee directors of the Company are eligible to participate in the
1995 Directors' Stock Option Plan (the "Directors Plan"). A total of 150,000
shares of Common Stock are reserved for issuance to eligible directors pursuant
to the Directors Plan. The Plan is currently administered by the Compensation
Committee of the Board and is intended to qualify for the exemption provided by
Rule 16b-3 under the Exchange Act. On the date on which an eligible director is
elected, the director is granted a non-qualified stock option (normally with a
term of ten years) (an "Initial Option") to acquire 20,000 shares. Thereafter,
on the first business day after the Company's annual meeting of shareholders, an
eligible director will be granted a ten year option (an "Annual Option") to
acquire 1,000 shares. The exercise price of all such options is the fair market
value of the shares on the grant date. Initial Options generally are exercisable
immediately with respect to 25% of the shares subject to the option, and become
exercisable with respect to the remaining shares subject to the option upon the
first, second, third and fourth anniversaries of the grant date. Annual Options
become exercisable with respect to 25% of the shares subject to the option on
each of the first, second, third and fourth anniversaries of the grant date. At
September 30, 1997, options to purchase 76,000 shares of Common Stock were
outstanding under the Directors Plan, 23,750 of which were then currently
exercisable.

EMPLOYMENT AGREEMENTS

Mr. Forrest, President and Chief Executive Officer, and the Company entered
into an employment agreement dated November 20, 1996. The base term of the
agreement is through December 1, 2000. The agreement provides for a base
compensation of $265,000 per year. Either the Company or Mr. Forrest may
terminate the agreement at any time upon notice to the other party. The
agreement provides that, upon termination without cause, Mr. Forrest will be
paid twelve months severance and continuation of benefits during the period
severance payments are made. The agreement provides for the payment of a $50,000
bonus,

46
<PAGE> 48

which was paid to Mr. Forrest upon the effectiveness of the agreement. The
agreement provides for the granting of an option to purchase 245,000 shares of
Common Stock, of which 25,000 shares are fully vested at the date of grant, and
of which 25,000 shares are vested six months after the date of grant. An
additional 45,000 shares issuable upon exercise of the option will vest at the
earlier of the accomplishment of certain milestones or after five years from
date of grant. The remaining 150,000 shares of Common Stock vest over four years
from the grant date (in four equal annual installments) if there has been no
Employment Termination.

Dr. Thornfeldt and the Company entered into an employment agreement dated
January 21, 1996. The base term of the agreement is through December 31, 1999.
The agreement provides for payments of $9,000 per month as long as Dr.
Thornfeldt is devoting at least five business days per month to the affairs of
the Company. If, at any time, Dr. Thornfeldt devotes less than five business
days per month to the Company for two consecutive months, then commencing with
the next month his salary would be reduced to $6,000 per month. Reinstatement of
the $9,000 per month salary will then occur only after Dr. Thornfeldt has
recommenced devoting five business days per month to the affairs of the Company.
The agreement provides for the assignment to the Company, subject to certain
exclusions, of inventions of Dr. Thornfeldt during the term of the agreement.
Under the agreement, he may not engage in any activity that is competitive with
the business of the Company, including, without limitation, acting as a
consultant to any business that competes, directly or indirectly, with the
business of the Company. The agreement may be terminated before expiration of
its term upon certain events, including Dr. Thornfeldt's death, a material
breach of the agreement by the other party or by either party upon prior notice
to the other party.

Mr. Juelis became Vice President, Finance, Chief Financial Officer and
Secretary in March 1996 after consulting with the Company on a part time basis
since November 1994. His agreement with the Company dated May 10, 1996 provides
for a base compensation of $150,000 and for certain stock option grants.

Dr. Francoeur became Vice President, Research and Development in May 1996.
His agreement with the Company dated May 22, 1996 provides for a base
compensation of $150,000 and an initial stock option grant to purchase 75,000
shares, subject to certain vesting provisions.

Dr. Mak became Vice President, Cutaneous Research in January 1996 after
joining the Company initially as a consultant in October 1995. Her agreement
with the Company dated January 1, 1996 provides for a base compensation of
$100,000 per year and for certain stock option grants.

Dr. Azarnoff became Vice President, Clinical and Regulatory Affairs in
October 1997. His agreement with the Company provides that he will devote
approximately 20 hours per week to the affairs of the Company, and provides for
a base compensation of $115,000 per year and for certain stock option grants.

Dr. Elias, who was a director until September 1997 and is Co-Chairman of
the Scientific Advisory Board, entered into a consulting agreement with the
Company dated May 1, 1996, pursuant to which Dr. Elias agreed to provide
consulting services in the fields of dermatology, skin pharmacology and drug
development not less than two days per month. The agreement provides for
consulting fees of approximately $3,500 per month.

CERTAIN TRANSACTIONS

In August 1997, the Company agreed with Dr. Francoeur and Dr. Mak to cancel
a portion of certain stock options they held to acquire 60,000 and 12,000 shares
at an exercise price of $7.25 per share, in consideration of the grant of new
stock options to acquire 60,000 and 12,000 shares at an exercise price of $3.75
per share. This price represented the fair market value of the Common Stock on
the date of grant. The new options were exercisable with respect to the same
number of shares of Common Stock that were exercisable under the old options,
but vesting with respect to the remainder of the new options began on the grant
date of the new options.

See "Employment Agreements."

47
<PAGE> 49

PRINCIPAL SHAREHOLDERS

The following table sets forth, as of October 10, 1997, certain information
known to the Company regarding the ownership of shares of Common Stock by (i)
each person known to the Company to be a beneficial owner of more that 5% of the
outstanding shares of Common Stock, (ii) each director, (iii) each Named Officer
(see "Executive Compensation") and (iv) all directors and executive officers as
a group. Except as set forth below, the address of each named individual is the
address of the Company.

<TABLE>
<CAPTION>
PERCENTAGE OWNERSHIP
SHARES ------------------------
NAME OF BENEFICIAL OWNER OR GROUP BENEFICIALLY BEFORE THE AFTER THE
AND NATURE OF BENEFICIAL OWNERSHIP OWNED(1) OFFERING OFFERING
- ------------------------------------------------------------ ------------ ---------- ---------
<S> <C> <C> <C>
Four Partners............................................... 1,053,500 13.9% 11.3%
667 Madison Avenue
New York, New York 10021
Sundance Venture Partners, L.P.............................. 583,482 7.7% 6.2%
10600 N. DeAnza Boulevard, Suite 215
Cupertino, California 95014
Biotechnology Value Fund.................................... 490,560 6.5% 5.2%
333 W. Wacker Drive, Suite 1600
Chicago, Illinois 60606
Larry J. Wells(2)........................................... 597,794 7.9% 6.4%
10600 N. DeAnza Boulevard, Suite 215
Cupertino, California 95014
K. Michael Forrest(3)....................................... 463,327 6.0% 4.9%
Carl R. Thornfeldt, M.D.(4)................................. 460,618 6.0% 4.9%
A. Richard Juelis(5)........................................ 53,627 * *
Michael L. Francoeur, Ph.D.(6).............................. 23,625 * *
Vivien H.W. Mak, Ph.D.(7)................................... 21,810 * *
Denis R. Burger, Ph.D.(8)................................... 13,375 * *
Alan A. Steigrod(9)......................................... 11,375 * *
Tobi B. Klar, M.D.(10)...................................... 7,710 * *
Jack L. Bowman(11).......................................... 7,500 * *
All directors and executive officers as a group
(11 persons)(12).......................................... 1,660,761 21.0% 17.2%
</TABLE>

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

* Less than one percent.

(1) Based upon information supplied by officers, directors and principal
shareholders. Beneficial ownership is determined in accordance with rules
of the Securities and Exchange Commission that deem shares to be
beneficially owned by any person who has or shares voting or investment
power with respect to such shares. Unless otherwise indicated, the persons
named in this table have sole voting and sole investing power with respect
to all shares shown as beneficially owned, subject to community property
laws where applicable. Shares of Common Stock subject to an option that is
currently exercisable or exercisable within 60 days of October 10, 1997 are
deemed to be outstanding and to be beneficially owned by the person holding
such option for the purpose of computing the percentage ownership of such
person but are not treated as outstanding for the purpose of computing the
percentage ownership of any other person.
(2) Includes 583,482 shares held by Sundance Venture Partners, L.P., of which
Mr. Wells may be deemed a beneficial owner. Includes 4,736 shares issuable
upon exercise of presently exercisable common stock purchase warrants.
Includes 9,576 shares subject to stock options exercisable before December
10, 1997.
(3) Includes 87,500 shares subject to stock options exercisable before December
10, 1997.

48
<PAGE> 50

(4) Excludes 38,223 and 38,126 shares, respectively, held in trust for two
relatives of Dr. Thornfeldt and a total of 14,174 shares held by other
relatives with respect to which Dr. Thornfeldt has no voting control.
Includes 75,663 shares subject to stock options exercisable before December
10, 1997. Includes 190,463 shares held by Dr. Thornfeldt's spouse.
(5) Includes 53,627 shares subject to stock options exercisable before December
10, 1997.
(6) Includes 23,625 shares subject to stock options exercisable before December
10, 1997.
(7) Includes 21,810 shares subject to stock options exercisable before December
10, 1997.
(8) Includes 13,375 shares subject to stock options exercisable before December
10, 1997.
(9) Includes 9,375 shares subject to stock options exercisable before December
10, 1997.
(10) Includes 7,710 shares subject to stock options exercisable before December
10, 1997.
(11) Includes 5,000 shares subject to stock options exercisable before December
10, 1997.
(12) Includes 307,261 shares subject to stock options exercisable before
December 10, 1997. Includes 583,482 shares held by Sundance Venture
Partners, L.P., of which Mr. Wells may be deemed a beneficial owner.
Includes 4,736 shares issuable upon exercise of presently exercisable
common stock purchase warrants.

EMPLOYEE BENEFIT PLANS

The Company's 1995 Equity Incentive Plan (the "Incentive Plan") was
approved by the Board and the Company's shareholders effective August 1995. A
total of 1,450,000 shares of Common Stock are reserved for issuance under the
Incentive Plan. The Incentive Plan provides for the award of options, which may
either be incentive stock options ("ISOs") within the meaning of Section 422A of
the Internal Revenue Code of 1986 (the "Code") or non-qualified options ("NQOs")
which are not subject to special tax treatment under the Code. The Incentive
Plan also provides for the award of stock bonuses and restricted stock. The
Incentive Plan is administered by the Board or a committee appointed by the
Board (the "Administrator"). Directors, officers and employees of, and
consultants to, the Company or any parent or subsidiary corporation selected by
the Administrator are eligible to receive options under the Incentive Plan.
Subject to certain restrictions, the Administrator is authorized to designate
the number of shares to be covered by each award, the terms of the award, the
dates on which and the rates at which options or other awards may be exercised,
the method of payment and other terms.

ISOs cannot be less than the fair market value of the stock subject to the
option on the grant date and the exercise price of a NQO may not be less than
85% of such value. Unless the Administrator determines otherwise, options
generally have a 10-year term (or five years in the case of ISOs granted to a
participant owning more than 10% of the total voting power of the Company's
stock). Unless the Administrator provides otherwise, options terminate upon the
termination of a participant's employment, except that the participant may
exercise an option for a certain period of time after termination.

Generally, awards must be exercised by cash payment to the Company of the
exercise price. However, the Administrator may allow a participant to pay all or
a portion of the exercise price by means of a promissory note, stock or other
lawful consideration. The Incentive Plan also allows the Administrator to
provide for withholding and employment taxes payable by a participant to the
Company upon exercise of an award by delivery of a promissory note or
already-owned Common Stock, or by withholding shares acquired upon exercise of
the award. Additionally, the Company may make cash grants or loans to
participants relating to the participant's withholding and employment tax
obligations and the income tax liability incurred by a participant upon exercise
of an award.

See "Director Compensation" for a description of the Directors Plan.

INDEMNIFICATION OF DIRECTORS AND EXECUTIVE OFFICERS AND LIMITATION OF LIABILITY

The Company's Amended and Restated Articles of Incorporation (the "Restated
Articles") include a provision that eliminates the personal liability of its
directors to the Company and its shareholders for monetary damages for breach of
the directors' fiduciary duties to the maximum extent permitted under California
law. This limitation has no effect on a director's liability (i) for acts or
omissions that involve

49
<PAGE> 51

intentional misconduct or a knowing and culpable violation of law, (ii) for acts
or omissions that a director believes to be contrary to the best interests of
the Company or its shareholders or that involve the absence of good faith on the
part of the director, (iii) for any transaction from which a director derived an
improper personal benefit, (iv) for acts or omissions that show a reckless
disregard for the director's duty to the Company or its shareholders in
circumstances in which the director was aware, or should have been aware, in the
ordinary course of performing a director's duties, of a risk of a serious injury
to the Company or its shareholders, (v) for acts or omissions that constitute an
unexcused pattern of inattention that amounts to an abdication of the director's
duty to the Company or its shareholders, (vi) under Section 310 of the
California Corporations Code (the "California Code") (concerning contracts or
transactions between the Company and a director) or (vii) under Section 316 of
the California Code (concerning directors' liability for improper dividends,
loans and guarantees). The provision does not extend to acts or omissions of a
director in his capacity as an officer. Further, the provision has no effect on
claims arising under federal or state securities laws and will not affect the
availability of injunctions and other equitable remedies available to the
Company's shareholders for any violation of a director's fiduciary duty to the
Company or its shareholders.

The Restated Articles also include an authorization for the Company to
indemnify its agents (as defined in Section 317 of the California Code), through
bylaw provisions, by agreement or otherwise, to the fullest extent permitted by
law. Pursuant to this latter provision, the Company's Bylaws provide for
indemnification of the Company's directors, officers and employees.
Indemnification may only be authorized by a majority of Company's directors or
shareholders or by order of a court, unless the agent has been successful on the
merits. In addition, the Company's policy is to enter into indemnification
agreements with each of its officers and directors. These indemnification
agreements provide that directors and officers will be indemnified and held
harmless to the fullest extent permitted by law. These agreements, together with
the Restated Articles, may require the Company, among other things, to indemnify
such directors, officers and employees against certain liabilities that may
arise by reason of their status or service as directors or officers (other than
liabilities resulting from willful misconduct of a culpable nature), to advance
expenses to them as they are incurred, provided that they undertake to repay the
amount advanced if it is ultimately determined by a court that they are not
entitled to indemnification, and to obtain directors' and officers' insurance if
available on reasonable terms.

Section 317 of the California Code makes provisions for the indemnification
of officers, directors and other corporate agents in terms sufficiently broad to
indemnify such persons, under certain circumstances, for liabilities (including
reimbursement of expenses incurred) arising under the Securities Act.

The Underwriting Agreement referred to below sets forth certain provisions
with respect to the indemnification of the Company and certain directors,
officers, and controlling persons against certain losses and liabilities,
including certain liabilities under the Securities Act.

Certain of the registration rights agreements that the Company has entered
into with certain of its security holders provide for cross indemnification of
certain holders of the Company's securities with respect to registration
statements filed under the Securities Act with respect to securities held by
such holders, and of the Company and its officers and directors for certain
liabilities existing under the Securities Act and otherwise.

The Company also maintains a director and officer liability policy.

50
<PAGE> 52

DESCRIPTION OF CAPITAL STOCK

The authorized capital stock of the Company consists of 20,000,000 shares
of Common Stock and 5,000,000 shares of Preferred Stock. As of October 10, 1997,
there were 7,594,959 shares of Common Stock outstanding held of record by
approximately 96 shareholders, and no outstanding shares of Preferred Stock. In
the Company's initial public offering in August 1995, the Company sold 661,250
units ("Units"), each Unit consisting of two shares of Common Stock and one
warrant to purchase one share of Common Stock (the "IPO Warrants"). The Units
separated immediately and the Common Stock and IPO Warrants traded on the Nasdaq
SmallCap Market through November 18, 1997. The Company's Common Stock and IPO
Warrants were approved for quotation on the Nasdaq National Market, and the
Common Stock and IPO Warrants will trade on the Nasdaq National Market upon
effectiveness of this Registration Statement.

COMMON STOCK

Subject to preferences that may be applicable to any outstanding Preferred
Stock, the holders of outstanding shares of Common Stock are entitled to receive
dividends out of assets legally available therefor at such times and in such
amounts as the Board may, from time to time, determine. Each shareholder is
entitled to one vote for each share of Common Stock held of record on all
matters submitted to a vote of shareholders. The Company's bylaws provide that
so long as the Company is a "listed company" as defined by applicable California
law, there will not be cumulative voting in connection with the election of
directors. Upon approval of the listing of the Company's Common Stock for
trading on the Nasdaq National Market the Company became a listed company as so
defined, and therefore cumulative voting no longer applies in connection with
the election of directors. Holders of Common Stock have no preemptive rights or
rights to convert their Common Stock into any other securities under the
Company's charter documents. There are no redemption or sinking fund provisions
applicable to the Common Stock. Upon liquidation, dissolution or winding up of
the Company, the assets legally available for distribution to shareholders are
distributable ratably among the holders of the Common Stock outstanding at that
time after payment of liquidation preferences, if any, on any outstanding
Preferred Stock and payment of claims of creditors. All outstanding shares of
Common Stock are fully paid and nonassessable.

PREFERRED STOCK

General

The Company's Restated Articles provide that the Company may issue shares
of Preferred Stock in one or more series. The Board of Directors is authorized
to establish from time to time the number of shares to be included in, and the
designation of, any such series, to determine or alter the rights, preferences,
privileges and restrictions granted to or imposed upon any wholly unissued
series of Preferred Stock, and to increase or decrease the number of shares of
any such series (but not below the number of shares of such series then
outstanding) without any further vote or action by the shareholders. The
issuance of Preferred Stock may have the effect of delaying, deferring or
preventing a change in control of the Company without further action by the
shareholders. The issuance of Preferred Stock with voting and conversion rights
may adversely affect the voting power or other rights of the holders of Common
Stock. The Company has no present plans as of the date of this Prospectus to
issue any shares of Preferred Stock.

WARRANTS

Underwriter Warrant

In connection with the Offering, the Company has issued to the Underwriter
an Underwriter Warrant for nominal consideration, entitling the Underwriter to
purchase up to 125,000 shares of the Company's Common Stock at a price per share
equal to 130% of the public offering price. The Underwriter Warrant is
exercisable for a period of four years, commencing one year following the
closing of this Offering and contains certain demand and piggyback registration
rights with respect to the Common Stock issuable upon the exercise of the
Underwriter Warrant. The Underwriter Warrant is not transferable for a period of
one year from the closing of this Offering, except as to officers of the
Underwriter. The exercise price and the number of shares issuable

51
<PAGE> 53

upon exercise may, under certain circumstances, be subject to adjustment
pursuant to antidilution provisions. See "Underwriting."

Representatives' Warrants

In connection with the Company's initial public offering, the Company
issued 57,500 Representatives' Warrants and has reserved 172,500 shares of
Common Stock for issuance upon exercise of such warrants (including the warrants
issuable upon exercise of the Representatives' Warrants). Each Representatives'
Warrant entitles the holder to acquire, at an exercise price of $20.63 per Unit,
two shares of Common Stock and a warrant to acquire one share of Common Stock at
an exercise price equal to $10.31. The other terms of the Representatives'
Warrants are substantially similar to the IPO Warrants, except that the
Representatives' Warrants (and the warrants included therein) are not publicly
tradeable and are not redeemable by the Company. The Representatives' Warrants
are exercisable until August 11, 2000.

The IPO Warrants

Each IPO Warrant entitles the holder to purchase one share of Common Stock
at a price of $9.375 per share. The IPO Warrants are, subject to certain
conditions, exercisable at any time from August 11, 1996 until August 11, 2000,
unless earlier redeemed. The IPO Warrants are redeemable by the Company, at $.05
per IPO Warrant, upon 30 days' notice at any time after August 11, 1996 (and
sooner with the consent of either Paulson Investment Company, Inc. or National
Securities Corporation, the underwriters of the Company's initial public
offering) if the closing price per share of the Common Stock for 10 consecutive
trading days ending on a date within 30 business days preceding the date notice
of redemption is given equals or exceeds $12.50. If the Company gives notice of
its intention to redeem, a holder would be forced either to exercise his or her
IPO Warrant before the date specified in the redemption notice or accept the
redemption price. The IPO Warrants were issued in registered form under a
Warrant Agreement (the "Warrant Agreement") between the Company and First
Interstate Bank of California, San Francisco, California, as warrant agent (the
"Warrant Agent").

Other Warrants

At various times before the date of this Prospectus, the Company has issued
warrants to acquire a total of 659,561 shares of Common Stock at various
exercise prices ranging from $0.01 to $9.02 per share, with a weighted average
exercise price of $6.68 per share.

As long as the above warrants are exercisable, the holders thereof have the
opportunity to profit from a rise in the market price of the Common Stock
without assuming the risk of ownership of the shares of Common Stock issuable
upon the exercise of the warrants, with a resulting dilution in the interests of
the Company's shareholders by reason of exercise of warrants at a time when the
exercise price is less than the market price for the Common Stock. Further, the
terms on which the Company could obtain additional capital during the life of
the warrants may be adversely affected. The warrant holders may be expected to
exercise their warrants at a time when the Company would, in all likelihood, be
able to obtain any needed capital by an offering of Common Stock on terms more
favorable than those provided for by the warrants.

REGISTRATION RIGHTS

The Company has granted registration rights at various times in the past in
connection with certain prior issuances of Common Stock and warrants. Pursuant
to the Company's Amended and Restated Registration Rights Agreement dated as of
April 16, 1992, as amended (the "1992 Registration Agreement"), the Company
filed a registration statement on Form S-3 to register the sale, from time to
time, of approximately 6,800,000 shares of Common Stock, including 5,966,250
outstanding shares and 833,750 shares issuable upon the exercise of certain
warrants. Holders of registration rights under the 1992 Registration Agreement
also have piggyback registration rights, subject to certain marketing and other
limitations. The Company is required to bear all registration expenses, other
than underwriting discounts and selling commissions, incurred

52
<PAGE> 54

in connection with the registration of Registrable Shares in one demand
registration, one Form S-3 registration and all Company registrations.

Pursuant to a registration rights agreement with the holders of certain
warrants (the "Bridge Registration Rights Agreement"), the Company has filed a
registration statement on Form S-3 covering the issuance of shares of common
stock (the "Bridge Warrant Shares") issuable upon exercise of the warrants or
the resale of Bridge Warrant Shares that are "Registrable Securities" as defined
in the Bridge Registration Rights Agreement, to cause such registration
statement to become effective, and to keep the registration statement effective
until the earlier to occur of (i) the resale of Warrant Shares, (ii) two years
after the effective date of such registration statement or (iii) with respect to
any particular holder, at such time as all of the registered Warrant Shares held
by such holder may be publicly resold pursuant to Rule 144 or otherwise under
the Securities Act within the succeeding six months without regard to the volume
of trading in the Company's securities.

The Representatives' Warrants provide certain rights with respect to the
registration under the Securities Act of the 172,500 shares issuable upon
exercise thereof (including the warrants included therein). The Company has
registered the issuance of such shares upon the exercise of the Representatives'
Warrants (and, if necessary, their resale) so as to permit their public resale
without restriction.

In connection with the issuance of 1,547,827 shares of Common Stock in a
private placement transaction in July 1997, the Company agreed to file a
registration statement covering the resale from time to time of the purchased
shares, as well as certain other shares of Common Stock held by such purchasers.
Such a registration statement has been filed and declared effective.

Pursuant to the Underwriter Warrant, the Company has granted to the
Underwriter certain demand and piggyback registration rights with respect to the
Common Stock issuable upon exercise of the Underwriter's Warrants. See
"Underwriting."

Pursuant to the Anogesic Agreement, the Company has agreed to register for
resale shares of Common Stock that may be issued to Neptune or its shareholders
in connection with the Anogesic Acquisition, and to keep such registration
effective until such shares are sold or until the shares may be publicly resold
without restriction pursuant to Rule 144.

TRANSFER AGENT AND REGISTRAR

The Transfer Agent and Registrar for the Company's Common Stock and the IPO
Warrants is ChaseMellon Shareholder Services.

LISTING

The Common Stock and the IPO Warrants have been approved for quotation on
the Nasdaq National Market under the trading symbols "CLGY" and "CLGYW,"
respectively.

SHARES ELIGIBLE FOR FUTURE SALE

Upon completion of this offering, the Company will have outstanding an
aggregate of 9,344,959 shares of Common Stock (based upon shares outstanding at
September 30, 1997), assuming no exercise of the Underwriter's over-allotment
option and no exercise of outstanding options or warrants. Of these shares, the
1,150,000 shares sold in the Company's initial public offering, and all of the
1,750,000 shares sold in this Offering, will be freely tradable without
restriction or further registration under the Securities Act, unless such shares
are held by "affiliates" of the Company as that term is defined in Rule 144
under the Securities Act (the "Affiliates"). Of the remaining shares, 2,892,824
shares of Common Stock held by existing shareholders are "restricted securities"
as that term is defined in Rule 144 under the Securities Act ("Restricted
Shares"). Restricted Shares may be sold in the public market only if registered
or if they qualify for an exemption from registration under Rule 144 or 701
promulgated under the Securities Act, which rules are summarized below. Except
for the 1,547,827 shares of Common Stock sold in a July 1997 private placement
transaction,

53
<PAGE> 55

substantially all of the outstanding Restricted Securities satisfied the
one-year holding period of Rule 144 and thus may be publicly sold in compliance
with the provisions of Rule 144. A substantial majority of such outstanding
securities have also satisfied the two-year holding period of Rule 144(k) and
thus may be sold by persons who are not affiliates of the Company pursuant to
the provisions of Rule 144(k) without regarding to the volume and other
limitations of Rule 144. In addition, the Company has filed registration
statements registering the sale from time to time of certain of such Restricted
Securities, as well as other shares of Common Stock that are issuable upon the
exercise of certain options and warrants. The Company's directors, executive
officers and certain other shareholders who in the aggregate hold approximately
2,362,344 shares of Common Stock have agreed not to offer, pledge, sell,
contract to sell, sell any option or contract to purchase, purchase any option
or contract to sell, grant any option, right or warrant to purchase, or
otherwise transfer or dispose of, directly or indirectly (or enter into any swap
or other arrangement that transfers to another, in whole or in part, any of the
economic consequences of ownership of), any shares of Common Stock or any
securities convertible into or exercisable or exchangeable for shares of Common
Stock, for a period of 90 days after the date of this Prospectus, without the
prior written consent of the Underwriter.

In general, under Rule 144 as currently in effect, a person (or persons
whose shares are aggregated) who has beneficially owned Restricted Shares for at
least one year (including the holding period of any prior owner except an
Affiliate) would be entitled to sell within any three-month period a number of
shares that does not exceed the greater of: (i) 1% of the number of shares of
Common Stock then outstanding (which will equal approximately 9,344,959 shares
immediately after this Offering); or (ii) the average weekly trading volume of
the Common Stock on the Nasdaq National Market during the four calendar weeks
preceding the filing of a notice on Form 144 with respect to such sale. Sales
under Rule 144 are also subject to certain manner of sale provisions and notice
requirements and to the availability of current public information about the
Company. Under Rule 144(k), a person who is not deemed to have been an Affiliate
of the Company at any time during the 90 days preceding a sale, and who has
beneficially owned the shares proposed to be sold for at least two years
(including the holding period of any prior owner except an Affiliate), is
entitled to sell such shares without complying with the manner of sale, public
information, volume limitation or notice provisions of Rule 144; therefore,
unless otherwise restricted, "144(k) shares" may be sold immediately upon the
completion of this Offering. In general, under Rule 701 of the Securities Act as
currently in effect, any employee, consultant or advisor of the Company who
purchases shares from the Company before the Company's initial public offering
in connection with a compensatory stock or option plan or other written
agreement may resell such shares in reliance on Rule 144, but without compliance
with certain restrictions, including the holding period, contained in Rule 144.

54
<PAGE> 56

UNDERWRITING

Subject to the terms and conditions of an underwriting agreement (the
"Underwriting Agreement"), the Company has agreed to sell to CIBC Oppenheimer
Corp. (the "Underwriter"), and the Underwriter has agreed to purchase from the
Company, 1,750,000 shares of Common Stock.

The Underwriter proposes to offer the shares of Common Stock directly to
the public at the public offering price set forth on the cover page of this
Prospectus. The Underwriting Agreement provides that the obligations of the
Underwriter thereunder are subject to approval of certain legal matters by
counsel and of various other conditions. The Underwriter is obligated to take
and pay for all of the shares of Common Stock offered hereby (other than those
covered by the over-allotment option described below) if any are taken.

The Company has granted to the Underwriter a 30-day over-allotment option
to purchase up to 262,500 additional shares of Common Stock at the public
offering price less the underwriting discount. The Underwriter may exercise such
option only to cover over-allotments made in connection with the sale of the
shares of Common Stock offered hereby.

The Company has also agreed to sell to the Underwriter, for nominal
consideration, a warrant (the "Underwriter Warrant") to purchase up to 125,000
shares of Common Stock at a price per share equal to 130% of the public offering
price. The Underwriter Warrant will be exercisable for a period of four years,
commencing one year following the closing of this Offering, and will contain
certain demand and piggyback registration rights with respect to the Common
Stock issuable upon the exercise of the Underwriter Warrant. Such demand and
piggyback registration rights will expire five years from the closing of the
Offering. The Underwriter Warrant will be restricted from sale, transfer,
assignment or hypothecation for a period of one year from the closing of this
Offering, except as to officers of the Underwriter. The exercise price and the
number of shares issuable upon exercise may, under certain circumstances, be
subject to adjustment pursuant to antidilution provisions.

The Company has agreed to indemnify the Underwriter against certain
liabilities, including, without limitation, liabilities under the Securities
Act, and to contribute to payments that the Underwriter may be required to make
in respect thereof. The Company has also agreed to reimburse the Underwriter for
certain out-of-pocket expenses incurred in connection with the Offering.

In connection with the Offering, the Underwriter and its affiliates may
engage in transactions that stabilize, maintain or otherwise affect the market
price of the Common Stock. Such transactions may include stabilization
transactions effected in accordance with Rule 104 of Regulation M, pursuant to
which such persons may bid for or purchase Common Stock for the purpose of
stabilizing its market price. The Underwriter also may create a short position
for its account by selling more shares of Common Stock in connection with the
Offering than it is committed to purchase from the Company, and in such case may
purchase Common Stock in the open market following completion of the Offering to
cover all or a portion of such short position. The Underwriter may also cover
all or a portion of such short position, up to 262,500 shares of Common Stock,
by exercising the Underwriter's over-allotment option referred to above. Any of
the transactions described in this paragraph may result in the maintenance of
the price of the Common Stock at a level above that which might otherwise
prevail in the open market. None of the transactions described in this paragraph
is required, and, if they are undertaken, they may be discontinued at any time.

The Company's executive officers, directors and certain shareholders who,
after giving effect to the Offering, will collectively own an aggregate of
approximately 2,362,344 shares of Common Stock, have agreed that they will not
directly or indirectly, sell, offer, contract to sell, make a short sale, pledge
or otherwise dispose of any shares of Common Stock (or any securities
convertible into or exchangeable or exercisable for any other rights to purchase
or acquire shares of Common Stock owned by them, for a period of 90 days after
the date of this Prospectus, without the prior written consent of the
Underwriter, subject to certain limited exceptions. The Company has also agreed
not to issue, sell or register with the Commission, or otherwise dispose of,
directly or indirectly, any equity securities of the Company (or any securities
convertible into or exercisable or exchangeable for equity securities of the
Company) for a period of 90 days after the date of this Prospectus, without the
prior written consent of the Underwriter, subject to certain limited exceptions.
The

55
<PAGE> 57

Underwriter may, in its sole discretion, and at any time without notice, release
all or any portion of the securities subject to the lock-up agreements.

The Underwriter has advised the Company that it does not intend to make
sales to discretionary accounts.

LEGAL MATTERS

The validity of the issuance of the shares of Common Stock offered hereby
will be passed upon for the Company by Fenwick & West LLP, Palo Alto,
California. Certain matters will be passed upon for the Underwriter by Cooley
Godward LLP, Palo Alto, California.

EXPERTS

The financial statements of Cellegy Pharmaceuticals, Inc. as of December
31, 1995 and 1996 and for each of the three years in the period ended December
31, 1996 and for the period from June 26, 1989 (inception) through December 31,
1996 appearing in the Prospectus and Registration Statement have been audited by
Ernst & Young LLP, independent auditors, as set forth in their report thereon
appearing elsewhere herein and in the Registration Statement and are included in
reliance upon such report given upon the authority of such firm as experts in
accounting and auditing.

AVAILABLE INFORMATION

The Company is subject to the informational requirements of the Exchange
Act, and, in accordance therewith, files reports, proxy statements and other
information with the Securities and Exchange Commission (the "Commission"). Such
reports, proxy statements and other information filed by the Company can be
inspected and copied at the public reference facilities of the Commission
located at Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C.
20549, and at the Commission's regional offices at Seven World Trade Center,
13th Floor, New York, New York 10048; and Northwestern Atrium Center, 500 West
Madison Street, Suite 1400, Chicago, Illinois 60661-2511. Copies of such
material can also be obtained from the Public Reference Section of the
Commission at Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington,
D.C. 20549 at prescribed rates. The Commission also maintains a World Wide Web
site (located at http://www.sec.gov) that contains reports, proxy and
information statements and other information regarding the Company. The
Company's Common Stock is listed on the Nasdaq National Market and reports,
proxy statements and other information concerning the Company may be inspected
at the offices of the Nasdaq Stock Market, 1735 K Street, N.W., Washington, D.C.
20006-1500.

The Company has filed with the Commission a Registration Statement on Form
S-1 under the Securities Act with respect to the Shares offered hereby. This
Prospectus does not contain all of the information set forth in the Registration
Statement and the exhibits thereto. For further information with respect to the
Company and the Common Stock offered hereby, reference is made to the
Registration Statement and the exhibits filed therewith or incorporated therein
by reference. Statements contained in this Prospectus as to the contents of any
contract or any other document referred to herein are not necessarily complete,
and in each instance reference is made to the copy of such contract or other
document filed as an exhibit to the Registration Statement or incorporated
therein by reference, each such statement being qualified in all respects by
such reference. A copy of the Registration Statement may be inspected, without
charge, at the offices of the Commission in Washington, D.C. and copies of all
or any part of the Registration Statement may be obtained from the Public
Reference Section of the Commission at Room 1024, Judiciary Plaza, 450 Fifth
Street, N.W., Washington, D.C. 20549, upon the payment of the fees prescribed by
the Commission.

56
<PAGE> 58

INDEX TO FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
Report of Ernst & Young LLP, Independent Auditors.................................... F-2
Balance Sheets....................................................................... F-3
Statements of Operations............................................................. F-4
Statements of Shareholders' Equity (Deficit)......................................... F-5
Statements of Cash Flows............................................................. F-7
Notes to Financial Statements........................................................ F-9
</TABLE>

F-1
<PAGE> 59

REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

The Board of Directors and Shareholders
Cellegy Pharmaceuticals, Inc.

We have audited the accompanying balance sheets of Cellegy Pharmaceuticals, Inc.
(a development-stage company) as of December 31, 1995 and 1996, and the related
statements of operations, shareholders' equity (deficit), and cash flows for
each of the three years in the period ended December 31, 1996, and for the
period from June 26, 1989 (inception) through December 31, 1996. 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 Cellegy Pharmaceuticals, Inc.
at December 31, 1995 and 1996, and the results of its operations and its cash
flows for each of the three years in the period ended December 31, 1996, and for
the period from June 26, 1989 (inception) through December 31, 1996, in
conformity with generally accepted accounting principles.

ERNST & YOUNG LLP
San Jose, California
February 5, 1997, except
for note 10, as to which
the date is November 5, 1997

F-2
<PAGE> 60

CELLEGY PHARMACEUTICALS, INC.
(A DEVELOPMENT-STAGE COMPANY)

BALANCE SHEETS

ASSETS

<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER
--------------------------- 30,
1995 1996 1997
----------- ----------- -----------
(UNAUDITED)
<S> <C> <C> <C>
Current assets:
Cash and cash equivalents......................... $ 2,320,130 $ 36,453 $ 1,338,344
Short-term investments............................ 1,500,000 5,255,668 4,974,533
Other current assets.............................. 149,040 350,561 448,130
---------- ---------- ----------
Total current assets................................ 3,969,170 5,642,682 6,761,007
Property and equipment, net......................... 58,665 31,281 16,025
Long-term investments............................... -- 2,022,499 3,063,864
---------- ---------- ----------
Total assets........................................ $ 4,027,835 $ 7,696,462 $ 9,840,896
========== ========== ==========

LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities.......... $ 192,232 $ 270,013 $ 181,978
Deferred revenue.................................. -- -- 500,000
Accrued research fees............................. -- 21,000 21,000
Accrued compensation and related expenses......... 187,266 17,958 24,413
---------- ---------- ----------
Total current liabilities........................... 379,498 308,971 727,391
Shareholders' equity:
Preferred stock, no par value; 5,000,000 shares
authorized:
Series A convertible preferred stock; 1,100
shares designated; no shares issued or
outstanding at December 31, 1995 and 195 shares
issued and outstanding at December 31, 1996 (no
shares issued and outstanding at September 30,
1997 -- unaudited)............................. -- 2,161,271 --
Common stock, no par value; 20,000,000 shares
authorized: 3,777,075 shares issued and
outstanding at December 31, 1995 and 5,152,752
shares issued and outstanding at December 31,
1996 (7,594,959 shares issued and outstanding
at September 30, 1997 -- unaudited)............ 13,803,793 20,141,370 26,495,852
Unrealized gain on investments.................... -- 22,167 48,398
Deficit accumulated during the development
stage.......................................... (10,155,456) (14,937,317) (17,430,745)
---------- ---------- ----------
Total shareholders' equity........................ 3,648,337 7,387,491 9,113,505
---------- ---------- ----------
Total liabilities and shareholders' equity.......... $ 4,027,835 $ 7,696,462 $ 9,840,896
========== ========== ==========
</TABLE>

See accompanying notes.

F-3
<PAGE> 61

CELLEGY PHARMACEUTICALS, INC.
(A DEVELOPMENT-STAGE COMPANY)

STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
PERIOD FROM PERIOD FROM
JUNE 26, 1989 JUNE 26, 1989
(INCEPTION) NINE MONTHS ENDED (INCEPTION)
YEARS ENDED DECEMBER 31, THROUGH SEPTEMBER 30, THROUGH
--------------------------------------- DECEMBER 31, ------------------------- SEPTEMBER 30,
1994 1995 1996 1996 1996 1997 1997
----------- ----------- ----------- ------------- ----------- ----------- -------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C>
Revenues:
Licensing and contract
revenue from affiliate... $ -- $ 1,000,000 $ 15,000 $ 1,145,373 $ 15,000 $ -- $ 1,145,373
Licensing, milestone, and
development funding...... -- -- 559,157 559,157 -- 516,656 1,075,813
Government grants.......... -- -- 73,503 73,503 -- 126,498 200,001
----------- ----------- ----------- ----------- ----------- ----------- -----------
Total revenues............... -- 1,000,000 647,660 1,778,033 15,000 643,154 2,421,187
Operating expenses:
Research and development... 1,510,478 1,224,841 2,712,008 9,122,229 1,865,673 2,389,522 11,511,751
General and
administrative........... 1,031,599 1,310,144 1,633,917 6,182,230 1,170,790 1,065,757 7,247,987
----------- ----------- ----------- ----------- ----------- ----------- -----------
Total operating expenses..... 2,542,077 2,534,985 4,345,925 15,304,459 3,036,463 3,455,279 18,759,738
----------- ----------- ----------- ----------- ----------- ----------- -----------
Operating loss............... (2,542,077) (1,534,985) (3,698,265) (13,526,426) (3,021,463) (2,812,125) (16,338,551)
Interest expense............. (4,755) (752,391) -- (863,740) -- -- (863,740)
Interest income and other,
net........................ 3,333 135,499 330,169 866,614 271,017 353,437 1,220,051
----------- ----------- ----------- ----------- ----------- ----------- -----------
Net loss..................... (2,543,499) (2,151,877) (3,368,096) (13,523,552) (2,750,446) (2,458,688) (15,982,240)
Non-cash preferred
dividends.................. -- -- 1,413,765 1,413,765 1,368,538 34,740 1,448,505
----------- ----------- ----------- ----------- ----------- ----------- -----------
Net loss applicable to common
shareholders............... $(2,543,499) $(2,151,877) $(4,781,861) $(14,937,317) $(4,118,984) $(2,493,428) $(17,430,745)
=========== =========== =========== =========== =========== =========== ===========
Pro forma net loss per share
applicable to common
shareholders............... $ (0.76) $ (0.67) $ (1.11) $ (1.02) $ (0.41)
=========== =========== =========== =========== ===========
Shares used in calculation of
pro forma net loss per
share...................... 3,344,328 3,205,696 4,306,550 4,050,303 6,076,482
=========== =========== =========== =========== ===========
</TABLE>

See accompanying notes

F-4
<PAGE> 62

CELLEGY PHARMACEUTICALS, INC.
(A DEVELOPMENT-STAGE COMPANY)

STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
SERIES A SERIES B SERIES C
CONVERTIBLE CONVERTIBLE CONVERTIBLE
PREFERRED STOCK PREFERRED STOCK PREFERRED STOCK COMMON STOCK
----------------- ------------------ --------------------- ------------------
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT
------- ------- ------- -------- -------- ---------- -------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Issuance of common stock for cash through
December 31, 1993.......................... -- $ -- -- $ -- -- $ -- 834,893 $81,725
Issuance of common stock for services
rendered through December 31, 1993......... -- -- -- -- -- -- 269,116 24,261
Issuance of common stock in connection with
merger with Pacific Pharmaceuticals, Inc.
in April 1992.............................. -- -- -- -- -- -- 97,062 8,750
Issuance of Series B convertible preferred
stock in exchange for convertible
promissory notes in 1992................... -- -- 12,750 114,000 -- -- -- --
Issuance of Series C convertible preferred
stock for cash, net of issuance costs,
through December 31, 1993.................. -- -- -- -- 477,081 4,978,505 -- --
Repurchase of common shares in 1992......... -- -- -- -- -- -- (3,586) (324)
Issuance of Series A convertible preferred
stock for cash through December 31, 1993... 26,899 48,500 -- -- -- -- -- --
Issuance of Series A convertible preferred
stock and warrants to purchase 14,191
shares of Series A convertible preferred
stock in exchange for convertible
promissory notes and accrued interest
through December 31, 1993.................. 625,845 1,199,536 -- -- -- -- -- --
Issuance of Series A convertible preferred
stock for services rendered through
December 31, 1993.......................... 40,597 73,198 -- -- -- -- -- --
Issuance of Series A convertible preferred
stock in exchange for license agreement
through December 31, 1993.................. 9,513 100,000 -- -- -- -- -- --
Net loss for the period from June 26, 1989
(inception) through December 31, 1993...... -- -- -- -- -- -- -- --
------ ------- ------ -------- ------- ---------- ------- -------
Balance at December 31, 1993................ 702,854 1,421,234 12,750 114,000 477,081 4,978,505 1,197,485 114,412
Exercise of options to purchase common
stock...................................... -- -- -- -- -- -- 964 1,739
Net loss in 1994............................ -- -- -- -- -- -- -- --
------ ------- ------ -------- ------- ---------- ------- -------
Balance at December 31, 1994................ 702,854 1,421,234 12,750 114,000 477,081 4,978,505 1,198,449 116,151

DEFICIT
ACCUMULATED TOTAL
UNREALIZED DURING THE SHAREHOLDERS'
GAIN ON DEVELOPMENT EQUITY
INVESTMENTS STAGE (DEFICIT)
----------- ----------- -------------
<S> <<C> <C> <C>
Issuance of common stock for cash through
December 31, 1993.......................... $ -- $ -- $ 81,725
Issuance of common stock for services
rendered through December 31, 1993......... -- -- 24,261
Issuance of common stock in connection with
merger with Pacific Pharmaceuticals, Inc.
in April 1992.............................. -- -- 8,750
Issuance of Series B convertible preferred
stock in exchange for convertible
promissory notes in 1992................... -- -- 114,000
Issuance of Series C convertible preferred
stock for cash, net of issuance costs,
through December 31, 1993.................. -- -- 4,978,505
Repurchase of common shares in 1992......... -- -- (324)
Issuance of Series A convertible preferred
stock for cash through December 31, 1993... -- -- 48,500
Issuance of Series A convertible preferred
stock and warrants to purchase 14,191
shares of Series A convertible preferred
stock in exchange for convertible
promissory notes and accrued interest
through December 31, 1993.................. -- -- 1,199,536
Issuance of Series A convertible preferred
stock for services rendered through
December 31, 1993.......................... -- -- 73,198
Issuance of Series A convertible preferred
stock in exchange for license agreement
through December 31, 1993.................. -- -- 100,000
Net loss for the period from June 26, 1989
(inception) through December 31, 1993...... -- (5,460,080) (5,460,080)
------- ------- ----------
Balance at December 31, 1993................ -- (5,460,080) 1,168,071
Exercise of options to purchase common
stock...................................... -- -- 1,739
Net loss in 1994............................ -- (2,543,499) (2,543,499)
------- ------- ----------
Balance at December 31, 1994................ -- (8,003,579) (1,373,689)
</TABLE>

See accompanying notes.

F-5
<PAGE> 63

CELLEGY PHARMACEUTICALS, INC.
(A DEVELOPMENT-STAGE COMPANY)

STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT) (CONTINUED)
<TABLE>
<CAPTION>
SERIES B SERIES C CONVERTIBLE
SERIES A CONVERTIBLE CONVERTIBLE COMMON
PREFERRED STOCK PREFERRED STOCK PREFERRED STOCK STOCK
----------------------- ----------------- --------------------- ----------
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT SHARES
--------- ----------- ------- -------- --------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
Exercise of options to purchase common
stock................................. -- -- -- -- -- -- 20,481
Issuance of warrants in connection with
notes payable financing............... -- -- -- -- -- -- --
Conversion of preferred stock to common
stock in connection with IPO.......... (702,854) (1,421,234) (12,750) (114,000) (477,081) (4,978,505) 1,192,685
Issuance of common stock in connection
with IPO.............................. -- -- -- -- -- -- 1,322,500
Issuance of common stock in exchange
for notes payable..................... -- -- -- -- -- -- 42,960
Net loss in 1995....................... -- -- -- -- -- -- --
-------- ---------- ------- -------- --------- ---------- ---------
Balance at December 31, 1995........... -- -- -- -- -- -- 3,777,075
Issuance of Series A convertible
preferred stock, net of issuance
costs................................. 750 6,753,230 -- -- -- -- --
Conversion of preferred stock,
including dividends, to common
stock................................. (555) (6,005,724) -- -- -- -- 1,234,077
Exercise of warrants to purchase common
stock................................. -- -- -- -- -- -- 135,256
Exercise of options to purchase common
stock................................. -- -- -- -- -- -- 6,344
Compensation expense related to the
extension of option exercise
periods............................... -- -- -- -- -- -- --
Unrealized gain on investments......... -- -- -- -- -- -- --
Non-cash preferred dividends........... -- 1,413,765 -- -- -- -- --
Net loss in 1996....................... -- -- -- -- -- -- --
-------- ---------- ------- -------- --------- ---------- ---------
Balance at December 31, 1996........... 195 2,161,271 -- -- -- -- 5,152,752
Exercise of warrants to purchase common
stock (unaudited)..................... -- -- -- -- -- -- 205,474
Non-cash preferred dividends
(unaudited)........................... -- 34,740 -- -- -- -- --
Conversion of preferred stock,
including dividends, to common stock
(unaudited)........................... (195) (2,196,011) -- -- -- -- 587,879
Exercise of options to purchase common
stock (unaudited)..................... -- -- -- -- -- -- 101,027
Compensation expense related to the
extension of option exercise periods
(unaudited)........................... -- -- -- -- -- -- --
Issuance of common stock, net of
issuance costs (unaudited)............ -- -- -- -- -- -- 1,547,827
Unrealized gain on investments
(unaudited)........................... -- -- -- -- -- -- --
Net loss for the nine months ended
September 30, 1997 (unaudited)........ -- -- -- -- -- -- --
-------- ---------- ------- -------- --------- ---------- ---------
Balance at September 30, 1997
(unaudited)........................... -- $ -- -- $ -- -- $ -- 7,594,959
======== ========== ======= ======== ========= ========== =========

DEFICIT
ACCUMULATED TOTAL
UNREALIZED DURING THE SHAREHOLDERS'
GAIN ON DEVELOPMENT EQUITY
AMOUNT INVESTMENTS STAGE (DEFICIT)
----------- ----------- ------------ -------------
<S> <C> <C> <C> <C>
Exercise of options to purchase common
stock................................. 34,285 -- -- 34,285
Issuance of warrants in connection with
notes payable financing............... 487,333 -- -- 487,333
Conversion of preferred stock to common
stock in connection with IPO.......... 6,513,739 -- -- --
Issuance of common stock in connection
with IPO.............................. 6,383,785 -- -- 6,383,785
Issuance of common stock in exchange
for notes payable..................... 268,500 -- -- 268,500
Net loss in 1995....................... -- -- (2,151,877) (2,151,877)
---------- ------- ----------- -----------
Balance at December 31, 1995........... 13,803,793 -- (10,155,456) 3,648,337
Issuance of Series A convertible
preferred stock, net of issuance
costs................................. -- -- -- 6,753,230
Conversion of preferred stock,
including dividends, to common
stock................................. 6,005,724 -- -- --
Exercise of warrants to purchase common
stock................................. 51,814 -- -- 51,814
Exercise of options to purchase common
stock................................. 11,553 -- -- 11,553
Compensation expense related to the
extension of option exercise
periods............................... 268,486 -- -- 268,486
Unrealized gain on investments......... -- 22,167 -- 22,167
Non-cash preferred dividends........... -- -- (1,413,765) --
Net loss in 1996....................... -- -- (3,368,096) (3,368,096)
---------- ------- ----------- -----------
Balance at December 31, 1996........... 20,141,370 22,167 (14,937,317) 7,387,491
Exercise of warrants to purchase common
stock (unaudited)..................... 930 -- -- 930
Non-cash preferred dividends
(unaudited)........................... -- -- (34,740) --
Conversion of preferred stock,
including dividends, to common stock
(unaudited)........................... 2,196,011 -- -- --
Exercise of options to purchase common
stock (unaudited)..................... 268,807 -- -- 268,807
Compensation expense related to the
extension of option exercise periods
(unaudited)........................... 69,995 -- -- 69,995
Issuance of common stock, net of
issuance costs (unaudited)............ 3,818,739 -- -- 3,818,739
Unrealized gain on investments
(unaudited)........................... -- 26,231 -- 26,321
Net loss for the nine months ended
September 30, 1997 (unaudited)........ -- -- (2,458,688) (2,458,688)
---------- ------- ----------- -----------
Balance at September 30, 1997
(unaudited)........................... $26,495,852 $ 48,398 $(17,430,745) 9,113,505
========== ======= =========== ===========
</TABLE>

See accompanying notes

F-6
<PAGE> 64

CELLEGY PHARMACEUTICALS, INC.
(A DEVELOPMENT-STAGE COMPANY)

STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
PERIOD FROM
PERIOD FROM JUNE 26,
JUNE 26, 1989
1989 (INCEPTION)
(INCEPTION) NINE MONTHS ENDED THROUGH
YEARS ENDED DECEMBER 31, THROUGH SEPTEMBER 30, SEPTEMBER
--------------------------------------- DECEMBER 31, ------------------------- 30,
1994 1995 1996 1996 1996 1997 1997
----------- ----------- ----------- ------------ ----------- ----------- ------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net loss...................... $(2,543,499) $(2,151,877) $(3,368,096) $(13,523,552) $(2,750,446) $(2,458,688) $(15,982,240)
Adjustments to reconcile net
loss to net cash used in
operating activities:
Depreciation and
amortization.............. 28,418 27,726 35,384 246,638 28,560 15,256 261,894
Compensation expense related
to the extension of option
exercise periods.......... -- -- 268,486 268,486 34,062 69,995 338,481
Loss on sale of property and
equipment................. -- 3,724 -- 3,724 -- -- 3,724
Amortization of discount on
notes payable and deferred
financing costs........... 4,755 562,748 -- 567,503 -- -- 567,503
Issuance of common shares
for services.............. -- -- -- 24,261 -- -- 24,261
Issuance of Series A
convertible preferred
stock for services
rendered.................. -- -- -- 73,198 -- -- 73,198
Issuance of Series A
convertible preferred
stock for interest........ -- -- -- 67,720 -- -- 67,720
Issuance of Series A
convertible preferred
stock for license
agreement................. -- -- -- 100,000 -- -- 100,000
Changes in operating assets
and liabilities:
Affiliate receivable........ 29,264 -- -- -- -- -- --
Other current assets........ 45,401 (138,811) (201,521) (350,561) (169,383) (97,569) (448,130)
Accounts payable and accrued
liabilities............... 245,136 (149,813) 77,781 270,013 (61,427) (88,035) 181,978
Accrued research fees....... -- -- 21,000 21,000 -- -- 21,000
Accrued compensation and
related expenses.......... 36,039 136,554 (169,308) 17,958 (157,574) 6,455 24,413
Deferred revenue............ 1,000,000 (1,000,000) -- -- -- 500,000 500,000
----------- ----------- ----------- ------------ ----------- ----------- ------------
Net cash used in operating
activities.................. (1,154,486) (2,709,749) (3,336,274) (12,213,612) (3,076,208) (2,052,586) (14,266,198)
INVESTING ACTIVITIES
Purchase of property and
equipment................... -- (22,794) (8,000) (172,893) (8,000) -- (172,893)
Purchases of investments...... -- (1,500,000) (9,576,000) (16,622,520) (5,625,505) (6,990,000) (23,612,520)
Sales and maturities of
investments................. 1,049,861 21,681 3,820,000 9,366,520 220,000 6,256,001 15,622,521
----------- ----------- ----------- ------------ ----------- ----------- ------------
Net cash provided by (used in)
investing activities........ 1,049,861 (1,501,113) (5,764,000) (7,428,893) (5,413,505) (733,999) (8,162,892)
</TABLE>

See accompanying notes.

F-7
<PAGE> 65

CELLEGY PHARMACEUTICALS, INC.
(A DEVELOPMENT-STAGE COMPANY)

STATEMENTS OF CASH FLOWS (CONTINUED)

<TABLE>
<CAPTION>
PERIOD FROM
PERIOD FROM JUNE 26,
JUNE 26, 1989
1989 (INCEPTION)
(INCEPTION) NINE MONTHS ENDED THROUGH
YEARS ENDED DECEMBER 31, THROUGH SEPTEMBER 30, SEPTEMBER
--------------------------------------- DECEMBER 31, ------------------------- 30,
1994 1995 1996 1996 1996 1997 1997
----------- ----------- ----------- ------------ ----------- ----------- ------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C>
FINANCING ACTIVITIES
Proceeds from notes payable... $ 536,000 $ 1,749,800 $ -- $ 3,547,424 $ -- $ -- $ 3,547,424
Repayment of notes payable.... -- (2,017,300) -- (2,110,608) -- -- (2,110,608)
Net proceeds from issuance of
common stock................ 1,739 6,418,070 63,367 6,564,901 15,746 4,088,476 10,653,377
Repurchase of common stock.... -- -- -- (324) -- -- (324)
Issuance of convertible
preferred stock, net of
issuance costs.............. -- -- 6,753,230 11,757,735 6,753,230 -- 11,757,735
Deferred financing costs...... (80,170) -- -- (80,170) -- -- (80,170)
----------- ----------- ----------- ------------ ----------- ----------- ------------
Net cash provided by financing
activities.................. 457,569 6,150,570 6,816,597 19,678,958 6,768,976 4,088,476 23,767,434
----------- ----------- ----------- ------------ ----------- ----------- ------------
Net increase (decrease) in
cash........................ 352,944 1,939,708 (2,283,677) 36,453 (1,720,737) 1,301,891 1,338,344
Cash at beginning of period... 27,478 380,422 2,320,130 -- 2,320,130 36,453 --
----------- ----------- ----------- ------------ ----------- ----------- ------------
Cash at end of period......... $ 380,422 $ 2,320,130 $ 36,453 $ 36,453 $ 599,393 $ 1,338,344 $ 1,338,344
============ ============ ============ ============= ============ ============ =============
SUPPLEMENTAL DISCLOSURE OF
NON-CASH TRANSACTIONS
Conversion of preferred stock
and dividends to common
stock....................... $ -- $ 6,513,739 $ 6,005,724 $ 12,519,463 $ 5,498,000 $ 2,196,011 $ 14,715,474
============ ============ ============ ============= ============ ============ =============
Issuance of common stock for
notes payable............... $ -- $ 268,500 $ -- $ 268,500 $ -- $ -- $ 268,500
============ ============ ============ ============= ============ ============ =============
Issuance of warrants in
connection with notes
payable financing........... $ -- $ 487,333 $ -- $ 487,333 $ -- $ -- $ 487,333
============ ============ ============ ============= ============ ============ =============
Issuance of Series A
convertible preferred stock
for notes payable $ -- $ -- $ -- $ 1,153,316 $ -- $ -- $ 1,153,316
============ ============ ============ ============= ============ ============ =============
Issuance of Series B
convertible preferred stock
for notes payable........... $ -- $ -- $ -- $ 115,000 $ -- $ -- $ 115,000
============ ============ ============ ============= ============ ============ =============
Issuance of common stock for
Pacific Pharmaceuticals,
Inc......................... $ -- $ -- $ -- $ 8,750 $ -- $ -- $ 8,750
============ ============ ============ ============= ============ ============ =============
</TABLE>

See accompanying notes.

F-8
<PAGE> 66

CELLEGY PHARMACEUTICALS, INC.
(A DEVELOPMENT-STAGE COMPANY)

NOTES TO FINANCIAL STATEMENTS

(INFORMATION AT SEPTEMBER 30, 1997
AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1996 AND 1997 IS UNAUDITED)

1. ACCOUNTING POLICIES

Description of Business

The Company is engaged in the development of prescription drugs and
cosmeceutical products based upon its patented transdermal and topical drug
delivery technologies and its expertise in skin biology. The Company is in the
development stage.

Basis of Presentation

In the course of its development, the Company has incurred significant
losses and will continue to incur additional losses during its development
phase. As a result, the Company will require substantial additional funds for
its operational activities and may seek private or public equity financings and
future collaborative arrangements with third parties to meet its cash needs.
There is no assurance that such additional funds will be available on acceptable
terms or available at all. Insufficient funding may require the Company to
delay, reduce, or eliminate some or all of its research and development, planned
clinical trials, and administrative programs.

Interim Financial Statements

In the opinion of management, the unaudited financial statements include
all adjustments (consisting of normal recurring accruals) necessary to present
fairly the Company's results of operations and cash flows for the nine months
ended September 30, 1996 and 1997. Results for the nine months ended September
30, 1997 are not necessarily indicative of the results to be expected for the
year ended December 31, 1997.

Use of Estimates

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

Revenues and Research and Development Expenses

Revenues related to cost reimbursement provisions under development
contracts are recognized as the costs associated with the projects are incurred.
Revenues related to milestones specified under development contracts are
recognized as the milestones are achieved. Research and development costs are
expensed as incurred.

The Company receives certain United States government grants that support
the Company's research effort in defined research projects. These grants
generally provide for reimbursement of approved costs incurred as defined in the
various grants. Revenues associated with these grants are recognized as costs
under each grant are incurred.

Cash, Cash Equivalents, and Investments

Cash equivalents consist of highly liquid financial instruments with
original maturities of three months or less.

The Company accounts for its investments in accordance with Statement of
Financial Accounting Standards No. 115, "Accounting for Certain Investments in
Debt and Equity Securities" (FAS 115). Under

F-9
<PAGE> 67

CELLEGY PHARMACEUTICALS, INC.
(A DEVELOPMENT-STAGE COMPANY)

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

(INFORMATION AT SEPTEMBER 30, 1997
AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1996 AND 1997 IS UNAUDITED)

FAS 115, management classifies investments as available-for-sale or
held-to-maturity at the time of purchase and periodically reevaluates such
designations. Investments in marketable equity securities and debt securities
are classified as held-to-maturity when the Company has the positive intent and
ability to hold the securities to maturity. Held-to-maturity securities are
stated at amortized cost with corresponding premiums or discounts amortized to
interest income over the life of the investment. Debt securities, not classified
as held-to-maturity, are classified as available-for-sale and are reported at
fair market value. Unrealized gains or losses on available-for-sale securities
are included in shareholders' equity until their disposition. Realized gains or
losses and declines in value judged to be other than temporary on
available-for-sale securities are included in other income or expense.

While the Company's intent is to hold debt securities to maturity, they are
classified as available-for-sale because the sale of such securities may be
required prior to maturity.

Property and Equipment

Property and equipment are stated at cost less accumulated depreciation.
Depreciation is provided over the estimated useful life of five years using the
straight-line method.

Stock-Based Compensation

The Company accounts for its stock option grants in accordance with
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees" (APB Opinion No. 25) and has elected to follow the disclosure-only
alternative prescribed by Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation" (FAS 123).

Pro forma Net Loss Per Share Applicable to Common Shareholders

Net loss per share applicable to common shareholders is computed using the
weighted average number of shares of common stock outstanding. Common equivalent
shares are excluded from the computation as their effect is antidilutive, except
that, pursuant to Securities and Exchange Commission Staff Accounting Bulletins,
common and common equivalent shares issued (stock options and warrant grants) at
prices below the public offering price during the twelve-month period prior to
the initial public offering have been included in the calculation as if they
were outstanding for all periods through March 31, 1995 using the treasury stock
method. The net loss per share applicable to common shareholders, computed on
this basis, was $(1.18), $(0.86), and $(1.11) for the years ended December 31,
1994, 1995, and 1996, respectively. Shares used in the net loss per share
calculation were 2,151,643, 2,509,963, and 4,306,550 for the years ended
December 31, 1994, 1995, and 1996, respectively.

The pro forma net loss per share applicable to common shareholders
presented in the statements of operations is computed as described above and
also gives effect for all periods presented to the conversion of all outstanding
shares of convertible preferred stock into common stock that took place upon the
closing of the Company's initial public offering in August 1995.

F-10
<PAGE> 68

CELLEGY PHARMACEUTICALS, INC.
(A DEVELOPMENT-STAGE COMPANY)

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

(INFORMATION AT SEPTEMBER 30, 1997
AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1996 AND 1997 IS UNAUDITED)

2. INVESTMENTS

At December 31, 1996, investments consist of the following:

<TABLE>
<CAPTION>
UNREALIZED UNREALIZED
COST GAINS LOSSES FAIR VALUE
---------- ------- ------- ----------
<S> <C> <C> <C> <C>
Short-term:
Corporate notes............ $2,000,000 $ 8,280 $ -- $2,008,280
U.S. Government notes...... 2,400,000 310 (1,886) 2,398,424
Time Deposits.............. 500,000 -- -- 500,000
Commercial paper........... 356,000 -- (7,036) 348,964
---------- ------- ------- ----------
5,256,000 8,590 (8,922) 5,255,668
Long-term:
U.S. Government notes...... 2,000,000 22,499 -- 2,022,499
---------- ------- ------- ----------
Total...................... $7,256,000 $31,089 $(8,922) $7,278,167
========== ======= ======= ==========
</TABLE>

The cost and estimated fair market value of investments in debt securities
at December 31, 1996, by contractual maturity, were as follows:

<TABLE>
<CAPTION>
FAIR
MARKET
COST VALUE
---------- ----------
<S> <C> <C>
Due in 1 year or less........................... $5,256,000 $5,255,668
Due in 1-3 years................................ 2,000,000 2,022,499
---------- ----------
Total investments............................... $7,256,000 $7,278,167
========== ==========
</TABLE>

At December 31, 1995, short-term investments consisted of a U.S. government
obligation that matured in May 1996. There have been no net realized gains or
losses on the sale of securities for the years ended December 31, 1994, 1995 and
1996.

3. PROPERTY AND EQUIPMENT

Property and equipment consist of the following:

<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
1995 1996
-------- ---------
<S> <C> <C>
Furniture and fixtures................................ $ 41,702 $ 49,702
Office equipment...................................... 39,142 39,142
Laboratory equipment.................................. 65,310 65,310
Leasehold improvements................................ 3,610 3,610
-------- --------
149,764 157,764
(91,099) (126,483)
-------- --------
Less accumulated depreciation......................... $ 58,665 $ 31,281
======== ========
</TABLE>

4. NOTES PAYABLE

In a December 1994 private placement, the Company issued $536,000 principal
amount of 10% convertible subordinated debentures and warrants to acquire
107,200 shares of common stock at an exercise price of $7.81. The value ascribed
to the warrants for financial statement purposes was not material.

F-11
<PAGE> 69

CELLEGY PHARMACEUTICALS, INC.
(A DEVELOPMENT-STAGE COMPANY)

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

(INFORMATION AT SEPTEMBER 30, 1997
AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1996 AND 1997 IS UNAUDITED)

In February 1995 and June 1995 private placements, the Company issued
$1,749,800 principal amount of 10% convertible secured debentures (Notes) and
warrants (Warrants) to acquire units (Units), each Unit consisting of one share
of common stock and one common stock purchase warrant (Unit Warrant). In
connection with the February 1995 transaction, all investors who acquired notes
and warrants in December 1994 exchanged the securities acquired in December 1994
for an equal principal amount of Notes and Warrants on the same terms as the
other investors. The Warrants were valued by an outside valuation firm for
financial statement purposes at approximately $487,000, which amount was
recorded as an addition to common stock with a corresponding discount on the
notes payable. The discount was amortized using the interest method. The Notes
were convertible at the option of the noteholder into Units consisting of one
share of common stock and one warrant (Conversion Warrant) to purchase one share
of common stock. The exercise price of the Warrants is $0.01 per unit. The
exercise price of the Unit Warrants is $7.81 per share.

In August 1995, in connection with the close of its initial public
offering, the Company repaid Notes totaling approximately $2,017,000 and accrued
interest totaling approximately $100,000. Notes totaling $268,500 were converted
into 42,960 shares of common stock and warrants to acquire 42,960 shares of
common stock. The warrants were exercisable beginning in February 1996 at an
exercise price of $5.19 per share and will expire December 31, 1999.

5. LEASE COMMITMENTS

The Company leases its facilities and equipment under non-cancelable
operating leases. Future minimum lease payments at December 31, 1996 are as
follows:

Lease expense was $72,764, $67,959, and $209,715 for the years ended
December 31, 1994, 1995, and 1996, respectively. For the year ended December 31,
1996, such lease expense included $63,836 of equipment lease expense.

6. SHAREHOLDERS' EQUITY

Initial Public Offering

In August 1995, the Company completed an initial public offering of 661,250
units with each unit consisting of two shares of common stock and one common
stock purchase warrant with an exercise price of $9.375 per share. The Company
received net proceeds of approximately $6.4 million. In connection with the
initial public offering, Series A, B, and C preferred stock, then outstanding,
converted into 1,192,685 shares of common stock.

In July 1995, the Company's Board of Directors also approved a
0.746-for-one reverse stock split of issued and outstanding common and preferred
shares and commensurate adjustments of outstanding options and warrants
(including purchase prices and exercise prices). All share amounts in the
accompanying financial statements have been retroactively adjusted to reflect
this reverse stock split.

F-12
<PAGE> 70

CELLEGY PHARMACEUTICALS, INC.
(A DEVELOPMENT-STAGE COMPANY)

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

(INFORMATION AT SEPTEMBER 30, 1997
AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1996 AND 1997 IS UNAUDITED)

Convertible Series A Preferred Stock Offering

On April 19, 1996, the Company completed a $7,500,000 private placement of
750 shares of convertible Series A preferred stock (Series A Preferred) or
(Preferred Stock Financing). Net proceeds were $6,753,230. The shares were
convertible, at the option of the holder, into common stock. The number of
shares of common stock issuable on conversion of a share of Series A Preferred
was calculated based on the lower of $6.6275 or a variable conversion price of
85% of the average market price of the common stock on the five trading days
proceeding the conversion date. At September 30, 1997, all Series A Preferred
have been converted to common stock.

Two years after issuance of Series A Preferred, if there were any remaining
unconverted preferred shares, such shares would have automatically been
converted into common stock. A conversion premium accrued at the rate of 8
percent per annum and was payable upon conversion in shares of common stock. As
of September 30, 1997, 1,821,956 shares of common stock have been issued in
conjunction with the conversion of Series A Preferred. The holders of the Series
A Preferred had no voting rights except as required by applicable California
law.

For the year ended December 31, 1996, the Company accrued noncash preferred
dividends of $1,125,000 reflecting the 15% discount in conjunction with the
common stock variable conversion price of the Series A preferred stock, and
noncash preferred dividends of $288,765 ($34,740 for the nine months ended
September 30, 1997) reflecting the 8% per annum mandatory preferred dividends of
the Series A preferred stock.

In the event of any liquidation, the Series A Preferred shareholders were
entitled to receive a preferential amount equal to $10,000 per share plus the 8%
per annum accrued dividends.

Common Stock Private Placement

On July 23, 1997, the Company completed a $3,850,000 private placement of
1,547,827 shares of common stock. The purchase price for all investors, except
the Company's chief executive officer, was $2.375 per share. The purchase price
for the shares purchased by the Company's chief executive officer in the private
placement was $2.875 per share, which is equal to the closing price of the
common stock on the Nasdaq SmallCap Market on the date immediately preceding the
closing date.

Preferred Stock

The Company's Articles of Incorporation provide that the Company may issue
shares of preferred stock in one or more series. The Board of Directors is
authorized to establish from time to time the numbers of shares to be included
in, and the designation of, any such shares to determine or alter the rights,
preferences, privileges, and restrictions granted to or imposed upon any wholly
unissued series of preferred stock and to increase or decrease the number of
shares of any such series without any further vote or action by the
shareholders.

F-13
<PAGE> 71

CELLEGY PHARMACEUTICALS, INC.
(A DEVELOPMENT-STAGE COMPANY)

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

(INFORMATION AT SEPTEMBER 30, 1997
AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1996 AND 1997 IS UNAUDITED)

Warrants

The Company has the following warrants outstanding to purchase common stock
at September 30, 1997:

<TABLE>
<CAPTION>
NUMBER OF EXERCISE PRICE EXPIRATION
SHARES PER SHARE DATE ISSUED DATE
- ---------- -------------- -------------- ------------------
<S> <C> <C> <C>
35,496 $ 4.51 October 1994.. December 31, 1999
52,768 February
$ 0.01 1995.......... December 31, 1999
365,728 February
$ 7.81 1995.......... December 31, 1999
44,604 $ 9.02 March 1995.... December 31, 1999
42,960 $ 5.19 August 1995... December 31, 1999
115,000 $ 10.31 August 1995... August 11, 2000
57,500 $ 15.47 August 1995... August 11, 2000
661,250 $ 9.375 August 1995... August 11, 2000
86,005 $ 7.23 April 1996.... April 18, 2001
7,000 $ 6.25 April 1996.... April 24, 1998
25,000 $ 4.00 July 1997 July 22, 1998
- ----------
1,493,311
==========
</TABLE>

Included in the table above are warrants to acquire 661,250 shares of
common stock at a price of $9.375 per share that were issued in connection with
the Company's initial public offering. The warrants are exercisable at any time
unless previously redeemed until August 11, 2000. The Company may redeem the
warrants, in whole or in part, at any time upon at least thirty days prior
written notice to the warrant holders at a price of $0.05 per warrant provided
that the closing price of the common stock has been at least $12.50 for at least
ten consecutive trading days ending on a date within 30 days before the date of
the notice of redemption. No warrants have been redeemed through September 30,
1997.

Stock Option Plans

In 1995, the Company adopted the Equity Incentive Plan (the Plan) to
provide for the issuance of incentive stock options and nonstatutory stock
options. When the Plan was established, the Company reserved 700,000 shares for
issuance. In 1996, an additional 300,000 shares were reserved for issuance under
the Plan. In June 1997, an additional 450,000 shares were reserved for issuance
under the Plan. Under the Plan, incentive stock options may be granted at a
price per share of not less than the fair market value of common stock on the
date of grant. Nonqualified options may be granted at a price per share of not
less than 85% of fair market value on the date of grant. Options are exercisable
to the extent vested. Vesting is established by the Compensation Committee.

F-14
<PAGE> 72

CELLEGY PHARMACEUTICALS, INC.
(A DEVELOPMENT-STAGE COMPANY)

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

(INFORMATION AT SEPTEMBER 30, 1997
AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1996 AND 1997 IS UNAUDITED)

Activity under the Plan is summarized as follows:

<TABLE>
<CAPTION>
SHARES UNDER PRICE RANGE WEIGHTED AVERAGE
OPTION PER SHARE EXERCISE PRICE
------------ ------------- ----------------
<S> <C> <C> <C>
Balance at December 31, 1993............ 131,942 $1.81 $ 1.81
Granted............................... 66,743 $0.45 - $1.81 $ 1.42
Canceled.............................. (61,426) $1.81 $ 1.81
Exercised............................. (964) $1.81 $ 1.81
--------
Balance at December 31, 1994............ 136,295 $0.45 - $4.50 $ 1.64
Granted............................... 619,382 $2.09 - $6.66 $ 3.48
Canceled.............................. (84,511) $1.81 - $4.50 $ 1.92
Exercised............................. (20,481) $0.50 - $1.81 $ 1.67
--------
Balance at December 31, 1995............ 650,685 $0.45 - $6.66 $ 3.35
Granted............................... 605,447 $4.56 - $8.25 $ 5.43
Canceled.............................. (253,443) $1.39 - $6.38 $ 4.49
Exercised............................. (6,344) $1.81 - $2.09 $ 1.82
--------
Balance at December 31, 1996............ 996,345 $0.45 - $8.25 $ 4.34
Granted............................... 303,500 $3.00 - $6.06 $ 3.96
Canceled.............................. (213,371) $3.07 - $8.25 $ 5.58
Exercised............................. (101,027) $0.50 - $4.38 $ 2.66
--------
Balance at September 30, 1997........... 985,447 $0.45 - $8.25 $ 4.12
========
</TABLE>

At December 31, 1996, options to purchase 441,840 shares of common stock
were vested and exercisable at exercise prices ranging from $0.45 to $8.25 per
share. At December 31, 1996, options to purchase 91,500 shares of common stock
at exercise prices ranging from $4.56 to $7.25 per share vest in the year of
2001 but are subject to earlier vesting if certain performance criteria are met.
At December 31, 1996, no options to purchase shares of common stock were
available for future option grants under the Plan.

As of September 30, 1997, options to purchase 347,481 shares of common
stock were vested and exercisable at exercise prices ranging from $0.45 to $6.66
per share. At September 30, 1997, 335,737 options to purchase shares of common
stock were available for future option grants under the Plan.

The following table summarizes information about stock options outstanding
and exercisable at December 31, 1996:

<TABLE>
<CAPTION>
OPTIONS OUTSTANDING
--------------------------------------- OPTIONS EXERCISABLE
WEIGHTED -------------------------
NUMBER AVERAGE WEIGHTED NUMBER WEIGHTED
OUTSTANDING AT REMAINING AVERAGE EXERCISABLE AT AVERAGE
DECEMBER 31, CONTRACTUAL EXERCISE DECEMBER 31, EXERCISE
RANGE OF EXERCISE PRICE 1996 LIFE PRICE 1996 PRICE
- --------------------------------------- -------------- ----------- -------- -------------- --------
<S> <C> <C> <C> <C> <C>
$0.45 - $3.07.......................... 277,170 5.4 years.. $ 2.10 183,643 $ 2.00
$4.38 - $5.75.......................... 579,975 8.2 years.. $ 4.76 218,447 $ 4.68
$6.25 - $8.25.......................... 139,200 8.0 years.. $ 7.02 39,750 $ 6.78
------- -------
Total.................................. 996,345 7.4 years.. $ 4.34 441,840 $ 3.76
======= =======
</TABLE>

F-15
<PAGE> 73

CELLEGY PHARMACEUTICALS, INC.
(A DEVELOPMENT-STAGE COMPANY)

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

(INFORMATION AT SEPTEMBER 30, 1997
AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1996 AND 1997 IS UNAUDITED)

In February 1995, the Company adopted the Directors' Stock Option Plan. The
Company reserved 100,000 shares of common stock for issuance under the Plan. In
June 1997, an additional 50,000 shares were reserved for issuance under the
Plan. The Plan provides for the automatic annual grant of an option to acquire
1,000 shares of common stock to each nonemployee then serving as a director at
an exercise price equal to the fair value of the common stock on the date of
grant. The Plan also provides for an initial option grant (Initial Option) to
acquire 20,000 shares of common stock to each current and future nonemployee
director of the Company at an exercise price equal to the fair value of the
common stock on the date of grant. Vesting generally occurs over four years from
the date of grant except that 25% of the shares subject to the Initial Option
generally become exercisable on the grant date. Pursuant to the Plan, one option
to purchase 20,000 shares of common stock at an exercise price of $5.00 per
share was granted during the year ended December 31, 1995. During the year ended
December 31, 1996, options were granted to purchase a total of 50,000 shares of
common stock at exercise prices ranging from $4.50 to $8.50. Options to purchase
18,750 shares of common stock at exercise prices ranging from $4.50 to $5.50
were vested and exercisable at December 31, 1996. At December 31, 1996, options
to purchase 30,000 shares of common stock were available for future option
grants under the Plan. For the nine months ended September 30, 1997, the Company
granted 6,000 options under the Plan at an exercise price of $3.25.

The following table summarizes information about stock options outstanding
and exercisable related to the Directors' Stock Option Plan at December 31,
1996:

<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------ --------------------------
NUMBER WEIGHTED NUMBER
OUTSTANDING AVERAGE WEIGHTED EXERCISABLE WEIGHTED
AT REMAINING AVERAGE AT AVERAGE
RANGE OF DECEMBER 31, CONTRACTUAL EXERCISE DECEMBER 31, EXERCISE
EXERCISE PRICE 1996 LIFE PRICE 1996 PRICE
- --------------------------------- ------------ ------------ -------- ------------ ---------
<S> <C> <C> <C> <C> <C>
$4.50 - $5.50.................... 65,000 9.5 years.. $ 4.97 18,750 $5.00
$8.50............................ 5,000 9.4 years.. $ 8.50 -- $ --
------ ------
Total............................ 70,000 9.5 years.. $ 5.22 18,750 $5.00
====== ======
</TABLE>

The Company has elected to follow APB Opinion No. 25 and related
interpretations in accounting for its stock options since, as discussed below,
the alternative fair market value accounting provided for under FAS 123 requires
use of option valuation models that were not developed for use in valuing stock
options. Under APB Opinion No. 25, if the exercise price of the Company's stock
options is equal to the market price of the underlying stock on the date of
grant, no compensation expense is recognized.

F-16
<PAGE> 74

CELLEGY PHARMACEUTICALS, INC.
(A DEVELOPMENT-STAGE COMPANY)

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

(INFORMATION AT SEPTEMBER 30, 1997
AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1996 AND 1997 IS UNAUDITED)

Pro forma information regarding net loss and net loss per share is required
by FAS 123, which also requires that the information be determined as if the
Company has accounted for its stock options granted subsequent to December 31,
1994 under the fair market value method. The fair market value for options
granted in 1995 prior to the IPO was estimated at the date of the grant using
the Minimum Value Method. The fair market value for options granted in 1995
after the IPO, as well as in 1996, was estimated at the date of the grant using
a Black-Scholes option pricing model. The Company valued its options using the
following weighted average assumptions for the years ended December 31, 1995 and
1996:

<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31,
------------------
1995 1996
------ ------
<S> <C> <C>
Risk-free interest rate................................... 6.37% 6.23%
Dividend yield............................................ 0% 0%
Volatility................................................ 0.235 0.517
Expected life of options in years......................... 4.0 4.8
</TABLE>

The Black-Scholes option valuation model was developed for use in
estimating the fair market value of traded options that 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 stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair market value
estimate, in management's opinion, the existing models do not necessarily
provide a reliable single measure of the fair market value of its 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:

<TABLE>
<CAPTION>
1995 1996
----------- -----------
<S> <C> <C>
Pro forma net loss applicable to common
shareholders.................................... $(5,494,675) $(2,235,129)
Pro forma net loss per share applicable to common
shareholders.................................... $ (1.29) $ (0.70)
</TABLE>

The weighted average grant date fair value of options granted during the
years ended December 31, 1995 and 1996 was $1.17 and $2.79, respectively.

As a result of FAS 123 only being applicable to options granted subsequent
to December 31, 1994, its pro forma effect will not be fully reflected until the
year ending December 31, 1999.

7. LICENSE AGREEMENTS

In November 1996, the Company entered into an agreement with Glaxo Wellcome
Inc. (Glaxo) for licensing rights to Glylorin, Cellegy's lipid compound for the
treatment of ichthyoses. Under the terms of the agreement, Cellegy provided
Glaxo with an exclusive license of patent rights and know-how covering Glylorin
in most of the world's major markets. In exchange for this license, the Company
received from Glaxo an initial license fee payment and could potentially receive
future milestone payments (upon achievement of the specified milestones)
totaling, including the initial payment, over $8.0 million, as well as a royalty
on net sales assuming successful completion of product development and market
launch. There can be no assurances, however, that the Company will receive any
additional payments from Glaxo. The agreement provides that

F-17
<PAGE> 75

CELLEGY PHARMACEUTICALS, INC.
(A DEVELOPMENT-STAGE COMPANY)

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

(INFORMATION AT SEPTEMBER 30, 1997
AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1996 AND 1997 IS UNAUDITED)

Glaxo will assume responsibility for and the associated costs of all future
development and commercialization, including certain development costs incurred
prior to the date of the agreement.

In October 1993, the Company entered into a license agreement with the
University of California (the "Licensor") providing for an exclusive, worldwide,
royalty-bearing license, subject to customary government rights, for patent
rights relating to barrier repair formulations, jointly held by the Licensor and
the Company, in consideration of the issuance to the Licensor of certain shares
of preferred stock (which subsequently converted into shares of common stock)
and the payment by the Company of a licensing fee. In March 1994, the Company
entered into a second exclusive, worldwide, royalty-bearing license agreement
with the Licensor for patent rights jointly held by the Licensor and the
Company, relating to drug delivery technologies, in consideration of the payment
by the Company of a licensing fee, and an annual maintenance fee payable each
year until the Company is commercially selling a licensed product. Both
agreements require the Company to pay the Licensor royalties based on net sales
of consumer and prescription products (with minimum annual royalty payments).
The Company has the right to grant sublicenses to third parties under both
agreements. In May and October 1997, the Licensor and the Company amended these
agreements. The amendments modified and extended certain development and
commercialization milestones contained in the original agreements. The revised
milestones are tied to the achievement of certain clinical, regulatory, or
product commercialization goals over the next several years. Although there can
be no assurance that such goals will be achieved, the Company believes its
development programs in place will result in the satisfaction of such
milestones.

In April 1992, the Company entered into the License Option Agreement (the
"License Option Agreement"), the Azelaic Acid OTC License Agreement (the
"Azelaic Acid Agreement") and the Metabolic Moisturizer OTC License Agreement
(the "Metabolic Moisturizer Agreement"), with Neutrogena Corporation. The
Azelaic Acid Agreement was terminated and replaced by the Patent License
Agreement effective June 1, 1994 (the "Patent License Agreement"). Pursuant to
the Patent License Agreement, Neutrogena paid the Company $1.0 million for an
exclusive, royalty-free license for certain azelaic acid uses for both
prescription and consumer products in most major markets of the world. In July
1997, Neutrogena and the Company terminated the Metabolic Moisturizer Agreement
and the License Option Agreement (except as it relates to azelaic acid), and the
metabolic moisturizer technology that had been licensed to Neutrogena was
returned to the Company. The Company agreed to continue prosecution of patents
related to azelaic acid on behalf of Neutrogena and will be reimbursed by
Neutrogena for legal costs, up to a certain limit.

8. RELATED PARTY TRANSACTIONS

The Company has entered into consulting agreements with certain
shareholders of the Company. The total consulting fees paid to these
shareholders was $201,000, $129,000, and $52,250 for the years ended December
31, 1994, 1995, and 1996, respectively. One of these consulting agreements
requires a shareholder to provide consulting services through May 1999 in
exchange for monthly payments of approximately $3,500.

9. INCOME TAXES

At December 31, 1996, the Company has net operating loss carryforwards of
approximately $12,805,000 and $4,666,000 for federal and state purposes,
respectively. The federal net operating loss carryforwards expire between the
years 2004 and 2011. The state net operating loss carryforwards expire between
the years 1997 and 2001. At December 31, 1996, the Company also has research and
development credit carryforwards of

F-18
<PAGE> 76

CELLEGY PHARMACEUTICALS, INC.
(A DEVELOPMENT-STAGE COMPANY)

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

(INFORMATION AT SEPTEMBER 30, 1997
AND FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1996 AND 1997 IS UNAUDITED)

approximately $262,000 and $95,000 for federal and state purposes, respectively.
The federal credits expire between the years 2006 and 2011. The state credits
have no expiration date.

Pursuant to the "change in ownership" provisions of the Tax Reform Act of
1986, utilization of the Company's net operating loss and research and
development tax credit carryforwards may be limited if a cumulative change of
ownership of more than 50% occurs within any three-year period.

Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the Company's deferred tax liabilities and assets are as follows:

<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------
1995 1996
----------- -----------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards........................ $ 3,500,000 $ 4,634,000
Credit carryforwards.................................... 258,000 357,000
Capitalized research and development costs.............. 139,000 251,000
Capital loss carryforwards.............................. 39,000 39,000
Capitalized license fee................................. 50,000 50,000
Other................................................... 33,000 17,000
----------- -----------
Total deferred tax assets................................. 4,019,000 5,348,000
Valuation allowance....................................... (3,980,000) (5,315,000)
----------- -----------
Net deferred tax assets................................... 39,000 33,000
Deferred tax liabilities.................................. (39,000) (33,000)
----------- -----------
Net deferred tax assets................................... $ -- $ --
=========== ===========
</TABLE>

10. SUBSEQUENT EVENT

On November 3, 1997, the Company signed a legally binding letter of intent
with Neptune Pharmaceutical Corporation ("Neptune"), to acquire all patent and
other intellectual property rights relating to "Anogesic" (the "Anogesic
Acquisition"), a topical product candidate for the treatment of anal fissures
and hemorrhoids. The closing of the Anogesic Acquisition is subject to the
satisfaction of certain conditions, and there can be no assurance that the
Company will conclude the Anogesic Acquisition. The Company expects to record a
material charge to operations for in-process technology upon completion of the
Anogesic Acquisition.

F-19
<PAGE> 77

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

NO DEALER, SALESPERSON OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS IN CONNECTION WITH THIS OFFERING
OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN OR MADE, SUCH
INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED
BY THE COMPANY OR THE UNDERWRITER. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER
TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY OF THE SECURITIES OFFERED
HEREBY IN ANY JURISDICTION TO ANY PERSON TO WHOM IT IS UNLAWFUL TO MAKE SUCH
OFFER OR SOLICITATION IN SUCH JURISDICTION. NEITHER THE DELIVERY OF THIS
PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE
ANY IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE COMPANY
SINCE THE DATE AS OF WHICH INFORMATION IS FURNISHED.

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

TABLE OF CONTENTS

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary.................... 3
Recent Developments................... 6
Risk Factors.......................... 7
Use of Proceeds....................... 14
Price Range of Common Stock........... 14
Capitalization........................ 15
Dividend Policy....................... 15
Dilution.............................. 16
Selected Financial Data............... 17
Management's Discussion and Analysis
of Financial Condition and Results
of Operations....................... 18
Business.............................. 22
Management............................ 40
Certain Transactions.................. 47
Principal Shareholders................ 48
Description of Capital Stock.......... 51
Shares Eligible for Future Sale....... 53
Underwriting.......................... 55
Legal Matters......................... 56
Experts............................... 56
Available Information................. 56
Index to Financial Statements......... F-1
</TABLE>

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

1,750,000 SHARES

LOGO

COMMON STOCK
------------------------

PROSPECTUS
------------------------
LOGO

NOVEMBER 19, 1997

======================================================
<PAGE> 78

PART II

INFORMATION NOT REQUIRED IN PROSPECTUS

ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.

The following table sets forth the costs and expenses to be paid in
connection with the sale of the shares of Common Stock being registered hereby,
all of which will be paid by the Company. All amounts are estimates except for
the Securities and Exchange Commission registration fee.

<TABLE>
<S> <C>
Securities and Exchange Commission registration fee............ $ 6,763
NASD fee....................................................... 2,700
Nasdaq National Market listing fee............................. 15,000
Blue sky fees and expenses..................................... --
Accounting fees and expenses................................... 60,000
Legal fees and expenses........................................ 200,000
Transfer Agent and Registrar Fees.............................. 6,537
Printing and miscellaneous..................................... 175,000
--------
Total................................................ $466,000
========
</TABLE>

ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS.

The Registrant's Amended and Restated Articles of Incorporation (the
"Restated Articles") include a provision that eliminates the personal liability
of its directors to the Registrant and its shareholders for monetary damages for
breach of the directors' fiduciary duties to the maximum extent permitted under
California law. This limitation has no effect on a director's liability (i) for
acts or omissions that involve intentional misconduct or a knowing and culpable
violation of law, (ii) for acts or omissions that a director believes to be
contrary to the best interests of the Registrant or its shareholders or that
involve the absence of good faith on the part of the director, (iii) for any
transaction from which a director derived an improper personal benefit, (iv) for
acts or omissions that show a reckless disregard for the director's duty to the
Registrant or its shareholders in circumstances in which the director was aware,
or should have been aware, in the ordinary course of performing a director's
duties, of a risk of a serious injury to the Registrant or its shareholders, (v)
for acts or omissions that constitute an unexcused pattern of inattention that
amounts to an abdication of the director's duty to the Registrant or its
shareholders, (vi) under Section 310 of the California Corporations Code (the
"California Code") (concerning contracts or transactions between the Registrant
and a director) or (vii) under Section 316 of the California Code (concerning
directors' liability for improper dividends, loans and guarantees). The
provision does not extend to acts or omissions of a director in his capacity as
an officer. Further, the provision has no effect on claims arising under federal
or state securities laws and will not affect the availability of injunctions and
other equitable remedies available to the Registrant's shareholders for any
violation of a director's fiduciary duty to the Registrant or its shareholders.

The Restated Articles also include an authorization for the Registrant to
indemnify its agents (as defined in Section 317 of the California Code), through
bylaws provisions, by agreement or otherwise, to the fullest extent permitted by
law. Pursuant to this latter provision, the Registrant's Bylaws provide for
indemnification of the Registrant's directors, officers and employees.
Indemnification may only be authorized by a majority of Registrant's directors
or shareholders or by order of a court, unless the agent has been successful on
the merits. In addition, the Registrant's policy is to enter into
indemnification agreements with each of its officers and directors. These
indemnification agreements provide that directors and officers will be
indemnified and held harmless to the fullest extent permitted by law. These
agreements, together with the Restated Articles, may require the Registrant,
among other things, to indemnify such directors, officers and employees against
certain liabilities that may arise by reason of their status or service as
directors or officers (other than liabilities resulting from willful misconduct
of a culpable nature), to advance expenses to them as they are incurred,
provided that they undertake to repay the amount advanced if it is ultimately
determined by a court that they

II-1
<PAGE> 79

are not entitled to indemnification, and to obtain directors' and officers'
insurance if available on reasonable terms.

The Underwriting Agreement referred to below sets forth certain provisions
with respect to the indemnification of the Registrant and certain directors,
officers, and controlling persons against certain losses and liabilities,
including certain liabilities under the Securities Act.

The Amended and Restated Registration Rights Agreement dated April 10,
1992, entered into by and among the Registrant and various investors, and the
Amended and Restated Registration Rights Agreement dated February 10, 1995,
entered into by and among the Registrant and various investors provide for cross
indemnification of certain holders of Registrant's securities, and of Registrant
and its officers and directors for certain liabilities existing under the
Securities Act and otherwise.

The Registrant also maintains a director and officer liability policy.

ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES.

1. Bridge Financing. On December 7, 1994, the Company issued $536,000
principal amount of Bridge Notes and Bridge Warrants to acquire 76,571 shares of
Common Stock in a private placement transaction 21. Net proceeds were
approximately $455,000. The foregoing securities were issued in reliance upon
Section 4(2) of the Securities Act, based primarily upon the fact that the
holders were small in number, were sophisticated and were familiar with the
business of the Company.

In February 1995, the Company issued an additional $1,679,800 principal
amount of Bridge Notes and Bridge Warrants to acquire 239,971 shares of Common
Stock in a private placement transaction to 15 investors. Net proceeds were
approximately $1,537,000. The foregoing securities were issued in reliance upon
Section 4(2) of the Securities Act, based primarily upon the fact that the
holders were small in number, were sophisticated and were familiar with the
business of the Company.

In June 1995, the Company issued an additional $70,000 principal amount of
Bridge Notes and Bridge Warrants in a private placement transaction to three
investors. Net proceeds were approximately $64,400. The foregoing securities
were issued in reliance upon Section 4(2) of the Securities Act, based primarily
upon the fact that the holders were small in number, were sophisticated and were
familiar with the business of the Company.

2. Series A Convertible Preferred Stock. In April 1996, the Company issued
750,000 shares of Convertible Series A Preferred Stock ("Series A Preferred") in
a private placement transaction to 18 investors. Net proceeds were approximately
$6.8 million. This Series A Preferred was convertible into shares of Common
Stock based on a formula. As of the date of this Registration Statement, all
750,000 shares of Series A Preferred had converted into Common Stock. The
foregoing securities were issued in reliance upon Section 4(2) of the Securities
Act, based primarily upon the fact that the holders were smaller in number, were
sophisticated and were familiar with the business of the Company, and in
reliance upon Regulation S promulgated under the Securities Act.

3. In July 1997, the Company issued 1,547,827 shares of Common Stock in a
private placement transaction. Net proceeds were approximately $3,800,000. The
foregoing securities were issued in reliance upon Section 4(2) of the Securities
Act, based primarily upon the fact that the holders were small in number, were
sophisticated and were familiar with the business of the Company.

4. Before the Company's initial public offering in August 1995, the Company
issued certain options to require shares of Common Stock to a limited number of
employees and consultants. All of such issuances were under the Company's stock
option plan. No consideration was paid to the Company by any recipient of any of
the foregoing options for the grant of any such options. The options were
granted, and shares were issued upon exercise of such options, in reliance on
Section 4(2) of the Securities Act and Section 3(b) of the

II-2
<PAGE> 80

Securities Act and Rule 701 promulgated thereunder. The Company has also issued
common stock purchase warrants to a limited number of investor relations firms
and other consultants. No consideration was paid to the Company by any recipient
of any such warrants for the grant of such warrants. The warrants were issued in
reliance on Section 4(2) of the Securities Act, based primarily upon the fact
that the holders were small in number, were sophisticated and were familiar with
the business of the Company.

5. In November 1997, the Company issued 33,057 shares of Common Stock to
Neptune Pharmaceutical Corporation pursuant to the Anogesic Agreement, in
connection with the proposed acquisition by the Company of the Anogesic product
candidate by the Company. The forgoing securities were issued in reliance on
Section 4(2) of the Securities Act, based primarily upon the fact that the
holders were small in number, were sophisticated and were familiar with the
business of the Company.

ITEM 16. EXHIBITS.

The following exhibits are filed herewith or incorporated by reference
herein:

I. EXHIBITS

(a) The following exhibits are attached hereto or incorporated herein by
reference.

<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT TITLE
- ------ -----------------------------------------------------------------------------------
<C> <S>
1.1 Form of Underwriting Agreement.*
3.1 Amended and Restated Articles of Incorporation of the Company. (Incorporated by
reference to Exhibit 3.2 to the Company's Registration Statement on Form SB-2
(Registration No. 33-93288 LA) declared effective on August 11, 1995 (the
"SB-2")).*
3.2 Bylaws of the Company. (Incorporated by reference to Exhibit 3.3 to the SB-2).*
4.1 Specimen Common Stock Certificate. (Incorporated by reference to Exhibit 4.1 to the
SB-2).*
4.2 Specimen Warrant Certificate. (Incorporated by reference to Exhibit 4.2 to the
SB-2).*
4.3 Form of Underwriter Warrant.*
5.1 Opinion of Fenwick & West LLP.
10.1 Barrier Repair Formulations License Agreement, dated October 26, 1993 between the
Company and the University of California. (Incorporated by reference to Exhibit
10.5 to the SB-2).*
10.2 License Agreement, dated March 4, 1994, regarding Drug Delivery by Skin Barrier
Disruption, between the Company and University of California. (Incorporated by
reference to Exhibit 10.6 to the SB-2).*
10.3 Agreement dated May 14, 1997, between the Company and the University of California.
(Confidential treatment has been requested with respect to the information
contained within the ["**"] markings. Such marked portions have been omitted from
this filing and have been filed separately with the Securities and Exchange
Commission).*
10.4 Agreement dated October 6, 1997, between the Company and the University of
California.* (Confidential treatment has been requested with respect to the
information contained within the ["**"] markings. Such marked portions have been
omitted from this filing and have been filed separately with the Securities and
Exchange Commission).
**10.5 Employment Agreement, dated as of January 21, 1996, between the Company and Dr.
Carl Thornfeldt. (Incorporated by reference to Exhibit 10.7 to the Company's Form
10-KSB for fiscal year ended December 31, 1995 (the "1995 Form 10-KSB").*
10.6 Employment Agreement dated November 20, 1996, between the Company and K. Michael
Forrest. (Incorporated by reference to Exhibit 10.19 to the Company's Form 10-KSB
for the fiscal year ended December 31, 1996 (the "1996 Form 10-KSB").*
10.7 Amended and Restated Registration Rights Agreement dated April 10, 1992.
(Incorporated by reference to Exhibit 10.11 to the SB-2).*
</TABLE>

II-3
<PAGE> 81

<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT TITLE
- ------ -----------------------------------------------------------------------------------
<C> <S>
10.8 Amended and Restated Registration Rights Agreement dated as of February 10, 1995.
(Incorporated by reference to Exhibit 10.14 to the SB-2).*
10.9 1995 Equity Incentive Plan (Incorporated by reference to Exhibit 10.17 to the 1995
Form 10-KSB).*
**10.10 1995 Directors' Stock Option Plan (Incorporated by reference to Exhibit 10.18 to
the 1995 Form 10-KSB).*
10.11 Standard Industrial Lease dated April 6, 1992, between the Company and H&H
Management. (Incorporated by reference to Exhibit 10.20 to the 1995 Form 10-KSB).*
10.12 Exclusive Licensing Agreement for Glylorin between the Company and Glaxo Wellcome,
Inc. dated November 11, 1996. (Incorporated by reference to Exhibit 10.20 to the
1996 Form 10-KSB). (Confidential treatment has been requested with respect to the
information contained within the ["**"] markings. Such marked portions have been
omitted from this filing and have been filed separately with the Securities and
Exchange Commission).*
*10.13 Consulting Agreement between the Company and Dr. Peter M. Elias dated May 1, 1996.
(Incorporated by reference to Exhibit 10.21 to the Form 10-KSB).*
10.14 Binding Letter of Intent dated November 3, 1997 between the Company and Neptune
Pharmaceutical Corporation. (Confidential Treatment has been requested with respect
to the information contained within the ["**"] markings. Such marked portions have
been omitted from this filing and have been filed separately with the Securities
and Exchange Commission).*
23.1 Consent of Ernst & Young LLP, Independent Auditors.
23.2 Consent of Fenwick & West LLP (contained in Exhibit 5.1).
24.1 Power of Attorney (See signature page).
</TABLE>

- ---------------
* Previously filed.

** Represents a management contract or compensatory plan or arrangement.

ITEM 17. UNDERTAKINGS.

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

The undersigned Registrant hereby undertakes:

(1) That, for the purpose of determining any liability under the
Securities Act, each post-effective amendment shall be deemed a
new registration statement relating to the securities offered
therein, and the offering of the securities at that time shall be
deemed to be the initial bona fide offering thereof.

(2) That, for purposes of determining any liability under the
Securities Act, each filing of the Registrant's annual report
pursuant to Section 13(a) or Section 15(d) of the Exchange Act
that is incorporated by reference in this Registration Statement
shall be deemed to be a new Registration Statement relating to the
securities offered therein, and the offering of such securities at
that time shall be deemed to be the initial bona fide offering
thereof.

II-4
<PAGE> 82

SIGNATURES

In accordance with the requirements of the Securities Act of 1933, the
registrant certifies that it has reasonable grounds to believe that it meets all
of the requirements for filing on Form S-1 and authorized this Amendment No. 2
to the Registration Statement to be signed on its behalf by the undersigned,
thereunto duly authorized, in the City of Foster City, State of California, on
November 19, 1997.

CELLEGY PHARMACEUTICALS, INC.

By: /s/ K. MICHAEL FORREST
------------------------------------
K. Michael Forrest
President and Chief Executive
Officer

In accordance with the requirements of the Securities Act of 1933, this
Amendment No. 2 to the Registration Statement has been signed by the following
persons in the capacities and on the dates stated.

<TABLE>
<CAPTION>
NAME TITLE DATE
- --------------------------------------------- ---------------------------- ------------------
<C> <S> <C>
PRINCIPAL EXECUTIVE OFFICER:

/s/ K. MICHAEL FORREST President, Chief Executive November 19, 1997
- --------------------------------------------- Officer and Director
K. Michael Forrest
PRINCIPAL FINANCIAL OFFICER AND PRINCIPAL
ACCOUNTING OFFICER:

/s/ A. RICHARD JUELIS Vice President, Finance, November 19, 1997
- --------------------------------------------- Chief Financial Officer
A. Richard Juelis and Secretary

DIRECTORS:

/s/ CARL R. THORNFELDT, M.D.* Chairman of the Board of November 19, 1997
- --------------------------------------------- Directors
Carl R. Thornfeldt, M.D.

/s/ JACK L. BOWMAN* Director November 19, 1997
- ---------------------------------------------
Jack L. Bowman

/s/ DENIS R. BURGER, PH.D.* Director November 19, 1997
- ---------------------------------------------
Denis R. Burger, Ph.D.

/s/ TOBI B. KLAR, M.D.* Director November 19, 1997
- ---------------------------------------------
Tobi B. Klar, M.D.

/s/ ALAN A. STEIGROD* Director November 19, 1997
- ---------------------------------------------
Alan A. Steigrod

/s/ LARRY J. WELLS* Director November 19, 1997
- ---------------------------------------------
Larry J. Wells

*By: /s/ K. MICHAEL FORREST
----------------------------------------
K. Michael Forrest
Attorney-in-Fact
</TABLE>

II-5
<PAGE> 83

EXHIBIT INDEX

<TABLE>
<CAPTION>
EXHIBIT SEQUENTIALLY
NUMBER DESCRIPTION OF DOCUMENT NUMBERED PAGE
- ------ -------------------------------------------------------------------- -------------
<C> <S> <C>
1.1 Form of Underwriting Agreement.*
3.1 Amended and Restated Articles of Incorporation of the Company.
(Incorporated by reference to Exhibit 3.2 to the Company's
Registration Statement on Form SB-2 (Registration No. 33-93288 LA)
declared effective on August 11, 1995 (the "SB-2")).*
3.2 Bylaws of the Company. (Incorporated by reference to Exhibit 3.3 to
the SB-2).*
4.1 Specimen Common Stock Certificate. (Incorporated by reference to
Exhibit 4.1 to the SB-2).*
4.2 Specimen Warrant Certificate. (Incorporated by reference to Exhibit
4.2 to the SB-2).*
4.3 Form of Underwriter Warrant.*
5.1 Opinion of Fenwick & West LLP.
10.1 Barrier Repair Formulations License Agreement, dated October 26,
1993 between the Company and the University of California.
(Incorporated by reference to Exhibit 10.5 to the SB-2).*
10.2 License Agreement, dated March 4, 1994, regarding Drug Delivery by
Skin Barrier Disruption, between the Company and University of
California. (Incorporated by reference to Exhibit 10.6 to the
SB-2).*
10.3 Agreement dated May 14, 1997, between the Company and the University
of California. (Confidential treatment has been requested with
respect to the information contained within the ["**"] markings.
Such marked portions have been omitted from this filing and have
been filed separately with the Securities and Exchange Commission).*
10.4 Agreement dated October 6, 1997, between the Company and the
University of California. (Confidential treatment has been requested
with respect to the information contained within the ["**"]
markings. Such marked portions have been omitted from this filing
and have been filed separately with the Securities and Exchange
Commission).*
**10.5 Employment Agreement, dated as of January 21, 1996, between the
Company and Dr. Carl Thornfeldt. (Incorporated by reference to
Exhibit 10.7 to the Company's Form 10-KSB for fiscal year ended
December 31, 1995 (the "1995 Form 10-KSB").*
10.6 Employment Agreement dated November 20, 1996, between the Company
and K. Michael Forrest. (Incorporated by reference to Exhibit 10.19
to the Company's Form 10-KSB for the fiscal year ended December 31,
1996 (the "1996 Form 10-KSB").*
10.7 Amended and Restated Registration Rights Agreement dated April 10,
1992. (Incorporated by reference to Exhibit 10.11 to the SB-2).*
10.8 Amended and Restated Registration Rights Agreement dated as of
February 10, 1995. (Incorporated by reference to Exhibit 10.14 to
the SB-2)*.
10.9 1995 Equity Incentive Plan (Incorporated by reference to Exhibit
10.17 to the 1995 Form 10-KSB).*
**10.10 1995 Directors' Stock Option Plan (Incorporated by reference to
Exhibit 10.18 to the 1995 Form 10-KSB).*
10.11 Standard Industrial Lease dated April 6, 1992, between the Company
and H&H Management. (Incorporated by reference to Exhibit 10.20 to
the 1995 Form 10-KSB).*
</TABLE>

<PAGE> 84

<TABLE>
<CAPTION>
EXHIBIT SEQUENTIALLY
NUMBER DESCRIPTION OF DOCUMENT NUMBERED PAGE
- ------ -------------------------------------------------------------------- -------------
<C> <S> <C>
10.12 Exclusive Licensing Agreement for Glylorin between the Company and
Glaxo Wellcome, Inc. dated November 11, 1996. (Incorporated by
reference to Exhibit 10.20 to the 1996 Form 10-KSB). (Confidential
treatment has been requested with respect to the information
contained within the ["**"] markings. Such marked portions have been
omitted from this filing and have been filed separately with the
Securities and Exchange Commission).*
**10.13 Consulting Agreement between the Company and Dr. Peter M. Elias
dated May 1, 1996. (Incorporated by reference to Exhibit 10.21 to
the Form 10-KSB).*
10.14 Binding Letter of Intent dated November 3, 1997 between the Company
and Neptune Pharmaceutical Corporation. (Confidential Treatment has
been requested with respect to the information contained within the
["**"] markings. Such marked portions have been omitted from this
filing and have been filed separately with the Securities and
Exchange Commission).*
23.1 Consent of Ernst & Young LLP, Independent Auditors.
23.2 Consent of Fenwick & West LLP (contained in Exhibit 5.1).
24.1 Power of Attorney (See signature page).
</TABLE>

- ---------------
* Previously filed.

** Represents a management contract or compensatory plan or arrangement.

<PAGE> 1

EXHIBIT 5.1

November 18, 1997

Cellegy Pharmaceuticals, Inc.
1065 E. Hillsdale Blvd.
Suite 418
Foster City, CA 94404

Gentlemen/Ladies:

At your request, we have examined the Registration Statement on Form S-1
(the "Registration Statement") filed by you with the Securities and Exchange
Commission (the "Commission") on or about October 17, 1997, as amended, in
connection with the registration under the Securities Act of 1933, as amended,
of an aggregate of 2,012,500 shares of your Common Stock (the "Stock"), all of
which will be sold by the Company.

In rendering this opinion, we have examined the following:

(1) the Registration Statement, together with the Exhibits filed as a
part thereof;

(2) your registration statement on Form 8-A filed with the Commission
in connection with the Company's initial public offering in August 1995;

(3) the Prospectus prepared in connection with the Registration
Statement;

(4) the minutes of meetings and actions by written consent of the
Board of Directors that are contained in your minute books and that are in
our possession, that relate to issuance of the Stock;

(5) the articles of incorporation of the Company as amended through
the date of this opinion and the Bylaws of the Company, both certified by
the Secretary of the Company on October 17, 1997; and

(6) a Management Certificate addressed to us and dated of even date
herewith executed by the Company containing certain factual and other
representations.

In our examination of documents for purposes of this opinion, we have
assumed, and express no opinion as to, the genuineness of all signatures on
original documents, the authenticity of all documents submitted to us as
originals, the conformity to originals of all documents submitted to us as
copies, the legal capacity of all natural persons executing the same, the lack
of any undisclosed terminations, modifications, waivers or amendments to any
documents reviewed by us and the due execution and delivery of all documents
where due execution and delivery are prerequisites to the effectiveness thereof.

As to matters of fact relevant to this opinion, we have relied solely upon
our examination of the documents referred to above and have assumed the current
accuracy and completeness of the information obtained from records included in
the documents referred to above. We have made no independent investigation or
other attempt to verify the accuracy of any of such information or to determine
the existence or non-existence of any other factual matters; however, we are not
aware of any facts that would lead us to believe that the opinion expressed
herein is not accurate.

In rendering any opinion that the shares of Stock are, or will when issued
be, "fully paid," we have assumed that such shares will be issued in accordance
with the terms of the underwriting agreement attached as an exhibit to the
Registration Statement, and that the Company will receive full consideration for
the issuance of such shares provided for in such agreement.

Based upon the foregoing, it is our opinion that the shares of Stock to be
sold by the Company pursuant to the Registration Statement are legally issued
and nonassessable and, to our knowledge, fully paid.

We consent to the use of this opinion as an exhibit to the Registration
Statement and further consent to all references to us, if any, in the
Registration Statement, the Prospectus constituting a part thereof and any
amendments thereto.

This opinion speaks only as of its date and is intended solely for your use
as an exhibit to the Registration Statement for the purpose of the above sale of
the Stock and is not to be relied upon for any other purpose.

Very truly yours,

FENWICK & WEST LLP
By: /s/ Fenwick & West LLP

<PAGE> 1

EXHIBIT 23.1

CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

We consent to the reference to our firm under the caption "Experts" and to
the use of our report dated February 5, 1997, except note 10, as to which the
date is November 5, 1997, in the Registration Statement (Form S-1) No.
333-38179, as amended, and related Prospectus of Cellegy Pharmaceuticals, Inc.
for the registration of 2,012,500 shares of its Common Stock.

/s/ ERNST & YOUNG LLP

San Jose, California
November 14, 1997