<PAGE>   1
 
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                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                            ------------------------
 
                                   FORM 10-K
 
              ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
                      SECURITIES AND EXCHANGE ACT OF 1934
                    FOR FISCAL YEAR ENDED SEPTEMBER 30, 1996
 
                                    0-14732
                            (COMMISSION FILE NUMBER)
 
                            ADVANCED MAGNETICS, INC.
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
 

<TABLE>
<S>                                           <C>
                   DELAWARE                                     4-2742593
           (STATE OF INCORPORATION)                (IRS EMPLOYER IDENTIFICATION NUMBER)

              725 CONCORD AVENUE                                  02138
           CAMBRIDGE, MASSACHUSETTS                             (ZIP CODE)
   (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
</TABLE>

 
                                 (617) 354-3929
                        (REGISTRANT'S TELEPHONE NUMBER)
 
          SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
                     Common Stock, par value $.01 per share
 
     Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.  Yes X  No  _
 
     Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.  [X]
 
     The aggregate market value of Common Stock held by nonaffiliates of the
registrant at December 16, 1996 was approximately $93,373,851, based upon the
last reported sale price of the Common Stock on The American Stock Exchange. The
number of shares of the registrant's Common Stock outstanding at December 16,
1996 was 6,796,318.
 
                      DOCUMENTS INCORPORATED BY REFERENCE
 
     Portions of the Company's Proxy Statement relating to the Company's Annual
Meeting of Stockholders to be held on February 4, 1997 are incorporated by
reference into Part III hereof.
 
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<PAGE>   2
 

                                     PART I
 

ITEM 1.  BUSINESS:
 
COMPANY OVERVIEW
 
     Advanced Magnetics, Inc., a Delaware Corporation ("Advanced Magnetics" or
the "Company"), develops, manufactures and markets organ-specific contrast
agents to improve the diagnostic capabilities of soft tissue magnetic resonance
imaging ("MRI") scans and is developing a targeted drug delivery platform that
delivers therapeutics directly to the liver. Sales of the Company's liver
contrast agent, Feridex I.V., have commenced in Europe. The Company received
U.S. Food and Drug Administration ("FDA") approval to market Feridex I.V. in
August 1996 and sales commenced in the United States in October 1996.
GastroMARK, used for marking of the bowel in MRI procedures, has been approved
for marketing in several European countries and Canada, and the Company received
approval to market GastroMARK in the United States in December 1996. With
respect to Combidex, the Company's contrast agent for the liver, spleen,
lymphatic system and blood flow, the Company is currently in Phase III trials
for lymph node imaging and in Phase II for magnetic resonance angiography
("MRA"). The Company has completed Phase III trials for Combidex in the United
States for imaging liver lesions and hopes to submit a New Drug Application
("NDA") to the FDA in 1997. Advanced Magnetics is also applying its
liver-targeting technology and expertise to the delivery of therapeutics to the
liver.
 
     MRI is a diagnostic imaging technique that is used to identify internal
abnormalities and changes in structure. Contrast agents increase the usefulness
of MRI by allowing radiologists to differentiate structures and organs with
greater diagnostic confidence. The Company believes that MRI studies produced
with contrast agents are clearer and permit the identification of smaller
abnormalities than images produced by MRI without contrast agents or contrast
enhanced computer tomography ("CECT"). MRI contrast agents frequently allow for
more accurate diagnosis and monitoring of treatment results and may be a
cost-effective way to assess medical treatments and to improve patient outcomes.
Currently, the primary use of MRI is for studies of the central nervous system.
The Company believes that the development of effective contrast agents will
increase the use of MRI as a diagnostic imaging technique and will allow MRI to
be used for a wider range of applications, in turn generating additional demand
for MRI contrast agents.
 
     Feridex I.V. is the first organ-specific MRI contrast agent, designed
specifically for the liver, marketed in the United States and Europe. The liver
and the lymphatic system are among the principal sites for metastasis of many
common cancers (including colon, prostate and breast cancer). CECT is currently
the primary imaging technique used to confirm a preliminary or suspected
diagnosis of liver cancer. With respect to the lymphatic system, there currently
are no effective imaging techniques. An MRI contrast agent that localizes to and
causes contrast enhancement of the lymph nodes, such as the Combidex product the
Company has under development, could allow for more accurate disease diagnosis
and monitoring of treatment results. The Company believes that GastroMARK,
because it enhances the contrast between the bowel and other abdominal
structures, will increase the use of MRI as an imaging technology for the
abdomen.
 
     To facilitate the marketing and distribution of its contrast agents, the
Company has entered into strategic relationships with certain established
pharmaceutical companies. These relationships, both in the United States and
abroad, include: (i) Guerbet, S.A. ("Guerbet"), a leading European producer of
contrast agents, in Western Europe and Brazil; (ii) Eiken Chemical Co., Ltd.,
("Eiken"), one of Japan's leading medical diagnostics manufacturers, in Japan;
(iii) Berlex Laboratories, Inc. ("Berlex"), the leading marketer of MRI contrast
agents, in the United States; and (iv) Mallinckrodt Medical, Inc.
("Mallinckrodt"), a leading manufacturer of contrast agents, in the United
States, Canada and Mexico.
 
     The Company's expertise in organ-specific technology provides it with
biopharmaceutical opportunities beyond its core MRI contrast agent products.
Advanced Magnetics is developing targeted therapeutics technology for the
treatment of liver diseases. The Company believes that arabinogalactan, a
naturally occurring polysaccharide that binds to the asialoglycoprotein ("ASG")
receptor found in abundance on hepatocytes, the principal cells comprising the
liver, has commercial promise in drug delivery. Advanced Magnetics hopes to
study the efficacy of therapeutic agents combined with arabinogalactan for the
treatment of liver diseases through strategic alliances with other
pharmaceutical companies that the Company may establish.
 
                                        1

<PAGE>   3
 
     The Company was incorporated in Delaware in 1981. The Company's principal
executive offices are located at 725 Concord Avenue, Cambridge, Massachusetts
02138, and its telephone number is (617) 354-3929.
 
MRI CONTRAST AGENTS
 
     OVERVIEW
 
     Diagnostic Imaging.  Diagnostic imaging is generally a non-invasive method
to visualize internal structures, abnormalities or anatomical changes in order
to diagnose disease and injury. Today, the most widely accepted imaging
techniques include x-rays, ultrasound, nuclear medicine, CT and MRI. Since the
introduction of x-rays, the need for increasingly accurate and detailed
non-invasive visualization of soft tissue has increased. For example, diagnostic
imaging frequently is used to determine whether a cancer has metastasized and to
assist physicians in determining whether a treated cancer has recurred and the
location of metastatic tumors. In addition, diagnostic imaging is used in the
diagnosis of disease and injury conditions affecting the cardiovascular and
central nervous systems and certain joints, such as the knee and shoulder. In
1994, over 76 million soft tissue and organ imaging procedures were performed in
the United States. The choice of diagnostic imaging technique to be used in any
particular circumstance depends upon a variety of factors, including the
particular disease or condition to be studied, image quality, availability of
imaging machines, availability of contrast agents and cost. There is no imaging
technique that is considered superior to all others for most or all
applications.
 
     Contrast agents play a significant role in improving the quality of
diagnostic images by increasing contrast between different internal structures
or types of tissues. The availability of an effective contrast agent often
determines the choice of imaging technique for a particular procedure.
Consequently, contrast agents, which are administered intravenously or orally,
are widely used when available. Currently available imaging techniques can be of
limited usefulness in visualizing certain soft-tissue structures. For example,
clinically useful diagnostic imaging of small lesions in lymph nodes, a common
site of metastasis for some frequently occurring cancers such as breast cancer,
is not currently available because, the Company believes, there are no effective
contrast agents for differentiating cancerous lymph nodes from other nodes.
 
     Magnetic Resonance Imaging.  Introduced in the 1980's, MRI is the
diagnostic imaging technique of choice for the central nervous system and is
widely used for the imaging of ligaments and tendons. MRI, which represents the
first major advance in imaging since the advent of CT scanning, provides
high-quality spatial resolution and does not use radiation. In MRI procedures,
the patient is placed within the core of a large magnet where radio frequency
signals are transmitted into the patient's body. The interaction of the radio
frequency signal with the patient's body produces signals that are processed by
a computer to create cross-sectional images. MRI contrast agents currently
marketed in the United States are used primarily in imaging the central nervous
system.
 
     TECHNOLOGY
 
     Advanced Magnetics' core imaging agent technology is based on the design
and manufacture of extremely small, polysaccharide-coated superparamagnetic iron
oxide particles of controlled sizes. The superparamagnetic particles range in
size from approximately one-thousandth to one-twentieth the size of a normal red
blood cell. When placed in a magnetic field, superparamagnetic iron oxide
particles become strongly magnetic, but do not retain their magnetism once the
field is removed. The powerful magnetic properties of the Company's iron oxide
particles result in images that show greater soft tissue contrast to increase
the information available to the reviewing radiologist. The Company's technology
and expertise enable it to synthesize, sterilize and stabilize superparamagnetic
particles in a manner necessary for their use in pharmaceutical products as MRI
contrast agents to aid in the diagnosis of cancer and other diseases. The
Company's rights to its contrast agent technology are derived from and protected
by license agreements, patents, patent applications and trade secrets. See
"Patents and Trade Secrets."
 
                                        2

<PAGE>   4
 
TARGETED DRUG DELIVERY PLATFORM
 
     OVERVIEW
 
     Effective treatment of organ-specific diseases is often limited by the
inability to deliver sufficient quantities of therapeutic pharmaceuticals to the
affected organ without creating unacceptable levels of toxicity in the rest of
the body. The Company believes the treatment of liver disease and other
organ-specific diseases would be significantly improved by delivering
therapeutics to the organ while limiting the exposure of the rest of the body to
the drug. The Company discovered that arabinogalactan, a compound it studied to
target contrast agents to the liver, could be useful in delivering therapeutic
agents to hepatocytes, cells which comprise approximately 95% of the liver but
do not exist in the rest of the body. The Company's first therapeutic product,
under development to demonstrate the technical feasibility of its approach, is a
conjugate of arabinogalactan and vidarabine monophosphate ("AraAMP") for the
treatment of hepatitis B.
 
     TECHNOLOGY
 
     The Company's drug delivery technology includes joining a therapeutic agent
to a targeting agent, which binds specifically with certain receptors on the
surface of cells. Receptors are specialized protein structures that will only
bind with specific molecules. Certain receptors are prevalent only or primarily
on specific kinds of cells. For example, the ASG receptor exists primarily on
hepatocytes. After binding with the receptor, the targeting agent and an
attached pharmaceutical are transported into the cell, where the pharmaceutical
causes a therapeutic effect. The Company believes that targeted drug delivery
based on the binding action of targeting agents to receptors offers the
possibility of delivering effective therapeutic doses to affected cells without
general distribution of toxic agents throughout the body.
 
     In its first targeted drug delivery proof of principle project, the Company
has completed animal testing of a potential therapeutic product for hepatitis B
composed of AraAMP and arabinogalactan. Vidarabine ("AraA"), an antiviral agent
which is used in the United States and abroad for the treatment of herpes
simplex, has not been approved for treatment of hepatitis B in the United States
because, although it is an effective agent against the hepatitis virus, when
administered systemically in an unconjugated form, it is often toxic to the bone
marrow, blood cells and peripheral nervous system in the dosage regimen
necessary to treat the hepatitis B virus. AraA and other nucleoside products
must be phosphorylated with three phosphate ions in order to have a therapeutic
effect. When AraA is injected directly, however, many molecules of AraA do not
become phosphorylated. The Company believes that much of the toxicity associated
with AraA results from toxic compounds created when the drug breaks down in the
body. The Company has discovered that AraA, when phosphorylated with one
phosphate (monophosphate) and chemically linked with arabinogalactan prior to
injection, shows far greater therapeutic effect in animals and reduced toxicity.
Toxicity is reduced because (i) less therapeutic compound is needed since AraAMP
is directed by the arabinogalactan to hepatocytes through the ASG receptor, (ii)
the probability of successful triphosphorylation is increased by the targeted
delivery of the monophosphate to the cell and (iii) the arabinogalactan AraAMP
conjugate does not, the Company believes, metabolize into any toxic product
during its short blood half-life.
 
     The Company believes that the delivery and use enhancements seen when
AraAMP is attached to arabinogalactan may be obtained with other therapeutic
agents. The attachment of a variety of therapeutic agents to arabinogalactan,
such as ribavirin and acyclovir, is an active area of research for Advanced
Magnetics and may lead to a series of arabinogalactan delivered pharmaceuticals
for the treatment of such liver diseases as hepatitis B, hepatitis C, hepatitis
D and liver cancer. The Company is attempting to establish strategic alliances
with other pharmaceutical companies to exploit the advantages of its drug
delivery platform and polysaccharide conjugation technology.
 
     The Company holds three United States patents and a notice of allowance for
a European patent covering the delivery of therapeutic agents with
arabinogalactan. A fourth patent covering the use of arabinogalactan with
radiotherapy has been issued in the United States. The Company has also
developed a proprietary purification scheme for purifying arabinogalactan that
enables it to manufacture a pharmaceutical grade of arabinogalactan suitable for
use in therapeutic products. See "Patents and Trade Secrets."
 
                                        3

<PAGE>   5
 
PRODUCTS UNDER DEVELOPMENT
 
     The following table summarizes potential applications, marketing partners
and current United States and foreign status for each of the company's products.

<TABLE>
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                 ADVANCED MAGNETICS PRODUCTS UNDER DEVELOPMENT
 

<CAPTION>
                                         MARKETING        UNITED STATES         FOREIGN
     PRODUCT        APPLICATIONS         PARTNERS            STATUS             STATUS
- ----------------- -----------------  -----------------  -----------------  -----------------
<S>               <C>                <C>                <C>                <C>
CONTRAST AGENTS
Feridex I.V.      Diagnosis of       Berlex (United     FDA approval       Approved and
                  liver lesions      States), Eiken     received in        marketed in most
                                     (Japan), Guerbet   August 1996.       EU countries.
                                     (Western Europe    Marketing of       Japanese NDA
                                     and Brazil)        product began in   filed in March
                                                        October 1996.      1994. Approval
                                                                           expected in late
                                                                           1997.
Combidex          Diagnosis of       Guerbet (Western   Phase III          Phase III
                  lesions of the     Europe and         liver/spleen       clinical trials
                  liver, spleen and  Brazil), Eiken     trial completed    for lymphatic
                  lymphatic system,  (Japan)            in 1996. Phase II  imaging began in
                  as well as blood                      clinical trials    Europe in 1996.
                  flow in MRA                           for MRA and Phase
                                                        III for lymph
                                                        nodes currently
                                                        under way.
GastroMARK        Marking of the     Guerbet (Western   FDA approval       Approved and
                  bowel in           Europe and         received in        marketed in many
                  abdominal imaging  Brazil),           December 1996.     European
                                     Mallinckrodt                          countries,
                                     (United States,                       including France.
                                     Canada and                            Approved in
                                     Mexico)                               Canada.
TARGETED DRUG DELIVERY PRODUCTS
AraAMP-
arabinogalactan
conjugate         Therapeutic for    --                 Pre-clinical       Phase I Clinical
                  hepatitis B                           research           trials began in
                                                        completed.         Germany in July
                                                                           1996.
                                                                           Discontinued in
                                                                           December 1996 due
                                                                           to inadequate
                                                                           patient
                                                                           enrollment after
                                                                           testing only two
                                                                           patients in the
                                                                           first five
                                                                           months.
Ribavirin-
arabinogalactan
conjugate         Therapeutic for    --                 Pre-clinical       --
                  hepatitis C                           research in
                                                        progress.
- ---------------------------------------------------------------------------------------------------------- 
</TABLE>

 
     "Phase I clinical trials" refers to the first phase of human pharmaceutical
clinical trials in which testing for the safety and tolerance of the product is
conducted on a small group of normal subjects. "Phase II clinical trials" and
"Phase III clinical trials" refer to the second and third phases of human
clinical trials, where preliminary dosing and efficacy studies are conducted and
where additional testing for efficacy and safety is conducted on an expanded
patient group. For a further description of the substantial regulatory
requirements subsequent to the completion of preclinical testing, see
"Government Regulation and Reimbursement."
 
                                        4

<PAGE>   6
 
     CONTRAST AGENTS
 
     Feridex I.V.  The liver is a principal site for metastasis of primary
cancer originating in other parts of the body, particularly cancer of the colon,
a common cancer in the United States. Diagnosis of metastasis at an early stage
can be difficult because small tumors are frequently not accompanied by
detectable physical symptoms. Identification of metastatic tumors in the liver
has a significant impact on physicians' treatment plans for cancer. The Company
believes that Feridex I.V. will allow for MRI scans of liver tumors that may not
be visible with CT scanning or ultrasound, the most widely used techniques for
liver imaging and that a substantial number of liver scans will now be done
using MRI instead of, or in addition to, CT scanning and ultrasound.
 
     The Company received FDA approval to market Feridex I.V. in August 1996.
Marketing of the product began in October 1996 by Berlex Laboratories in the
United States. Feridex I.V. was approved in August 1994 by the European Union's
(the "EU") Committee for Proprietary Medicinal Products and most of the member
states of the EU have since issued local approvals to market the product.
Guerbet has begun marketing the product in Europe. Eiken filed an application
for Japanese regulatory approval in March 1994 and expects to receive an
approval for marketing in 1997. Berlex Laboratories is the Company's exclusive
marketing partner for Feridex I.V. in the United States. See "Licensing and
Marketing Arrangements."
 
     Combidex.  The Company believes that Combidex will be useful in diagnostic
imaging of the liver, spleen and lymphatic system in MRA. Lymph nodes are
frequently sites for metastases of different types of cancer, particularly
breast cancer and prostate cancer, and efficient imaging of lymph nodes could
play a major role in determining courses of treatment. There are currently no
available noninvasive methods for distinguishing between lymph nodes enlarged by
tumorous infiltration as opposed to inflammation. Since CT, the only imaging
modality currently used for lymph nodes cannot distinguish between enlarged
nodes and cancerous nodes, the current practice is to assume that enlarged nodes
are cancerous and to perform a biopsy to establish their true status. The
Company believes that Combidex will enable doctors using MRI to distinguish
between cancerous and non-cancerous enlarged lymph nodes because its
accumulation in normal lymph node tissue permits differentiation between normal
and tumor-infiltrated nodes.
 
     The long circulating half-life of Combidex may also permit its use in
analyzing the perfusion, or blood flow, in tissues such as the coronary
arteries. Heart attacks and strokes can be caused by decreased blood flow and
the Company believes that Combidex may be useful in delineating the areas of
decreased blood flow or visualizing areas of vascular constriction whether
before or after such a cardiovascular event. The Company also believes that
Combidex can be used to identify tumors in the liver and spleen because tumors
generally have different vascularity than the surrounding tissues.
 
     The Company is preparing an NDA for Combidex as a liver imaging agent,
having completed Phase III trials, and hopes to submit the NDA to the FDA in
1997. Phase III trials in imaging of lymph nodes and Phase II trials in MRA are
currently in progress.
 
     Of the approximately 459 patients and subjects who were administered
Combidex during its product development, one suffered an allergic reaction and
died in January 1996. There can be no assurance that this death or any
subsequent death that may occur during the clinical trials for this product
would not have an adverse effect on the Company's ability to continue clinical
trials or obtain regulatory approvals for Combidex or otherwise have a material
adverse effect on the Company's business, financial condition and results of
operations.
 
     The Company has granted exclusive rights to manufacture, market and sell
Combidex in Japan to Eiken and an exclusive right to market and sell Combidex in
Western Europe and Brazil to Guerbet. See "Licensing and Marketing
Arrangements."
 
     GASTROMARK.  MRI imaging of organs and tissues in the abdomen without
contrast agents is difficult because these organs and tissues cannot be easily
distinguished from the loops of the bowel. GastroMARK, the Company's oral
contrast agent for marking of the bowel, when ingested, flows through and
darkens the bowel. By more clearly identifying the intestinal loops, GastroMARK
improves visualization of adjacent abdominal tissues, including the pancreas and
pelvis.
 
                                        5

<PAGE>   7
 
     The Company received FDA marketing approval for GastroMARK in December
1996. The Company has granted Mallinckrodt the exclusive right to co-market
GastroMARK in the United States, Canada and Mexico. The Company has licensed the
manufacturing and marketing rights to GastroMARK on an exclusive basis to
Guerbet in Western Europe and Brazil. During fiscal 1993, Guerbet received
marketing approval for the product in several European countries including
France, and marketing of the product in Europe has begun. In addition,
GastroMARK was approved for marketing in Canada in 1996. See "Licensing and
Marketing Arrangements."
 
     TARGETED DRUG-DELIVERY PRODUCTS
 
     The Company believes that arabinogalactan will prove useful in delivering
therapeutic pharmaceuticals to the liver because of its lack of toxicity and
high specificity for hepatocytes. The Company began Phase I clinical trials for
the AraAMP conjugate in Germany in July 1996. This trial was terminated in
December 1996 due to inadequate enrollment of patients.
 
     The Company believes that the delivery and use enhancements seen when
AraAMP is attached to arabinogalactan may be obtainable with other therapeutic
agents. The attachment of a variety of therapeutic agents to arabinogalactan,
such as ribavirin and acyclovir, is an active area of research for Advanced
Magnetics and may lead to a series of arabinogalactan-based pharmaceuticals for
the treatment of such liver diseases as hepatitis B, hepatitis C, hepatitis D
and liver cancer.
 
LICENSING AND MARKETING ARRANGEMENTS
 
     BERLEX.  In February 1995, the Company entered into a license and marketing
agreement and supply agreement with Berlex, granting Berlex exclusive marketing
rights to Feridex I.V. in the United States. The Company is responsible for
performing all work necessary to obtain FDA approval for commercial marketing of
Feridex I.V. in the United States. Under the terms of the agreements, Berlex
paid a $5,000,000 license fee upon execution of the agreements and paid an
additional $5,000,000 license fee in October 1996 upon the Company's delivery of
FDA-approved product to Berlex. In addition, the Company will receive payments
for manufacturing the agent and royalties on future sales of the agent. These
agreements expire in 2010 but can be terminated earlier upon the occurrence of
certain specified events.
 
     GUERBET.  In 1987, the Company entered into a supply and distribution
agreement with Guerbet. Under this agreement, Guerbet has been appointed the
exclusive distributor of Feridex I.V. in Western Europe (under the tradename
Endorem) and Brazil. Guerbet is responsible for conducting clinical trials and
securing the necessary regulatory approvals in the countries in its territory.
Guerbet paid the Company license fees and is required to pay royalties based on
sales. The Company is entitled to receive an additional percentage of Guerbet's
sales in return for selling to Guerbet its requirements for the active
ingredient used in Feridex I.V. The agreement terminates on the later of (i) the
expiration of the last to expire technology patent or (ii) ten years after the
date all necessary approvals are obtained in France.
 
     In 1989, the Company entered into a second supply and distribution
agreement with Guerbet granting Guerbet an exclusive right in Western Europe
(under the tradename Lumirem) and Brazil to manufacture and sell GastroMARK and
any future Advanced Magnetics MRI contrast agents that Guerbet decides to
market, including Combidex. Under the terms of this second distribution
agreement, Guerbet paid the Company a license fee in 1989. In addition, Guerbet
will pay the Company both royalties and a percentage of net sales as the
purchase price for the active ingredient. The Company is required to sell to
Guerbet its requirements for the active ingredient used in the contrast agents.
The agreement is perpetual but terminable upon specified events such as
nonperformance, insolvency or assignment without consent.
 
     MALLINCKRODT.  In 1990, the Company entered into a manufacturing and
distribution agreement for GastroMARK with Mallinckrodt Medical, Inc. Under this
agreement, Mallinckrodt received the exclusive right to manufacture and
co-market GastroMARK in the United States, Canada and Mexico. The Company may
also sell the product through its own direct sales personnel. Mallinckrodt has
paid $1,350,000 under the contract and agreed to pay $500,000 on FDA approval of
the NDA. Additionally, the Company will receive royalties based on
Mallinckrodt's GastroMARK sales and a percentage of sales for supplying the
active ingredient. The agreement is perpetual but terminable upon specified
events such as nonperformance, insolvency or assignment without consent.
 
                                        6

<PAGE>   8
 
     EIKEN.  In 1988, the Company entered into a manufacturing and distribution
agreement with Eiken, granting Eiken the exclusive right to manufacture and
distribute Feridex I.V. in Japan. Eiken is responsible for conducting clinical
trials and securing the necessary regulatory approval in Japan. Under the terms
of the agreement, Eiken paid the Company a license fee of $1,500,000. In
addition, Eiken is required to pay royalties based upon sales. The agreement
terminates on the later of (i) the expiration of the last to expire technology
patent or (ii) ten years after the date all necessary approvals are obtained.
 
     In 1990, the Company entered into a manufacturing and distribution
agreement with Eiken, granting Eiken the exclusive right in Japan to manufacture
and distribute GastroMARK and Combidex. In addition, for a period of 180 days
after the Company files an NDA for any future Advanced Magnetics MRI contrast
agents, Eiken has the right of first refusal to manufacture and distribute such
product in Japan. Upon execution of this agreement, Eiken paid the Company a
license fee of $1,000,000. Additionally, Eiken agreed to pay the Company
royalties on sales of all products sold by Eiken under the agreement. The
agreement is perpetual but terminable upon specified events such as
nonperformance, insolvency or assignment without consent. Due to market
conditions in Japan, Eiken has decided not to market GastroMARK.
 
     SQUIBB DIAGNOSTICS.  In 1991, the Company entered into agreements with
Squibb Diagnostics, a division of Bristol-Myers Squibb Co. ("Squibb
Diagnostics") covering certain technology and the manufacturing and marketing of
certain contrast agents including Combidex, which agreements have been
terminated. Under agreements returning the products and technology rights to
Advanced Magnetics, the Company is obligated to pay Squibb Diagnostics up to a
maximum of $2,000,000 and $2,750,000 in royalties in connection with product
sales of an arabinogalactan receptor-mediated contrast agent and Combidex,
respectively.
 
MANUFACTURING AND SUPPLY ARRANGEMENTS
 
     The Company's Cambridge, Massachusetts facility is registered with the FDA
and is subject to "Good Manufacturing Practices" ("GMP") as prescribed by the
FDA. The Company currently manufactures Feridex I.V. bulk product for sale to
Guerbet, manufactures Feridex I.V. finished product for sale to Berlex and
GastroMARK bulk product for sale to Guerbet and Mallinckrodt. The Company also
manufactures Combidex for pre-clinical and clinical testing. The Company expects
to utilize contract manufacturers from time to time if appropriate.
 
     The manufacture of the Company's therapeutic products currently in research
and development would require the continuous availability of commercial grade
arabinogalactan, a naturally occurring polysaccharide that is commercially
available, which the Company purifies at its Cambridge facility into a
pharmaceutical grade material.
 
PATENTS AND TRADE SECRETS
 
     The Company considers the protection of its technology to be material to
its business. The Company's policy is to aggressively protect its competitive
technology position by a variety of means, including applying for patents in the
United States and in appropriate foreign countries. The Company has been granted
25 United States patents and has pending several patent applications. The
Company has filed counterpart patent applications in several foreign countries.
In addition, the Company is a party to various license agreements, including
nonexclusive cross-licensing arrangements covering MRI imaging technology with
Nycomed Imaging A.S. of Oslo, Norway ("Nycomed") and Schering AG ("Schering").
The Company's proprietary position depends in part on these licenses, and
termination of the licenses for any reason could have a material adverse effect
on the Company by limiting or prohibiting the commercial sale of its products.
Although the Company believes that further patents will be issued on pending
applications, no assurance to this effect can be given.
 
     The patent positions of pharmaceuticals and biopharmaceutical firms,
including Advanced Magnetics, are generally uncertain and involve complex legal
and factual questions. There can be no assurance that any claims which are
included in pending or future patent applications will be issued, that any
issued patents will provide the Company with competitive advantages or will not
be challenged by others, or that the existing or
 
                                        7

<PAGE>   9
 
future patents of third parties will not have an adverse effect on the ability
of the Company to commercialize its products.
 
     The Company believes it has a strong intellectual property position
regarding arabinogalactan for use in targeting therapeutic compounds. It has
three U.S. patents and a notice of allowance for a European patent covering the
delivery of therapeutic agents with arabinogalactan. A fourth patent covering
the use of arabinogalactan with radiotherapy has issued in the United States.
Additional therapeutic applications are pending, but there is no assurance that
any additional patents will issue to the Company.
 
     The Company also intends to rely on its trade secrets, know-how, continuing
technological innovations and licensing opportunities to maintain and develop
its competitive position. Although the Company seeks to protect its proprietary
information, there can be no assurance that others will not independently
develop the same or similar information, design around the patents, obtain
unauthorized access to the Company's proprietary information or misuse
information to which the Company has granted access. Litigation may be necessary
to enforce any patents issued to the Company or to determine the scope of other
person's proprietary rights in court or administrative proceedings. Any
litigation or administrative proceeding could result in substantial costs to the
Company and distraction of the Company's management. An adverse ruling in any
litigation or administrative proceeding could have a material adverse effect on
the Company's business, financial condition and results of operations.
 
COMPETITION
 
     The pharmaceutical and biopharmaceutical industries are subject to intense
competition and rapid technological change. The Company expects competition in
the development of new MRI contrast agents to increase substantially. Certain
companies, including the Company's collaborators, which have greater human and
financial resources dedicated to product development and clinical testing than
the Company, are developing MRI contrast agents. The Company's collaborators are
not restricted from developing and marketing competing products and as a result
of certain cross license agreements among the Company and certain of its
competitors (including one of its collaborators), the Company's competitors will
be able to utilize certain of the Company's technology in the development of
competing products. There can be no assurance that the Company will be able to
compete successfully with these companies.
 
     The Company believes that its ability to compete successfully in the MRI
contrast agent market will depend on a number of factors including the
development of efficacious products, timely receipt of regulatory approvals and
product manufacturing at commercially acceptable costs. In addition, the
Company's MRI contrast agents represent a new approach to imaging certain organs
and market acceptance of both MRI as an appropriate technique for such organs
and the Company's products as part of such imaging is critical to the success of
its contrast agent products. Although the Company believes that its contrast
agents will offer advantages over competing MRI, CT or X-ray contrast agents,
there can be no assurance that there will be greater acceptance of its products
over other contrast agents. In addition, to the extent that other diagnostic
techniques such as CT and X-ray may be perceived as providing greater value than
MRI, any corresponding decrease in the use of MRI could have an adverse effect
on the demand for the Company's contrast agent products. There can be no
assurance that the Company will be able to successfully develop efficacious
products, obtain timely regulatory approvals, manufacture products at
commercially acceptable costs, gain satisfactory market acceptance or otherwise
successfully compete in the future.
 
     There are several MRI contrast agents for imaging lesions of the liver in
various phases of human testing in the United States and abroad. Schering has
two products in development, Resovist, a carboxydextran superparamagnetic iron
oxide formulation, and Eovist, a chelated gadolinium compound. The Company
believes that Resovist is in Phase III trials in Europe and Japan and that
Eovist has completed Phase II trials in Europe. Nycomed has filed an NDA for its
MnDPDP product in the United States and Europe for MRI of liver lesions and has
received an approvable letter from the FDA. The Company believes that Bracco
S.p.A. is conducting Phase II trials in Europe for Gadolinium BOPTA, another
chelated gadolinium compound for MR imaging of liver lesions.
 
                                        8

<PAGE>   10
 
     In the area of oral contrast agents, Pharmacyclics, Inc. filed an NDA in
late 1995 for GADOLITE, its gadolinium-based product candidate, and Bracco S.p.A
has filed an NDA in the United States for Lumenhance, its liposomal encapsulated
oral manganese compound. The Company believes that
GastroMARK, being first to market with a safe and effective product will have a
major competitive advantage. There can be no assurance, however, that these
competitive products or other products developed by the Company's competitors
will not be more effective than any products developed by the Company or render
the Company's technology obsolete.
 
     Many of these companies have substantially greater capital, research and
development, manufacturing and marketing resources and experience than the
Company and represent significant competition for Advanced Magnetics. Such
companies may succeed in developing technologies and products that are more
effective or less costly than any that may be developed by the Company and may
also prove to be more successful than the Company in production and marketing.
There can be no assurance that Advanced Magnetics will successfully develop any
proposed drug delivery products, obtain required regulatory approvals or gain
satisfactory market acceptance for such products. Furthermore, there can be no
assurance that products developed by the Company's competitors will not be more
effective than any products developed by the Company or render the Company's
technology obsolete. The Company believes, however, that no single therapeutic
will be effective for all patients with diverse liver diseases, and that low
production costs will be a significant determinant of future success in the
worldwide marketplace.
 
GOVERNMENT REGULATION AND REIMBURSEMENT
 
     The production and marketing of the Company's products and its ongoing
research and development activities are subject to regulation for safety,
efficacy and quality by numerous governmental authorities in the United States
and other countries. Pharmaceutical products intended for therapeutic use in
humans are principally governed by FDA regulations in the United States and by
comparable government regulations in foreign countries. Various federal, state
and local statutes and regulations also govern or influence the research and
development, manufacturing, safety, labeling, storage, record-keeping,
distribution and marketing of such products. The process of completing
pre-clinical and clinical testing and obtaining the approval of the FDA and
similar health authorities in foreign countries to market a new drug product
requires a significant number of years and the expenditure of substantial
resources. Failure to obtain requisite governmental approvals or failure to
obtain approvals of the scope requested will delay or preclude the Company or
its licensees or collaborators from marketing the Company's products or limit
the commercial use of the products and will have a material adverse effect on
the Company's business, financial condition and results of operations.
 
     The steps required by the FDA before a new human pharmaceutical product,
including a contrast agent or therapeutic drug, may be marketed in the United
States include: (a) pre-clinical laboratory tests, in vivo pre-clinical studies
and formulation studies; (b) the submission to the FDA of a request for
authorization to conduct clinical trials subject to an Investigational New Drug
("IND") exemption, to which the FDA must not object, before human clinical
trials may commence; (c) adequate and well-controlled human-clinical trials to
establish the safety and efficacy of the drug for its intended use; (d)
submission to the FDA of an NDA; (e) approval and validation of manufacturing
facilities and production uses of the pharmaceutical; and (f) review and
approval of the NDA by the FDA before the drug product may be shipped or sold
commercially.
 
     Pre-clinical tests include the laboratory evaluation of product chemistry
and formulation, as well as animal studies to assess the potential safety and
efficacy of the product. Pre-clinical test results are submitted to the FDA as a
part of the IND. Clinical trials are typically conducted in three sequential
phases, although the phases may overlap. Phase I involves the initial
administration of the drug to a small group of humans, either healthy volunteers
or patients, to test for safety, dosage tolerance, absorption, distribution,
metabolism, excretion and clinical pharmacology and, if possible, early
indications of effectiveness. Phase II involves studies in a small sample of the
actual intended patient population to assess the preliminary efficacy of the
investigational drug for a specific clinical indication, to ascertain dose
tolerance and the optimal dose range and to collect additional clinical
information relating to safety and potential adverse effects. Once an
investigational drug is found to have some efficacy and an acceptable clinical
safety profile in the targeted
 
                                        9

<PAGE>   11
 
patient population, Phase III studies can be initiated to further establish
safety and efficacy of the investigational drug in a broader sample of the
target patient population. The results of the clinical trials together with the
results of the pre-clinical tests and complete manufacturing information are
submitted in an NDA to the FDA for approval. The FDA may suspend clinical trials
at any point in this process if it concludes that patients are being exposed to
an unacceptable health risk.
 
     Both before and after approval is obtained, a product, its manufacturer,
and the holder of the NDA for the product are subject to comprehensive
regulatory oversight. Violations of regulatory requirements at any stage,
including the preclinical and clinical testing process, the approval process, or
thereafter (including after approval) may result in various adverse
consequences, including the FDA's delay in approving or refusal to approve a
product, withdrawal of an approved product from the market, and/or the
imposition of criminal penalties against the manufacturer and/or NDA holder. In
addition, later discovery of previously unknown problems may result in
restrictions on such product, manufacturer, or NDA holder, including withdrawal
of the product from the market. Also, new government requirements may be
established that could delay or prevent regulatory approval of the Company's
products under development.
 
     If an NDA is submitted to the FDA, there can be no assurance that such
application will be reviewed and approved by the FDA in a timely manner, if at
all. Among the conditions for NDA approval is the requirement that a prospective
manufacturer's manufacturing procedures conform to GMP requirements, which must
be followed at all times. In complying with those requirements, manufacturers
(including a drug sponsor's third-party contract manufacturers) must continue to
expend time, money and effort in the area of production and quality control to
ensure compliance. Even after initial FDA approval has been obtained, further
studies, including post-market studies, may be required to provide additional
information. Results of such post-market programs may limit or expand the
further marketing of the product. Even if initial marketing approval is granted,
such approval may entail limitations on the indicated uses for which a product
may be used and impose labeling requirements which may adversely impact the
Company's ability to market its products. Finally, product approvals may be
withdrawn if compliance with regulatory standards is not maintained or if
problems occur following initial marketing.
 
     Among the conditions for NDA approval is the requirement that a prospective
manufacturer's manufacturing procedures conform to GMP requirements, which must
be followed at all times. In complying with those requirements, manufacturers
(including a drug sponsor's third-party contract manufacturers) must continue to
expend time, money and effort in the area of production and quality control to
ensure compliance. Domestic manufacturing establishments are subject to periodic
inspections by the FDA in order to assess, among other things, GMP compliance.
To supply product for use in the United States, foreign manufacturing
establishments must comply with GMP and are subject to periodic inspection by
the FDA or by regulatory authorities in certain of such countries under
reciprocal agreements with the FDA. Failure to maintain compliance with GMP
regulations and other applicable manufacturing requirements of various
regulatory agencies could have a material adverse effect on the Company's
business, financial condition and results of operations.
 
     The Company is also subject to foreign regulatory requirements governing
development, manufacturing and sales of pharmaceutical products that vary widely
from country to country. Approval of a drug by applicable regulatory agencies of
foreign countries must be secured prior to the marketing of such drug in those
countries. The regulatory approval process may be more or less rigorous from
country to country and the time required for approval may be longer or shorter
than that required in the United States.
 
     The Company is subject to regulation under local, state and Federal law
regarding occupational safety, laboratory practices, handling of chemicals,
environmental protection and hazardous substances control. The Company possesses
a Byproduct Materials License from the Nuclear Regulatory Commission ("NRC") for
receipt, possession, manufacturing and distribution of radioactive materials.
The Company holds Registration Certificates from the United States Drug
Enforcement Administration and the Commonwealth of Massachusetts Department of
Public Health for handling controlled substances. The Company is registered with
the United States Environmental Protection Agency ("EPA") as a generator of
hazardous waste. All hazardous waste disposal must be made in accordance with
EPA and NRC requirements. The Company is subject to the
 
                                       10

<PAGE>   12
 
regulations of the Occupational Safety and Health Act and has in effect a safety
program to assure compliance with these regulations.
 
     In both the United States and foreign markets, the Company's ability to
commercialize its products successfully also depends in part on the extent to
which reimbursement for the costs of such products and related treatments will
be available from government health administration authorities, private health
insurers and other third-party payors. Significant uncertainty exists as to the
reimbursement status of newly approved health care products and products used
for indications not approved by the FDA. If adequate reimbursement levels are
not maintained by government and other third-party payors for the Company's
products and related treatments, the Company's business, financial condition and
results of operations may be materially adversely affected.
 
MAJOR CUSTOMERS
 
     No customer accounted for more than ten percent of the Company's revenues
for the fiscal year ended September 30, 1996. Revenues in fiscal 1996, 1995 and
1994, from customers and licensees outside of the United States, principally in
Europe, amounted to 3%, 23% and 3%, respectively, of the Company's total
revenues.
 
EMPLOYEES
 
     As of December 16, 1996, the Company had approximately 61 full-time
employees, 52 of whom were engaged in research and development. The Company's
success depends in part on its ability to recruit and retain talented and
trained scientific personnel. The Company has been successful to date in
obtaining such personnel, but there can be no assurance that such success will
continue.
 
     None of the Company's employees is represented by a labor union, and the
Company considers its relations with its employees to be excellent.
 
PRODUCT LIABILITY INSURANCE
 
     The use of any of the Company's potential products in clinical trials and
the sale of any approved products may expose the Company to liability claims
resulting from the use of products or product candidates. These claims might be
made by customers (including corporate partners), clinical trial subjects,
patients, pharmaceutical companies or others. The Company maintains product
liability insurance coverage for claims arising from the use of its products in
clinical trials. However, coverage is becoming increasingly expensive and no
assurance can be given that the Company will be able to maintain insurance at a
reasonable cost. There can be no assurance that the Company's insurance will
provide sufficient amounts to protect the Company against losses due to
liability that could have a material adverse effect on the Company's business,
financial conditions and results of operations. The Company maintains product
liability insurance covering the sale of its products approved for commercial
marketing but there can be no assurance that the Company will be able to obtain
commercially reasonable product liability insurance for any product approved for
marketing in the future or that insurance coverage and the resources of the
Company would be sufficient to satisfy any liability resulting from product
liability claims. A product liability claim or series of claims brought against
the Company could have a material adverse effect on its business, financial
condition and results of operations, whether or not the plaintiffs in such
claims ultimately prevail.
 

I
TEM 2.  PROPERTIES:
 
     The Company's principal pharmaceutical manufacturing and research and
development operations are located in a modern Company-owned building of
approximately 25,000 square feet in Cambridge, Massachusetts. The Company has
leased two additional premises in Cambridge of approximately 18,000 total square
feet to be used for manufacturing, warehousing and executive office space. One
lease expires on October 31, 1997 and the other lease expires on December 31,
1997. In addition, the Company has leased premises of approximately 5,200 square
feet in Princeton, New Jersey used by the Company's clinical development group
as a general business, sales and administrative office. This lease expires on
September 30, 1997. The Company
 
                                       11

<PAGE>   13
 
believes these facilities are adequate for its current and anticipated
short-term needs and that it will be able to enter into lease extensions or to
lease comparable space, if necessary. However, the acquisition and required
regulatory approvals for additional pharmaceutical manufacturing space can be
time consuming and expensive. There is no assurance that if the Company desired
to expand its manufacturing capacity it would be able to do so on a timely
basis, if at all.
 

ITEM 3.  LEGAL PROCEEDINGS:
 
     The Company and certain of its officers were sued in an action entitled
David D. Stark, M.D. v. Advanced Magnetics, Inc., Jerome Goldstein, Ernest V.
Groman, and Lee Josephson, Civil Action No. 92-12157-WGY, in the United States
District Court for the District of Massachusetts on September 3, 1992. The
plaintiff, a former consultant to the Company, claims that he was incorrectly
omitted as an inventor or joint inventor on certain of the Company's patents and
on pending applications, and seeks injunctive relief and unspecified damages. In
addition, the complaint also alleges state law claims for breach of contract,
breach of good faith and fair dealing, breach of implied contract,
misappropriation of trade secrets, conversion, negligent misrepresentation,
misrepresentation, unjust enrichment and unfair trade practices. The District
Court has held that the plaintiff cannot succeed on both his claims to correct
inventorship under federal law and his state law claims as these claims are
mutually exclusive. The plaintiff appealed the District Court's analysis of the
federal law to the United States Court of Appeals for the Federal Circuit. While
the outcome of the action cannot be determined, the Company believes the action
is without merit and intends to defend the action vigorously if it is reopened.
There can be no assurance, however, that the Company will be able to
successfully defend this action and the failure by the Company to prevail for
any reason could have an adverse effect on the Company's future business,
financial condition and results of operations.
 
     The Company and certain of its officers were sued in David D. Stark v.
Advanced Magnetics, Inc., Jerome Goldstein, Ernest V. Groman and Lee Josephson,
Civil Action No. 93-02846-C, in the Superior Court Department of the
Massachusetts Trial Court for Middlesex County. This case involves claims of
breach of contract, breach of good faith and fair dealing, breach of implied
contract, unjust enrichment and unfair trade practices that were originally
dismissed by, but later remanded to, the Federal Court in the above-mentioned
action, as well as a new count alleging tortious interference with contractual
or advantageous relations. The Superior Court granted partial summary judgment
in the Company's favor and dismissed the unfair trade practices and tort counts.
The Superior Court has stayed the action. While the outcome of the action cannot
be determined, the Company believes the action is without merit and intends to
defend the action vigorously. There can be no assurance, however, that the
Company will be able to successfully defend this action and the failure by the
Company to prevail for any reason could have an adverse effect on the Company's
future business, financial condition and results of operations.
 

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS:
 
     No matters were submitted to a vote of the company's security holders
during the quarter ended September 30, 1996.
 
                                       12

<PAGE>   14
 

                                    PART II
 

ITEM 5.  MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS:
 
     The Company's common stock is listed on the American Stock Exchange under
the symbol AVM. The table below sets forth the high and low sales price of the
Company's common stock on the American Stock Exchange for the fiscal quarters of
1996 and 1995.
 

<TABLE>
<CAPTION>
                                                                FISCAL QUARTER
                                                     -------------------------------------
                                                     FIRST     SECOND     THIRD     FOURTH
                                                     -----     ------     -----     ------
        <S>                                          <C>       <C>        <C>       <C>
        1996
        High.......................................  $29 1/2    $30       $23       $19 7/8
        Low........................................  $24        $19 1/2   $16 1/8   $16 1/4

        1995
        High.......................................  $16 3/4    $19 1/4   $23 3/8   $29
        Low........................................  $13 1/4    $14 1/4   $17 1/2   $21
</TABLE>

 
     On December 16, 1996 there were approximately 306 shareholders of record.
The Company believes that the number of beneficial holders of Common Stock
exceeds 2,300. The last reported sale price of the Common Stock on December 16,
1996 was $15.375 per share. The Company has never declared or paid a cash
dividend on its capital stock.
 

ITEM 6.  SELECTED CONSOLIDATED FINANCIAL DATA:
 
     The selected financial data set forth below has been derived from the
audited financial statements of the Company. This information should be read in
conjunction with the financial statements and notes thereto set forth elsewhere
herein.
 

<TABLE>
<CAPTION>
                                                   FOR THE YEARS ENDED SEPTEMBER 30,
                                   ------------------------------------------------------------------
                                      1996          1995          1994         1993          1992
                                   -----------   -----------   ----------   -----------   -----------
<S>                                <C>           <C>           <C>          <C>           <C>
Statement of Operations Data:
Revenues:
  License fees...................  $        --   $ 5,000,000   $5,505,000   $ 1,010,000   $ 1,550,000
  Royalties......................       50,000       189,493       15,924       906,138     1,313,532
  Product sales..................       12,762     2,120,457      280,975     3,836,300     4,062,299
  Contract research and
     development.................        6,810            --           --       402,911       810,881
  Interest, dividends and net
     gains and losses on sales of
     securities..................    1,761,450     2,287,311    1,845,005     2,823,102     2,513,000
                                   -----------   -----------   ----------   -----------   -----------
          Total revenues.........    1,831,022     9,597,261    7,646,904     8,978,451    10,249,712
Costs and Expenses:
  Cost of product sales..........        2,550       425,187       54,983     1,525,564     1,736,949
  Contract research and
     development expenses........           --            --           --       193,391       607,163
  Company-sponsored research and
     development expenses........    9,671,897     8,601,791    6,621,929     6,863,229     5,431,911
  Charge (credit) for purchase of
     in-process research and
     development*................           --      (380,000)     760,000            --            --
  Selling, general and
     administrative expenses.....    1,871,568     1,759,348    1,963,480     2,777,840     2,201,633
                                   -----------   -----------   ----------   -----------   -----------
          Total costs and
            expenses.............   11,546,015    10,406,326    9,400,392    11,360,024     9,977,656
</TABLE>

 
                                       13

<PAGE>   15
 

<TABLE>
<CAPTION>
                                                   FOR THE YEARS ENDED SEPTEMBER 30,
                                   ------------------------------------------------------------------ 
                                      1996          1995          1994         1993          1992
                                   -----------   -----------   ----------   -----------   -----------
<S>                                <C>           <C>           <C>          <C>           <C>
Other Income:
  Gain on sale of in vitro
     product line**..............           --     3,404,527    2,649,580            --            --
                                   -----------   -----------   ----------   -----------   -----------
  Income (loss) before provision
     for income taxes and
     cumulative effect of
     accounting change...........   (9,714,993)    2,595,462      896,092    (2,381,573)      272,056
  Income tax provision...........           --       400,000        8,000            --            --
                                   -----------   -----------   ----------   -----------   -----------
  Income (loss) before cumulative
     effect of accounting
     change......................   (9,714,993)    2,195,462      888,092   $(2,381,573)  $   272,056
  Cumulative effect of accounting
     change......................           --       117,540           --            --            --
                                   -----------   -----------   ----------   -----------   -----------
  Net income (loss)..............  $(9,714,993)  $ 2,313,002   $  888,092   $(2,381,573)  $   272,056
                                   ===========   ===========   ==========   ===========   ===========
  Income (loss) per share before
     cumulative effect of
     accounting change...........  $     (1.44)  $       .32   $      .13   $      (.36)  $       .04
  Cumulative effect of accounting
     change......................           --           .02           --            --            --
                                   -----------   -----------   ----------   -----------   -----------
  Net income (loss) per share....  $     (1.44)  $       .34   $      .13   $      (.36)  $       .04
                                   ===========   ===========   ==========   ===========   ===========
  Weighted average number of
     common and common equivalent
     shares......................    6,762,748     6,870,839    6,806,525     6,651,061     6,759,882
                                   -----------   -----------   ----------   -----------   -----------
</TABLE>

 
- ---------------
*  In August 1994, the Company reacquired the development and marketing rights
   to the MRI contrast agent Combidex previously licensed to Squibb Diagnostics,
   a Division of Bristol Myers Squibb Company Inc., and recorded a related
   $760,000 charge for the purchase of in-process research and development. In
   the first fiscal quarter of 1995, a credit for $380,000 was recorded to the
   purchase of in-process research and development.
 
** On October 15, 1993, the Company sold its in vitro product line to PerSeptive
   Biosystems, Inc.
 

<TABLE>
<CAPTION>
                                                           AT SEPTEMBER 30,
                                  -------------------------------------------------------------------
                                     1996          1995          1994          1993          1992
                                  -----------   -----------   -----------   -----------   -----------
<S>                               <C>           <C>           <C>           <C>           <C>
Balance Sheet Data:
  Working capital...............  $33,605,818   $41,985,100   $38,891,406   $37,547,326   $40,911,752
                                  -----------   -----------    ----------   -----------   -----------
  Total assets..................  $41,066,373   $50,843,222   $46,672,700   $45,877,548   $48,127,736
                                  -----------   -----------    ----------   -----------   -----------
  Stockholders' equity..........  $40,132,545   $49,071,072   $45,451,475   $44,654,428   $47,085,724
                                  -----------   -----------    ----------   -----------   -----------
</TABLE>

 

ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
         OF OPERATIONS:
 
OVERVIEW
 
     Since its inception in November 1981, Advanced Magnetics, Inc., (the
"Company") has focused its efforts on developing its core superparamagnetic iron
oxide particle technology to develop magnetic resonance imaging ("MRI") contrast
agents and its core polysaccharide technology for targeted delivery of
therapeutics. The Company has funded its operations with cash from license fees
from corporate partners, royalties, sales of its products, fees from contract
research performed for third parties, the proceeds of financings and income
earned on invested cash. The Company's success in the market for diagnostic and
therapeutic products will depend, in part, on the Company's ability to
successfully develop, test, produce and market its products; obtain
 
                                       14

<PAGE>   16
 
necessary governmental approvals in a timely manner; attract and maintain key
employees; and successfully respond to technological changes in its marketplace.
 
     The Company's operating results may continue to vary significantly from
quarter to quarter or from year to year depending on a number of factors,
including: the timing of payments from corporate partners and research grants;
the introduction of new products by the Company; the timing and size of orders
from the Company's customers; and the acceptance of the Company's products. The
Company's current planned expense levels are based in part upon expectations as
to future revenue. Consequently, profits may vary significantly from quarter to
quarter or year to year based on the timing of revenue. Revenue or profits in
any period will not necessarily be indicative of results in subsequent periods
and there can be no assurance that the Company will maintain profitability or
that revenue growth can be sustained in the future.
 
     A substantial portion of the Company's expenses consists of research and
development expenses. The Company expects its research and development expenses
to increase as it funds additional clinical trials and associated toxicology and
pharmacology studies and as it devotes resources to developing additional
contrast agents and its targeted drug delivery programs.
 
SALE OF IN VITRO PRODUCT LINE
 
     On October 15, 1993 the Company sold its in vitro product line to
PerSeptive Biosystems, Inc. ("PerSeptive") for 151,759 shares of PerSeptive
common stock which was worth $4,156,674 as of that date, plus an additional
earn-out amount based on the results of fiscal 1995. The amount of the earn-out
at September 30, 1995 was $3,404,527 which PerSeptive satisfied by issuing
373,080 shares of PerSeptive common stock. The Company recognized pre-tax gains
on this sale of $3,404,527 and $2,649,580 in fiscal 1995 and 1994, respectively.
As of the end of fiscal 1996, the Company had sold all of its holdings of
PerSeptive common stock.
 
RESULTS OF OPERATIONS
FISCAL 1996 COMPARED TO FISCAL 1995
 
     Revenues
 
     Total revenues for the fiscal year ended September 30, 1996 were $1,831,022
compared to $9,597,261 for the fiscal year ended September 30, 1995.
 
     There were no license fee revenues for the fiscal year ended September 30,
1996 compared to $5,000,000 for the fiscal year ended September 30, 1995. The
Company received a non-refundable $5,000,000 license fee on February 1, 1995
from Berlex Laboratories, Inc. ("Berlex") under an agreement (the "Berlex
Agreement") granting Berlex a product license and exclusive marketing rights to
the Company's Feridex I.V. MRI contrast agent in the United States. On September
3, 1996, the Company and Berlex announced that the United States Food and Drug
Administration ("FDA") granted marketing approval for Feridex I.V. The Company
received a $5,000,000 milestone payment from Berlex on October 15, 1996 as a
result of Berlex's market launch of Feridex I.V. in the United States.
 
     Royalties for the fiscal year ended September 30, 1996 were $50,000
relating to product sales in Europe by Guerbet, S.A. ("Guerbet")of the Company's
Feridex I.V. (marketed in Europe under the trade name Endorem) and GastroMARK
(marketed in Europe under the trade name Lumirem) MRI contrast agents. Royalties
of $50,000 in the fiscal year ended September 30, 1996 as compared with $189,493
in fiscal 1995 reflect lower sales in Europe of Feridex I.V., the Company's
liver imaging agent, in the 1996 fiscal year.
 
     Product sales for the fiscal year ended September 30, 1996 were $12,762
compared to $2,120,457 for the fiscal year ended September 30, 1995 which
resulted primarily from the initial product launch by Guerbet in Europe of
Feridex I.V. in the 1995 fiscal year. Although Guerbet marketed and sold the
Company's product during fiscal 1996, a sufficient level of inventory from 1995
existed to satisfy 1996 current customer needs.
 
     Interest, dividends and gains and losses on sales of securities resulted in
revenues of $1,761,450 for the fiscal year ended September 30, 1996 compared to
$2,287,311 for the fiscal year ended September 30, 1995.
 
                                       15

<PAGE>   17
 
Interest income for the fiscal year ended September 30, 1996 was $1,400,597
compared to $1,644,328 for the fiscal year ended September 30, 1995. The
decrease was primarily due to the maturity of United States Treasury Notes and
lower interest rates earned on money market accounts in fiscal 1996. Dividend
income of $354,500 for the year ended September 30, 1996 was $233,516 less than
the $588,016 for the fiscal year ended September 30, 1995. The decrease was
primarily due to a reduction in funds invested in dividend paying preferred
stock. There was a net gain on sales of securities of $6,353 for the fiscal year
ended September 30, 1996 compared to a net gain of $54,967 for the fiscal year
ended September 30, 1995.
 
     Costs and Expenses
 
     The cost of product sales for the fiscal year ended September 30, 1996 was
$2,550 compared to $425,187 for the fiscal year ended September 30, 1995. The
cost of product sales for the fiscal year ended September 30, 1995 related
primarily to the introduction in Europe of Feridex I.V. The cost of product
sales for both fiscal years was 20% of product sales. Research and development
expenses for the fiscal year ended September 30, 1996 were $9,671,897, an
increase of 12% compared to $8,601,791 for the fiscal year ended September 30,
1995. The increase was primarily a result of costs associated with Phase III
human clinical trials for the Company's Combidex contrast agent used in imaging
lymph nodes, liver, spleen and blood perfusion and pre-clinical developments of
the Company's targeted drug delivery programs. In addition, the Company made
payments of $725,000 in accordance with its agreements to license technology
from third parties, of which $400,000 was based on the achievement of certain
milestones.
 
     Selling, general and administrative expenses for the fiscal year ended
September 30, 1996 were $1,871,568, an increase of 6% from $1,759,348 for the
fiscal year ended September 30, 1995. The increase was primarily attributable to
the write-off of expenses associated with a proposed, but later terminated,
public offering of the Company's common stock.
 
     Other
 
     The Company adopted Statement of Financial Accounting Standards No. 115,
"Accounting for Certain Investments in Debt and Equity Securities," in the
fiscal year ended September 30, 1995. As a result, the Company recorded a
cumulative effect of accounting change of $117,540 during the year ended
September 30, 1995.
 
     Income Taxes
 
     There was no income tax provision for the fiscal year ended September 30,
1996 due to an operating loss. The income tax provision for the fiscal year
ended September 30, 1995 was $400,000. The tax rate was lower than the 34%
statutory rate as a result of the tax benefit of temporary differences and
dividend income exclusions.
 
     Earnings
 
     In the fiscal year ended September 30, 1996, the Company recorded a net
loss of $9,714,993 or $1.44 per share. In the fiscal year ended September 30,
1995, the Company recorded a net profit of $2,195,462 or $.32 per share before
the cumulative effect of accounting change. Including the cumulative effect of
accounting change of $117,540 or $.02 per share, net income was $2,313,002 or
$.34 per share for the fiscal year ended September 30, 1995.
 
RESULTS OF OPERATIONS
FISCAL 1995 COMPARED TO FISCAL 1994
 
     Revenues
 
     Total revenues for the fiscal year ended September 30, 1995 increased 26%
to $9,597,261 from $7,646,904 for the fiscal year ended September 30, 1994.
 
                                       16

<PAGE>   18
 
     License fee revenues for the fiscal year ended September 30, 1995 were
$5,000,000 compared to $5,505,000 for fiscal year ended September 30, 1994. The
Company received a non-refundable $5,000,000 license fee on February 1, 1995
from Berlex under the Berlex Agreement. License fee revenues for the fiscal year
ended September 30, 1994 included a non-refundable license fee of $3,000,000
paid by Squibb Diagnostics, a division of Bristol-Myers Squibb Co. ("Squibb
Diagnostics") and a non-refundable milestone license fee of $2,500,000 paid by
Sterling Winthrop, Inc., a subsidiary of Eastman Kodak Company ("Sterling"). On
October 6, 1994, the Company terminated its marketing and distribution agreement
with Sterling for Feridex I.V. as a direct result of the sale by Sterling of its
prescription pharmaceuticals business. The agreement with Sterling was not
assignable without the Company's consent which was not granted.
 
     Product sales for the fiscal year ended September 30, 1995 were $2,120,457
compared to $280,975 for the fiscal year ended September 30, 1994. Product sales
increased as a result of $2,013,869 of Feridex I.V. contrast agent sales to
Guerbet, the Company's European licensee. Product sales of $280,975 for the
fiscal year ended September 30, 1994 were primarily attributable to the sale of
GastroMARK to Guerbet.
 
     Royalties for the fiscal year ended September 30, 1995 were $189,493
compared to $15,924 for the fiscal year ended September 30, 1994. The royalties
were earned on Guerbet's European product sales of Feridex I.V. and GastroMARK
contrast agents.
 
     Interest, dividends and gains and losses on sales of securities resulted in
revenues of $2,287,311 in the fiscal year ended September 30, 1995 compared to
revenues of $1,845,005 in the fiscal year ended September 30, 1994. These
amounts include interest and dividends of $2,232,345 for the fiscal year ended
September 30, 1995 compared to $1,801,436 for the fiscal year ended September
30, 1994. The increase was primarily a result of an increase in interest revenue
from the purchase of United States Treasury Notes. Net gains from the sale of
marketable securities were $54,966 for the fiscal year ended September 30, 1995
compared to a net gain of $161,109 in the fiscal year ended September 30, 1994.
There were net unrealized losses of $117,540 resulting from an adjustment to the
carrying value of marketable securities from cost to market during fiscal 1994.
In the first fiscal quarter ended December 31, 1994, the Company adopted
Statement of Financial Accounting Standards No. 115, "Accounting for Certain
Investments in Debt and Equity Securities" and recorded a cumulative effect of
the accounting change of $117,540, including the reversal of the reserve for the
carrying value of marketable securities.
 
     Cost and Expenses
 
     The cost of product sales for the fiscal year ended September 30, 1995 was
$425,187 compared to $54,983 for the fiscal year ended September 30, 1994. The
cost of product sales as a percentage of product sales remained constant at 20%
for both fiscal years. Research and development expenses for the fiscal year
ended September 30, 1995 were $8,601,791, an increase of 30% compared to
$6,621,929 for the fiscal year ended September 30, 1994. The increase in
research and development expenses was primarily due to expenditures for the
human clinical trials of Combidex and pre-clinical development of the Company's
targeted drug delivery programs. In addition, in fiscal 1995, the Company
recorded a credit of $380,000 to the purchase of in-process research and
development as a result of a modification of a prior agreement (see footnote O
to the financial statements). Selling, general and administrative expenses for
the fiscal year ended September 30, 1995 were $1,759,348, a decrease of 10% from
$1,963,480 for the fiscal year ended September 30, 1994. The decrease was
primarily due to a decrease in legal and consulting fees.
 
     Gain on Sale of In Vitro Product Line
 
     On October 15, 1993, the Company sold its in vitro product line to
PerSeptive for $4,156,674 in PerSeptive common stock, plus an earn-out based on
PerSeptive's 1995 in vitro product line revenues. The Company recognized a
pre-tax gain of $2,649,580 in the fiscal year ended September 30, 1994. The
amount of the earn-out at September 30, 1995 was $3,404,527. Accordingly, the
Company recognized a pre-tax gain of $3,404,527 and recorded an account
receivable in the fourth quarter of fiscal 1995.
 
                                       17

<PAGE>   19
 
     Income Taxes
 
     The income tax provision for the fiscal year ended September 30, 1995 was
$400,000. The tax rate was lower than the 34% statutory rate as a result of a
tax benefit of temporary differences and dividend income exclusions. For the
fiscal year ended September 30, 1994, the income tax provision was $8,000.
 
     Earnings
 
     In the fiscal year ended September 30, 1995, the Company recorded a net
profit of $2,195,462 or $.32 per share before the cumulative effect of
accounting change. Including the cumulative effect of accounting change of
$117,540 or $.02 per share, net income was $2,313,002 or $.34 per share for the
fiscal year ended September 30, 1995 compared to net income of $888,092 or $.13
per share for the fiscal year ended September 30, 1994.
 
LIQUIDITY AND CAPITAL RESOURCES
 
     At September 30, 1996, the Company's cash equivalents totaled $10,805,842,
representing an increase of $9,739,423 from September 30, 1995. In addition, the
Company had marketable securities of $23,271,169 at September 30, 1996 as
compared to $36,561,263 on September 30, 1995. Net cash used in operating
activities was $7,424,117 in the fiscal year ended September 30, 1996 compared
to net cash used in operating activities of $1,858,766 in the fiscal year ended
September 30, 1995. The increase in cash used in operating activities was due
primarily to an increase in the net loss for the year ended September 30, 1996.
Cash provided by investing activities was $17,330,928 for the fiscal year ended
September 30, 1996 compared to $3,850,553 used in investing activities in the
fiscal year ended September 30, 1995. Cash provided by investing activities in
the fiscal year ended September 30, 1996 included the proceeds of $9,499,911
from maturing United States Treasury notes and $10,727,188 from the sale of
marketable securities. Offsetting these proceeds was the purchase of marketable
securities of $2,378,934 in the fiscal year ended September 30, 1996. Cash used
in investing activities in the fiscal year ended September 30, 1995 included the
purchase of marketable securities of $6,703,475. Proceeds from United States
Treasury notes maturing was $3,000,000 and proceeds from the sale of marketable
securities was $1,385,830 in the first year ended September 30, 1995. Cash used
in financing activities was $167,338 for the fiscal year ended September 30,
1996 and included proceeds of $308,957 from the issuances of common stock offset
by the purchase of 26,200 shares of the Company's common stock on the open
market for $476,345. In May 1996, the Board of Directors authorized the purchase
of up to 250,000 shares of the Company's common stock on the open market at
prevailing market prices.
 
     Capital expenditures in the fiscal year ended September 30, 1996 were
$466,452 compared to $1,484,382 in the fiscal year ended September 30, 1995.
Capital expenditures in the fiscal year ended September 30, 1995 included an
upgrade to the Company's magnetic resonance imaging equipment and furnishings
and equipment associated with the establishment of the Clinical Development
Group in the Company's Princeton, New Jersey office. Expenditures of $466,452 in
the fiscal year ended September 30, 1996 continued the Company's efforts to
upgrade existing equipment. The Company has no current commitment for any
significant expenditures on property, plant and equipment. The Company expects
that expenditures for research and development for fiscal 1997 will continue to
increase due to human clinical trials for the Company's development stage
contrast agents and targeted delivery of therapeutics.
 
     Management believes that funds for future needs can be generated from
existing cash balances, cash generated from investing activities and cash
generated from operations. In addition, the Company will consider from time to
time various financing alternatives and may seek to raise additional capital
through equity or debt financing or to enter into corporate partnering
arrangements. There can be no assurance, however, that funding will be available
on terms acceptable to the Company, if at all.
 
IMPACT OF RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
 
     Statement of Financial Accounting Standards No. 123, "Accounting for Stock
Based Compensation," is effective for fiscal years beginning after December 15,
1995. This statement establishes financial accounting and reporting standards
for stock based employee compensation plans. While the Company is reviewing the
 
                                       18

<PAGE>   20
 
adoption and impact of this statement, it expects to adopt the "disclosure only"
alternative and accordingly this standard will have no impact on the Company's
results of operations or its financial position.
 
CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS
 
     The Company does not provide forecasts of its future financial performance.
However, from time to time, information provided by the Company or statements
made by its employees may contain "forward looking" information that involves
risks and uncertainties. In particular, statements contained in this Form 10-K
that are not historical facts (including, but not limited to statements
contained in this Item 7 relating to liquidity and capital resources) constitute
forward looking statements and are made under the safe harbor provisions of the
Private Securities Litigation Reform Act of 1995. The Company's actual results
of operations and financial condition have varied and may in the future vary
significantly from those stated in any forward looking statements. Factors that
may cause such differences include, without limitation, the risks, uncertainties
and other information discussed below and within this Form 10-K, as well as the
accuracy of the Company's internal estimates of revenue and operating expense
levels. The following discussion of the Company's risk factors should be read in
conjunction with the financial statements and related notes thereto. Such
factors, among others, may have a material adverse effect upon the Company's
business, results of operations and financial condition.
 
     Early Stage of Product Commercialization; Uncertainty of Product
Development.  The Company has not generated significant revenues from the sale
of its products. Feridex I.V. and GastroMARK have only recently been approved
for sale in the United States, and the sale of Feridex I.V. and GastroMARK has
only recently begun in certain European countries. While the Company is
conducting human clinical testing of Combidex, this product and the Company's
other product candidates, in particular its targeted therapeutic products, will
require significant additional research and development efforts, including
extensive human clinical testing, prior to submission of any regulatory
application for commercial sale of such products. Such products are not expected
to be commercially available for several years, if at all. The development of
new pharmaceutical products is highly uncertain and no assurance can be given
that any of the Company's development programs will be completed successfully,
that required regulatory approvals will be obtained on a timely basis, if at
all, or that any product, including Feridex I.V., will be commercially
successful.
 
     The Company's long term viability and growth will depend on the successful
commercialization of products resulting from its research activities. If any of
the Company's development programs are not completed successfully, required
regulatory approvals are not obtained or products for which approvals are
obtained are not commercially successful, the Company's business, financial
condition and results of operations could be materially adversely affected.
 
     Need for Future Funding; Uncertainty of Access to Capital.  The Company has
expended and will continue to expend substantial funds to complete the research,
development, clinical trials, regulatory approvals and other activities through
final commercialization of its products. It is possible that the Company may
need additional financing to satisfy its capital and operating requirements
relating to the development, manufacturing and marketing of its products. The
Company may seek such financing through arrangements with collaborative partners
and through public or private sales of the Company's securities, including
equity securities. No assurance can be given that such financing will be
available to the Company on acceptable terms, if at all. Any additional equity
financings could be dilutive to the Company's stockholders. If adequate
additional funds are not available, the Company may be required to curtail
significantly one or more of its research and development programs or obtain
funds through arrangements with collaborative partners or others that may
require the Company to relinquish rights to certain of its products and product
candidates on terms that it might otherwise find unacceptable.
 
     Government Regulation; No Assurance of Regulatory Approval.  Prior to
marketing, every product candidate must undergo an extensive regulatory approval
process in the United States and in every country in which the Company intends
to test and market its product candidates and products. This regulatory process
includes testing and clinical trials of such product candidate to demonstrate
safety and efficacy and can require many years and the expenditure of
substantial resources in the United States and in foreign countries in which
 
                                       19

<PAGE>   21
 
approval is sought. Data obtained from preclinical testing and clinical trials
are subject to varying interpretations, which can delay, limit or prevent FDA
approval. In addition, changes in FDA approval policies or requirements may
occur or new regulations may be promulgated which may result in delay or failure
to receive FDA approval. Similar delays or failures may be encountered in
foreign countries. Delays and related costs in obtaining regulatory approvals
could have a material adverse effect on the Company's business, financial
condition and results of operation. Although the Company has received approval
in the United States and in certain foreign countries to market Feridex I.V. and
GastroMARK, there can be no assurance that further regulatory approvals will be
obtained for any products developed by the Company. Failure to obtain requisite
governmental approvals or failure to obtain approvals of the scope requested
could delay and may preclude the Company or its licensees or other collaborators
from marketing the Company's products or limit the commercial use of the
products and could have a material adverse effect on the Company's business,
financial condition and results of operations.
 
     Regulatory approvals may entail limitations on the indicated uses of such
products and impose labeling requirements which may adversely impact the
Company's ability to market its products. Even if regulatory approval is
obtained, a marketed product and its manufacturer are subject to continuing
regulatory review. Noncompliance with regulatory requirements of the approval
process at any stage may result in various adverse consequences, including the
FDA's delay in approving or its refusal to approve a product, withdrawal of an
approved product from the market or, under certain circumstances, the imposition
of criminal penalties. Any such adverse consequences could have a material
adverse effect on the Company's business, financial condition and results of
operations.
 
     Uncertainties Relating to Clinical Trials; Technological
Uncertainty.  Before obtaining regulatory approvals for the commercial sale of
any of its contrast agents or other product candidates, the Company must
demonstrate through extensive preclinical testing and human clinical trials that
the product is safe and efficacious. The results from preclinical testing and
early clinical trials of products under development by the Company may not be
predictive of results obtained in subsequent clinical trials. Clinical trials
are often conducted with patients in the most advanced stages of disease. During
the course of treatment, these patients can die or suffer adverse medical
effects for reasons that may not be related to the product being tested, but
which can nevertheless adversely affect clinical trial results or approvals by
the FDA. Clinical testing of pharmaceutical product is itself subject to
approvals by various governmental regulatory authorities. There can be no
assurance that Advanced Magnetics will be permitted by regulatory authorities to
commence or continue clinical trials. Any delays in or termination of the
Company's clinical trial efforts could have a material adverse effect on the
Company's business, financial condition and results of operations.
 
     Many of the Company's products are subject to technological uncertainty.
Only two of the Company's products, Feridex I.V. and GastroMARK, have been
approved for sale in the United States. Furthermore, the FDA has not approved
the use of arabinogalactan as an intravenous delivery agent nor has it approved
the use of vidarabine ("AraA") or vidarabine monophoshate for the treatment of
hepatitis. There can be no assurance that this combination will receive
regulatory approval for the treatment of any condition or disease. In addition,
obtaining regulatory approval for products consisting of arabinogalactan
connected to any other therapeutic compound may be more difficult than obtaining
approval for a single compound because it could be more difficult to determine
the safety and efficacy of the two compounds together. Furthermore, AraA has
demonstrated unacceptable levels of toxicity when used in an unconjugated form
in clinical trials for the treatment of hepatitis. The Company's MRI contrast
agents may cause adverse reactions, including death, in certain persons under
certain conditions. There can be no assurances that these factors will not
adversely affect the development or commercialization of the Company's products.
 
     Dependence on Collaborative Relationships.  The Company's strategy for the
development and commercialization of its contrast agent product candidates is to
enter into strategic alliances with various corporate partners, licensees, and
other collaborators. In some cases, the Company is dependent upon these
collaborators to conduct preclinical and clinical testing, to obtain regulatory
approvals and to manufacture and market products. There can be no assurance that
any revenues or profits will continue or that the Company will be able to enter
into future collaborative relationships. If any of the Company's collaborators
breaches its
 
                                       20

<PAGE>   22
 
agreement with the Company or otherwise fails to perform, such event could have
a material adverse effect on the Company's business, financial condition and
results of operations.
 
     Competition and Risk of Technological Obsolescence.  The pharmaceutical and
biopharmaceutical industries are subject to intense competition and rapid
technological change. The Company has many competitors, many of which have
substantially greater capital and other resources than the Company and represent
significant competition for Advanced Magnetics. Such companies may succeed in
developing technologies and products that are more effective or less costly than
any that may be developed by the Company, and such companies may be more
successful than the Company in developing, manufacturing and marketing products.
In addition, the Company's MRI contrast agents represent a new approach to
imaging certain organs, and market acceptance of both MRI as an appropriate
imaging technique for such organs and the Company's products is critical to the
Company's ability to compete successfully. There can be no assurance that the
Company will be able to compete successfully in the future or that developments
by others will not render the Company's products or product candidates or
technologies obsolete or noncompetitive or that the Company's collaborators or
customers will not choose to use competing technologies or products.
 
     Uncertainty Regarding Patents and Proprietary Rights.  The patent positions
of pharmaceutical and biopharmaceutical firms, including Advanced Magnetics, are
generally uncertain and involve complex legal and factual questions. Because of
the substantial length of time and expense associated with bringing new products
through development and regulatory approval to the marketplace, the
pharmaceutical and
biopharmaceutical industries place considerable importance on obtaining patent
and trade secret protection for new technologies, products and processes. There
can be no assurance as to the success or timeliness in obtaining any such
patents, that the breadth of the claims obtained will provide any significant
protection of the Company's technology, or that the degree of protection
afforded by patents for licensed technologies or for future discoveries will be
adequate to protect the Company's proprietary technology. Moreover, no assurance
can be given that patents issued to Advanced Magnetics will not be contested,
invalidated or circumvented. There can be no assurance that future patent
interferences involving patents of either the Company or its licensors will not
have a material adverse effect on the Company's business. Moreover, there can be
no assurance that claims of infringement or violation of the proprietary rights
of others will not be asserted against the Company. If Advanced Magnetics is
required to defend against such claims or to protect its own proprietary rights
against others, the Company may incur substantial costs which could have a
material adverse effect on the Company's business, financial condition and
results of operations.
 
     In the future, Advanced Magnetics may be required to obtain additional
licenses to patents or other proprietary rights of others. There can be no
assurance that any such licenses will be available on acceptable terms, if at
all. The failure to obtain such licenses could result in delays in marketing the
Company's products or the inability to proceed with the development,
manufacturing or sale of product candidates requiring such licenses. In
addition, the termination of any of the Company's existing licensing
arrangements could have a material adverse effect on the Company's business,
financial condition and results of operations.
 
     The Company also relies upon unpatented trade secrets and improvements,
unpatented know-how and continuing technological innovation to develop and
maintain its competitive position, which it seeks to protect, in part, by
confidentiality agreements with its corporate partners, collaborators, employees
and consultants. There can be no assurance that these agreements will not be
breached, that the Company will have adequate remedies for any such breach or
that the Company's trade secrets will not otherwise become known or be
independently discovered by its competitors. In addition, the Company cannot be
certain that others will not independently develop substantially equivalent or
superseding proprietary technology, or that an equivalent product will not be
marketed in competition with the Company's products, thereby substantially
reducing the value of the Company's proprietary rights.
 
     Uncertainty of Third-Party Reimbursement.  In both the United States and
foreign markets, the Company's ability to commercialize its products may depend
in part on the extent to which reimbursement for the costs of such products and
related treatments will be available from government health administration
authorities, private health insurers and other third-party payors. In the United
States, there has been, and the Company expects that there will continue to be,
a number of federal and state proposals to reform the health
 
                                       21

<PAGE>   23
 
care system. Significant uncertainty exists as to the reimbursement status of
both newly-approved health care products and products used for indications not
approved by the FDA. If adequate reimbursement levels are not maintained by
government and other third-party payors for the Company's products and related
treatments, the Company's business, financial condition and results of
operations may be materially adversely affected.
 
     Limited Manufacturing Experience and Capacity.  Advanced Magnetics has no
experience in manufacturing targeted therapeutic products and limited experience
in manufacturing contrast agents in commercial quantities. Currently, the
Company manufactures bulk Feridex I.V. product for sale by Guerbet, Feridex I.V.
finished product and GastroMARK bulk product in its Massachusetts facilities.
These facilities are subject to current Good Manufacturing Practices ("GMP")
regulations prescribed by the FDA. There can be no assurance that the Company
will be able to continue to operate at commercial scale in compliance with the
GMP regulations. Failure to operate in compliance with such GMP regulations and
other applicable manufacturing requirements of various regulatory agencies could
have a material adverse effect on the Company's business, financial condition
and results of operations. In addition, the Company is dependent on contract
manufacturers for the production of certain of its product candidates. In the
event that the Company is unable to obtain or retain manufacturing for its
product candidates, it will not be able to develop and commercialize its
products as planned. There can be no assurance that the Company will be able to
enter into agreements for the manufacture of future products with manufacturers
whose facilities and procedures comply with GMP and other regulatory
requirements or that such manufacturer will be able to deliver required
quantities of product that conform to specifications in a timely manner.
 
     Lack of Marketing and Sales History.  Advanced Magnetics has no experience
in marketing and selling its current products and product candidates and relies
on its corporate partners to market and sell certain products. In order to
achieve commercial success for any product candidate approved by the FDA for
which the Company does not have a marketing partner, Advanced Magnetics may have
to enlarge and expand its marketing and sales force or enter into arrangements
with others to market and sell its products. There can be no assurance that
Advanced Magnetics will be successful in attracting and retaining qualified
marketing and sales personnel or that it will be able to enter into marketing
and sales agreements with others on acceptable terms, if at all. Furthermore,
there can be no assurance that Advanced Magnetics or its corporate partners will
be successful in marketing and selling the Company's products.
 
     Potential Product Liability; Uncertainties Related to Insurance.  The use
of any of the Company's product candidates in clinical trials and the sale of
any approved products may expose the Company to liability claims resulting from
the use of products or product candidates. The Company maintains product
liability insurance coverage for claims arising from the use of its products in
clinical trials. However, coverage is becoming increasingly expensive and no
assurance can be given that the Company will be able to maintain insurance at a
reasonable cost. Furthermore, there can be no assurance that the Company's
insurance will provide sufficient coverage amounts to protect the Company
against losses due to liability that could have a material adverse effect on the
Company's business, financial condition and results of operations. The Company
presently maintains product liability insurance covering the sale of Feridex
I.V., but there can be no assurance that the Company will be able to obtain
commercially reasonable product liability insurance for any product presently
being marketed or for any product approved for marketing in the future or that
insurance coverage and the resources of the Company would be sufficient to
satisfy any liability resulting from product liability claims. A product
liability claim or series of claims brought against the Company could have a
material adverse effect on its business, financial condition and results of
operations, whether or not the plaintiffs in such claims ultimately prevail.
 
     Attraction and Retention of Key Employees.  Because of the specialized
nature of its business, Advanced Magnetics is highly dependent on its ability to
attract and retain qualified scientific and technical personnel for the research
and development activities conducted or sponsored by the Company. In addition,
the Company is substantially dependent upon Jerome Goldstein, its Chairman of
the Board, Chief Executive Officer and President. The loss of Mr. Goldstein, or
other certain key executive officers could be detrimental to the Company.
Furthermore, the Company's anticipated growth and expansion into areas and
activities requiring additional expertise, such as clinical testing, regulatory
compliance, manufacturing and marketing, may
 
                                       22

<PAGE>   24
 
require the addition of new management personnel and the development of
additional expertise by existing management 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 of its
business. The failure to attract and retain such personnel or to develop such
expertise could adversely affect the Company's business, financial condition and
results of operations.
 
     Volatility of Common Stock Price.  The market prices for securities of
biopharmaceutical and pharmaceutical companies, including the Company, have
historically been highly volatile. Such fluctuations in operating results may
cause the market price of the Company's Common Stock to be volatile. In
addition, the market prices for securities of biopharmaceutical and
pharmaceutical companies have from time to time experienced significant price
and volume fluctuations that are unrelated to the operating performance of such
companies. Various factors and events, including announcements by the Company or
its competitors concerning technological innovations, new products, clinical
trial results, agreements with collaborators, governmental regulations,
developments in patent or other proprietary rights, public concern regarding the
safety of drugs developed by the Company or others, may have a significant
impact on the market price of the Company's Common Stock and dividend policy.
 

I
TEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA:
 
     The Company's Financial Statements and related Report of Independent
Accountants are presented in the following pages. The financial statements filed
in this Item 8 are as follows:
 
     Report of Independent Accounts
 
     Financial Statements:
 
        Balance Sheets -- September 30, 1996 and 1995
 
        Statements of Operations -- Years ended September 30, 1996, 1995 and
        1994
 
        Statements of Stockholders' Equity -- Years ended September 30, 1996,
        1995 and 1994
 
        Statements of Cash Flows -- Years ended September 30, 1996, 1995 and
        1994
 
        Reconciliation of Net Income to Net Cash Provided by Operating
        Activities -- Years ended September 30, 1996, 1995 and 1994
 

        Notes to Financial Statements
 

I
TEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
         FINANCIAL DISCLOSURE:
 
     Not applicable.
 
                                       23

<PAGE>   25
 
                            ADVANCED MAGNETICS, INC.
 
                         INDEX TO FINANCIAL STATEMENTS
 

<TABLE>
<S>                                                                                         <C>
Report of Independent Accountants.....................................................      25
Balance Sheets........................................................................      26
Statements of Operations..............................................................      27
Statements of Stockholders' Equity....................................................      28
Statements of Cash Flows..............................................................      29
Reconciliation of Net Income to Net Cash Provided by Operating Activities.............      30
Notes to Financial Statements.........................................................      31

</TABLE>

 
                                       24

<PAGE>   26
 

                       REPORT OF INDEPENDENT ACCOUNTANTS
 
To the Directors and Stockholders of Advanced Magnetics, Inc.:
 
     We have audited the accompanying balance sheets of Advanced Magnetics, Inc.
(the "Company") as of September 30, 1996 and 1995 and the related statements of
operations, stockholders' equity, and cash flows for each of the three years in
the period ended September 30, 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 Advanced Magnetics, Inc. as
of September 30, 1996 and 1995, and the results of its operations and its cash
flows for each of the three years in the period ended September 30, 1996, in
conformity with generally accepted accounting principles.
 
     As discussed in Note A to the financial statements, effective October 1,
1994, Advanced Magnetics, Inc. adopted the Statement of Financial Accounting
Standards No. 115, "Accounting for Certain Investments in Debt and Equity
Securities".
 
                                          COOPERS & LYBRAND L.L.P.
 
Boston, Massachusetts
November 6, 1996

 
                                       25

<PAGE>   27
 
                            ADVANCED MAGNETICS, INC.
 
                                 BALANCE SHEETS
 

<TABLE>
<CAPTION>
                                                                            SEPTEMBER 30,
                                                                      -------------------------
                                                                         1996          1995
                                                                      -----------   -----------
<S>                                                                   <C>           <C>
                                            ASSETS
Current Assets:
  Cash and cash equivalents.......................................    $10,805,842   $ 1,066,419
  Marketable securities (Note C)..................................     23,271,169    36,561,263
  Accounts receivable.............................................        149,235     5,884,542
  Recoverable income taxes (Note G)...............................             --        90,117
  Inventories (Note D)............................................        182,166        55,567
  Prepaid expenses................................................        131,234        99,342
                                                                      -----------   -----------
          Total current assets....................................     34,539,646    43,757,250
                                                                      -----------   -----------
Property, plant and equipment:
  Land............................................................        360,000       360,000
  Buildings.......................................................      4,320,766     4,320,766
  Laboratory equipment............................................      7,316,534     6,886,813
  Furniture and fixtures..........................................        553,149       516,418
                                                                      -----------   -----------
                                                                       12,550,449    12,083,997
  Less - accumulated depreciation and amortization................     (6,219,579)   (5,143,097)
                                                                      -----------   -----------
  Net property, plant and equipment...............................      6,330,870     6,940,900
                                                                      -----------   -----------
Other assets......................................................        195,857       145,072
                                                                      -----------   -----------
          Total assets............................................    $41,066,373   $50,843,222
                                                                      ===========   ===========
                             LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
  Accounts payable................................................    $   383,335   $   407,998
  Accrued expenses (Note F).......................................        500,365     1,214,152
  Income taxes payable (Note G)...................................         50,128       150,000
                                                                      -----------   -----------
          Total current liabilities...............................        933,828     1,772,150
                                                                      -----------   -----------
Commitments and contingencies (Notes E, N and O)
Stockholders' equity (Notes C, H, I, K, and L):
  Preferred stock, par value $.01 per share, authorized 2,000,000
     shares; none issued..........................................             --            --
  Common Stock, par value $.01 per share, authorized 15,000,000
     shares; issued and outstanding 6,761,612 shares in 1996 and
     6,753,413 in 1995............................................         67,616        67,534
  Additional paid-in capital......................................     44,926,502    45,093,972
  Retained earnings (deficit).....................................     (6,678,476)    3,036,517
  Net unrealized gain on marketable securities....................      1,816,903       873,049
                                                                      -----------   -----------
     Total stockholders' equity...................................     40,132,545    49,071,072
                                                                      -----------   -----------
          Total liabilities and stockholders' equity..............    $41,066,373   $50,843,222
                                                                      ===========   ===========
</TABLE>

 
    The accompanying notes are an integral part of the financial statements.
 
                                       26

<PAGE>   28
 
                            ADVANCED MAGNETICS, INC.
 
                            STATEMENTS OF OPERATIONS
 

<TABLE>
<CAPTION>
                                                           FOR THE YEARS ENDED SEPTEMBER 30,
                                                       ------------------------------------------
                                                          1996            1995            1994
                                                       -----------     -----------     ----------
<S>                                                    <C>             <C>             <C>
Revenues:
  License fees.....................................    $        --     $ 5,000,000     $5,505,000
  Royalties........................................         50,000         189,493         15,924
  Product sales....................................         12,762       2,120,457        280,975
  Contract research and development................          6,810              --             --
  Interest, dividends and net gains and losses on
     sales
     of securities.................................      1,761,450       2,287,311      1,845,005
                                                       -----------     -----------     ----------
          Total revenues...........................      1,831,022       9,597,261      7,646,904
Cost and Expenses:
  Cost of product sales............................          2,550         425,187         54,983
  Company-sponsored research and development
     expenses......................................      9,671,897       8,601,791      6,621,929
  Charge (credit) for purchase of in-process
     research and development (Note O).............             --        (380,000)       760,000
  Selling, general and administrative expenses.....      1,871,568       1,759,348      1,963,480
                                                       -----------     -----------     ----------
          Total costs and expenses.................     11,546,015      10,406,326      9,400,392
Other Income:
  Gain on sale of in vitro product line (Note B)...             --       3,404,527      2,649,580
                                                       -----------     -----------     ----------
Income (loss) before provision for income taxes and
  cumulative effect of accounting change...........     (9,714,993)      2,595,462        896,092
  Income tax provision.............................             --         400,000          8,000
                                                       -----------     -----------     ----------
Income (loss) before cumulative effect of
  accounting change................................     (9,714,993)      2,195,462        888,092
  Cumulative effect of accounting change (Note
     C)............................................             --         117,540             --
                                                       -----------     -----------     ----------
Net income (loss)..................................    $(9,714,993)    $ 2,313,002     $  888,092
                                                       ===========     ===========     ==========
Income (loss) per share before cumulative effect of
  accounting change................................    $     (1.44)    $      0.32     $     0.13
  Cumulative effect of accounting change...........             --            0.02             --
                                                       -----------     -----------     ----------
Net income (loss) per share........................    $     (1.44)    $      0.34     $     0.13
                                                       ===========     ===========     ==========
Weighted average number of common and common
  equivalent shares (Note A).......................      6,762,748       6,870,839      6,806,525
                                                       -----------     -----------     ----------
</TABLE>

 
    The accompanying notes are an integral part of the financial statements.
 
                                       27

<PAGE>   29
 
                            ADVANCED MAGNETICS, INC.
 
                       STATEMENTS OF STOCKHOLDERS' EQUITY
               FOR THE YEARS ENDED SEPTEMBER 30, 1994, 1995, 1996
 

<TABLE>
<CAPTION>
                                                                                           NET
                                                                                        UNREALIZED
                                         COMMON STOCK       ADDITIONAL     RETAINED      GAIN ON        TOTAL
                                      -------------------     PAID-IN      EARNINGS     MARKETABLE   STOCKHOLDERS'
                                       SHARES     AMOUNTS     CAPITAL      (DEFICIT)    SECURITIES     EQUITY
                                      ---------   -------   -----------   -----------   ----------   -----------
<S>                                   <C>         <C>       <C>           <C>           <C>          <C>
Balance at September 30, 1993.......  6,660,462   $66,605   $44,752,400   $  (164,577)          --   $44,654,428
Shares issued in connection with the
  exercise of stock options.........     70,648       706       417,406            --           --       418,112
Shares surrendered in connection
  with the exercise of stock
  options...........................     (4,193)      (42)      (58,147)           --           --       (58,189)
Shares issued in connection with
  employee stock purchase plan (Note
  H)................................     10,355       104       105,517            --           --       105,621
Common shares repurchased (Note
  K)................................    (24,700)     (247)     (316,342)           --           --      (316,589)
Repurchase of warrants (Note K).....         --        --      (240,000)           --           --      (240,000)
Net income..........................         --        --            --       888,092           --       888,092
                                      ---------   -------   -----------   -----------   ----------   -----------
Balance at September 30, 1994.......  6,712,572    67,126    44,660,834       723,515           --    45,451,475
Shares issued in connection with the
  exercise of stock options.........     29,494       295       207,060            --           --       207,355
Shares surrendered in connection
  with the exercise of stock
  options...........................     (1,476)      (15)      (24,588)           --           --       (24,603)
Shares issued in connection with
  employee stock purchase plan (Note
  H)................................     12,823       128       130,666            --           --       130,794
Repurchase of warrants (Note K).....         --        --       120,000            --           --       120,000
Net change in unrealized gain on
  marketable securities.............         --        --            --            --   $  873,049       873,049
Net income..........................         --        --            --     2,313,002           --     2,313,002
                                      ---------   -------   -----------   -----------   ----------   -----------
Balance at September 30, 1995.......  6,753,413    67,534    45,093,972     3,036,517      873,049    49,071,072
Shares issued in connection with the
  exercise of stock options.........     26,445       264       185,697            --           --       185,961
Shares surrendered in connection
  with the exercise of stock
  options...........................       (921)       (9)      (18,463)           --           --       (18,472)
Shares issued in connection with
  employee stock purchase plan (Note
  H)................................      8,875        89       141,379            --           --       141,468
Common shares repurchased (Note
  K)................................    (26,200)     (262)     (476,083)           --           --      (476,345)
Net change in unrealized gain on
  marketable securities.............         --        --            --            --      943,854       943,854
Net (loss)..........................         --        --            --    (9,714,993)          --    (9,714,993)
                                      ---------   -------   -----------   -----------   ----------   -----------
Balance at September 30, 1996.......  6,761,612   $67,616   $44,926,502   $(6,678,476)  $1,816,903   $40,132,545
                                      =========   ========  ===========   ===========   ==========   ===========
</TABLE>

 
    The accompanying notes are an integral part of the financial statements.
 
                                       28

<PAGE>   30
 
                            ADVANCED MAGNETICS, INC.
 
                            STATEMENTS OF CASH FLOWS
 

<TABLE>
<CAPTION>
                                                            FOR THE YEARS ENDED SEPTEMBER 30,
                                                        -----------------------------------------
                                                            1996          1995           1994
                                                        ------------   -----------   ------------
  <S>                                                   <C>            <C>           <C>
  Cash Flows from Operating Activities:
    Cash received from customers......................  $  1,330,567   $ 5,380,513   $  5,864,116
    Cash paid to suppliers and employees..............   (10,850,727)   (8,920,459)    (8,112,462)
    Cash paid for purchase of in-process
       research and development (Note O)..............            --            --       (260,000)
    Dividends and interest received...................     2,099,445     1,876,214      1,716,811
    Income taxes paid.................................       (20,000)     (250,000)      (205,067)
    Income tax refund.................................        10,245            --        622,849
    Net realized gain on sales of marketable
       securities.....................................         6,353        54,966        161,109
                                                        ------------   -----------   ------------
    Net cash (used in) operating activities...........    (7,424,117)   (1,858,766)      (212,644)
                                                        ------------   -----------   ------------
  Cash Flows from Investing Activities:
    Proceeds from sales of marketable securities......    10,727,188     1,385,830      6,863,154
    Proceeds from notes and bonds maturing............     9,499,911     3,000,000             --
    Purchase of marketable securities.................    (2,378,934)   (6,703,475)   (25,117,742)
    Capital expenditures..............................      (466,452)   (1,484,382)      (780,586)
    Decrease in other assets..........................       (50,785)      (48,526)       (36,853)
                                                        ------------   -----------   ------------
    Net cash provided by (used in) investing
       activities.....................................    17,330,928    (3,850,553)   (19,072,027)
                                                        ------------   -----------   ------------
  Cash Flows from Financing Activities:
    Proceeds from issuances of common stock...........       308,957       313,545        465,544
    Purchase of treasury stock........................      (476,345)           --       (316,589)
    Purchase of warrants..............................            --            --       (240,000)
                                                        ------------   -----------   ------------
    Net cash provided by (used in) financing
       activities.....................................      (167,388)      313,545        (91,045)
                                                        ------------   -----------   ------------
    Net increase (decrease) in cash and cash
       equivalents....................................     9,739,423    (5,395,774)   (19,375,716)
  Cash and cash equivalents at beginning of year......     1,066,419     6,462,193     25,837,909
                                                        ------------   -----------   ------------
  Cash and cash equivalents at end of year............  $ 10,805,842   $ 1,066,419   $  6,462,193
                                                         ===========    ==========    ===========
</TABLE>

 
    The accompanying notes are an integral part of the financial statements.
 
                                       29

<PAGE>   31
 
                            ADVANCED MAGNETICS, INC.
 
                    RECONCILIATION OF NET INCOME TO NET CASH
                        PROVIDED BY OPERATING ACTIVITIES
 

<TABLE>
<CAPTION>
                                                             FOR THE YEARS ENDED SEPTEMBER 30,
                                                          ---------------------------------------
                                                              1996         1995          1994
                                                          ------------  -----------   -----------
  <S>                                                     <C>           <C>           <C>
  Net income (loss).....................................  $(9,714,993)  $ 2,313,002   $   888,092
                                                          -----------   -----------   -----------
  Adjustments to Reconcile Net Income to Net Cash
  Used in Operating Activities, net of assets disposed
    of:
    Depreciation and amortization.......................     1,076,482    1,007,005       877,803
    Net unrealized loss on market value of securities...            --           --       117,540
    Cumulative effect of accounting change..............            --     (117,540)           --
    Accretion of U.S. Treasury Notes discount...........       (32,217)     (53,943)           --
    (Increase) decrease in accounts receivable..........     1,637,558   (2,231,625)      (22,332)
    (Increase) in inventories...........................      (126,599)     (55,567)           --
    (Increase) decrease in prepaid expenses.............       (31,892)      13,504       134,063
    Decrease in recoverable income taxes................        90,117           --       259,831
    (Decrease) increase in accounts payable and accrued
       expenses.........................................      (222,701)     900,925      (318,061)
    Increase (decrease) in income taxes payable.........       (98,872)     150,000            --
    Gain on sale of in vitro product line (Note B)......            --   (3,404,527)   (2,649,580)
    Accrual (credit) for the purchase of in-process
       research and development (Note O)................            --     (380,000)      500,000
                                                          ------------  -----------   -----------
         Total adjustments..............................     2,290,876   (4,171,768)   (1,100,736)
                                                          ------------  -----------   -----------
  Net cash (used in) operating activities...............   $(7,424,117) $(1,858,766)  $  (212,644)
                                                           ===========  ===========   ===========
</TABLE>

 
    The accompanying notes are an integral part of the financial statements.
 
                                       30

<PAGE>   32
 
                         NOTES TO FINANCIAL STATEMENTS
 
A.  SUMMARY OF ACCOUNTING POLICIES
 
     Business
 
     Founded in November 1981, Advanced Magnetics, Inc., a Delaware Corporation
(the "Company"), is a biopharmaceutical company engaged in the development and
manufacture of compounds utilizing the Company's core proprietary colloidal
superparamagnetic particle technology for magnetic resonance imaging ("MRI") and
for polysaccharide directed drug delivery systems. The initial products
developed by the Company are diagnostic imaging agents for use in conjunction
with MRI to aid in the diagnosis of cancer and other diseases. In therapeutics,
the Company is developing targeted drug delivery programs.
 
     The Company is subject to risks common to companies in the industry
including, but not limited to, development by the Company or its competitors of
new technological innovations, dependence on key personnel, market acceptance of
products, product liability, protection of proprietary technology, and
compliance with FDA government regulations.
 
     Use of Estimates
 
     The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make certain estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the reported
period. Actual results could differ from those estimates.
 
     Cash and Cash Equivalents
 
     Cash and cash equivalents consist of cash on hand, money market funds and
marketable securities having a maturity of less than three months at the date
acquired. Substantially, all of the cash and cash equivalents at September 30,
1996 were held in a money market account.
 
     Marketable Securities
 
     In the fiscal quarter ended December 31, 1994, the Company adopted
Statement of Financial Accounting Standards No. 115, "Accounting for Certain
Investments in Debt and Equity Securities". Prior period financial statements
have not been restated. The Company's current portfolio consists of securities
classified as available-for-sale which are recorded at fair market value. The
fair values of marketable securities are based on quoted market prices. Net
unrealized gains or losses on marketable securities are recorded as a separate
component of equity. Interest income is accrued as earned. Dividend income is
accrued on the ex-dividend date, and net realized gains and losses are computed
on the basis of average cost and are recognized when realized.
 
     Inventories
 
     Inventories are stated at the lower of cost (determined on a first-in,
first-out basis) or market.
 
     Property, Plant and Equipment
 
     Property, plant and equipment are stated at cost. The cost of additions and
improvements is charged to the property accounts while maintenance and repairs
are expensed as incurred. Upon sale or other disposition of property and
equipment, the cost and related depreciation are removed from the accounts and
any resulting gain or loss is reflected in income.
 
                                       31

<PAGE>   33
 
                  NOTES TO FINANCIAL STATEMENTS -- (Continued)
 
     Depreciation and Amortization
 
     Depreciation and amortization are recorded on the straight line method
based on rates sufficient to provide for retirement over estimated useful lives
as follows: buildings - 40 years; laboratory equipment and furniture and
fixtures - 5 years; and leasehold improvements - over the life of the lease.
 
     Revenue Recognition
 
     Revenue is recognized when products are shipped, when contract objectives
are achieved or when research activities are performed. License and royalty
revenues are accrued as earned.
 
     Income Taxes
 
     The provision for income taxes includes federal and state income taxes
currently payable and deferred income taxes arising from the recognition of
certain income and expenses in different periods for financial and tax reporting
purposes.
 
     Income (Loss) per Share
 
     Income per share is computed on the basis of the weighted average number of
common and common share equivalents outstanding during each period. Loss per
share is computed on the weighted average number of shares outstanding during
the period.
 
B.  SALE OF IN VITRO PRODUCT LINE
 
     On October 15, 1993, the Company sold its in vitro product line to
PerSeptive Biosystems, Inc. ("PerSeptive") for 151,759 shares of PerSeptive
common stock which had a market value of $4,156,674 as of that date, plus an
additional earn-out amount based on the results of fiscal 1995. The amount of
the earn-out at September 30, 1995 was $3,404,527, which PerSeptive satisfied by
issuing 373,080 shares of PerSeptive common stock. The Company recognized
pre-tax gains on this sale of $3,404,527 and $2,649,580 in fiscal 1995 and 1994,
respectively.
 
C.  MARKETABLE SECURITIES
 
     The cost and fair value of the marketable securities portfolio at September
30 are as follows:
 

<TABLE>
<CAPTION>
                                                        1996                        1995
                                              -------------------------   -------------------------
                                                 COST       FAIR VALUE       COST       FAIR VALUE
                                              -----------   -----------   -----------   -----------
<S>                                           <C>           <C>           <C>           <C>
U.S. government securities
  Due in one year or less...................  $ 7,510,203   $ 7,481,250   $ 9,501,365   $ 9,476,430
  Due after one through five years..........    7,392,785     7,312,500    14,869,406    14,737,500
Corporate debt, due after five through ten
  years.....................................           --            --     1,980,040     2,002,500
Preferred stock.............................    3,062,404     3,145,029     6,116,668     5,740,023
Common stock................................    3,488,874     5,332,390     3,220,735     4,604,810
                                              -----------   -----------   -----------   -----------
                                              $21,454,266   $23,271,169   $35,688,214   $35,561,263
                                              ===========   ===========   ===========   ===========
</TABLE>

 
     At September 30, 1996, gross unrealized holding gains and gross unrealized
holding losses were $2,020,876 and $203,973, respectively, resulting in a net
unrealized holding gain of $1,816,903. At September 30, 1995, gross unrealized
holding gains and gross unrealized holding losses were $1,722,965 and $849,916,
respectively, resulting in a net unrealized holding gain of $873,049. For the
fiscal years ended September 30, 1996 and 1995, the net unrealized holding gains
have been recorded as a separate component of equity.
 
     At September 30, 1994, the Company recorded a $117,540 unrealized net loss
on the fair value of securities. In the first fiscal quarter ended December 31,
1994, the Company recorded a cumulative effect of
 
                                       32

<PAGE>   34
 
                  NOTES TO FINANCIAL STATEMENTS -- (Continued)
 
the accounting change of $117,540 including the reversal of the reserve for the
carrying value of the marketable securities.
 
     During the year ended September 30, 1996, gross realized gains and gross
realized losses on the sale of marketable securities were $660,126 and $653,773,
respectively, resulting in a net realized gain of $6,353. During the year ended
September 30, 1995, gross realized gains and gross realized losses on the sale
of marketable securities were $57,394 and $2,428, respectively, resulting in a
net realized gain of $54,966. Proceeds from U.S. treasury bonds maturing were
$9,499,911 and $3,000,000 in 1996 and 1995, respectively.
 
     Interest, dividends and net gains (losses) on sales of securities consist
of the following:
 

<TABLE>
<CAPTION>
                                                              FOR THE YEARS ENDED SEPTEMBER 30,
                                                             ------------------------------------
                                                                1996         1995         1994
                                                             ----------   ----------   ----------
<S>                                                          <C>          <C>          <C>
Interest income............................................  $1,400,597   $1,644,329   $1,135,614
Dividend income............................................     354,500      588,016      665,822
Net gains on sales of securities...........................       6,353       54,966      161,109
Unrealized (loss) included in the determination of
  income...................................................          --           --     (117,540)
                                                             ----------   ----------   ----------
                                                             $1,761,450   $2,287,311   $1,845,005
                                                             ==========   ==========   ==========
</TABLE>

 
D.  INVENTORIES
 
     As of September 30, 1996, the Company's inventory balance consisted of
$57,022 in finished goods and $125,144 in raw materials. As of September 30,
1995, the Company's inventory balance consisted of $55,567 in raw materials.
 
E.  COMMITMENTS
 
     The Company leases laboratory, office and warehouse and space under various
agreements. Rental expense for the years ended September 30, 1996, 1995 and 1994
amounted to $340,848, $320,920, and $38,017, respectively. Future minimum lease
payments for fiscal 1997 and 1998 amount to $330,692 and $21,532, respectively.
 
F.  ACCRUED EXPENSES
 
     Accrued expenses consist of the following at September 30:
 

<TABLE>
<CAPTION>
                                                                         1996          1995
                                                                       --------     ----------
<S>                                                                    <C>          <C>
Salaries and other compensation....................................    $195,889     $  194,881
Professional fees..................................................      75,638        154,668
Other..............................................................     228,838        348,856
Payable for the purchase of marketable securities..................          --        515,747
                                                                       --------     ----------
                                                                       $500,365     $1,214,152
                                                                       ========     ==========
</TABLE>

 
G.  INCOME TAXES
 
     Deferred tax assets and deferred tax liabilities are recognized based on
temporary differences between the financial reporting and tax basis of assets
and liabilities using statutory rates. A valuation allowance is recorded against
deferred tax assets if it is more likely than not that some or all of the
deferred tax assets will not be realized.
 
                                       33

<PAGE>   35
 
                  NOTES TO FINANCIAL STATEMENTS -- (Continued)
 
     The income tax provision consists of the following:
 

<TABLE>
<CAPTION>
                                                                   FOR THE YEARS ENDED
                                                                      SEPTEMBER 30,
                                                               ---------------------------
                                                               1996      1995        1994
                                                               ---     --------     ------
    <S>                                                        <C>     <C>          <C>
    Currently payable:
      Federal..............................................    $--     $385,000     $   --
      State................................................     --       15,000      8,000
                                                               ----    --------     ------
                                                               
                                                                --      400,000      8,000
                                                               ---     --------     ------
                                                               
    Deferred:
      Federal..............................................     --           --         --
      State................................................     --           --         --
                                                               ---     --------     ------
                                                               
                                                                --           --         --
                                                               ---     --------     ------
                                                               
                                                               $--     $400,000     $8,000
                                                               ===     ========     ======
</TABLE>

 
     The provisions for income taxes were at different rates than the U.S.
statutory rates for the following reasons:
 

<TABLE>
<CAPTION>
                                                                     FOR THE YEARS ENDED
                                                                        SEPTEMBER 30,
                                                                  -------------------------
                                                                  1996      1995      1994
                                                                  -----     -----     -----
    <S>                                                           <C>       <C>       <C>
    U.S. federal statutory tax (benefit) rate.................    (34.0)%    34.0%     34.0%
    Dividends received deductions.............................     (0.9)     (5.2)    (17.7)
    Other.....................................................      0.1       1.0       1.7
    Losses without tax benefit................................     38.2        --        --
    Tax benefit of temporary differences......................     (3.4)    (14.4)    (17.1)
                                                                  -----     -----     -----
                                                                     --      15.4%      0.9%
                                                                  =====     =====     =====
</TABLE>

 
     The components of the deferred tax assets and liabilities at September 30,
were as follows:
 

<TABLE>
<CAPTION>
                                                                   1996            1995
                                                                -----------     -----------
    <S>                                                         <C>             <C>
    Assets
      Net operating loss carryforwards........................  $ 4,834,262     $   460,506
      Research and experimentation tax credit carryforward....    1,779,972       1,656,069
      Deductible intangibles..................................      481,360         911,066
      Other...................................................      539,140         630,670
    Liabilities
      Property, plant and equipment depreciation..............     (380,212)       (249,373)
      Other...................................................      (34,283)        (96,598)
      Unrealized gain on marketable securities................     (731,667)       (351,577)
                                                                -----------     -----------
                                                                  6,488,572       2,960,763
      Valuation allowance.....................................   (6,488,572)     (2,960,763)
                                                                -----------     -----------
    Net deferred taxes........................................  $        --     $        --
                                                                ===========     ===========
</TABLE>

 
     Due to the uncertainty surrounding the realization of the favorable tax
attributes in future tax returns, the Company has placed a valuation allowance
against its otherwise recognizable net deferred tax assets. Realization of
favorable tax attributes is, therefore, reflected as a tax benefit in the
provision for income taxes.
 
     At September 30, 1995, the recoverable income taxes resulted from carryback
of current year losses for federal income tax purposes to amounts paid for
income taxes in prior years.
 
                                       34

<PAGE>   36
 
                  NOTES TO FINANCIAL STATEMENTS -- (Continued)
 
     At September 30, 1996, the Company had unused net operating loss (NOL)
carryforwards for federal income tax purposes of approximately $11,750,000 which
expire in fiscal 2011. The Company also has federal research and experimentation
credits of approximately $1,560,000 which expire in fiscal 2011.
 
H.  EMPLOYEE STOCK PURCHASE PLAN
 
     The Company's 1992 Employee Stock Purchase Plan (the "Purchase Plan")
provides for the issuance of up to 150,000 shares of common stock to employees
of the Company. Under the terms of the Purchase Plan, eligible employees may
purchase shares in five annual offerings ending in 1997, through payroll
deductions of up to a maximum of 10% of the employee's earnings, at a price
equal to the lower of 85% of the fair market value of the stock on the
applicable annual offering commencement date of June 1 or termination date of
May 31. The fourth offering under the Purchase Plan ended on May 31, 1996 and
8,875 shares of common stock were purchased by eligible employees at a price of
approximately $15.94 per share. As of September 30, 1996, 45,351 shares have
been issued under the Purchase Plan.
 
I.  STOCK OPTION PLAN
 
     The Company's 1993 Stock Option Plan (the "1993 Stock Plan") provides for
the grant of options to the Company's directors, officers, employees and
consultants to purchase up to an aggregate of 500,000 shares of common stock at
a price equal to the fair market value of the stock at the date of grant. The
maximum term of the options under the 1993 Stock Plan is ten years. The number
of shares available for future grants at September 30, 1996 was 283,225.
 
     The Company's 1983 Stock Option Plan (the "Plan") does not allow for option
grants after June 1993. The Plan provided for the grant of options to purchase
up to 900,000 shares of common stock at a price equal to the fair market value
of the stock at the date of grant to the Company's employees and mandatory
grants to outside directors upon initial election to the Board of Directors. The
maximum terms of incentive stock options and non-statutory options under the
Plan are ten years and ten years plus thirty days, respectively.
 
     The Company has also granted to certain scientific advisors non-statutory
options to purchase a total of 32,625 shares of common stock at a price equal to
fair market value at the date of grant. As of September 30, 1996, 29,625 options
have been exercised.
 
     The table below summarizes stock option activity during the past three
fiscal years for the Company's 1993 and 1983 Stock Option Plans:
 

<TABLE>
<CAPTION>
                                                                 NUMBER
                                                                OF SHARES       OPTION PRICE
                                                                ---------    -------------------
    <S>                                                         <C>          <C>     <C>  <C>
    Options outstanding at September 30, 1993.................   292,159     $ 1.00  to   $15.00
      Granted.................................................   126,500      12.00  to    16.00
      Exercised...............................................   (70,648)      1.00  to    12.00
      Expired.................................................   (40,752)      7.00  to    15.00
                                                                 -------
    Options outstanding at September 30, 1994.................   307,259       1.00  to    16.00
      Granted.................................................    86,200      15.00  to    22.00
      Exercised...............................................   (29,494)      1.00  to    15.00
      Expired.................................................    (4,775)     12.00  to    15.00
                                                                 -------
    Options outstanding at September 30, 1995.................   359,190       1.33  to    22.00
      Granted.................................................    11,500      18.17  to    18.20
      Exercised...............................................   (26,445)      1.33  to    14.88
      Expired or canceled.....................................    (5,725)     12.13  to    22.00
                                                                 -------
    Options outstanding at September 30, 1996 (209,170 shares
      exercisable)............................................   338,520     $ 1.33  to   $22.00
</TABLE>

 
                                       35

<PAGE>   37
 
                  NOTES TO FINANCIAL STATEMENTS -- (Continued)
 
     On November 5, 1991, the Company's Board of Directors adopted the 1992
Non-Employee Director Stock Option Plan which the shareholders approved. This
plan provides for the grant to each non-employee director on November 5, 1991,
and each fifth anniversary thereafter of an option to purchase 5,000 shares of
common stock up to an aggregate of 100,000 shares at a price equal to the fair
market value of the stock at the date of the grant, vesting over a five year
period. Under this plan, options to purchase 30,000 shares of common stock at a
price of $21.00 per share were granted, none of which have been exercised. In
addition, 30,000 shares of common stock at a price of $15.25 per share were
granted on November 5, 1996. No grants may be made under this plan after
November 4, 2001.
 
     On November 10, 1992, the Company's Board of Directors adopted the 1993
Non-Employee Director Stock Option Plan which the shareholders approved. This
plan provides for the grant to each non-employee director on November 10, 1992,
and each sixth anniversary thereafter an option to purchase 5,000 shares of
common stock up to an aggregate of 100,000 shares at a price equal to the fair
market value of the stock at the date of the grant, vesting over a five year
period. Under this plan, options to purchase 30,000 shares of common stock at a
price of $14.50 per share were granted, none of which have been exercised. No
grants may be made under this plan after November 10, 2002.
 
J.  EMPLOYEE'S SAVING PLAN
 
     The Company provides a 401(k) Plan to employees of the Company by which
they may defer compensation for income tax purposes under Section 401(k) of the
Internal Revenue Code. Each employee may elect to defer a percentage of his or
her salary on a pre-tax basis up to a specified maximum percentage. The Company
matches every dollar each employee contributes to the 401(k) Plan up to six
percent of each employee's salary to a maximum of $2,000 annually per employee.
Salary deferred by employees and contributions by the Company to the 401(k) Plan
are not taxable to employees until withdrawn from the 401(k) Plan and
contributions are deductible by the Company when made. The amount of the
Company's matching contribution for the 401(k) Plan was $110,542, $99,751, and
$79,851 for 1996, 1995, and 1994, respectively.
 
K.  COMMON STOCK TRANSACTIONS
 
     On February 11, 1991, Squibb Diagnostics, a division of Bristol-Myers
Squibb Co., purchased a warrant for $950,000 to purchase 600,000 shares of
common stock at $10.92 per share. On August 30, 1994, the Company signed an
agreement to reacquire the development and marketing rights to the MRI contrast
agent Combidex. As part of the transaction, Bristol-Myers Squibb Co. returned
the warrant which was valued at $240,000 to the Company. In the first quarter of
fiscal 1995, the Company and Bristol-Myers Squibb Co. agreed to modify the
agreement. As a result, payments to be made under the agreement were modified
(See Note O). Accordingly, the Company adjusted the value of the warrant to
purchase 600,000 shares of the Company's common stock by $120,000 in the first
quarter of fiscal 1995.
 
     In May 1996, the Board of Directors authorized the purchase of 250,000
shares of the Company's common stock on the open market. Through September 30,
1996, the Company purchased 26,200 shares for $476,345 and the shares have been
retired. The Board had previously authorized the purchase of 350,000 shares of
which 24,700 were retired through fiscal 1995.
 
L.  PREFERRED STOCK
 
     The preferred stock may be issued from time to time in one or more series.
The rights, preferences, restrictions, qualifications and limitations of such
stock shall be determined by the Board of Directors.
 
M.  BUSINESS SEGMENTS AND CUSTOMERS
 
     The Company's operations are located solely within the United States. The
Company is focused principally on developing and manufacturing MRI contract
agents and drug delivery systems. Accordingly, its
 
                                       36

<PAGE>   38
 
                  NOTES TO FINANCIAL STATEMENTS -- (Continued)
 
revenues are attributable to one principal business segment. The Company
performs ongoing credit evaluations of its customers and generally does not
require collateral. Two customers accounted for 52% and 23% respectively of the
Company's revenues in fiscal 1995 and two customers accounted for 39% and 33%
respectively of the Company's revenues in fiscal 1994. No customer accounted for
more than 10% of the Company's revenues in fiscal 1996.
 
     Revenues in fiscal 1996, 1995 and 1994, from customers and business outside
of the United States, principally in Europe and Japan, amount to 3%, 23% and 3%
respectively.
 
N.  LEGAL PROCEEDINGS
 
     The Company and certain of its officers were sued in an action in the
United States District Court for the District of Massachusetts on September 3,
1992. The plaintiff, a former consultant to the Company, claims that he was
incorrectly omitted as an inventor or joint inventor on certain of the Company's
patents and on pending applications, and seeks injunctive relief and unspecified
monetary damages. In October 1995, the plaintiff appealed an interlocutory order
of the United States District Court to the United States Court of Appeals for
the Federal Circuit. The plaintiff's appeal is pending and the United States
District Court has administratively closed the case. The plaintiff filed a
related case in the Superior Court of the Commonwealth of Massachusetts. The
Superior Court has dismissed most of the related tort claims on summary
judgment. While the final outcome of these actions cannot be determined, the
Company believes that the plaintiff's claims are without merit and intends to
defend the actions vigorously.
 
O.  AGREEMENTS
 
     In fiscal 1993, the Company entered into an agreement with Sterling for a
product license and exclusive marketing rights to Advanced Magnetics' Feridex
I.V. MRI liver imaging contrast agent in the United States, Canada, Mexico and
Australia. Under the agreement, Sterling would have paid up to $7,750,000 in
license fees based on achieving certain milestones, of which $1,000,000 was
received and recognized in license revenues in fiscal 1993.
 
     In fiscal 1994, Sterling paid a $2,500,000 non-refundable milestone payment
upon the Company's filing of a New Drug Application ("NDA") with the U.S. Food
and Drug Administration ("FDA") for Feridex I.V. On October 6, 1994, the Company
terminated its marketing and distribution agreement with Sterling as a direct
result of the sale by Sterling of its prescription pharmaceutical business. The
agreement with Sterling was not assignable without the Company's consent, which
was not sought by Sterling nor given by the Company.
 
     In fiscal 1991, the Company entered into agreements with Squibb
Diagnostics, granting exclusive world-wide rights (except for Japan, Western
Europe and Brazil) to manufacture and sell two MRI products, AMI-HS and
Combidex. In addition, Squibb Diagnostics received the right to use the
Company's core technology in its own development of other MRI contrast agents.
The Company was to receive up to $10,000,000 in licensing fees, of which
$4,000,000 was received and recognized in license revenues when the agreements
were signed in fiscal 1991 and $1,000,000 was received in fiscal 1992, when the
Company filed an Investigational New Drug Application ("IND") with the FDA for
Combidex. The Company and Squibb Diagnostics amended their agreement regarding
Combidex in fiscal 1994 for which the Company received a non-refundable license
fee of $1,000,000. Also in fiscal 1994, the Company and Squibb Diagnostics
terminated their agreement with respect to the AMI-HS product and Squibb
Diagnostics paid a $2,000,000 license fee milestone payment for Combidex. On
August 30, 1994, the Company signed an agreement to reacquire the development
and marketing rights to Combidex previously licensed to Squibb Diagnostics. The
Company agreed to pay Bristol-Myers Squibb Co. $1,000,000 in two cash payments,
of which $500,000 was paid on August 30, 1994 and $500,000 was to be paid upon
acceptance of the 1,200 vials of the Combidex product suitable for worldwide
preclinical and clinical studies. Furthermore, the Company is required to pay up
to $2,750,000 in future royalties based on the Company's sale of Combidex. As
part of the transaction, Bristol-
 
                                       37

<PAGE>   39
 
                  NOTES TO FINANCIAL STATEMENTS -- (Continued)
 
Myers Squibb Co. returned to the Company a warrant to purchase 600,000 shares of
the Company's common stock, valued at $240,000. The Company recorded a $760,000
expense which represented the value of in-process research and development
reacquired. In the first quarter of fiscal 1995, the Company and Bristol-Myers
Squibb Co. agreed that the 1,200 vials of Combidex delivered to the Company were
not acceptable. In addition, they agreed that any future delivery of Combidex
under the agreement would not be required and that the Company would not be
required to make the $500,000 payment. Accordingly, the Company recorded a
credit for $380,000 to the purchase of in-process research and development and
adjusted the value of the warrant by $120,000 in the first quarter of fiscal
1995.
 
     On February 1, 1995, the Company entered into an agreement with Berlex
Laboratories, Inc. ("Berlex") granting Berlex a product license and exclusive
marketing rights to Feridex I.V. in the United States and Canada. Under the
terms of the agreement, Berlex paid a $5,000,000 non-refundable license fee in
fiscal 1995. An additional $5,000,000 license fee was received in October 1996
as a result of the FDA's marketing approval and Berlex's market launch of
Feridex I.V. in the United States. In addition, the Company will receive
payments for manufacturing the product and royalties on future sales.
 
     The Company is the licensee of certain technologies under agreements with
third parties which require the Company to make payments in accordance with
these license agreements and upon the attainment of particular milestones. The
Company is also required to pay royalties based on a percentage of certain
product sales, if any. During fiscal year 1996, 1995 and 1994, the Company made
payments of $725,000, $350,000, and $200,000 in relation to these agreements.
Future milestone payments are not to exceed $1,200,000.
 
P.  RELATED PARTY TRANSACTIONS
 
     During the fiscal years ended September 30, 1996, 1995 and 1994, the
Company paid approximately $26,573, $7,050 and $19,650 respectively, to
Fahnestock & Co. Inc. as commissions in transactions involving its investments
in securities. Mr. Leslie Goldstein, a shareholder and member of the Company's
Board of Directors and the brother of Jerome Goldstein, Chairman of the Board,
President and Treasurer of the Company, is employed by SRG Associates, a
division of Fahnestock & Co. Inc., as an investment analyst and advisor.
 
                                       38

<PAGE>   40
 
                  NOTES TO FINANCIAL STATEMENTS -- (Continued)
 
Q.  QUARTERLY FINANCIAL DATA -- UNAUDITED
 
     The following table provides quarterly data for the fiscal years ended
September 30, 1996, and 1995.
 

<TABLE>
<CAPTION>
                                                             FISCAL 1996 QUARTERS ENDED
                                              --------------------------------------------------------
                                              SEPTEMBER 30     JUNE 30      MARCH 31     DEC. 31, 1995
                                              ------------   -----------   -----------   -------------
<S>                                           <C>            <C>           <C>           <C>
Royalties...................................  $    (75,000)  $   (25,000)  $    75,000    $     75,000
Product sales...............................            --            --        12,762              --
Interest, dividends and net gains and losses
  on sales of securities....................       450,911       470,373       388,307         451,859
Research and development services...........         6,810            --            --              --
                                              ------------   -----------   -----------    ------------
          Total revenues....................       382,721       445,373       476,069         526,859
Cost of product sales.......................            --            --         2,550              --
Operating expenses..........................     2,871,713     3,308,476     2,911,732       2,451,544
Net loss....................................  $ (2,488,992)  $(2,863,103)  $(2,438,213)   $ (1,924,685)
Net loss per share..........................  $      (0.37)  $     (0.42)  $     (0.36)   $      (0.28)
</TABLE>

 

<TABLE>
<CAPTION>
                                                             FISCAL 1995 QUARTERS ENDED
                                              --------------------------------------------------------
                                              SEPTEMBER 30     JUNE 30      MARCH 31     DEC. 31, 1994
                                              ------------   -----------   -----------   -------------
<S>                                           <C>            <C>           <C>           <C>
License fees................................  $         --   $        --   $ 5,000,000    $         --
Royalties...................................       151,127        38,366            --              --
Product sales...............................            --     1,276,172       789,026          55,259
Interest, dividends and net gains and losses
  on sales of securities....................       591,484       575,172       438,669         681,986
                                              ------------   -----------   -----------    ------------
          Total revenues....................       742,611     1,889,710     6,227,695         737,245
Cost of product sales.......................            --       256,333       157,804          11,050
Operating expenses..........................     2,916,799     3,090,004     2,440,599       1,533,737
Gain on sales of in-vitro product line (Note
  B)........................................     3,404,527            --            --              --
Net Income (loss) before cumulative effect
  of accounting change......................     1,026,839    (1,278,127)    3,254,292        (807,542)
Cumulative effect of accounting change
  (Note C)..................................            --            --            --         117,540
Net income (loss)...........................  $  1,026,839   $(1,278,127)  $ 3,254,292    $   (690,002)
Income (loss) per share before cumulative
  effect of accounting change...............  $       0.15   $     (0.19)  $      0.48    $      (0.12)
Cumulative effect of accounting change......            --            --            --             .02
                                              ------------   -----------   -----------    ------------
Net income (loss) per share.................  $       0.15   $     (0.19)  $      0.48    $      (0.10)
                                              ------------   -----------   -----------    ------------
</TABLE>

 
R.  RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
 
     Statement of Financial Accounting Standard No. 123, "Accounting for Stock
Based Compensation," is effective for fiscal years beginning after December 15,
1995. This statement establishes financial accounting and reporting standards
for stock based employee compensation plans. While the Company is reviewing the
adoption and impact of this statement, it expects to adopt the "disclosure only"
alternative and accordingly this standard will have no impact on the Company's
results of operations or its financial position.
 
                                       39

<PAGE>   41
 

 
                                   PART III
 

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT:
 
     The information required by this item, with respect to the directors of the
registrant, is incorporated by reference from the Company's definitive proxy
statement in connection with its Annual Meeting of Stockholders to be held on
February 4, 1997, filed with the Commission on December 20, 1996, in the table
under the caption "Election of Directors."
 
THE EXECUTIVE OFFICERS OF THE REGISTRANT ARE AS FOLLOWS:
 
     Jerome Goldstein, 57, is a founder of the Company and has been Chairman of
the Board of Directors, President and Treasurer since the Company's organization
in November 1981. Mr. Goldstein is also a director of Matritech, Inc. Mr.
Goldstein was a cofounder of Clinical Assays, Inc., serving from 1972 to 1980 as
Vice President and then as President. Mr. Goldstein is the brother of Leslie
Goldstein, a director of the Company, and husband of Marlene Kaplan Goldstein.
 
     Lee Josephson, 51, is a founder of the Company and has been employed as
Senior Vice President-Research since November 1990. From December 1985 until
November 1990, Dr. Josephson was Vice President -- Research of the Company and
from December 1981 until December 1985, he was a Senior Scientist of the
Company.
 
     Jerome M. Lewis, 47, joined the Company in April 1986 as a Senior Scientist
and has been Vice President -- Scientific Operations since February 1991. Prior
to April 1986, Dr. Lewis was employed as a senior scientist by Petroferm Ltd., a
biotechnology company.
 
     James A. Matheson, 52, joined the Company in May 1996 as Vice
President -- Finance. Prior to May, 1996, Mr. Matheson was Controller of Diatech
Diagnostics, Inc.
 
     Paula M. Jacobs, 52, joined the Company in January 1986 as Vice
President -- Development. From 1981 to 1986, Dr. Jacobs was employed at Seragen,
Inc., first as Production Manager and later as General Manager of the Research
Products Division.
 
     Leonard M. Baum, 43, joined the Company in October 1994 as Senior Vice
President. From 1986 to 1994, Mr. Baum was employed as Senior Director,
Worldwide Regulatory Affairs/Drug Safety by Squibb Diagnostics.
 
     Mark C. Roessel, 46, joined the Company in January 1982 as Director of
Regulatory Affairs and has been Vice President -- Regulatory Affairs since
January 1995. Prior to January 1982, Mr. Roessel was Compliance Manager of the
Clinical Assay Division of Baxter International, Inc.
 
     Marlene Kaplan Goldstein is a founder of the Company and has been Secretary
of the Company since the Company's organization in November 1981.
 

ITEM 11.  EXECUTIVE COMPENSATION:
 
     The information required by this item is incorporated by reference from the
Company's definitive proxy statement in connection with its Annual Meeting of
Stockholders to be held on February 4, 1997, filed with the Commission on
December 20, 1996, under the captions "Compensation of Directors" and "Executive
Compensation."
 

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
          MANAGEMENT:
 
     The information required by this item is incorporated by reference from the
Company's definitive proxy statement in connection with its Annual Meeting of
Stockholders to be held on February 4, 1997, filed with the Commission on
December 20, 1996, in the tables under the captions "Principal Stockholders" and
"Election of Directors."
 

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS:
 
     Not applicable.
 
                                       40

<PAGE>   42
 

                                    PART IV
 

ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K:
 
     (a) The following documents are filed as part of this Annual Report on Form
         10-K:
 
          1. Consolidated Financial Statements.  The following consolidated
     financial statements of the Company and Report of Independent Accountants
     are incorporated in Item 8 of this report.
 

           Report of Independent Accountants
 
           Consolidated Balance Sheets at September 30, 1996 and 1995
 
           Consolidated Statements of Operations for the Years Ended September
           30, 1996, 1995 and 1994
 
           Consolidated Statements of Stockholders' Equity for the Years Ended
           September 30, 1996, 1995 and 1994

 
           Consolidated Statements of Cash Flows for the Years Ended September
           30, 1996, 1995 and 1994
 

           Notes to Consolidated Financial Statements
 
          2. Consolidated Financial Statement Schedules.  Consolidated financial
     statement schedules have been omitted because the required information is
     not present or not present in amounts sufficient to require submission of
     the schedule, or because the information required is included in the
     consolidated financial statements or the notes thereto.
 
          3(a). The exhibits listed in the Exhibit Index immediately preceding
     the Exhibits are filed as a part of this Annual Report on Form 10-K.
 
          3(b). Reports on Form 8-K: No reports on Form 8-K were filed by the
     Company during the fiscal quarter ended September 30, 1996.
 
                                       41

<PAGE>   43
 

 
                                  SIGNATURES
 
     Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
 
                                            ADVANCED MAGNETICS, INC.
 
                                                  /s/ JEROME GOLDSTEIN
                                            By:.................................
                                                      JEROME GOLDSTEIN
                                            CHAIRMAN OF THE BOARD OF DIRECTORS,
                                                  PRESIDENT AND TREASURER
 
     Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
 

<TABLE>
<CAPTION>
                SIGNATURE                               TITLE                        DATE
- ------------------------------------------  ------------------------------    ------------------
<S>                                         <C>                               <C>
           /s/ JEROME GOLDSTEIN             Chairman of the Board of           December 23, 1996
 ........................................     Directors, President and
             JEROME GOLDSTEIN                 Treasurer (principal
                                              executive and financial
                                              officer)
 
            /s/ JAMES MATHESON              Vice President-Finance             December 23, 1996
 ........................................     (principal accounting
              JAMES MATHESON                  officer)
 
             /s/ THOMAS COOR                Director                           December 23, 1996
 ........................................
               THOMAS COOR
 
           /s/ LESLIE GOLDSTEIN             Director                           December 23, 1996
 ........................................
             LESLIE GOLDSTEIN
 
         /s/ RICHARD L. MCINTIRE            Director                           December 23, 1996
 ........................................
           RICHARD L. MCINTIRE
 
          /s/ EDWARD B. ROBERTS             Director                           December 23, 1996
 ........................................
            EDWARD B. ROBERTS
 
           /s/ ROGER E. TRAVIS              Director                           December 23, 1996
 ........................................
             ROGER E. TRAVIS
 
         /s/ GEORGE M. WHITESIDES           Director                           December 23, 1996
 ........................................
           GEORGE M. WHITESIDES
</TABLE>

 
                                       42

<PAGE>   44
 

                                 EXHIBIT INDEX
 

<TABLE>
<CAPTION>
  EXHIBIT
  NUMBER                                       DESCRIPTION
- -----------  --------------------------------------------------------------------------------
<C>          <S>
  3.1(1)     Certificate of Incorporation of the Company, as amended.
  3.2(2)     By-Laws of the Company, as amended.
 10.1(6)     1983 Stock Option Plan of the Company, as amended on November 13, 1990.
 10.2(7)     1987 Employee Stock Purchase Plan.
 10.3(7)     1992 Employee Stock Purchase Plan.
 10.4(7)     1992 Non-Employee Director Stock Option Plan.
 10.5(9)     1993 Stock Plan.
 10.6(9)     1993 Non-Employee Director Stock Option Plan.
 10.7(3)     Technology Agreement dated January 21, 1983 between the Company and Corning
             Glass Works (now Ciba Corning Diagnostics Corp.) (confidential treatment
             previously granted).
 10.8(2)     Agreements between the Company and ML Technology Ventures, L.P. dated as of
             March 23, 1987 (confidential treatment previously granted).
 10.9(2)     Clinical Testing, Supply and Marketing Agreement between the Company and
             Guerbet, S.A. dated May 22, 1987 (confidential treatment previously granted).
 10.10(4)    Clinical Testing, Supply and Marketing Agreement between the Company and Eiken
             Chemical Co., Ltd., dated August 30, 1988 (confidential treatment previously
             granted).
 10.11(5)    Contrast Agent Agreement dated between the Company and Guerbet, S.A. dated
             September 29, 1989 (confidential treatment previously granted).
 10.12(6)    Contrast Agent Agreement between the Company and Eiken Chemical Co., Ltd. dated
             March 27, 1990 (confidential treatment previously granted).
 10.13(6)    Amendment to Clinical Testing, Supply and Marketing Agreement between the
             Company and Eiken Chemical Co., Ltd., dated September 29, 1990 (confidential
             treatment previously granted).
 10.14(6)    License, Supply and Marketing Agreement between the Company and Mallinckrodt
             Medical, Inc., dated June 28, 1990 (confidential treatment previously granted).
 10.15(6)    Agreement of Amendment between the Company and ML Technology Ventures, L.P.
             dated as of June 28, 1990.
 10.16(7)    Technology License Agreement between the Company and Squibb Diagnostics, dated
             February 5, 1991 (confidential treatment previously granted).
 10.17(7)    AMI-227 License Agreement between the Company and Squibb Diagnostics, dated
             February 5, 1991 (confidential treatment previously granted).
 10.18(7)    AMI-HS License Agreement between the Company and Squibb Diagnostics, dated
             February 5, 1991 (confidential treatment previously granted).
 10.19(7)    Warrant Purchase Agreement between the Company and Squibb Diagnostics, dated
             February 11, 1991.
 10.20(7)    Purchase Agreement between the Company and ML Technology
</TABLE>

 
                                       43

<PAGE>   45
 

<TABLE>
<CAPTION>
  EXHIBIT
  NUMBER                                       DESCRIPTION
- -----------  --------------------------------------------------------------------------------
<C>          <S>
 10.21(7)    Agreement of Amendment to Clinical Testing, Supply and Marketing Agreement
             between the Company and Guerbet, S.A., dated August 13, 1990.
 10.22(8)    Asset Purchase Agreement dated as of October 15, 1993 by and between the Company
             and PerSeptive Biosystems, Inc.
 10.23(10)   License, Supply and Marketing Agreement dated September 27, 1993 between the
             Company and Sterling (confidential treatment previously granted).
 10.24(10)   Termination Agreement dated November 8, 1993 between the Company and Squibb
             Diagnostics (confidential treatment previously granted).
 10.25(10)   Amendment to License Agreement dated November 8, 1993 between the Company and
             Squibb Diagnostics (confidential treatment previously granted).
 10.26(11)   Termination Agreement dated August 30, 1994 between the Company and
             Bristol-Myers Squibb Co.
 10.27(12)   License and marketing agreement between the Company and Berlex Laboratories,
             Inc. dated as of February 1, 1995.
 10.28(12)   Supply Agreement between the Company and Berlex Laboratories, Inc. dated as of
             February 1, 1995.
 11.1        Computation of earnings per share.
 23.1        Consent of Coopers & Lybrand L.L.P., independent accountants.
 27          Financial Data Schedule.
</TABLE>

 
- ---------------
 (1) Incorporated herein by reference to the exhibits to the Company's
     Registration Statement on Form S-8 (File No. 33-13953).
 
 (2) Incorporated herein by reference to the exhibits to the Company's Annual
     Report on Form 10-K for the fiscal year ended September 30, 1987.
 
 (3) Incorporated herein by reference to the exhibits to the Company's
     Registration Statement on Form S-1 (File No. 33-5312).
 
 (4) Incorporated herein by reference to the exhibits to the Company's Annual
     Report on Form 10-K for the fiscal year ended September 30, 1988.
 
 (5) Incorporated herein by reference to the exhibits to the Company's Annual
     Report on Form 10-K for the fiscal year ended September 30, 1989.
 
 (6) Incorporated herein by reference to the exhibits to the Company's Annual
     Report on Form 10-K for the fiscal year ended September 30, 1990.
 
 (7) Incorporated herein by reference to the exhibits to the Company's Annual
     Report on Form 10-K for the fiscal year ended September 30, 1991.
 
 (8) Incorporated herein by reference to the exhibits to the Company's Current
     Report on Form 8-K dated October 15, 1993.
 
 (9) Incorporated herein by reference to the exhibits to the Company's
     definitive proxy statement for the fiscal year ended September 30, 1992.
 
(10) Incorporated herein by reference to the exhibits to the Company's Annual
     Report on Form 10-K, as amended, for the fiscal year ended September 30,
     1993.
 
(11) Incorporated herein by reference to the exhibits to the Company's Annual
     Report on Form 10-K, for the fiscal year ended September 30, 1994.
 
(12) Incorporated herein by reference to the exhibits to the Company's Quarterly
     Report on Form 10-Q, for the fiscal quarter ended December 31, 1994.
 
                                       44





<PAGE>   1

                                                                   EXHIBIT 11.1

                            ADVANCED MAGNETICS, INC.

<TABLE>
                 STATEMENT RE: COMPUTATION OF PER SHARE EARNINGS
                  YEARS ENDED SEPTEMBER 30, 1996, 1995 AND 1994

<CAPTION>
                                                       1996         1995        1994
                                                       ----         ----        ----

       <S>                                          <C>          <C>          <C>
       Weighted average number of shares             
           issued and outstanding...............     6,762,748     6,730,315    6,690,500
       Assumed exercise of options reduced
       by the number of shares which could have
          been purchased with the proceeds of
          those options.....................                 --      140,524      104,191
       Assumed exercise of warrants reduced
       by the number of shares which could have
          been purchased with the proceeds of
          those warrants........................             --           --       11,834
                                                      ---------    ---------    ---------
       Weighted average number of common             
          and equivalent shares.................      6,762,748*   6,870,839    6,806,525
                                                      ---------   ---------     ---------
</TABLE>

 

* Due to the net loss for fiscal 1996, computation of per share earnings
  include only the weighted average number of shares issued and outstanding. 






<PAGE>   1

                                                                   EXHIBIT 23.1

                       CONSENT OF INDEPENDENT ACCOUNTANTS

   We consent to the incorporation by reference in the Registration Statements
of Advanced Magnetics, Inc. on Form S-8 (File Nos. 33-8697, 33-13953, 33-40744,
33-46963, and 33-62522) of our report, which includes an explanatory paragraph
regarding the adoption of Statement of Financial Accounting Standards No. 115,
dated November 6, 1996, on our audits of the financial statements of Advanced
Magnetics, Inc. as of September 30, 1996 and 1995, and for the years ended
September 30, 1996, 1995, and 1994, which report is incorporated by reference in
this Annual Report on Form 10-K.

COOPERS & LYBRAND LLP


BOSTON, MASSACHUSETTS

DECEMBER 20, 1996








<TABLE> <S> <C>

<ARTICLE> 5
<CURRENCY> US DOLLARS
       
<S>                             <C>
<PERIOD-TYPE>                   YEAR
<FISCAL-YEAR-END>                          SEP-30-1996
<PERIOD-START>                             OCT-01-1996
<PERIOD-END>                               SEP-30-1996
<EXCHANGE-RATE>                                      1
<CASH>                                      10,805,842
<SECURITIES>                                23,271,169
<RECEIVABLES>                                  149,235
<ALLOWANCES>                                         0
<INVENTORY>                                    182,166
<CURRENT-ASSETS>                            34,539,646
<PP&E>                                      12,550,449
<DEPRECIATION>                               6,219,579
<TOTAL-ASSETS>                              41,066,373
<CURRENT-LIABILITIES>                          933,828
<BONDS>                                              0
<PREFERRED-MANDATORY>                           67,616
<PREFERRED>                                          0
<COMMON>                                             0
<OTHER-SE>                                           0
<TOTAL-LIABILITY-AND-EQUITY>                41,066,373
<SALES>                                         12,762
<TOTAL-REVENUES>                             1,831,022
<CGS>                                            2,550
<TOTAL-COSTS>                               11,546,015
<OTHER-EXPENSES>                                     0
<LOSS-PROVISION>                                     0
<INTEREST-EXPENSE>                                   0
<INCOME-PRETAX>                            (9,714,993)
<INCOME-TAX>                                         0
<INCOME-CONTINUING>                                  0
<DISCONTINUED>                                       0
<EXTRAORDINARY>                                      0
<CHANGES>                                            0
<NET-INCOME>                               (9,714,993)
<EPS-PRIMARY>                                   (1.44)
<EPS-DILUTED>                                        0
        

</TABLE>