<PAGE>   1

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                       SECURITIES AND EXCHANGE COMMISSION
                              WASHINGTON, DC 20549

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

                                   FORM 10-K
(MARK ONE)
[X]ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
   OF 1934
                  FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999

                                       OR

[ ]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
   ACT OF 1934
        FOR THE TRANSITION PERIOD FROM                TO

                         COMMISSION FILE NUMBER 0-12081

                        AQUILA BIOPHARMACEUTICALS, INC.
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

<TABLE>
<S>                             <C>                             <C>
          DELAWARE                     (508) 628-0100                    04-3307818
(STATE OR OTHER JURISDICTION      (REGISTRANT'S TELEPHONE       (IRS EMPLOYER IDENTIFICATION
    OF INCORPORATION OR              NUMBER, INCLUDING                      NO.)
        ORGANIZATION)                  AREA CODE)
</TABLE>

<TABLE>
                <S>                                                    <C>
                      175 CROSSING BOULEVARD, FRAMINGHAM, MA                01702
                     (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)             (ZIP CODE)
</TABLE>

       SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:  NONE

          SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
                     COMMON STOCK, $.01 PAR VALUE PER SHARE
                                (TITLE OF CLASS)

     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 6,774,317 shares of voting stock held by
non-affiliates of the registrant as of March 27, 2000 was approximately
$43,383,061 based on the last sale price of such stock on such date.

     Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 12, 13, or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court.  YES [X]     NO [ ]

       COMMON STOCK OUTSTANDING AS OF MARCH 27, 2000:  8,506,915 SHARES.

                      DOCUMENTS INCORPORATED BY REFERENCE.

     Portions of the definitive proxy statement in connection with the annual
meeting of shareholders to be held May 25, 2000 are incorporated by reference
into Part III of Form 10-K.

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<PAGE>   2

FIGHTING DISEASE THROUGH IMMUNE MODULATION

                                     PART I

ITEM 1.  BUSINESS.

INTRODUCTION

     Aquila Biopharmaceuticals, Inc. engages in discovery, development and
commercialization of products to prevent, treat or control infectious diseases,
autoimmune disorders and cancers. Advances in biotechnology and immunology have
enabled scientists to develop a new generation of products that specifically
modulate the immune system to produce an effective immune response. These
technology advances are causing significant changes in the market for these
products. Historically, these products were generally low priced because they
were used to prevent disease in healthy people (prophylaxis) and, due to the
lack of product differentiation, companies generally competed on price. However,
development of products based on our current understanding of the immune system
involves significant technological innovation that can result in more effective
and safer products with increased profit margins. The market potential of these
products is high since current understanding of the immune system allows
expansion of the market to address new areas and the development of safer, more
effective substitutions for older products. In addition, within today's
approaches to disease management and current cost management strategies,
immunological products have been recognized as very effective contributors to
controlling the total medical costs of certain diseases.

     We conduct research and development involving two proprietary core
technologies, the Stimulon(TM) family of adjuvants and the CD1 antigen
presentation system. We are currently advancing three products through clinical
trials and collaborating on the clinical development efforts of seven corporate
partners that are testing ten other products. One product has already been
approved for sale.

     The Stimulon(TM) family of adjuvants has been shown to enhance the quality
and the quantity of the immune response to a variety of antigens, both in
pre-clinical studies and in a number of human clinical trials. Use of the
Stimulon(TM) adjuvants is allowing scientists to design products that can
activate specific T cell responses and result in a new highly effective class of
vaccines for both therapeutic and prophylactic applications. New applications
include diseases involving poorly immunogenic antigens such as polysaccharides
or diseases affecting the elderly, whose immune systems have deteriorated so
that they do not respond to traditional approaches. New therapeutic products for
treating people with diseases such as malaria, chronic hepatitis infection,
acquired immune deficiency syndrome ("AIDS") or various cancers, where a
cytotoxic T lymphocyte ("CTL") response is thought to be essential, may be
possible using the StimulonTM adjuvants.

     The CD1 antigen presentation system is a potentially powerful new approach
to the development of immunological products. Until recently, scientists
believed that antigen presenting cells of the immune system processed and
presented antigens as peptides through two mechanisms, the Class I and the Class
II MHC pathways. Recent discoveries have demonstrated that there is a third
pathway, called the CD1 pathway, through which antigens with lipid tails are
presented. Our scientists and other scientists are working to establish proof
that the CD1 system is involved in providing protection from infection. Through
our acquisition of VacTex, Inc., which operates as a wholly owned subsidiary, we
have exclusive license to the CD1 technology and are using it to advance the
development of proprietary products to prevent and treat infectious diseases,
cancers and autoimmune disorders.

     Our product development programs include the Quilimmune(TM) human health
products, the Quilvax(TM) animal health products and the CD1 products. Our
animal health product, Quilvax-M(TM) for controlling bovine mastitis, has
undergone extensive testing in bovine immunogenicity and challenge trials. We
initiated formal USDA licensing trials in 1999. We are developing
Quilimmune-P(TM) for preventing Streptococcus pneumoniae ("S. pneumoniae")
infections in people over the age of 65. In initial clinical testing the safety
profile of Quilimmune-P(TM) was good but the product in this formulation was not
significantly better than the control formulation. We have altered the
formulation further and are preparing

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<PAGE>   3

for additional clinical testing. A third potential product designed to help
control malaria infections, SPf66 antigen combined with the Stimulon(TM)
adjuvant QS-21, has been studied in Phase I clinical trials and has shown very
compelling immunological results. We are planning to evaluate additional malaria
antigens in combination with QS-21 for ability to provide protection from
malaria infection. Our first CD1 product, designed to prevent TB infection, is
in animal testing. Initial studies have shown that CD1-TB has the potential to
significantly reduce bacterial colony counts after TB challenge. We have a
program developing the CD1 technology for cancer and are identifying CD1
antigens for additional disease applications including Chlamydia trachomatis, S.
aureus, and Nontypeable Haemophilus.

     Our corporate partners are SMITHKLINE BEECHAM, P.L.C., WYETH-LEDERLE
VACCINES AND PEDIATRICS, a business group of Wyeth-Ayerst International, Inc., a
subsidiary of American Home Products Corporation, AVENTIS PASTEUR, BRISTOL MYERS
SQUIBB (PROGENICS PHARMACEUTICALS, INC.), VAXGEN, INC., ELAN CORPORATION, P.L.C.
and VIRBAC S.A.

SCIENTIFIC BACKGROUND

     The human immune system is made up of several different cell types
including antigen presenting cells ("APCs"), B cells and T cells. In general,
the role of APCs is to process antigens from pathogens such as viruses, bacteria
or parasites into smaller fragments and to present the resulting proteins
(peptides), lipids, or carbohydrates to T cells. Antigens can be processed by
APCs through three pathways -- the MHC Class I, MHC Class II or the CD1 pathway.
Peptide fragments from antigens processed through the Class I pathway are
displayed on the surface of the APC by the MHC Class I protein and typically
result in a cellular immune response. This specific activation of cytotoxic T
cells is called a CTL response and is thought to be critical for many
immunotherapeutic approaches to the treatment of cancer and the treatment or
prevention of diseases such as herpes, hepatitis, HIV and malaria. A different
response, called the humoral response, results when antigens processed by the
Class II pathway are displayed by MHC Class II proteins. In a humoral response,
B cells are activated to produce antibodies that are specific for the antigen
encountered. The antibodies produced by B cells will bind to and can neutralize
the pathogens, bacteria, parasites and viruses that have invaded the body. In
the third pathway, antigens with lipid components are processed through the CD1
pathway and generate a cellular immune response that also results in the
specific activation of cytotoxic T cells.

     Traditional approaches for developing immune protection from infection in
humans involved the use of animal viruses or the use of attenuated or killed
pathogens as vaccines. While these approaches are effective for some pathogens,
there is a small but significant risk of the development of disease in people
receiving these types of vaccines. With the advent of recombinant technology,
scientists realized that safer products could be created using specific
components of an organism rather than the whole organism. For example, the genes
for the surface antigens from a pathogen can be cloned using genetic engineering
and used to make recombinant proteins. The recombinant proteins are then used in
a vaccine, to make a so-called sub-unit vaccine. Alternately the DNA coding for
proteins can be used in DNA vaccines. Other specific cellular components have
been used to stimulate disease specific responses, including proteins isolated
from the pathogen itself, synthetic peptides, carbohydrates and lipoproteins.

     When these new sub-unit vaccines were first used it was found that while a
pathogen specific immune response was stimulated, the response was often not of
the right quality or strength to provide protection from infection or disease.
As a result, immune modulation technologies have been developed that have been
coupled with pathogen specific antigen approaches. These methods for modulating
the immune system include conjugation of the antigen to a carrier protein, the
use of viral or bacterial vectors to carry specific genes, the use of cytokines
or lymphokines to stimulate the immune system and the use of adjuvants. Carrier
proteins such as keyhole limpet hemocyanin (KLH) or the toxoids from diphtheria,
tetanus and cholera have been used effectively. Viral vectors such as vaccinia,
canary pox, or the bacteria BCG are under evaluation as carriers of disease
specific genes to determine whether they stimulate a protective immune response.
Adjuvants that have been used or that are in development include aluminum
hydroxide (alum); MF59, a product of Chiron Corporation and its affiliates
("Chiron"); monophosphoryl lipid A (MPL) and LeIF, products of Corixa
Corporation ("Corixa"); Adjumer, a product of AVANT


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Immunotherapeutics Inc. ("Avant"); CpG, a product of Coley Pharmaceutical Corp.;
and saponins from Quillaja saponaria such as QS-21. These adjuvant technologies
are not all the same and affect the humoral and cell mediated pathways
differently. Our Stimulon(TM) family of adjuvants, QS-21 and QS-7, are purified,
defined molecules, derived from a natural source. They stimulate antigen
specific responses and have been shown to promote both antibody and CTL immune
responses in animals and humans.

CORE TECHNOLOGIES

     We are developing new products based on two core technologies, the
Stimulon(TM) family of adjuvants that specifically enhance antibody and CTL
responses, and proprietary CD1 presented antigens and CD1 molecules that are
specific for the target disease.

     The typical development pathway for a disease specific product includes
antigen identification, preparation of research quantities of the antigen,
formulation studies, demonstration of a biological effect of a product
containing the antigen and development of commercial scale, and product
production procedures. These developmental efforts can be accomplished
internally or result from technology licensed from outside sources, or a
combination of both approaches.

     Our ability to discover and produce proprietary disease specific antigens
allows us to develop products targeted at specific applications and populations.
Our scientists have expertise in: (1) recombinant DNA cloning methods; (2)
mammalian, insect and bacterial cell expression; (3) extraction and purification
of protein, glycoside and lipid compounds from natural sources and (4)
carbohydrate and polysaccharide production. Furthermore, our scientists have
demonstrated their expertise with a variety of antigens from both viral and
bacterial pathogens including those that require high level bio-containment.

  The CD1 Antigen Presentation System

     In a breakthrough discovery, Michael Brenner, M.D. (Brigham and Women's
Hospital and Harvard Medical School), and Steven Porcelli M.D. (Albert Einstein
College of Medicine), found that lipid-containing antigens, in addition to
proteins, can be processed and presented to the immune system by antigen
presenting cells. These antigens are presented by a newly recognized antigen
presenting system called the CD1 pathway, which involves a family of conserved
mammalian proteins that are related to the MHC molecules. The CD1 proteins bind
and present antigens that are fundamentally different from those presented
through the MHC system. The CD1 presented antigens contain a lipid component as
part of their chemical structure. Lipid containing antigens presented through
CD1 stimulate the production of additional cytotoxic T cells that recognize and
kill invading pathogens.

     Since the initial discovery of the CD1 system, a large and growing body of
research has further characterized the CD1 pathway, suggesting that modulating
the immune system with lipid antigens has therapeutic potential for a broad
range of diseases such as tuberculosis, type I diabetes, and cancer. The
research has shown that the lipid antigen pathway can be used to activate
anti-tumor responses. Researchers have determined the crystal structure of mouse
CD1 and the model provides a structural rationale that supports its biological
activity. The three dimensional structure shows a binding groove on CD1 that is
attractive to lipids due to its hydrophobic nature. CD1 proteins resemble MHC
proteins in a number of ways, and it appears that they arose from the same
ancestral lineage as the MHC proteins. Aquila scientists are working to
establish proof that the CD1 system is involved in providing protection from
infection and although progress has been sufficient to justify continuance of
the research, proof has not yet been established. The promise is that CD1
antigens will provide an opportunity for the discovery of a wholly new set of
antigens in infectious diseases, cancer and autoimmune disorders that can be
developed into products

The Stimulon(TM) Family of Adjuvants

     QS-21 is the lead Stimulon(TM) adjuvant. It is a natural product, purified
from the bark of a tree that grows in South America, called Quillaja saponaria.
Up to 10% of the bark from Quillaja is composed of saponins of which QS-21 is
typically one of the more predominant. The bulk bark extract is available in


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<PAGE>   5

the United States. The Company believes QS-21 is well suited to pharmaceutical
development and formulation because it has good stability as a dried powder (at
least 3 years), is water soluble, and when rehydrated, is a clear liquid that
mixes easily with other vaccine components. QS-21 is compatible with alum and
micro-particles that are used in many experimental product formulations. QS-21
is well characterized with a known molecular structure thus distinguishing it
from competing adjuvant candidates, which are typically emulsions or
biologicals. Because QS-21 is currently regulated by the FDA as a "constituent
material" used in drug preparation, the FDA does not require specific licensure
of facilities used for its manufacture. A second Stimulon(TM) molecule, QS-7,
which has a slightly different safety and activity profile, is in development.
Patents have issued to Aquila with composition of matter claims covering QS-7
and QS-21, as well as two other identified saponins, QS-17 and QS-18. We have
also been issued a patent for saponins conjugated to antigens. All patents
include the use of all of these molecules as adjuvants. See "Patents and
Proprietary Rights".

     The use of Stimulon(TM) adjuvants improves the quality of the immune
response. Addition of QS-21 to antigens will generally broaden the type of
antibody produced, increase the titer or amount of antibodies produced, and
stimulate cell mediated responses. It is potent and active at microgram doses
when used with many types of antigens, including recombinant proteins derived
from viruses and bacteria and polysaccharide antigens from bacterial pathogens.

     We believe that the performance of QS-21 will vary depending upon the
nature of the antigen and the target population. Initial human studies conducted
by our licensees and collaborators have focused on proving the safety of QS-21
and experimenting with different formulations and dose levels. We and our
collaborators have completed over 30 studies to date, and more than 2,500
subjects have received QS-21 in various formulations. These studies have shown
that the addition of QS-21 to product formulations improves the immune response
to certain antigens, as evidenced by increased antibody titer.

STRATEGY

     Our objective is to create and commercialize products that modulate the
immune system to prevent, control or treat infectious diseases, autoimmune
disorders and cancers. We intend to exploit our expertise in adjuvant and
antigen research to create products and develop them through Food and Drug
Administration ("FDA") or United States Department of Agriculture ("USDA")
licensure, and to market products to end users, resellers or partners based on
market attributes. In addition, we intend to support our corporate partners'
product development programs, further develop our manufacturing capacity, and to
in-license and develop related technology.

  Exploit Expertise in Immunology

     We have developed unique expertise in understanding the molecular
mechanisms involved in stimulating and tuning the immune response to specific
antigens to allow the development of safe and effective therapeutic and
prophylactic products. We intend to continue to integrate our proprietary core
technologies and to identify targeted applications of our technology. In
addition, we plan to broaden our expertise in research and development to
include different antigens such as lipid antigens, recombinant proteins,
peptides, polysaccharides and other classes of antigenic molecules. Our strategy
is to acquire related products and technologies to supplement our scientific
expertise, capabilities and product portfolio.

  Create and Develop Products

     We have established a large number of corporate partnerships and a
significant number of products are being developed through these partnerships.
However, we believe that we can also develop and retain significant value
through our own product development efforts. We have three products in clinical
development: (i) Quilvax-M(TM) to control bovine mastitis currently in final
licensing trials; (ii) Quilimmune-M(TM) for controlling malaria; and (iii)
Quilimmune-P(TM) for preventing pneumococcal infections in the elderly. We have
completed the development and licensure of one product, Quilvax-FeLV(TM) for
preventing leukemia in cats. See "Product Development Programs".

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     We have a large number of ongoing academic collaborations involving other
antigens. A number of these are cancer vaccines. In certain cases we have
options to license related technology should we wish to accelerate the
development of these products. We intend to develop human products primarily but
will exploit unique, significant product opportunities in animal health.

  Support Corporate Partners Programs

     We have entered into collaborative agreements with SmithKline Beecham,
p.l.c., Elan Corporation, p.l.c., Aventis Pasteur, Wyeth-Lederle Vaccines and
Pediatrics, VaxGen, Inc. and Bristol-Myers Squibb (Progenics Pharmaceuticals,
Inc.) as well as a number of other biotechnology companies. We intend to use
these partnerships to speed discovery and development of certain products that
the Company does not have the resources or skills to develop. These
collaborations allow us to focus our own efforts on products that have different
markets than those of interest to large pharmaceutical companies. We have a
number of discussions underway involving potential licenses and intend to
continue to selectively license our technology. See "Corporate Partner
Programs".

  Develop Manufacturing Capacity

     We have retained rights to the manufacture of QS-21 on a worldwide basis in
all of our licensing agreements, and have been producing QS-21 for clinical
trials for all of our partners and our product programs. In addition, we operate
a small production facility to supply FeLV antigens and vaccine to our corporate
partner, Virbac S.A. We intend to continue to develop manufacturing expertise
and capacity to allow us to retain value from the products that we develop.

  In-license Related Technology

     We have been and will continue to be opportunistic by in-licensing products
and technology related to immune modulation to supplement our product pipeline.
In addition to expanding the product portfolio, this strategy will allow us to
capitalize on newly developed technologies that are synergistic with our
existing technology base.

PRODUCT DEVELOPMENT PROGRAMS

     Our strategy is to develop products internally and in partnership with
other companies. We have a number of products in development or commercialized.

             CD1, QUILIMMUNE(TM) & QUILVAX(TM) PRODUCT DEVELOPMENT

<TABLE>
<CAPTION>
PRODUCT                            MARKET                    STATUS                   PARTNER
-------                            ------                    ------                   -------
<S>                       <C>                       <C>                       <C>
QUILVAX-M(TM)             31 million milk cows in   Licensing trials started  Aquila, N. America
Product to control        the U.S. & Europe         in 1999                   Virbac S.A., Europe
bovine mastitis (S.
aureus & E. coli)

QUILIMMUNE-M(TM)          1-2 billion persons at    Clinical testing          Academic partners and
Product to control        risk                                                the CDC
malaria (Plasmodium
falciparum)

QUILIMMUNE-P(TM)          Adults $ 65 years S 34    Clinical testing          Aquila, worldwide rights
Product to prevent        million in U.S
pneumococcal infections

QUILVAX-FELV(TM)          S 15 million cats         On market, trade name     Virbac S.A. worldwide
Product to prevent        vaccinated per year       Leucogen(R)               rights
feline leukemia
</TABLE>

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<TABLE>
<CAPTION>
PRODUCT                            MARKET                    STATUS                   PARTNER
-------                            ------                    ------                   -------
<S>                       <C>                       <C>                       <C>
CD1 - TB                  Affects  1/3 of world's   Preclinical research      Aquila
                          population

CD1 - CHLAMYDIA           14 million young adults   Research                  Aquila
                          at risk per year, U.S.

CD1- S. AUREUS            Results in  1/2 million   Research                  Aquila.
                          hospitalizations
                          annually

CD1 - NONTYPEABLE         Cause of 30% of otitis    Research                  Aquila
HAEMOPHILUS               media cases
</TABLE>

QUILVAX-M(TM) FOR THE CONTROL OF BOVINE MASTITIS

     Bovine mastitis is an inflammation of a dairy cow's udder. Two pathogens
cause the majority of infections resulting in mastitis: Staphylococcus aureus
("S. aureus") and Escherichia coli ("E. coli"). Mastitis is the most costly
disease affecting the dairy industry. The economic impact in the United States
of bovine mastitis is estimated to be $1.8 billion per year. According to the
National Mastitis Council, losses per cow per year are $184 (there are about 9.5
million dairy cows in the U.S.). Many times when an animal develops mastitis,
treatment is ineffective and the animal must be culled from the herd. As a
result, the farmer incurs costs due to animal treatment as well as replacement.
In addition, dairies pay a premium for high milk quality. Mastitis results in
lower milk quality and lower milk value.

     There are a number of bovine mastitis vaccines on the market, but these are
directed towards E. coli only. Our Quilvax-M(TM) bovine mastitis product is
bivalent, containing antigens for both S. aureus and E. coli, and is expected to
provide broader control of mastitis.

     The S. aureus component of Quilvax-M(TM) is based on a patented cell
surface protein from S. aureus called fibronectin binding protein. Fibronectin
binding protein is primarily responsible for attachment of S. aureus to host
tissue, in this case the epithelium of the bovine mammary gland. It is believed
that this attachment is a critical step in the disease process and results in
the inflammation and tissue destruction that characterizes mastitis. In our
Quilvax-M(TM) program, fibronectin binding protein is used as the target antigen
for development of a beneficial immune response. Antibodies directed against
fibronectin binding protein may block the attachment of S. aureus to mammary
gland tissue and may help kill infected cells through antibody-dependent
mechanisms.

     We have been making use of the ability to experimentally cause S. aureus
mastitis by direct challenge of dairy cattle with bacteria deposited in the
mammary gland. In a typical challenge experiment, the response of several groups
of animals, both treated and non-treated controls, to a S. aureus challenge are
compared. Recent studies indicate that Quilvax-M(TM) is safe and that it reduces
the inflammatory response that develops upon infection. Measurement of
parameters that determine milk quality and the price dairy producers would
receive for their milk indicates that milk from animals vaccinated with
Quilvax-M(TM) would have a higher value than that from non-treated controls.

     The E. coli portion of Quilvax-M(TM) is modeled after the E. coli mastitis
products currently on the market. The marketed products make use of a mutant
strain of E. coli that has a slightly altered surface carbohydrate structure.
Quilvax-M(TM) makes use of a similar E. coli mutant. Biochemical anlysis of
Quilvax-M(TM) and the marketed products indicate that the amount of active
component directed against E. coli present in Quilvax-M(TM) is similar to or
exceeds that present in the marketed products.

     In order to receive authorization from the USDA to market Quilvax-M(TM), we
are conducting formal efficacy trials for both the S. aureus and E. coli
components of the product and a safety trial, all planned to be completed in the
first half of 2000. We believe we could add a streptococcal component in a next
generation product.

     The research costs were 50% funded by Virbac S.A.; we fund 100% of
development and clinical trial costs. We have retained exclusive marketing
rights in North America while Virbac S.A. has exclusive

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marketing rights in Europe. The parties share marketing rights in the rest of
the world. We are in discussions with potential marketing partners.

  Quilimmune-M(TM) for the Control of Malaria

     According to estimates in published reports, about two billion people
reside in malaria-infected areas. The yearly incidence of malaria is estimated
by the World Health Organization at 300 to 500 million cases, with a death toll
of 1.5 to 3 million persons. While anti-malarial drugs have been in use for
decades, they are expensive and resistant malarial strains are becoming
increasingly common. The World Health Organization has identified malaria as a
priority vaccine target in developing countries.

     We are involved in a number of programs to develop products to control
malaria. One of the programs is a collaboration with SmithKline Beecham, p.l.c.
(see "Corporate Partner Programs").

     In addition to this program, we have a collaboration with the World Health
Organization (WHO) on another malaria product involving the antigen SPf66. SPf66
is a polymerized synthetic peptide developed by Dr. Manuel Patarroyo of the
Institute de Inmunologia in Bogota, Colombia. We have investigated the
effectiveness of a Quilimmune-M(TM) product containing QS-21 and SPf66. In a
human clinical trial 90 volunteers were enrolled in five groups. The clinical
trial was designed to evaluate QS-21 versus alum-adjuvanted SPf66 formulations.
Safety data indicated that Quilimmune-M(TM) was generally well tolerated and
very significantly increased the immune response after both two and three
immunizations compared to the SPf66/alum control. Antibody titers of volunteers
receiving Quilimmune-M(TM) were over 100 times higher than those of volunteers
receiving the SPf66/alum control. We plan to continue our evaluation of
potential malaria antigens with QS-21.

  Quilimmune-P(TM) for the Prevention of Pneumococcal Infections

     Healthy adults are not typically at risk for developing significant disease
following exposure to S. pneumoniae. However, in the elderly, infections by S.
pneumoniae cause serious disease. There are over 80 recognized serotypes of
pneumococci, each with varying geographic and age group prevalence.
Quilimmune-P(TM) is intended to be used to prevent pneumococcal infections in
the elderly.

     There are approximately 34 million people over the age of 65 in the United
States ("U.S."), and an additional 36 million adults with immune compromising
conditions who are at risk for developing disease caused by S. pneumoniae.
Various strains of S. pneumoniae are responsible for most community-acquired
cases of pneumonia (500,000 cases per year) and are the second most common cause
of bacteremia (50,000 cases per year, with 25% mortality). It is estimated that
S. pneumoniae causes 40,000 deaths in the elderly and immunocompromised adults
each year.

     The currently available vaccines, which were developed and approved in the
early 1980s are composed of purified capsular polysaccharides from the 23
serotypes that cause about 90% of infections. These vaccines are under-utilized
by the elderly. Reports in the medical literature and confirmed in our trials
indicate that, using the current vaccines, only 60 - 70% of healthy volunteers
and 50 - 60% of the elderly respond with a 2-fold or greater increase in the
level of specific antibody.

     In a series of clinical studies that began in 1998, we are evaluating
Quilimmune-P(TM) formulations that contain QS-21 and the capsular
polysaccharides. The first study completed in the target population was a
prospective, randomized, double blind comparison of a single immunization of
Quilimmune-P(TM) to the currently licensed vaccine product in an elderly
population. Quilimmune-P(TM) was generally well tolerated; however, the
differences between Quilimmune-P(TM) and the control vaccine in the frequency of
a two-fold or greater increase in antibody titer following the single
immunization were not consistent, and only reached statistical significance with
one serotype. We have also evaluated a second immunization of Quilimmune-P(TM)
twelve months following the first, but this did not improve the effectiveness
further. We have identified several additional formulations and are planning
human clinical trials to evaluate one of these.

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<PAGE>   9

  Quilvax-FeLV(TM) for the Prevention of Feline Leukemia

     We have developed a recombinant sub-unit vaccine against the feline
leukemia virus. The product was approved in 1990 in the U.S. and 1991 in Europe.
This product represents one hundred percent of our product sales. We manufacture
the product and sell it to Virbac S.A., which markets it in Europe, Australia
and Japan under the trade name Leucogen(R). We believe European sales are $18 to
$22 million. Virbac S.A. has indicated that it intends to market the product
directly in the U.S. Feline leukemia is a highly contagious and commonly fatal
disease of cats. Our product was the first recombinant vaccine ever developed
against a tumor-causing virus in mammals. A patent covering Quilvax-FeLV(TM) has
been issued in the U.S. and a number of other countries. We manufacture bulk
formulated product for the Australian markets, and supply Virbac with bulk
antigen and adjuvant for further manufacture for the European and Japanese
markets. The product is the leading feline leukemia vaccine in Europe and in an
independent study was found to be the most effective of three leading feline
leukemia products on the market.

  CD1-TB

     Mycobacteria tuberculosis is one of the most prevalent infectious disease
pathogens. It infects one third of all people and kills more individuals (2-3
million per year) than any other infectious agent. Strains of Mycobacteria
tuberculosis that are multi-drug resistant have been isolated and their
frequency is increasing. Our tuberculosis program is based on research initiated
at the Brigham & Women's Hospital by Drs. Brenner and Porcelli involving the
discovery that lipid antigens of Mycobacteria tuberculosis are presented to the
immune system by CD1. Identification and characterization has shown that these
antigens have lipid and carbohydrate components. Initial immunization challenge
studies have been conducted in laboratory animals using a vaccine containing a
mixture of these lipid antigens in a formulation with QS-21. Following
immunization and challenge, animals receiving the experimental vaccine had a
significantly reduced bacterial burden when compared to non-immunized controls.
This outcome is encouraging but does not provide proof that immunization with
CD1 antigens can provide protection from infection. Our ongoing work, a
collaborative effort between Brigham & Women's Hospital, Albert Einstein College
of Medicine, and our scientists, is focused on identifying specific Mycobacteria
tuberculosis antigens that provide immunological benefit and demonstrating
usefulness in animal models as a prelude to human studies.

  CD1-Chl

     Genital tract infections due to Chlamydia trachomatis have been identified
as the cause of half a million infections in the United States with as many as
half of these found in women 15 to 19 years old. This makes this sexually
transmitted disease the most common reportable disease in the U.S. Cases are
almost certainly underestimated since 75% of women and 50% of men with Chlamydia
have either no symptoms or such mild ones that they do not seek care. Left
untreated, C. trachomatis is a major cause of pelvic inflammatory disease (PID),
ectopic pregnancy, and infertility among women.

     Perinatal transmission of C. trachomatis to infants can cause neonatal
conjunctivitis and pneumonia. In 1994, the estimated cost of untreated
chlamydial infections and their complications was $2 billion in the United
States.

     From a public health and commercial perspective, this is one of the largest
potential areas for vaccine development. There are 20 million women between the
ages of 15 and 19 years. In principal, all men and women in this age group might
be vaccinated should a safe and effective vaccine become available.

     Although the role of CD1 antigen presentation in the control of
Chlamydiainfection has not been established, C. trachomatis has a large surface
density of lipopolysaccharide (LPS) and produces many other lipids. In addition,
Chlamydia has a profound influence on host cell lipids by interrupting normal
intracellular tracking of host produced lipids. These lipids all represent
potential targets for CD1-related therapies. Our research effort is concentrated
on antigen discovery with a particular interest in antigens presented to the
immune system by CD1.

                                        8
<PAGE>   10

  CD1-S. aureus

     Staphylococcus aureus, a common inhabitant of the skin and mucus membranes
of humans, may cause infection to internal tissues during surgery or
trauma-induced damage to the skin or mucus membrane. Such infections may lead to
complications associated with staphylococcal bacteremia, including infectious
arthritis, pneumonia, septic shock, endocarditis and abscesses, and result in
half a million hospitalizations per year in the U.S. These conditions have
historically been effectively treated with antibiotics. However, recent
increases in staphylococcal resistance to penicillins, and especially
vancomycin, the antibiotic of last resort, have made it necessary and imperative
to seek alternative approaches to therapy for these infections.

     An immunological approach to preventing or treating S. aureus infections is
a viable alternative to traditional means of therapy. A vaccine-based approach
has commercial application for individuals having elective surgery and for those
in the health care field as well as potentially for general childhood
immunization. Current vaccine development has focused on raising antibodies to
different antigens such as type-specific polysaccharide conjugates, proteins
such as adhesins or virulence factors, and a surface polysaccharide antigen. The
efficacy of any of these vaccines has yet to be demonstrated in humans.

     Immunity to a gram-positive pathogen such as S. aureus occurs via
circulating antibacterial antibodies and complement factors. The role of cell
mediated immunity to gram positive infection is unclear but may occur through T
cell help for antibody production and production of cytokines involved in
killing of bacteria. Much of the protective antibody against gram positive
bacteria is directed against polysaccharides and lipoglycans, suggesting that T
cells may recognize these nonpeptide molecules and provide appropriate B cell
help. Most staphylococci are rapidly killed and degraded following phagocytosis
but a minority of organisms can persist intracellularly to cause recurrent
infection. A vaccine approach that involves cell mediated immunity and lipid
antigen presentation through CD1 may be helpful in reducing the adverse effects
of such infections. Our research is focused on isolating and characterizing
lipid antigens that have the ability to stimulate immune cells through CD1
presentation.

  CD1-NTHi

     Nontypeable Haemophilus influenzae is a common cause of otitis media,
pneumonia, exacerbated chronic bronchitis, sinusitis, meningitis, postpartum and
neonatal infections, osteomyelitis, septicemia, bacteremia, and other invasive
bacterial diseases. The annual cost of the medical and surgical treatment of
otitis media in the United States is between $3 billion and $4 billion dollars.
Currently there is no vaccine available that can prevent the occurrence of NTHi
infections. H. influenzae conjugate vaccines currently in widespread use are
effective only against type b capsulated strains and do not confer protective
immunity against infection with nontypeable strains.

     Most children have had at least one episode of otitis media by their third
birthday, and one-third have experienced three or more ear infections.
Inappropriate antibiotic treatment of otitis media encourages the emergence of
multi-drug resistant strains of bacteria making the need for a vaccine more
urgent.

     Recently, scientists have reported the isolation of human CD1-restricted T
cells specific for nonprotein antigens from H. influenzae type b, thus
suggesting a role for CD1 presented lipid antigens in immunity to the related
nontypeable strains of H. influenzae. Aquila's research program involves the
identification of immunogenic lipid fractions and analysis of the antibody and
cellular proliferation responses to these lipids in animal models.

CORPORATE PARTNER PRODUCTS

     In addition to our internal product development programs, we have six
corporate partners that have licensed the Stimulon(TM) adjuvants for a variety
of human diseases: SMITHKLINE BEECHAM, P.L.C., WYETH-LEDERLE VACCINES AND
PEDIATRICS, AVENTIS PASTEUR, BRISTOL MYERS-SQUIBB (PROGENICS PHARMACEUTICALS,
INC.), VAXGEN, INC., AND ELAN CORPORATION, P.L.C. In return for rights to use
Stimulon(TM) adjuvant for specific diseases, the corporate partners have agreed
to pay us license fees, milestone payments, and

                                        9
<PAGE>   11

royalties on product sales. We have retained worldwide manufacturing rights for
QS-21. In addition to corporate partners, we have developed a number of academic
collaborations to test potential product formulations containing QS-21.

     - SMITHKLINE BEECHAM, P.L.C. ("SB") has licensed QS-21 for a number of
       different applications. The world's leading manufacturer of Hepatitis B
       vaccine, SB is aggressively marketing its existing portfolio of vaccines,
       while developing new and improved products. SB has completed a number of
       clinical trials of potential products containing QS-21 and is also
       investigating the use of combinations of different adjuvants.

       SB has completed Phase II studies of a malaria vaccine in The Gambia,
       Africa in semi-immune adult Gambian men. The trial involved 306
       volunteers. The vaccine was highly effective during the first two months
       of surveillance with efficacy against infection of 65%. Average efficacy
       during the whole surveillance period was 16%. SB has announced plans to
       initiate a pediatric study of this potential vaccine in The Gambia
       starting as early as this fall.

       SB is developing TH-GW, a therapeutic vaccine for genital warts, which is
       licensed from Cantab Pharmaceuticals, p.l.c. and has been reformulated
       with SBAS2, one of SB's adjuvant formulations that contains QS-21. A
       Phase I study and a Phase I/II dose ranging study have been completed. SB
       initiated two parallel randomized, double-blind, placebo controlled Phase
       IIb trials in 1999 at centers in western Europe, Canada, Scandanavia,
       Australia, and New Zealand. The trials are designed to assess wart
       recurrence rates and rates of disease regression following vaccination
       both in patients with newly diagnosed warts and those with recurrent
       warts. Data is expected in 2000.

       SB has completed Phase II studies of a therapeutic product for treating
       people chronically infected with hepatitis B, and is planning additional
       studies in 2000. Phase I clinical studies of a therapeutic vaccine for
       treating people with herpes infections have been completed.

     - AVENTIS PASTEUR ("AP") has licensed QS-21 for use in its HIV vaccine
       programs and has completed a number of clinical trials with different
       antigens. AP plans to start a Phase I clinical trial to evaluate a new
       HIV vaccine candidate in 2000.

     - WYETH-LEDERLE VACCINES AND PEDIATRICS ("WYETH-LEDERLE") licensed QS-21 in
       1992 for use in five vaccines. Wyeth-Lederle, formed as a result of the
       acquisition of American Cyanamid by American Home Products, is a leader
       in pediatric vaccines. Wyeth-Lederle has completed a Phase I clinical
       trial using a product formulated with QS-21. Wyeth has since reformulated
       this product and is planning to initiate studies of the new formulation
       early in 2000.

     - BRISTOL MYERS SQUIBB (PROGENICS PHARMACEUTICALS, INC.) ("BMS/P") licensed
       QS-21 for use in certain therapeutic products for cancer. BMS/P's most
       advanced program involves a vaccine called GMK that incorporates QS-21
       with a ganglioside preparation called GM2 to treat melanoma. The pivotal
       Phase III study in high-risk melanoma patients completed enrollment in
       1999. Initial clinical data is expected by the end of 2000. A second
       cancer product, MGV, which contains QS-21 and the gangliosides GD2 and
       GM1 along with GM2, is entering Phase II/III trials. This product is
       expected to be applicable to a number of cancers and Progenics plans to
       initiate several trials to focus on different cancers. We have licensed
       Progenics to use QS-21 in exchange for a license fee, an equity interest
       in Progenics, and royalties, and we have a supply agreement with BMS.

     - VAXGEN, INC. (an early stage company whose major corporate shareholder is
       Genentech, Inc.) has licensed QS-21 and the HIV protein gp120 for use in
       its HIV-1 vaccine program. VaxGen has conducted a number of Phase I
       clinical trials in healthy volunteers with a product formulated with
       QS-21, under the auspices of the National Institutes of Health.
       Volunteers received very low doses of gp120 antigen combined with QS-21
       and/or alum. These product formulations were well tolerated and resulted
       in immunogenicity equal to or better than the high dose gp120. A fourth
       trial based on these product formulations was completed in 1999 that
       confirmed the early data. Additional studies are being planned.


                                       10
<PAGE>   12

     - ELAN CORPORATION, P.L.C., through its wholly owned subsidiary, Neuralab
       Limited, has licensed QS-21 with an antigen in the field of Alzheimer's
       Disease. We have received two milestone payments and will receive
       additional fees and milestone payments plus royalties on future product
       sales. A phase I clinical trial was initiated in late 1999. Additional
       studies are being planned.

                [PRODUCT CLINICAL DEVELOPMENT STATUS BAR GRAPH]

MANUFACTURING AND SCALE-UP

     As part of each Stimulon(TM) adjuvant licensing agreement, we have retained
the right to be the exclusive supplier of Stimulon(TM) adjuvants. The license
agreements stipulate supply prices, within certain ranges. Pursuant to the
license agreements, we will also receive royalties on licensees' product sales.

     We currently manufacture QS-21 for commercial animal health use and for use
in human clinical trials. We have scaled the critical steps of the process to
produce a batch size suitable for large-scale commercial production up to
2,000,000 doses.

     The FDA classifies QS-21 as a constituent material used in vaccine
preparation. As a result, the FDA does not require licensure of facilities used
for the manufacture of QS-21. We believe that this classification affords
flexibility in the timing of investment in commercial manufacturing facilities.
After the safety and effectiveness of QS-21 has been demonstrated, we expect to
be in a position to reasonably project the capital investment required and can
adjust the scale of manufacturing as additional products reach the market.

     We also currently manufacture Quilvax-FeLV(TM) antigen and vaccine, which
were licensed for sale in the U.S. by USDA in 1990 and for European sales in the
European Community ("E.C.") in 1991. We produce commercial quantities at the 400
liter fermentation scale.

PATENTS AND PROPRIETARY RIGHTS

     We have pursued a policy of obtaining patent protection for our
technologies both in the U.S. and in selected foreign countries. We have filed
or have rights to a number of U.S. patents and patent

                                       11
<PAGE>   13

applications and their foreign counterparts. We also rely on trade secrets,
proprietary know-how, and continuing technical innovation to develop and
maintain our competitive position.

     Our future success will depend, in part, upon our ability to develop
products and technologies and to obtain patent protection for our products and
technologies both in the U.S. and Europe. There can be no assurance that patent
applications owned or licensed by us will issue as patents; that patent
protection will be secured for any particular technology, or that, if issued,
such patents will be valid, or that they will provide us with meaningful
protection against competitors. There can be no assurance that the patents will
not be challenged or designed around by others. Proceedings brought against our
patents could expose us to significant expense and the risk of adverse
determinations.

     We are not aware of any issued third party patents that would interfere
with development of any of our products. There can be no assurance that we will
not infringe existing or future patents owned by others; that third parties will
not bring suit against us for infringement of such patents. There can be no
assurance that we could obtain necessary or desirable licenses on acceptable
terms or that we could design around such patents. Any litigation instituted by
third party patent holders could expose us to significant expense and the risk
of adverse determination.

  QS-21 and Other Adjuvants

     We have three issued and five pending U.S. patents covering QS-21, QS-7,
and the other principal fractions of Quillaja saponaria and methods of their use
in vaccines. Comparable applications have been filed in appropriate additional
jurisdictions, sixteen of which have issued. We believe that the standard of
purity specified in the patent for the saponin fractions is necessary to achieve
a safety profile acceptable for human use. CSL and Seed Capital Inc. filed an
opposition with the European Patent Office ("EPO") on the issuance of our QS-21
patent in Europe. A hearing before the EPO was held in October of 1998. We
prevailed against all points raised in the opposition. CSL did not appeal the
EPO's decision.

  CD1 Antigen Presentation System

     We hold a license to a broad patent covering a CD1 restricted immune
response, a patent covering certain molecules presented through CD1 and have
several pending patents on the CD1 technology.

  Mastitis

     We exclusively licensed from Alfa Laval Agri AB certain base technology
used in the bovine mastitis program. This technology includes patents and patent
applications on fibronectin binding proteins from S. aureus, E. coli and S.
dysgalactiae. The Alfa Laval license calls for payment of an initial license
fee, royalties, and additional license fees as additional patents issue and upon
commercialization of the vaccines. As part of the joint development agreement
with Virbac S.A., we arranged for Alfa Laval to grant a direct license to Virbac
S.A. in certain territories.

     To date 11 patents have been issued in the U.S. related to fibronectin
binding proteins, the genes that encode these proteins, related synthetic
peptides and the use of these materials for treating infections.

  Other Patents

     We hold U.S. patents on Quilvax-FeLV(TM) vaccine and on drug delivery
compounds and methods. Patents on methods of expressing and purifying proteins
made in a baculovirus expression system have issued. We have a fully paid-up,
royalty-free license to U.S. Patent No. 4,734,362 and foreign counterparts
(protein purification) in the vaccine, therapeutic and related research fields.
We have a fully paid-up, royalty-free license to U.S. Patent No. 4,753,873 in
the veterinary diagnostic field; and a non-exclusive sublicense to U.S. Patent
No. 4,725,669 and U.S. Patent No. 5,068,174 (HIV-gp120-p27) in the vaccine,
therapeutic and related research fields. We also have several issued and pending
patents in the field of Lyme Disease and Human Granulocytic Ehrlichiosis.

                                       12
<PAGE>   14

COMPETITION

     The biotechnology and pharmaceutical industries are subject to rapid and
significant technological change. Our competitors in the U. S. and abroad are
numerous. They include, among others, major pharmaceutical and chemical
companies, specialized biotechnology firms, universities and other research
institutions. There can be no assurance that our competitors will not succeed in
developing technologies and products that are more effective than any that we
have developed or may be developed by us or which would render our technology
and products obsolete and noncompetitive. Many of these competitors have
substantially greater financial and technical resources and production and
marketing capabilities than we. In addition, some of our competitors have
substantially greater experience than we in preclinical testing and human
clinical trials of pharmaceutical products and in obtaining FDA and other
regulatory approvals of products for use in healthcare. Accordingly, our
competitors may succeed in obtaining FDA approval for products more rapidly than
could we. There can be no assurance that our products under development will be
able to compete successfully with existing products or products under
development by other companies, universities and other institutions or that they
will attain regulatory approval in the U. S. or elsewhere. If we commence
significant commercial sales of our products, we will also be competing with
respect to manufacturing efficiency and marketing capabilities, areas in which
we may have less experience. A significant amount of research in the field is
also being carried out at academic and government institutions. These
institutions are becoming increasingly aware of the commercial value of their
findings and are becoming more aggressive in pursuing patent protection and
negotiating licensing arrangements to collect royalties for use of technology
that they have developed. These institutions may also market competitive
commercial products on their own or in collaboration with competitors and will
compete with us in recruiting highly qualified scientific personnel.

     We are aware of certain programs and products under development by others
which may compete with our programs and products. Several companies, including
Coley Pharmaceutical Group ("CPG"), Corixa, Avant and Chiron Corporation, are
developing adjuvants and antigens.

     Merck Laboratories, Wyeth-Lederle, SB, Aventis Pasteur and possibly others
are in human clinical trials with conjugate pneumococcal vaccines and have
existing non-adjuvanted products on the market. Several companies market
mastitis vaccines for infections caused by E. coli. The existence of products
developed by these and other competitors, or other products of which we are not
aware or which may be developed in the future, may adversely affect the
marketability of products we develop.

     Our corporate partners are also licensees of Coley, Corixa and Avant.

GOVERNMENT REGULATION

     The FDA, the USDA, the Environmental Protection Agency, and comparable
state and other agencies, including those in foreign countries, impose
requirements governing the development, manufacture and marketing of certain of
our products and products under development. The regulatory process can take
several years, involves lengthy and detailed laboratory and clinical testing,
and requires substantial expenditures. Human biologicals and pharmaceuticals,
including vaccines, typically require three stages of clinical trials: Phase I
to determine the preliminary safety of the product; Phase II during which the
efficacy of the product is preliminarily assessed and treatment regimens
refined; and Phase III (sometimes referred to as "pivotal trials") during which
final safety and efficacy data are generated. Regulatory approval is required
prior to commencement of clinical trials. The clinical data, together with
comprehensive manufacturing and facility information, is filed with the FDA in a
Biologics License Application ("BLA") or a Product License Application ("PLA")
and an Establishment License Application ("ELA") on which the regulatory
agencies base their approval decisions. In some instances, particularly in cases
of life-threatening diseases for which there is no effective treatment, the
clinical trial phases may be combined, or approval may be sought after
completion of an expanded Phase II trial.

     Because QS-21 is currently classified by the FDA as a constituent material
used in drug preparation, the FDA does not require licensure of facilities used
in its manufacture. We believe that this affords investment flexibility in
commercial manufacturing facilities. We have filed a Biologics Master File for


                                       13
<PAGE>   15

QS-21 with the FDA, which its licensees can reference as part of their own PLAs
as they seek FDA approval.

     There can be no assurance that, at the end of the regulatory process,
approval will be obtained or that product developments by competitors in the
interim will not have made our products obsolete or economically unfeasible. The
extent of regulation which may arise from future legislative or administrative
action cannot be predicted, nor can the potential impact of such future
regulation, or changes in existing regulation, be predicted with any certainty.

PRODUCT LIABILITY

     We have potential liability risks that are inherent in the testing,
manufacturing and marketing of medical products. The use of our products or
conduct of clinical trials may expose us to product liability claims and
possible adverse publicity. These risks also exist with respect to our products,
if any, that receive regulatory approval for commercial sale. We currently have
limited product liability coverage for the clinical research use of our
products, which management believes is customary for companies with products at
this stage of clinical development. There can be no assurance that we will be
able to maintain our existing insurance coverage or obtain additional insurance
coverage at acceptable costs, if at all, or that a product liability claim would
not materially adversely affect our business or financial condition.

HUMAN RESOURCES

     As of December 31, 1999, we employed 41 full-time employees. The employees
are not represented by any labor unions, and we consider our relations with
those employees to be good. Our scientific staff has expertise in many relevant
areas and is augmented by consulting agreements with research scientists located
at various academic institutions and commercial organizations.

SCIENTIFIC ADVISORY BOARD

     Our Scientific Advisory Board consists of 6 individuals with recognized
expertise in immunology and oncology. The Scientific Advisory Board meets from
time to time to discuss matters relating to our current and long-term scientific
planning and research and development, and the individual members are available
for consultation on an informal basis. All members of the Scientific Advisory
Board are employed by academic institutions, and may have commitments or
consulting or advisory obligations to other entities that may limit their
availability to us. These entities may be competitors of ours. In certain
circumstances, the academic institutions which employ the Scientific Advisory
Board members may assert ownership rights to inventions or other technology that
may result from advice provided to us by such members. In such circumstances, we
could seek to negotiate licenses to such inventions or technology, but there can
be no assurance that we would be able to obtain such licenses on commercially
reasonable terms. No members of the Scientific Board are expected to devote more
than a small portion of their time to our business.

     The following persons are the current members of the Scientific Advisory
Board:

     Dr. Michael Brenner, M.D.
     K. Frank Austen Professor of Medicine
     Chief, Division of Rheumatology, Immunology & Allergy
     Brigham and Women's Hospital
     Smith Building, Room 225
     One Jimmy Fund Way
     Boston, MA 02115

     John R. David, M.D.
     Richard Pearson Strong Professor
     Department of Immunology and Infectious Diseases
     Harvard School of Public Health
     665 Huntington Avenue
     Boston, MA 02115

                                       14
<PAGE>   16

     Dr. Philip Livingston, M.D.
     Clinical Immunology Service
     Memorial Sloan-Kettering Cancer Center
     1275 York Avenue
     New York, NY 10021

     Dr. Steven A. Porcelli, M.D.
     Associate Professor
     Department of Microbiology and Immunology
     Albert Einstein College of Medicine of Yeshiva University
     Room 416 Frochheimer Building
     1300 Morris Park Avenue
     Bronx, NY 10461

     Dr. John Treanor, M.D.
     Associate Professor of Medicine
     University of Rochester Medical Center
     Infectious Diseases Unit
     601 Elmwood Avenue, Box 689
     Rochester, New York 14642

     Richard J. Whitley, M.D.
     Professor of Pediatrics, Microbiology and Medicine
     The University of Alabama at Birmingham
     616 Children's Hospital
     1600 Seventh Avenue South
     Birmingham, Alabama 35233

ITEM 2.  PROPERTIES.

     Our operations are conducted in a 41,000 square foot leased manufacturing,
research and office facility in Framingham, Massachusetts.

ITEM 3.  LEGAL PROCEEDINGS.

     None.

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

     No matter was submitted to a vote of our security holders during the fourth
quarter of the fiscal year ended December 31, 1999.

ITEM 4.A.  EXECUTIVE OFFICERS OF THE REGISTRANT.

     The following is a list of our management, their ages, positions, offices
and business experience, as of February 1, 2000:

          ALISON TAUNTON-RIGBY, Ph.D., 55, has been President, Chief Executive
     Officer and Director since March of 1996. Dr. Taunton-Rigby served as
     President and Chief Executive Officer and a member of the Board of
     Directors of our predecessor, Cambridge Biotech Corporation ("CBC") from
     April 1995 until October of 1996. From 1993 to 1994, she was President and
     Chief Executive Officer of Mitotix, Inc., a biopharmaceutical company.
     Prior to joining Mitotix, Dr. Taunton-Rigby was Senior Vice President,
     Biotherapeutics, of Genzyme Corporation, where she had overall
     responsibility for Genzyme's biotherapeutics business. Dr. Taunton-Rigby
     has been a member of the Board of Directors of BIO, the national trade
     organization and a past Chair of and member of the Emerging Companies
     Section. She is a member of the Board of Directors and a past President of
     the Massachusetts

                                       15
<PAGE>   17

     Biotech Council, the trade organization representing Massachusetts
     biotechnology companies. Dr. Taunton-Rigby received her doctorate in
     Chemistry from the University of Bristol in England, and is a graduate of
     the Advanced Management Program of the Harvard Business School. She is a
     director of Synaptic Pharmaceutical Corporation. She is also a member of
     the Bentley College Ethics Board.

          GERALD A. BELTZ, PH.D., 48, is Senior Vice President of Research and
     Development. Dr. Beltz served as Vice President of Research and Development
     of CBC from 1993 to 1996. For ten years prior to assuming these positions,
     Dr. Beltz held various scientific positions with CBC. Dr. Beltz was
     responsible for the initial development of our FeLV feline leukemia vaccine
     and CBC's HIV-1 diagnostic assays, and is the lead inventor on the patents
     covering these products. Dr. Beltz received his B.S. from Beloit College,
     his M.A. and Ph.D. from Princeton University, and did his post-doctoral
     work at Harvard University.

          DEBORAH B. GRABBE, 48, is Vice President of Manufacturing Operations.
     Ms. Grabbe served as Vice President of Manufacturing Operations for CBC
     from 1995 until 1996. She was Vice President of Regulatory Affairs and
     Product Quality for CBC from 1993 to 1994. Prior to joining CBC in 1993,
     Ms. Grabbe was Director of Regulatory and Clinical Affairs and Director of
     Product Support for Behring Diagnostics, Inc. From 1987 to 1988 she was
     Vice President of Operations at Biotechnica Diagnostics, Inc. Ms. Grabbe
     holds a B.A. from Oberlin College and an M.S. from John A. Burns School of
     Medicine, University of Hawaii.

          CHARLOTTE READ KENSIL, Ph.D., 45, has been Vice President of Research
     of the Company since November, 1998. Dr. Kensil has been with Aquila since
     1986 and has held various scientific positions. Dr. Kensil was responsible
     for the development of the saponin adjuvant and is the lead inventor on the
     patents covering this product as well as patents on saponins as drug
     delivery agents. Dr. Kensil is an author on 44 publications in scientific
     journals. She received her B.S. from the University of Illinois and an M.S.
     and Ph.D. from the University of California, and did postdoctoral research
     at the University of Connecticut Health Center. Dr. Kensil became an
     executive officer on December 15, 1999.

          JAMES L. WARREN, 54, joined us in January of 1998 as Vice President of
     Finance, Chief Financial Officer and Treasurer. From 1991 to January 1998,
     Mr. Warren was Vice President and Corporate Controller of Genzyme
     Corporation, a multinational biotechnology and health care product company.
     From 1984 to 1991, Mr. Warren was Vice President of Finance and
     Administration of Itek Graphics Corporation, Composition Systems Division,
     a supplier of composition software systems. Mr. Warren holds a B.S. from
     the University of Tennessee and an M.B.A. from Boston University.

                                       16
<PAGE>   18

                                    PART II

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

     The Company's common stock trades on the Nasdaq Stock Market under the
symbol AQLA. The prices quoted below represent last sale prices as reported by
the Nasdaq Stock Market ("NMS"). Aquila's stock was deemed registered pursuant
to Rule 12g-3(a) under the Securities Exchange Act of 1934 in October 1996 and
began trading on Nasdaq on October 24, 1996. As of March 27, 2000 there were
4,653 holders of record of Aquila's Common Stock. Such over the counter
quotations reflect inter-dealer prices without retail mark-up, mark-down or
commission and may not necessarily represent actual transactions.

<TABLE>
<CAPTION>
                                                  1999              1998              1997
                                             --------------    --------------    --------------
QUARTER                                      HIGH      LOW     HIGH      LOW     HIGH      LOW
-------                                      -----    -----    -----    -----    -----    -----
<S>                                          <C>      <C>      <C>      <C>      <C>      <C>
1st........................................  $4.06    $2.06    $8.63    $4.00    $7.50    $5.00
2nd........................................  $2.75    $1.56    $7.38    $4.00    $6.38    $3.75
3rd........................................  $2.50    $1.63    $4.50    $2.45    $5.75    $4.63
4th........................................  $3.25    $1.13    $4.31    $2.06    $5.25    $4.06
</TABLE>

     The Company has not paid dividends in the past and does not intend to pay
dividends in the near future. In 1999, the Company exchanged 216,974 shares of
Common Stock for debt of $488,798 including accrued interest. These securities
were exchanged under Section 3.(a)(9) of the Securities Act of 1933 and were
subsequently registered on behalf of the selling shareholders on Form S-3.

ITEM 6.  SELECTED FINANCIAL DATA.

                        AQUILA BIOPHARMACEUTICALS, INC.
                        FOR THE YEARS ENDED DECEMBER 31,
                (DOLLARS IN THOUSANDS EXCEPT PER SHARE AMOUNTS)

<TABLE>
<CAPTION>
                                        1999        1998        1997        1996        1995
                                      --------    --------    --------    --------    --------
<S>                                   <C>         <C>         <C>         <C>         <C>
Total revenues......................  $  2,068    $  5,597    $  6,928    $  6,573    $  5,728
Total expenses(1)...................   (10,527)    (22,145)    (10,564)    (11,745)    (12,242)
Other income........................       264       1,948       4,370       5,777       2,162
Total reorganization items(2).......        --          --          --      (1,715)       (813)
                                      --------    --------    --------    --------    --------
Income/(loss) continuing
  operations........................    (8,195)    (14,600)        734      (1,110)     (5,165)
                                      --------    --------    --------    --------    --------
Income/(loss) discontinued
  operations(3).....................        --          --         191       9,109         223
                                      --------    --------    --------    --------    --------
Income/(loss) before extraordinary
  loss(4)...........................    (8,195)    (14,600)        925       7,999      (4,942)
                                      --------    --------    --------    --------    --------
Extraordinary loss..................        --          --          --      (2,039)         --
                                      --------    --------    --------    --------    --------
Net Income/(loss)...................  $ (8,195)   $(14,600)   $    925    $  5,960    $ (4,942)
                                      ========    ========    ========    ========    ========
Income/(loss) per weighted average
  number of common shares (diluted):
  Continuing operations.............  $  (1.11)   $  (2.22)   $   0.14    $  (0.30)   $  (1.50)
At year end:
  Cash and marketable
     securities(5)..................  $  7,017    $ 15,156    $ 16,897    $ 17,675    $  7,072
  Working capital...................  $  5,252    $ 11,891    $ 16,029    $ 16,157    $  7,977
  Total assets......................  $ 15,742    $ 24,628    $ 20,667    $ 26,312    $ 23,045
  Long term debt....................  $  2,607    $  3,669    $    139    $  4,056    $     --
  Total long term obligations.......  $  2,757    $  3,894    $    364    $  4,281    $ 12,168
  Stockholder's equity..............  $  9,805    $ 15,653    $ 17,887    $ 16,917    $  3,946
</TABLE>

                                       17
<PAGE>   19

---------------
(1) 1998 includes $9.9 million charge for purchased incomplete technology.

(2) The Company recorded professional fee expense of $2.1 million and $1.2
    million, and interest earned on cash resulting from Chapter 11 proceedings
    of $0.4 million and $0.4 million in 1996 and 1995, respectively.

(3) In 1996, the Company sold the enterics diagnostics business for $5.7 million
    and the retroviral diagnostic business for $6.5 million, recording a
    combined gain of $7.6 million. In 1997, a gain of $0.2 million was recorded
    on the sale of inventory from these businesses. The Company's income from
    these businesses was $1.5 million and $0.2 million in 1996 and 1995,
    respectively.

(4) The Company recorded an extraordinary loss of $2.0 million in 1996 upon its
    reorganization and emergence from Chapter 11 bankruptcy for issuance of
    shares valued at $5.6 million in settlement of a shareholder class action
    suit offset by forgiveness of debt of $3.8 million on pre-petition
    liabilities.

(5) In 1996, cash and marketable securities balances reflect proceeds from the
    sale of the Company's diagnostic businesses for a combined $12.2 million,
    and a paid up license fee of $3.3 million. In 1997, net cash and marketable
    securities reflect proceeds of $2.0 million from the sale of the Company's
    Rockville, Maryland property. In 1998, cash and marketable securities
    reflect proceeds of $3.6 million from a private placement of Common Stock
    and $5.0 million from the issuance of debt. In 1999, cash and marketable
    securities reflect $1.5 million of proceeds from a private placement of
    Common Stock.

                                       18
<PAGE>   20

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

     This discussion contains forward-looking statements within the meaning of
Section 21E of the Securities Exchange Act of 1934, as amended. These
forward-looking statements represent the expectations of Aquila's management as
of the filing date of this Form 10-K. The Company's actual results could differ
materially from those anticipated by the forward-looking statements due to risks
and uncertainties such as general economic conditions; risks in product and
technology development; delays in the regulatory process; difficulties in
obtaining raw materials for the Company's products; failure of corporate
partners to successfully commercialize products using the Company's technology;
competition; the costs of acquiring additional technology; failure to obtain
additional funding for planned activities; and other risks and uncertainties
identified in this report on Form 10-K and in Aquila's Security and Exchange
Commission filings and the exhibits thereto.

RESULTS OF OPERATIONS

  1999 Compared to 1998

     Revenues

     Total revenues for 1999 were $2.1 million, a decrease of 63% from 1998.
Product revenues were $0.6 million, a decrease of 43% from 1998. Revenues from
research and development were $ 1.5 million, a decrease of 68% from 1998.

     Product revenues consist of sales of the feline leukemia vaccine to our
marketing partner Virbac, S.A., a private French company, which has exclusive
world wide rights to market the product. We estimate that European sales of this
product are between $18 and $22 million. Our product revenues were lower in 1999
because of low shipments in the first quarter while our new facility was being
prepared for operation, a reduction in inventories by Virbac and the acquisition
of a Virbac S.A. reseller by a competitor. Though Virbac S.A. has indicated its
intention to replace the sales of the lost reseller with sales by Virbac's U.S.
subsidiary, we have not been able to determine when this will happen.

     Revenues from research and development activities for 1999 were lower than
1998 due to lower contract research activity, license fees, and shipments of
QS-21, our adjuvant being used in clinical trials by our six partners. Shipments
of QS-21 were delayed while the new manufacturing facility was being prepared.
License fees were lower because we had a $3.0 million payment in 1998 from our
largest partner, the final in a series, partially offset by a $0.5 million
payment in 1999 from a new partner, Elan Corporation. Revenues from contract
research activities were lower in 1999 primarily because the mastitis program
reached the final licensing trial stage in the second half of 1999 where costs
are not shared with our research partner, Virbac S.A. These revenues were $0.9
million in 1998 and $0.2 million in 1999. We expect to file with the USDA for
approval to market the mastitis product in the first half of 2000. In 1999, we
were awarded a two year SBIR Phase II grant for $0.9 million from the National
Institute of Health to support our CD1 program in tuberculosis. We have applied
to the National Institute of Health for three additional grants in other CD1
programs.

     Costs and Operating Expenses

     Cost of sales as a percentage of product revenue was 152% and 97% in 1999
and 1998, respectively. The higher cost of sales in 1999 was due to downtime
caused by the required validation of the new manufacturing facilities we
occupied in September 1998. The overall high level of costs of sales is due to
downtime and validation costs incurred in both 1999 and 1998. The new
manufacturing facility was in full operation for the second half of 1999.

     Research and development expenses for 1999 were $6.6 million, a decrease of
11% from 1998. The decrease resulted from lower payments to a licensor for
patent issuance and lower clinical trial expense. Our research spending was
allocated primarily to preparing for and starting the final licensing trials for
the bovine mastitis product, which are expected to be completed in the first
half of 2000, and on the CD1 technology acquired when we bought VacTex, Inc. in
1998. Spending on the tuberculosis program,

                                       19
<PAGE>   21

which was the early stage research program acquired with VacTex, was $1.0
million in 1999 compared to $0.9 million in 1998. We are not committed to
funding this program in the future. We have not yet established
proof-of-principle; however, based on progress to date, we expect the TB program
to be a long-term program and to advance the tuberculosis program to the stage
where a partner can be enlisted to share the expense. We have initiated other
programs utilizing the CD1 technology in pursuit of antigens for diseases with
shorter and less costly development requirements than the tuberculosis program.

     General and administration spending was $3.0 million compared to $3.8
million in 1998, a decrease of 20%. The lower spending was a result of lower
staffing levels, lower legal and professional fees, and lower facility costs.

     Other Income

     Other income in 1999 was $0.3 million compared to $2.0 million in 1998. In
1999, royalty income, which is derived primarily from agreements from
discontinued operations, was $0.1 million compared to $0.5 million in 1998.
Royalty income from these sources may continue to decline as new products
replace products covered by the royalty agreements. Miscellaneous income in 1999
was $0.3 million compared to $0.5 million in 1998. Interest expense was $0.6
million in 1999 compared to interest expense of $0.1 million in 1998. The change
was due to a full year of interest expense on the loan for the fit-out of the
new facilities. Interest income was $0.5 million in 1999 compared to $1.0
million in 1998 due to declining investment balances.

  1998 Compared to 1997

     Revenues

     Total revenues for 1998 were $5.6 million, a decrease of 19% from 1997.
Product revenues were $1.0 million, a decrease of 28% from 1997. Revenues from
research and development were $4.6 million, a decrease of 17% from 1997.

     Product revenues were lower in 1998 due to the acquisition of a reseller by
a competitor. Revenues from research and development activities for 1998 were
lower than 1997 due to fluctuating shipments of our Stimulon(TM) adjuvant,
QS-21, used in clinical trials by corporate partners. Also, we received $0.9
million in 1998 from Virbac S.A. compared to $1.1 million in 1997. This program,
which is developing a product to treat bovine mastitis, had evolved from the
research stage, during which all costs were shared, to the development stage,
during which only certain costs were shared. In 1998, we received $3.0 million,
the final scheduled license payment from a partner for use of Stimulon(TM). In
1997, this payment was $3.5 million.

     Costs and Operating Expenses

     Cost of sales as a percentage of product sales was 97% and 78% in 1998 and
1997, respectively. The higher cost of sales in 1998 was due to downtime caused
by the move of the Company's corporate offices and all operations to new leased
facilities, partially offset by a price increase.

     Research and development expenses for 1998 were $17.4 million, including a
charge of $9.9 million for incomplete technology as a result of the purchase of
VacTex, Inc., ("VacTex") in April 1998. Through the purchase of VacTex, we
acquired rights to a patent involving the CD1 antigen presentation system (refer
to the business section of this 10K for a full description of this technology);
an option for access to research in tuberculosis being conducted at a research
institution in exchange for partial funding of that research; and an ongoing,
early stage research project to develop a CD1 vaccine and test it in an animal
model. The purchase price was charged to incomplete technology due to the early
stage of the technology and the need to expend additional resources to develop
the technology. The purchase was accounted for in this way primarily because
this very early stage technology had not been shown to provide protection from
infection in any animal models or in humans, thus rendering the patent rights
unqualified for capitalization, and because the time and cost to prove this
principle was significant and not determinable.

                                       20
<PAGE>   22

In 1998, we expended $0.9 million on the VacTex research and development
program. This program is expected to be a long-term endeavor for us that will be
evaluated periodically to determine future spending levels. It is expected that
development of a tuberculosis vaccine will cost several hundreds of millions of
dollars over 10 to 15 years. Aquila does not have the resources to fully develop
such a product. It is our intent to establish proof of principle that the CD1
system provides protection in tuberculosis and then to partner the program.
Also, once Aquila has established proof of principle, it will pursue other
commercial opportunities presented by this technology. Excluding the VacTex
charge, research and development spending was $7.4 million compared to $5.0
million in 1997, an increase of 48%. The increase was due to clinical and
licensing trial expenses, patent issuance expense, and spending on the CD1
research programs acquired from VacTex.

     General and administration spending was $3.8 million compared to $4.5
million in 1997, a decrease of 16%. The lower spending was a result of lower
staffing levels, lower legal and professional fees, and lower facility costs.

     Other Income

     Other income was $2.0 million, a decrease of 55% from 1997. In 1997, we had
a gain of $2.3 million on the sale of real estate. In 1998, royalty income,
which is derived primarily from agreements from discontinued operations, was
$0.5 million compared to $0.9 million in 1997. Miscellaneous income in 1998 was
$0.5 million compared to $0.1 million in 1997 and included $0.1 million from
settlement of a lawsuit and $0.3 million from abatement of real estate taxes.
Net interest income was $0.9 million in 1998 compared to $0.6 million in 1997.
The increase was due to higher interest expense in 1997 on a real estate
mortgage retired upon sale of the property in November 1997.

  Liquidity and Capital Resources

     At December 31, 1999 Aquila had cash, cash equivalents and marketable
securities of $7.0 million compared with $15.2 million at the end of 1998. In
February 2000, we liquidated an investment for proceeds of $0.6 million and
received license fee payments totaling $0.6 million from two corporate partners.
In March 2000, we sold 500,000 shares of Common Stock to the State of Wisconsin
Investment Board in a self directed private placement for proceeds of $3.0
million.

     In 1999, cash and cash equivalents declined $4.7 million and marketable
securities declined $3.4 million. Net working capital at the end of 1999 was
$5.3 million compared to $11.9 million at the end of 1998. Operations used $8.3
million primarily to fund the loss in 1999. Investing activities provided $3.3
million primarily from the sale of marketable securities. Financing activities
provided $0.3 million with a $1.5 million private placement of common stock more
than offsetting debt repayment.

     In 1998, marketable securities increased $0.3 million while cash and cash
equivalents declined $2.1 million. Operating activities required $3.4 million
primarily to fund the 1998 loss. Investing activities required $6.9 million,
primarily for the fit-out of the new leased facility. Financing activities
provided a total of $8.2 million, $3.6 from a private placement of common stock
and $5.0 million from a long-term loan partially offset by repayment of a $0.2
million outstanding bank loan and payment of $0.4 million on long-term debt.

     In 1997, marketable securities increased by $1.0 million while cash and
cash equivalents declined $1.8 million. Operating activities in 1997 required
$3.0 million. Investing activities generated cash from the sale of property of
$6.1 million while financing activities reflected the cash payment of $4.2
million to repay the mortgage on the property sold.

     We received a letter from Cambridge Biotech Corporation ("CBC"), the
predecessor of Aquila, in February 1999 alleging that the Aquila must indemnify
CBC under a Master Acquisition Agreement among Aquila, CBC and bioMerieux, Inc.
for potential losses from the termination of CBC's rights under a license
agreement. We have not had any further communication from CBC and upon review do
not feel

                                       21
<PAGE>   23

that adverse settlement of this matter will have a material effect on our
financial position or results of operations.

     Aquila's revenues and expenses vary and will continue to vary. Future
revenues depend primarily upon the success of efforts to license our proprietary
technology and to enter into cost sharing programs, and our ability to market
our products currently undergoing development or clinical trials. Aquila's
expenses fluctuate primarily due to clinical trials, which take from six months
to two years, and require varying degrees of financial support. Revenues or
operating results in any period will not necessarily be indicative of results in
subsequent periods.

     Under our operating plan for 2000, we expect that available cash, proceeds
from sale of investments, cash flow from research contracts, product sales and
materials transfers to our partners will be sufficient to finance operations and
capital requirements through at least the end of 2000. In 2001, we must raise
significant additional capital in order to continue operations at current levels
and to complete the commercialization of our proprietary programs. The bovine
mastitis program, if approved by the USDA in the second half of 2000, will
require additional working capital and capital equipment to support sales.
Management is considering various alternative financing strategies such as
public or private sales of our securities, or additional collaborative
arrangements. Capital requirements could differ materially from those currently
anticipated by management. There can be no assurance that Aquila will be
successful in raising additional capital.

  Accounting Pronouncements

     In December 1999, the United States Securities and Exchange Commission
issued Staff Accounting Bulletin 101, "Revenue Recognition in Financial
Statements" ("SAB 101"). SAB 101 provides the staff's views in applying
generally accepted accounting principles to selected revenue recognition issues,
as well as examples of how the staff applies revenue recognition guidance to
specific circumstances. Accordingly, no later than the second quarter of 2000
Aquila will change its accounting for initial license fees. Through 1999 revenue
was recognized when the agreement was reached and no contingent factors were
present. Under the new guidance of SAB 101, revenue will be deferred and
recognized ratably over the appropriate life. No later than the second quarter
of 2000, a cumulative adjustment will be recorded to create deferred revenue
that will be recognized over future years.

     In June 1998, the Financial Standards Board issued Statement of Financial
Accounting Standards No. 133 (SFAS No. 133), " Accounting for Derivative
Instruments and Hedging Activities." This statement requires companies to record
derivatives on the balance sheet as assets or liabilities, measured at fair
value. Gains or losses resulting from changes in the values of those derivatives
would be accounted for depending on the use of the derivative and whether it
qualifies for hedging accounting. SFAS 133 will be effective for the Company's
year ending December 31, 2001. The Company believes the adoption of SFAS No. 133
will not have a material effect on the financial statements.

  Subsequent Events

     In February 2000, we received $0.6 million in license fees from two
partners pursuant to license agreements that allow the partners to use our QS-21
adjuvant in their product development programs. We also sold 11,250 shares of
Progenics common stock for $0.6 million. These shares were carried at a cost of
$0.1 million and were classified as available-for-sale. We received $0.5 million
from the exercise of employee stock options and redeemed for cash $0.3 million
of VacTex debentures including accrued interest. In March 2000, we sold 500,000
shares of Common Stock to the State of Wisconsin Investment Board in a private
placement for proceeds of $3.0 million.

                                       22
<PAGE>   24

ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

  Interest Rate Risk

     Aquila invests cash balances in excess of operating requirements in
short-term marketable securities. At December 31, 1999, the fair market value of
these securities amounted to $5.9 million with unrealized losses of $56,000
included as a component of stockholder's equity. In connection with a facility
agreement, the Company maintains an investment of $0.8 million in a debt
security as collateral for a letter of credit. This debt security has an
implicit interest rate of 6.02% and matures in February 2001 at which time
proceeds of $0.8 million will be received. This investment is carried at fair
market value at December 31, 1999. This instrument is not leveraged and is not
held for purposes of trading. The Company has one loan outstanding at December
31, 1999 that is subject to interest rate risk. This loan carries an interest
rate of 13% and is payable as follows:

<TABLE>
<CAPTION>
                                        (DOLLARS IN THOUSANDS)
                                        ----------------------
<S>                                     <C>
2000..................................          $1,456
2001..................................          $1,456
2002..................................          $1,525
                                                ------
Total.................................          $4,437
</TABLE>

     In addition, the Company had $0.5 million of 7% debentures outstanding
issued in the purchase of VacTex.

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

     The financial statements filed as part of this Annual Report on Form 10-K
are listed under Item 14 below.

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

     None.

                                    PART III

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.

     Incorporated by reference to the Company's definitive proxy statement,
"Proposal 1, Election of Directors", to be filed pursuant to Regulation 14A, in
connection with the 2000 Annual Meeting of Shareholders. Information concerning
executive officers of the Registrant is included in Part I of this Report as
Item 4A -- Executive Officers of the Registrant.

ITEM 11.  EXECUTIVE COMPENSATION.

     Incorporated by reference to the Company's definitive proxy statement,
"Proposal 1, Election of Directors -- Executive Compensation", to be filed
pursuant to Regulation 14A, in connection with the 2000 Annual Meeting of
Shareholders.

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

     Incorporated by reference to the Company's definitive proxy statement,
"Proposal 1, Election of Directors -- Security Ownership of Certain Beneficial
Owners and Management", to be filed pursuant to Regulation 14A in connection
with the 2000 Annual Meeting of Shareholders.

                                       23
<PAGE>   25

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.

     Incorporated by reference to the Company's definitive proxy statement,
"Proposal 1, Election of Directors", to be filed pursuant to Regulation 14A in
connection with the 2000 Annual Meeting of Shareholders.

                                    PART IV

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

     (a) Financial Statements.

     The following documents are filed as part of this report:

        1. Report of Independent Auditors.

        2. Consolidated Statements of Operations for each of the three years in
           the period ended December 31, 1999.

        3. Consolidated Balance Sheets as of December 31, 1999 and 1998.

        4. Consolidated Statements of Cash Flows for each of the three years in
           the period ended December 31, 1999.

        5. Consolidated Statements of Shareholders' Equity for each of the three
           years in the period ended December 31, 1999.

        6. Notes to Financial Statements.

     (b) Financial Statement Schedules.

     None required.

     (c) Exhibits.

<TABLE>
<C>        <S>
    2.1    Confirmed Reorganization Plan (consisting of Reorganization
           Plan, dated May 20, 1996, and modification date of July 15,
           1996) (incorporated by reference to Exhibit 2 to current
           report on Form 8-K, dated July 18, 1996, File No. 0-12081).

    2.2    Agreement and Plan of Merger by and among Aquila
           Biopharmaceuticals, Inc., Aquila Acquisition, Inc. and
           VacTex, Inc. dated April 13, 1998 (incorporated by reference
           to Exhibit 2.1 to Form 8-K, dated April 13, 1998, File No.
           D-12081).

    3.1    Amended and Restated Certificate of Incorporation, effective
           July 25, 1996 (incorporated by reference to Exhibit 2 to
           Form 8-K, dated July 18, 1996, File No. 0-12081).

    3.2    Certificate of Amendment of Amended and Restated Certificate
           of Incorporation, effective March 24, 1997 (incorporated by
           reference to Exhibit 3.2 to Annual Report on Form 10-K for
           fiscal year ended December 31, 1996, File No. 0-12081).

    3.3    By-laws (incorporated by reference to Exhibit 2 to Form 8-K,
           dated July 18, 1996, File No. 0-12081).

    4.1    Specimen Certificate representing common stock of the
           Company (incorporated by reference to Exhibit 4.1 to From
           8-K, dated October 21, 1996, File No. 0-12081).

    4.2    Form of Debenture (incorporated by reference to Exhibit 4.1
           to Form 8-K, dated April 13, 1998, File No. 0-12081).

    4.3    Master Loan and Security Agreement dated July 15, 1998 by
           Aquila Biopharmaceuticals, Inc. in favor of Transamerica
           Business Credit Corporation (incorporated by reference to
           Exhibit 4.3 to Annual Report on Form 10-K for fiscal year
           ended December 31, 1998; File No. 0-12081).

    4.4    Shareholder Rights Agreement dated as of May 26, 1998
           (incorporated by reference to Exhibit 1 to Form 8-A dated
           May 26, 1998, File No. 0-12081).

  *10.1    Contract Research and License Agreement with Virbac
           Laboratories, S.A. dated July 6, 1983 (incorporated by
           reference to Exhibit 10.31 to Annual Report on Form 10-K for
           fiscal year ended December 31, 1983, File No. 0-12081).
</TABLE>

                                       24
<PAGE>   26
<TABLE>
<C>        <S>
  *10.1.1  Amendment to Agreement with Virbac Laboratories, S.A.
           (incorporated by reference to Exhibit 10.10.1 to Annual
           Report on Form 10-K for fiscal year ended December 31, 1988,
           File No. 0-12081).

   10.2    Lease for Framingham Massachusetts facility with NDNE 9/90
           Corporate Center LLC as landlord effective September 9, 1998
           (incorporated by reference to Exhibit 10.1 to
           Form S-3/A No.,1 filed May 6, 1998, File No. 0-12081).

  *10.3    License, Development and Supply Agreement with SmithKline
           Beecham, p.l.c., dated as of September 11, 1992, as amended
           by Agreement dated as of March 31, 1993 (incorporated by
           reference to Exhibit 10-17 to Annual Report of Form 10-K for
           fiscal year ended December 31, 1992, File No. 0-12081).

 tm10.4    Employment Agreement with Alison Taunton-Rigby, dated April
           6, 1995 (incorporated by reference to Exhibit 10.17 to
           Annual Report on From 10-K for fiscal year ended December
           31, 1995, File No. 01-12081).

 tm10.5    Employment Agreement with Gerald A. Beltz, dated August 21,
           1995 (incorporated by reference to Exhibit 10.18 to Annual
           Report on From 10-K for fiscal year ended December 31, 1995,
           File No. 01-12081).

 tm10.6    Employment Agreement with Deborah Blackburn Grabbe, dated
           August 21, 1995 (incorporated by reference to Exhibit 10.19
           to Annual Report on Form 10-K for fiscal year ended December
           31, 1995, File No. 01-12081).

 tm10.7    Employment Agreement with James L. Warren, dated January 17,
           1998 (incorporated by reference to Exhibit 10.15 to Annual
           Report on Form 10-K for the fiscal year ended December 31,
           1997, File No. 01-12081).

   10.9    Master Acquisition Agreement by and among bioMerieux Vitek,
           Inc., Aquila Biopharmaceuticals, Inc. and Cambridge Biotech
           Corporation, dated as of April 4, 1996 (incorporated by
           reference to Exhibit 10.1 to quarterly report on Form 10-Q
           for quarter ended June 30, 1996, File No. 0-12081).

   10.10   Asset Purchase Agreement between Meridian Diagnostics, Inc.
           and Cambridge Biotech Corporation, dated as of June 24, 1996
           (incorporated by reference to Exhibit 2.1 to current report
           on Form 8-K, dated June 24, 1996, File No. 0-12081).

   10.12   1996 Stock Award and Option Plan (incorporated by reference
           to Exhibit 10.12 to Annual Report on Form 10-K for the
           fiscal year ended December 31, 1996, File No. 01-12081).

   10.13   1996 Directors Stock Award and Option Plan (incorporated by
           reference to Exhibit 10.13
           to Annual Report on Form 10-K for the fiscal year ended
           December 31, 1996, File No. 01-12081).

   10.14   1996 Employee Stock Purchase Plan (incorporated by reference
           to Exhibit 10.14 to Annual Report on Form 10-K for the
           fiscal year ended December 31, 1996, File No. 01-12081).

   10.15   1996 Employee Retention Agreements (incorporated by
           reference to Exhibit 10.2 to Quarterly Report on Form 10-Q
           for fiscal quarter ended September 30, 1997).

   11.     Computation of Earnings Per Share.

   23.     Consent of PricewaterhouseCoopers LLP.

   27.     Financial Data Schedule.
</TABLE>

     (b) Reports on Form 8-K filed in the last quarter of 1999.

     None.
---------------
 o Filed herewith as part of this Annual Report on Form 10-K.

 * Confidential treatment previously granted.

tm Management contract or compensatory plan.

                                       25
<PAGE>   27

                       REPORT OF INDEPENDENT ACCOUNTANTS

     In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of operations, shareholders' equity and cash
flows present fairly, in all material respects, the financial position of Aquila
Biopharmaceuticals, Inc. and its subsidiary ("the Company") at December 31, 1999
and December 31, 1998, and the results of their operations and their cash flows
for each of the three years in the period ended December 31, 1999, in conformity
with accounting principles generally accepted in the United States. 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 of these statements in accordance with
auditing standards generally accepted in the United States, which 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, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for the opinion expressed above.

                                          /s/ PRICEWATERHOUSECOOPERS, LLP

Boston, Massachusetts
February 8, 2000
(except for Note 19, as to
which the date is March 24th, 2000)

                                       26
<PAGE>   28

                        AQUILA BIOPHARMACEUTICALS, INC.

         CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
                        FOR THE YEARS ENDED DECEMBER 31,

<TABLE>
<CAPTION>
                                                        1999            1998           1997
                                                     -----------    ------------    -----------
<S>                                                  <C>            <C>             <C>
Revenue:
  Product Sales....................................  $   564,170    $    995,321    $ 1,319,260
  Research and development.........................    1,503,494       4,642,088      5,608,977
                                                     -----------    ------------    -----------
                                                       2,067,664       5,597,409      6,928,237
Cost and expenses:
  Cost of Sales....................................      858,200         969,484      1,023,268
  Research and development.........................    6,642,407       7,447,359      5,019,775
  Purchased incomplete technology (Note 18)........           --       9,927,227             --
  General and administrative.......................    3,026,129       3,800,806      4,521,035
                                                     -----------    ------------    -----------
                                                      10,526,736      22,144,876     10,564,078
Other income, net (Notes 6, 12 and 13).............      264,296       1,947,832      4,370,107
                                                     -----------    ------------    -----------
Income/(loss) from continuing operations...........   (8,194,776)    (14,599,635)       734,266
Discontinued operations (Note 3):
  Gain on sale.....................................           --              --        191,250
                                                     -----------    ------------    -----------
Net Income/(loss)..................................  $(8,194,776)   $(14,599,635)   $   925,516
                                                     -----------    ------------    -----------
  Unrealized holding gains on available-for-sale
     securities....................................      483,190          79,434             --
  Less: reclassification adjustment for gain
     included in net income........................     (136,434)             --             --
                                                     -----------    ------------    -----------
  Total other comprehensive income.................      346,756          79,434             --
                                                     -----------    ------------    -----------
Comprehensive Income/(loss)........................  $(7,848,020)   $(14,520,201)   $   925,516
                                                     ===========    ============    ===========
Income/(loss) per weighted average number of common
  shares:
Basic earnings per share:
  Income/(loss) from continuing operations.........  $     (1.11)   $      (2.22)   $      0.15
  Net Income/(loss)................................  $     (1.11)   $      (2.22)   $      0.18
Diluted earnings per share:
  Income/(loss) from continuing operations.........  $     (1.11)   $      (2.22)   $      0.14
  Net Income/(loss)................................  $     (1.11)   $      (2.22)   $      0.18
Weighted average number of common shares
  outstanding:
  Basic............................................    7,394,147       6,580,602      5,003,703
  Diluted..........................................    7,394,147       6,580,602      5,141,815
</TABLE>

   The accompanying notes are an integral part of these financial statements.
                                       27
<PAGE>   29

                        AQUILA BIOPHARMACEUTICALS, INC.

                          CONSOLIDATED BALANCE SHEETS
                               AS OF DECEMBER 31,

<TABLE>
<CAPTION>
                                                                  1999             1998
                                                              -------------    -------------
<S>                                                           <C>              <C>
ASSETS
Current Assets:
  Cash and cash equivalents.................................  $     524,070    $   5,270,460
  Marketable securities (Notes 2, 4 and 6)..................      6,493,044        9,885,090
  Accounts and other receivables (less allowance for
     doubtful accounts of $47,000 in 1998)..................        636,555        1,027,711
  Inventories (Note 5)......................................        497,853          434,849
  Prepaid expenses and other current assets.................        280,041          353,448
                                                              -------------    -------------
          Total current assets..............................      8,431,563       16,971,558
Investments (Note 6)........................................        244,500          319,500
Property, Plant, and Equipment, Net (Note 7)................      6,191,244        6,372,345
Patents and Purchased Technology, Net (Note 8)..............         46,891          116,270
Other Assets (Note 13)......................................        827,738          848,726
                                                              -------------    -------------
          Total Assets......................................  $  15,741,936    $  24,628,399
                                                              =============    =============
LIABILITIES & SHAREHOLDERS' EQUITY
Current Liabilities:
  Accounts Payable..........................................  $     554,159    $     485,974
  Accrued Royalties.........................................             --          134,263
  Accrued professional fees.................................        164,967          298,684
  Accrued expenses and other (Note 9).......................        883,588        1,970,703
  Current maturities of long-term debt (Note 10)............      1,577,036        2,191,284
                                                              -------------    -------------
          Total current liabilities.........................      3,179,750        5,080,909
Deferred Revenue (Note 6)...................................        150,000          225,000
Long Term Debt (Note 10)....................................      2,607,397        3,669,494
                                                              -------------    -------------
          Total Liabilities.................................      5,937,147        8,975,403
                                                              -------------    -------------
Commitments and Contingencies (Note 13)
Shareholders' Equity (Note 14):
  Preferred stock, authorized: 5,000,000 shares, none
     issued.................................................             --               --
  Common stock, par value: $.01 per share, authorized:
     30,500,000 shares, issued: 7,888,446 and 6,992,483
     shares in 1999 and 1998, respectively..................         78,884           69,924
  Additional paid in capital................................    141,802,488      139,811,635
  Accumulated other comprehensive income....................        426,190           79,434
  Treasury stock at cost: 7,631 shares in 1999 and 1998.....        (34,339)         (34,339)
  Accumulated deficit.......................................   (132,468,434)    (124,273,658)
                                                              -------------    -------------
          Total Shareholders' Equity........................      9,804,789       15,652,996
                                                              -------------    -------------
          Total Liabilities and Shareholders' Equity........  $  15,741,936    $  24,628,399
                                                              =============    =============
</TABLE>

   The accompanying notes are an integral part of these financial statements.


                                       28
<PAGE>   30

                        AQUILA BIOPHARMACEUTICALS, INC.

                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                        FOR THE YEARS ENDED DECEMBER 31,

<TABLE>
<CAPTION>
                                                          1999            1998            1997
                                                       -----------    ------------    ------------
<S>                                                    <C>            <C>             <C>
Cash Flows From Operating Activities:
Net Income/(loss)....................................  $(8,194,776)   $(14,599,635)   $    925,516
Adjustments to reconcile net income/(loss) to net
  cash used in operating activities:
  Depreciation and amortization......................      816,427         292,650         402,555
  Provision (recovery) for doubtful accounts.........      (39,500)         40,000         (25,000)
  Purchased incomplete technology....................           --       9,927,227              --
  Non cash compensation expense......................           --              --          10,000
  Gain on sale of property, plant and equipment......      (14,300)        (25,115)     (2,340,983)
  Gain on sale of discontinued businesses............           --              --        (191,250)
  Issuance of common shares..........................           --              --          15,871
  Changes in assets and liabilities:
  Accounts and other receivables.....................      430,656         557,434         765,774
  Inventories........................................      (63,004)        243,742        (448,440)
  Deferred revenue...................................      (75,000)             --        (917,600)
  Prepaid and other current assets...................       73,407        (115,475)        540,954
  Accounts payable, accrued expenses and other.......   (1,246,795)        265,186      (1,720,026)
                                                       -----------    ------------    ------------
         Net cash used by operating activities.......   (8,312,885)     (3,413,986)     (2,982,629)
Cash Flows From Investing Activities:
  Purchases of available-for-sale securities.........   (8,789,784)    (20,693,209)             --
  Purchases of held-to-maturity securities...........           --              --     (12,163,261)
  Proceeds from maturities of marketable
    securities.......................................   12,595,957      20,507,296      11,181,249
  Other noncurrent assets............................       28,616        (737,814)         22,120
  Purchases of property, plant and equipment.........     (565,947)     (5,968,118)       (371,176)
  Proceeds from the sale of property, plant and
    equipment, net...................................       14,300          25,115       6,100,583
  Proceeds from the sale of discontinued
    businesses.......................................           --              --         412,123
                                                       -----------    ------------    ------------
         Net cash (used)/provided by investing
            activities...............................    3,283,142      (6,886,730)      5,181,638
Cash Flows From Financing Activities:
  Issuance of stock..................................    1,511,015       3,845,965          18,000
  Proceeds from debt.................................           --       5,000,000         208,017
  Payment of debt....................................   (1,227,662)       (647,239)     (4,184,667)
                                                       -----------    ------------    ------------
         Net cash provided/(used) by financing
            activities...............................      283,353       8,198,726      (3,958,650)
                                                       -----------    ------------    ------------
Net increase/(decrease) in cash and cash
  equivalents........................................   (4,746,390)     (2,081,990)     (1,759,641)
                                                       -----------    ------------    ------------
Cash and cash equivalents at the beginning of the
  year...............................................    5,270,460       7,352,450       9,112,091
                                                       -----------    ------------    ------------
Cash and cash equivalents at the end of the year.....  $   524,070    $  5,270,460    $  7,352,450
                                                       ===========    ============    ============
Supplemental disclosures:
Interest paid........................................  $   683,775    $     37,682    $    397,776
Issuance of treasury stock in settlement of
  liability..........................................           --          13,028              --
Issuance of warrants in conjunction with debt........           --          90,000              --
Issuance of stock in settlement of debt and accrued
  interest...........................................  $   488,798    $         --    $         --
</TABLE>

   The accompanying notes are an integral part of these financial statements


                                       29
<PAGE>   31

                        AQUILA BIOPHARMACEUTICALS, INC.

                CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
              FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997

<TABLE>
<CAPTION>
                                                                            ACCUMULATED
                                         COMMON STOCK        ADDITIONAL        OTHER
                                      -------------------     PAID-IN      COMPREHENSIVE   TREASURY
                                       SHARES     AMOUNT      CAPITAL         INCOME        STOCK        DEFICIT         TOTAL
                                      ---------   -------   ------------   -------------   --------   -------------   -----------
<S>                                   <C>         <C>       <C>            <C>             <C>        <C>             <C>
BALANCE, DECEMBER 31, 1996..........  5,000,000   $50,000   $127,514,223     $      0      $(47,367)  $(110,599,539)  $16,917,317
Exercises of options................      4,000        40         17,960           --            --              --        18,000
Stock issued to creditors pursuant
  to Reorganization plan............      3,527        35         15,836           --            --              --        15,871
Compensation expense................         --        --         10,000           --            --              --        10,000
Net income..........................         --        --             --           --            --         925,516       925,516
                                      ---------   -------   ------------     --------      --------   -------------   -----------
BALANCE, DECEMBER 31, 1997..........  5,007,527    50,075    127,558,019            0       (47,367)   (109,674,023)   17,886,704
Stock issued for private
  placement.........................    769,000     7,690      3,543,520           --            --              --     3,551,210
Stock issued for employee stock
  purchase..........................     11,331       113         48,724           --            --              --        48,837
Acquisition of Vactex, Inc..........  1,150,000    11,500      8,326,000           --            --              --     8,337,500
Exercises of options................     54,625       546        245,372           --            --              --       245,918
Warrants issued for debt
  obligation........................         --        --         90,000           --            --              --        90,000
Unrealized gain on
  available-for-sale securities.....         --        --             --       79,434            --              --        79,434
Treasury stock issued in settlement
  of Chapter 11 claim...............         --        --             --           --        13,028              --        13,028
Net loss............................         --        --             --           --            --     (14,599,635)  (14,599,635)
                                      ---------   -------   ------------     --------      --------   -------------   -----------
BALANCE, DECEMBER 31, 1998..........  6,992,483    69,924    139,811,635       79,434       (34,339)   (124,273,658)   15,652,996
Stock issued for private
  placement.........................    666,667     6,667      1,473,254           --            --              --     1,479,921
Stock issued for employee stock
  purchase..........................     12,322       123         30,971           --            --              --        31,094
Stock issued for debt...............    216,974     2,170        486,628           --            --              --       488,798
Unrealized gain on
  available-for-sale securities.....         --        --             --      346,756            --              --       346,756
Net loss............................         --        --             --           --            --      (8,194,776)   (8,194,776)
                                      ---------   -------   ------------     --------      --------   -------------   -----------
BALANCE, DECEMBER 31, 1999..........  7,888,446   $78,884   $141,802,488     $426,190      $(34,339)  $(132,468,434)  $ 9,804,789
                                      =========   =======   ============     ========      ========   =============   ===========
</TABLE>

   The accompanying notes are an integral part of these financial statements.


                                       30
<PAGE>   32

                        AQUILA BIOPHARMACEUTICALS, INC.

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. ORGANIZATION AND BUSINESS

     Aquila Biopharmaceuticals, Inc. (the "Company" or "Aquila"), engages in
discovery, product development and commercialization of products to prevent,
treat or control infectious diseases, autoimmune disorders and cancers. Aquila
is subject to risks common to companies in the biotechnology industry including,
but not limited to, development by Aquila or its competitors of new
technological innovations, dependence on key personnel, protection of
proprietary technology, the ability to raise additional capital and compliance
with FDA government regulations.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

     Principles of Consolidation -- The Consolidated Financial Statements
include Aquila Biopharmaceuticals, Inc. and VacTex, Inc. ("VacTex") its wholly
owned subsidiary. VacTex was acquired on April 14, 1998 (See Note 18). All
significant intercompany transactions and accounts have been eliminated.

     Segment Information -- Aquila's reportable segments are development and
manufacturing. All research programs are aggregated in the development segment.
Revenues from the sale of the Company's one commercial product, the feline
leukemia vaccine, the QS-21 material supplied to research partners, and license
fees relating to these products are reported in the manufacturing segment.
Aquila allocates resources among segments primarily on the basis of labor
utilization. Aquila's business is conducted entirely within the United States.

     The financial results of the Company's segments are presented on the same
accounting basis as the Company's consolidated results. There are no
inter-segment activities. The table below presents revenue and net income data
for the two segments for the years 1997, 1998 and 1999. Asset information by
segment is not reported because we do not produce such information internally.

<TABLE>
<CAPTION>
                                                                                               CONSOLIDATED
                          DEVELOPMENT              MANUFACTURING           RECONCILING            TOTALS
                       ------------------     -----------------------         ITEMS       -----------------------
                       REVENUE   NET LOSS     REVENUE   NET INC./LOSS     NET INC./LOSS   REVENUE   NET INC./LOSS
                       -------   --------     -------   -------------     -------------   -------   -------------
                                                         (DOLLARS IN THOUSANDS)
<S>                    <C>       <C>          <C>       <C>               <C>             <C>       <C>
1997.................  $1,134    $(4,962)(1)  $5,794       $2,548(2)         $ 3,339      $6,928      $    926
1998.................  $  872    $(8,317)(1)  $4,725       $2,285(2)         $(8,568)     $5,597      $(14,600)
1999.................  $  460    $(7,952)(1)  $1,608       $ (436)(2)        $   193      $2,068      $ (8,195)
</TABLE>

---------------
(1) Includes non-recurring license fees of $3.5 million, $3.0 million and $0.8
    million in 1997, 1998 and 1999 respectively. Total export sales of this
    segment were approximately $0.8 million, $1.4 million and $1.2 million in
    1999, 1998 and 1997, respectively.

(2) Includes $2.3 million gain from the sale of real estate, net royalty income
    of $0.9 million, net interest income of $0.6 million and rental income of
    $0.5 million in 1997; a charge for incomplete technology of $9.9 million,
    net interest income of $0.9 million, net royalty income of $0.5 million and
    $0.3 million real estate tax rebate in 1998, and net interest expense of
    $0.1 million and income from the sale of available-for-sale securities of
    $0.2 in 1999.

     One corporate partner, SmithKline Beecham, has historically been our
principle source of research and development revenue. Research and development
revenues from this corporate partner, included in the manufacturing segment,
represented 5%, 62% and 61% of Aquila's total revenue in 1999, 1998 and 1997,
respectively. This includes compensation to Aquila for producing QS-21 clinical
trial material for use in its product development programs. In 1998, this
partner made a payment of $3.0 million, the last scheduled payment under a
license agreement.

                                       31
<PAGE>   33
                        AQUILA BIOPHARMACEUTICALS, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     In 1999, Aquila received license fee revenue from Elan Corporation and
Progenics Pharmaceuticals. The research and development revenue from these two
partners, included in the manufacturing segment, represents 24% and 16%,
respectively, of Aquila's total revenue in 1999.

     A marketing partner, Virbac S.A., represents all of the Company's product
sales and a substantial portion of the Company's research and development
revenue. Product sales to this partner are included in the manufacturing segment
and represented 27%, 17% and 19% of total revenues in 1999, 1998 and 1997,
respectively. Revenue from development agreements with this partner are included
in the development segment and represented 11% of total revenues in 1999, and
16% of total revenues in 1998 and 1997.

     Aquila depends on a number of corporate collaborators for reimbursement for
the supply of its adjuvant for use in their clinical trials and for research
revenues.

     Use of Estimates -- The preparation of financial statements in conformity
with generally accepted accounting principles requires management to make
certain estimates and assumptions that effect the reported amounts of assets and
liabilities, disclosure of contingent assets and liabilities at the date of the
financial statements, and the reported amounts of revenues and expenses during
the reporting period. Such estimates include, but are not limited to, valuation
allowance against deferred tax assets. Actual results could differ from those
estimates.

     Cash and Cash Equivalents -- Aquila considers all highly liquid debt
instruments purchased with a maturity of three months or less to be cash
equivalents. Cash equivalents include money market accounts, certificates of
deposit, commercial paper and short-term investments.

     Marketable Securities -- Aquila classifies its marketable securities at the
time of purchase in accordance with the Statement of Financial Accounting
Standards No. 115 ("SFAS 115") "Accounting for Certain Investments in Debt and
Equity Securities". At December 31, 1999, all marketable securities were
classified as available-for-sale.

     Concentrations of Credit Risk -- Financial instruments that potentially
subject Aquila to concentration of credit risk are primarily cash investments
and accounts receivable. Cash investments are restricted to financial
institutions and corporations with high credit standings. Credit risk on
accounts receivable is minimized by the strong financial position of the
entities with which the Company does business. Write-offs for 1999, 1998 and
1997 were $7,500, $72,620 and $76,000, respectively.

     Inventories -- Inventories are stated at the lower of cost or market. Cost
has been determined using standard costs which approximate the first-in,
first-out method.

     Property, Plant and Equipment -- Property, plant and equipment are recorded
at cost. Depreciation for financial accounting purposes is computed by the
straight-line method over their estimated useful lives. The estimated useful
lives of the assets are as follows:

<TABLE>
<CAPTION>
                                                                    USEFUL LIFE
                                                              ------------------------
<S>                                                           <C>
Furniture, fixtures and equipment...........................                   3 -- 10
Leasehold and building improvements.........................     Lesser of Useful Life
                                                              or the Term of the Lease
</TABLE>

Maintenance and repairs are charged to operations as incurred, whereas additions
and improvements are capitalized. Upon retirement or disposal of assets, the
cost and the related accumulated depreciation are removed from the balance sheet
and any gain or loss is reflected in earnings.

     Long-Lived Assets -- The Company reviews long-lived assets for impairment
by comparing the cumulative undiscounted cash flows from the assets with their
carrying amount. Any write-downs are to be treated as permanent reductions in
the carrying amount of the assets. Management's policy regarding long-

                                       32
<PAGE>   34
                        AQUILA BIOPHARMACEUTICALS, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

lived assets is to evaluate the recoverability of its assets when the facts and
circumstances suggest that these assets may be impaired. This analysis relies on
a number of factors, including operating results, business plans, budgets,
economic projections and changes in management's strategic direction or market
emphasis. The test of such recoverability is a comparison of the asset value to
its expected cumulative net operating cash flow over the remaining life of the
asset.

     Patents and Purchased Technology -- Purchased technology related to the
acquisition of completed technology is recorded at fair market value at
acquisition date. Capitalized patent costs relate to patented technologies from
which the Company is deriving economic benefit. Purchased technology and patents
are amortized on a straight-line basis over their estimated useful lives ranging
from three to seven years.

     Revenue Recognition -- Revenue from product sales is recognized at the time
of product shipment. Revenue from research and development contracts is deferred
and recognized over the contractual periods as services are performed or as
distinct milestones are met. The initial fee in alliance agreements is
recognized as revenue when a definitive agreement is reached and no contingent
factors are present.

     Research and Development Costs -- Research and development costs are
charged to operations as incurred.

     Income Taxes -- Aquila uses the asset and liability method of accounting
for income taxes. Under this method, deferred tax assets and liabilities are
recognized for the expected future tax consequences of temporary differences
between the carrying amounts and the tax bases of assets and liabilities using
current statutory tax rates.

     Net Income/(Loss) Per Share -- Aquila applies Statement of Financial
Accounting Standards No. 128, ("SFAS 128") Earnings Per Share to compute loss
per share. Under SFAS 128, basic EPS is calculated by dividing net earnings
(loss) by the weighted-average common shares outstanding during the period.
Diluted EPS reflects the potential dilution to basic EPS that could occur upon
conversion or exercise of securities, options, or other such items, to common
shares using the treasury stock method based upon the weighted-average fair
value of our common shares during the period.

     Common stock equivalents consisting of stock options and warrants have been
excluded from the computation of diluted earnings/(loss) per share in 1999 and
1998 since inclusion would be anti-dilutive because Aquila was in a loss
position. Warrants to purchase 60,680 shares of common stock with an exercise
price of $4.12 and a term of 5 years were outstanding at December 31, 1999 and
1998. Options to purchase 1,136,288 and 1,091,560 shares of common stock at
weighted average exercise prices of $3.37 and $3.89, respectively, were
outstanding at December 31, 1999 and 1998, respectively. Options to purchase
180,375 shares of common stock at a weighted average exercise price of $5.16
were outstanding at December 31, 1997 and not included in the computation of
diluted income per share in 1997 because their exercise price was greater than
average market price making inclusion anti-dilutive (see also Note 19).

     Basic and diluted earnings per share from discontinued operations were
$0.04 for 1997.

Accounting Pronouncements

     In December 1999, the United States Securities and Exchange Commission
issued Staff Accounting Bulletin 101, "Revenue Recognition in Financial
Statements" ("SAB 101"). SAB 101 provides the staff's views in applying
generally accepted accounting principles to selected revenue recognition issues,
as well as examples of how the staff applies revenue recognition guidance to
specific circumstances. Accordingly, no later than the second quarter of 2000
Aquila will change its accounting for initial license fees. Through 1999 revenue
was recognized when the agreement was reached and no contingent factors were
present. Under the new guidance of SAB 101, revenue will be deferred and
recognized ratably over the appropriate

                                       33
<PAGE>   35
                        AQUILA BIOPHARMACEUTICALS, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

life. No later than the second quarter of 2000, a cumulative adjustment will be
recorded to create deferred revenue that will be recognized over future years.

     In June 1998, the Financial Standards Board issued Statement of Financial
Accounting Standards No. 133 (SFAS No. 133), "Accounting for Derivative
Instruments and Hedging Activities." This statement requires companies to record
derivatives on the balance sheet as assets or liabilities, measured at fair
value. Gains or losses resulting from changes in the values of those derivatives
would be accounted for depending on the use of the derivative and whether it
qualifies for hedging accounting. SFAS 133 will be effective for the Company's
year ending December 31, 2001. The Company believes the adoption of SFAS No. 133
will not have a material effect on the financial statements.

3. DISCONTINUED OPERATIONS

     During 1996, Aquila disposed of two separate diagnostics businesses
encompassing its diagnostic assets and operations for cash proceeds of
approximately $12.2 million. The accompanying financial statements include a
gain from the disposal of $0.2 million in 1997. Net revenue from discontinued
operations was $0.4 million in 1997.

4. MARKETABLE SECURITIES

     Available-for-sale marketable securities are carried at fair market value
based on quoted market prices. Held-to-maturity marketable securities are
carried at amortized cost, which approximates fair value. At December 31, 1999,
all marketable securities were classified as available-for-sale. Marketable
securities consisted of the following at December 31:

<TABLE>
<CAPTION>
                                                                       UNREALIZED
                                                            FAIR     ---------------    AMORTIZED
                                                           VALUE     GAINS    LOSSES      COST
                                                           ------    -----    ------    ---------
                                                                   (DOLLARS IN THOUSANDS)
<S>                                                        <C>       <C>      <C>       <C>
1999
Available-for-sale at fair market value
  Common stock...........................................  $  550    $475      $ --      $   75
  Corporate debt securities..............................     492      --        (7)        499
  Government-backed obligations..........................   5,451      --       (49)      5,500
                                                           ------    ----      ----      ------
          Total..........................................  $6,493    $475      $(56)     $6,074
1998
Available-for-sale at fair market value
  Common stock...........................................  $  139    $ 64      $ --      $   75
  Corporate debt securities..............................   6,746      15        --       6,731
  Government-backed obligations..........................   2,000      --        --       2,000
Held-to-maturity at amortized cost
  Corporate debt security................................   1,000      --        --       1,000
                                                           ------    ----      ----      ------
          Total..........................................  $9,885    $ 79      $ --      $9,806
</TABLE>

                                       34
<PAGE>   36
                        AQUILA BIOPHARMACEUTICALS, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

5. INVENTORIES

     Inventories consisted of the following at December 31:

<TABLE>
<CAPTION>
                                                                1999           1998
                                                              --------       --------
                                                              (DOLLARS IN THOUSANDS)
<S>                                                           <C>            <C>
Finished goods..............................................    $157           $231
Work in process.............................................     236            122
Raw materials and supplies..................................     105             82
                                                                ----           ----
                                                                $498           $435
                                                                ====           ====
</TABLE>

6. INVESTMENTS

     Aquila holds 270,000 shares of Protein Sciences Corporation stock as
payment for a paid up license and for royalties due and payable under terms of a
technology sublicense agreement. The shares are carried at a cost of $.35 per
share.

     Aquila received 45,000 shares of Progenics Pharmaceutical's Inc.
("Progenics") common stock in partial payment of a license fee under an
agreement executed in 1995. As Progenics attains certain milestones as defined
in the agreement, these shares are released from restriction and Aquila earns
permanent ownership of the shares. The value of the stock was determined to be
$0.3 million and was recorded in Investments and Deferred Revenue. The Company
earned the first milestone in 1996 and subsequently sold the unrestricted shares
for $0.2 million in 1999. In 1999, the Company earned the second milestone,
reclassified another 11,250 shares of Progenics common stock from Investments to
Marketable Securities, and recorded revenue of $75,000, which represented the
cost of these shares. At December 31, 1999, these shares had a market value of
$0.5 million and were classified as available-for-sale. The remaining 22,500
restricted shares are carried at cost of $150,000 and Deferred Revenue of the
same amount. In the first quarter of 2000, the Company sold the 11,250 shares of
unrestricted Progenics common stock for proceeds of $0.6 million.

7. PROPERTY, PLANT, AND EQUIPMENT

     Property, plant, and equipment consists of the following at December 31:

<TABLE>
<CAPTION>
                                                                1999         1998
                                                              ---------    ---------
                                                              (DOLLARS IN THOUSANDS)
<S>                                                           <C>          <C>
Furniture, fixtures, and equipment..........................   $ 3,594      $ 3,274
Leasehold and building improvements.........................     5,358        5,112
                                                               -------      -------
Sub-total...................................................     8,952        8,386
Less accumulated depreciation and amortization..............    (2,761)      (2,014)
                                                               -------      -------
                                                               $ 6,191      $ 6,372
                                                               =======      =======
</TABLE>

     Total depreciation expense during 1999, 1998 and 1997 was $0.7 million,
$0.2 million and $0.3 million, respectively. Interest cost of $0.1 million out
of total interest costs of $0.2 million was capitalized in 1998 in connection
with the fit-out of our new facility.

                                       35
<PAGE>   37
                        AQUILA BIOPHARMACEUTICALS, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

8. PATENTS AND PURCHASED TECHNOLOGY

     Purchased technology and intangibles consist of the following at December
31:

<TABLE>
<CAPTION>
                                                               1999            1998
                                                              ------          ------
                                                              (DOLLARS IN THOUSANDS)
<S>                                                           <C>             <C>
Purchased technology........................................  $ 240           $ 240
Patents and patent support..................................    746             746
                                                              -----           -----
Sub-total...................................................    986             986
Less accumulated amortization...............................   (939)           (870)
                                                              -----           -----
                                                              $  47           $ 116
                                                              =====           =====
</TABLE>

     Total amortization expense was $0.1 million, in each of in 1999, 1998 and
1997.

9. OTHER ACCRUED EXPENSES

     Accrued expenses consist of the following at December 31:

<TABLE>
<CAPTION>
                                                              1999            1998
                                                              -----          -------
                                                              (DOLLARS IN THOUSANDS)
<S>                                                           <C>            <C>
Fit-out of new facility.....................................  $ 40           $  700
Research contract obligations...............................   152              674
Compensation................................................   433              283
Other.......................................................   259              314
                                                              ----           ------
                                                              $884           $1,971
                                                              ====           ======
</TABLE>

10. DEBT

     In August 1997, Aquila entered into a three year $1 million credit facility
fully collateralized by equipment purchased. In December 1998, the balance of
$138,000, including interest was paid and the credit facility terminated.

     In April 1998, Aquila issued $1.3 million of debt as part of the purchase
of VacTex, Inc. (See Note 18). The debt bears interest of 7% and was callable as
of April 14, 1999. In 1999, Aquila redeemed $0.8 million of outstanding
debentures including accrued interest for 216,974 shares of common stock and
$0.3 million in cash. As of December 31, 1999, Aquila had $0.5 million in
outstanding debentures. In the first quarter of 2000 Aquila redeemed $0.3
million including accrued interest for cash.

     In July 1998, Aquila entered into a loan agreement (the "Agreement") with
Transamerica Business Credit Corporation. The Agreement made available $5.0
million for the build-out of the new facility in Framingham, Massachusetts and
for the purchase of new equipment. The Agreement calls for interest at 13
percent with a repayment term of four years and a 10 percent balloon payment at
the end of the loan term. Collateral for the loan consists of equipment and
leasehold improvements with a net book value of $4.5 million. Warrants to
purchase 60,680 shares of Aquila's common stock were issued in connection with
the loan agreement. The warrants have an exercise price of $4.12 and a term
ending July 1, 2003. The warrants were valued at $90,000 and will be amortized
over the life of the loan. As of December 31, 1999, the full amount had been
borrowed and $3.7 million was outstanding under the loan. At current interest
rates available to the Company, the fair value of the debt approximates the
carrying value. Repayment of the loan and related interest will require payments
of $1.5 million in each of the years 2000 through 2002.

                                       36
<PAGE>   38
                        AQUILA BIOPHARMACEUTICALS, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

11. INCOME TAXES

     The components of the deferred tax assets and liabilities at December 31,
1999 and 1998 are as follows:

<TABLE>
<CAPTION>
                                                                1999          1998
                                                              --------      --------
                                                              (DOLLARS IN THOUSANDS)
<S>                                                           <C>           <C>
Current:
  Inventory.................................................  $    110      $     44
  Other.....................................................       157           294
                                                              --------      --------
Total current...............................................       267           338
Noncurrent:
  Capital Loss Carryover....................................     3,318         3,318
  Depreciation and Amortization.............................      (156)           72
  Impairment of Long Lived Assets...........................       719            --
  Other.....................................................       (15)          635
  Federal and State NOL's...................................    34,199        30,251
  Federal and State tax credits.............................     1,421         1,617
                                                              --------      --------
Total noncurrent............................................    39,486        35,893
                                                              --------      --------
Sub-total...................................................    39,752        36,231
Less: valuation allowance...................................   (39,752)      (36,231)
                                                              --------      --------
Net deferred tax asset......................................  $      0      $      0
                                                              ========      ========
</TABLE>

     Management has assessed the evidence relating to recoverability of the
deferred tax asset and has determined that it is more likely than not that the
deferred tax benefit will not be realized due to the uncertainty of future
earnings. Accordingly, a valuation reserve has been established for the full
amount of the deferred tax asset.

     As of December 31, 1999, the Company had federal net operating loss (NOL)
carryforwards of approximately $89.0 million. These loss carryforwards begin to
expire in the year 2000 and expire fully by the year 2018. The Company has state
loss carryforwards of approximately $41.4 million. These state loss
carryforwards begin to expire in 1999 and expire fully by 2005. Utilization of
these NOL's may be limited pursuant to the provisions of Section 382 of the
Internal Revenue Code of 1986.

12. OTHER INCOME, NET

     At December 31, Other Income, Net consists of the following:

<TABLE>
<CAPTION>
                                                            1999      1998      1997
                                                            -----    ------    ------
                                                             (DOLLARS IN THOUSANDS)
<S>                                                         <C>      <C>       <C>
Gain on sale of Rockville real estate.....................  $  --    $   --    $2,332
Royalty income, net.......................................     65       527       854
Interest income...........................................    544     1,021     1,044
Interest (expense)........................................   (623)     (100)     (399)
Rental income, net........................................     --        --       500
Miscellaneous income, net.................................    278       500        39
                                                            -----    ------    ------
                                                            $ 264    $1,948    $4,370
                                                            =====    ======    ======
</TABLE>

                                       37
<PAGE>   39
                        AQUILA BIOPHARMACEUTICALS, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     In 1999, Aquila recorded $0.2 million of income (included in miscellaneous)
from the gain on the sale of available-for-sale securities. In December 1998,
Aquila received $0.3 million (included in miscellaneous) as a rebate of taxes
paid on its former leased facility in Worcester, Massachusetts. In November,
1997, Aquila sold the Rockville, Maryland facilities for $6.5 million and
recorded a gain of $2.3 million. Proceeds from the sale were used to retire the
mortgage. Royalty income represents royalties earned under license and
sublicense agreements related primarily to diagnostic technologies, net of
expenses due to third-party licensors. In 1997, rental income derived from the
rental of our real estate in Rockville, Maryland ceased upon the sale of the
Rockville facilities.

13. COMMITMENTS AND CONTINGENCIES

     Leases -- Costs incurred under facility leases are recorded as rent expense
and totaled $0.8 million, $0.9 million and $1.2 million in 1999, 1998 and 1997,
respectively, (net of sublease income of $28,500 in 1999). In 1998, Aquila
entered into a new operating, facility lease agreement for its executive
offices, research laboratories and manufacturing facilities in Framingham,
Massachusetts. The base lease period for this lease is twelve years and the
lease contains renewal options for two additional five-year periods. In
connection with the facility lease, the Company maintains a fully collateralized
letter of credit of $0.8 million. No amounts have been drawn on the letter of
credit. As of December 31, 1999, the future minimum lease payments (net of
sublease income of $85,000 in 2000) required under the operating lease are as
follows:

<TABLE>
<CAPTION>
YEAR ENDING DECEMBER 31,                            (DOLLARS IN THOUSANDS)
------------------------                            ----------------------
<S>                                                 <C>
2000............................................           $   792
2001............................................               877
2002............................................               896
2003............................................               939
2004............................................               939
Thereafter......................................             5,583
                                                           -------
Total...........................................           $10,111
                                                           =======
</TABLE>

     Employment and Consulting Agreements -- Aquila has agreements with various
consultants and key employees, with terms ranging from one to three years. These
agreements provide for future aggregate annual payments of approximately $1.0
million. Costs incurred and charged to operations under these contracts
aggregated $1.1 million, $1.3 million and $1.2 million in 1999, 1998 and 1997,
respectively.

     Other Agreements -- Aquila has licensed fibronectin binding technology from
a Swedish company, for use in mastitis research and development. Aquila recorded
$0.3 million and $0.6 million of expense in 1999 and 1998, respectively, for
milestone payments relating to patent issuance. The agreement provides for
additional payments upon the first commercial sale of future vaccines at $1.3
million per vaccine, and up to $0.6 million upon the granting of additional
patents in the United States and Europe on the technology acquired.

     Contingencies -- Five civil actions commenced in 1993 in the United States
District Court, District of Massachusetts against Cambridge Biotech Corporation
("CBC") a predecessor of Aquila, certain of its officers, and in three of the
actions, CBC's former auditors -- Deloitte & Touche, LLP ("Deloitte"), have all
been settled. The settlement of claims against CBC and the individual defendants
was approved by the court in July, 1996. Under the terms of the Settlement, the
class members received 1,250,000 shares of Aquila common stock. In the fourth
quarter of 1998, the class members received 90% of the recoveries from
prosecution of claims against Aquila's former auditors, with the balance of $0.1
million in recoveries paid to Aquila.

                                       38
<PAGE>   40
                        AQUILA BIOPHARMACEUTICALS, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     In March 1995, an Adversary Proceeding was commenced by Institut Pasteur
and Genetic Systems Corporation against CBC alleging patent infringement and
asking for damages and injunctive relief. Institut Pasteur appealed the
Bankruptcy Court's ruling in favor of CBC, and the United District Court's
affirmation thereof, to the Federal Circuit Court of Appeals, which on July 7,
1999, ruled in favor of CBC. The time in which to file an appeal from this
decision has expired.

     In 1998, using treasury stock valued at $13,028, Aquila settled the last
claim previously identified as Liabilities Subject to Chapter 11 Proceedings.

     Aquila had been named a potentially responsible party ("PRP") by the
Environmental Protection Agency ("EPA") at a waste disposal site. On July 16,
1999 the EPA sent Aquila a letter stating its intent to take no further action
against Aquila or its business regarding this matter.

     CSL International ACN ("CSL") and Seed Capital Inc., filed an opposition
with the European Patent Office ("EPO") on the issuance of Aquila's Stimulon(TM)
patent in Europe. A hearing before the EPO was held in October of 1998. The
Company prevailed against all points raised in the opposition. The period of
time in which to file an appeal from this decision has expired. There can be no
assurance that Aquila will prevail in any future actions taken to attack the
validity of its Stimulon(TM) patents.

     Aquila has received a letter from CBC in February 1999 alleging that we
must indemnify CBC under a Master Acquisition Agreement among Aquila, CBC and
bioMerieux, Inc. for potential losses from the termination of CBC's rights under
a license agreement. The Company has evaluated this claim and in the opinion of
management, any potential liability will not have a material adverse effect on
the Company's financial position, liquidity, or results of operations.

     Aquila has been and is engaged in negotiations of various contracts with
other parties regarding issues generally incidental to the normal course of
business. While the outcome of these negotiations and the ultimate liability
from these discussions is difficult to determine, in the opinion of management
any additional liability will not have a material adverse effect on our
financial position, liquidity, or results of operations.

14. STOCKHOLDERS' EQUITY

     Capital Stock -- Aquila has 5,000,000 shares of preferred stock and
30,500,000 shares of common stock authorized at December 31, 1999. No terms have
been established for the preferred stock and none has been issued.

15. STOCK BASED COMPENSATION PLANS

     Aquila's 1996 Employee Stock Purchase Plan which was approved in 1997,
allows full time employees, as defined in this plan, to purchase our stock at
85% of the lesser of beginning or ending fair market value at six month
intervals. Under this plan 200,000 shares of stock are authorized for issuance
of which 12,322 and 11,331 shares were issued in 1999 and 1998, respectively,
for gross proceeds of $31,094 and $48,837, respectively. A total of 176,347
shares remain available for issuance at December 31, 1999. No compensation
expense has been recorded related to this plan.

     At December 31, 1998, Aquila had two stock option plans. Under the 1996
Stock Award and Option Plan (the "Employee plan"), Aquila may grant incentive
stock options, nonqualified stock options, discounted stock options, deferred
stock awards, restricted stock awards, or Stock Appreciation Rights to its
employees for up to 2 million shares of common stock. Under the 1996 Directors
Stock Award and Option Plan (the "Directors plan"), Aquila may grant the same
types of options and awards as under the Employee plan, except that certain
additional restrictions apply to the grant of Stock Appreciation Rights under
the Directors plan. Up to 200,000 shares of common stock may be issued under the
Directors plan.

                                       39
<PAGE>   41
                        AQUILA BIOPHARMACEUTICALS, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

In general, options granted under these plans vest over 4 years and have maximum
terms of 10 years. The Company has applied APB 25 and related interpretations in
accounting for these plans. Accordingly, no compensation cost has been recorded
for activity under these plans for options issued to employees at fair market
value.

     Had compensation expense for our stock-based compensation plans been
determined based on the fair value at the grant dates, the Company's net
income/(loss) and earnings/(loss) per share for the years ended December 31,
1999, 1998 and 1997 would have been reduced to the pro forma amounts indicated
below:

<TABLE>
<CAPTION>
                                       1999                         1998                         1997
                            --------------------------   ---------------------------   ------------------------
                                              (DOLLARS IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
                              NET     BASIC    DILUTED     NET      BASIC    DILUTED    NET     BASIC   DILUTED
                             LOSS      EPS       EPS       LOSS      EPS       EPS     INCOME    EPS      EPS
                            -------   ------   -------   --------   ------   -------   ------   -----   -------
<S>                         <C>       <C>      <C>       <C>        <C>      <C>       <C>      <C>     <C>
As Reported..............   $(8,195)  $(1.11)  $(1.11)   $(14,600)  $(2.22)  $(2.22)    $926    $0.18    $0.18
Pro Forma................   $(8,718)  $(1.18)  $(1.18)   $(15,185)  $(2.31)  $(2.31)    $532    $0.11    $0.10
</TABLE>

     The effects of applying SFAS 123 in this pro forma disclosure are not
indicative of future effects. SFAS 123 does not apply to awards prior to 1995,
and additional awards in future years are anticipated. The weighted average fair
value of options granted in 1999, 1998 and 1997 is $1.28, $1.78 and $3.08,
respectively. The fair value of each option grant is estimated on the date of
grant using the Black-Scholes option pricing model with the following
assumptions used for grants in 1999, 1998 and 1997, respectively; expected
volatility of 85.19%, 63.60% and 63.74%, risk-free interest rates of 5.50%,
4.67% and 6.25%, expected lives of 5 years and no dividend yield. The fair value
of the employees' purchase rights was estimated using the Black-Scholes model
with the following assumptions in 1999, 1998 and 1997, respectively, expected
volatility of 85.19%, 63.74% and 63.74%, risk-free interest rate of 4.81%, 5.56%
and 5.56%; expected life of six months and no dividend yield. The weighted
average fair value of those purchase rights granted in 1999, 1998 and 1997,
respectively, is $0.79, $0.82 and $0.82.

     A summary of the status of Aquila's two stock option plans as of December
31, 1999, 1998 and 1997 respectively, and changes during those years are
presented below:

<TABLE>
<CAPTION>
                                        1999                           1998                          1997
                            ----------------------------   ----------------------------   --------------------------
                                        WEIGHTED AVERAGE               WEIGHTED AVERAGE             WEIGHTED AVERAGE
                             SHARES      EXERCISE PRICE     SHARES      EXERCISE PRICE    SHARES     EXERCISE PRICE
                            ---------   ----------------   ---------   ----------------   -------   ----------------
<S>                         <C>         <C>                <C>         <C>                <C>       <C>
Beginning outstanding.....  1,091,560        $3.89           831,655        $4.28         712,655        $4.09
Options granted at fair
  market value............    267,250         1.82           336,000         3.08         194,375         5.12
Options exercised.........         --           --           (54,625)        4.51          (4,000)        4.50
Options forfeited.........   (222,522)        4.08           (21,470)        4.56         (71,375)        4.68
                            ---------        -----         ---------        -----         -------        -----
Balance, December 31,.....  1,136,288        $3.37         1,091,560        $3.89         831,655        $4.28
                            =========        =====         =========        =====         =======        =====
</TABLE>

                                       40
<PAGE>   42
                        AQUILA BIOPHARMACEUTICALS, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

     The following table summarizes information about Aquila stock options
outstanding at December 31, 1999:

<TABLE>
<CAPTION>
                    OPTIONS OUTSTANDING                      OPTIONS EXERCISABLE
  -------------------------------------------------------   ----------------------
                  NUMBER          WEIGHTED       WEIGHTED     NUMBER      WEIGHTED
    RANGE OF    OUTSTANDING       AVERAGE        AVERAGE    EXERCISABLE   AVERAGE
    EXERCISE        AT           REMAINING       EXERCISE       AT        EXERCISE
     PRICES      12/31/99     CONTRACTUAL LIFE    PRICE      12/31/99      PRICE
  ------------  -----------   ----------------   --------   -----------   --------
  <S>           <C>           <C>                <C>        <C>           <C>
  $1.63-$2.75      468,884          9.25          $2.25       147,710      $2.18
  $2.80-$4.50      545,155          6.70          $3.93       519,655      $3.91
  $4.94-$7.38      122,249          7.72          $5.16        68,927      $5.17
                 ---------                                    -------
  $1.63-$7.38    1,136,288          7.86          $3.37       736,292      $3.68
</TABLE>

At December 31, 1999, there were 1,005,087 shares available for option grants.
Compensation expense of $10,000 was recorded in 1997 related to options granted
to consultants during the year. No compensation expense was recorded in 1999 and
1998.

16. EMPLOYEE BENEFITS PLAN

     Aquila has a savings plan for its employees pursuant to Section 401(k) of
the Internal Revenue Code. Substantially all employees can participate, and the
plan allows for a minimum deferral of 1% to a maximum deferral of 15% percent of
compensation, as permitted by law or as limited by the plan administrator.
Commencing on January 1, 1997 the Company matches 25% of the first 6% of the
employees compensation contributed to the plan. Any contributions made by Aquila
are vested at 33% for each year of employment. The amount charged to operations
for employer contributions to the plan was $37,750, $44,300 and $48,500 in 1999,
1998 and 1997, respectively.

17. AGREEMENTS

     Aquila has a comprehensive agreement with a corporate partner that allows
the partner to use our proprietary Stimulon adjuvant ("QS-21") in numerous
vaccines including hepatitis, lyme disease, human immunodeficiency virus (HIV),
influenza and malaria. The agreement grants exclusive worldwide rights in some
fields of use, and co-exclusive or non-exclusive rights in others. Aquila
recognized $3.0 million in license fees under this agreement in 1998, and $3.5
million in 1997. The agreement calls for royalties to be paid by the partner on
its future sales of licensed vaccines that include Aquila's adjuvant and for
Aquila to manufacture QS-21 for the partner.

     Aquila has product development agreements and supply agreements with Virbac
S.A. and a supply agreement with the Virbac S.A.'s U.S. subsidiary that cover a
collaboration on the development of products for feline immune deficiency virus
("FIV") and bovine mastitis and the supply of vaccine and adjuvant for feline
leukemia ("FeLV"). Aquila recorded $0.2 million, $0.9 million and $1.1 million
in research revenues under the product development agreements during 1999, 1998
and 1997, respectively. Sales to the partner under the terms of the supply
agreements were $0.6 million, $1.0 million and $1.3 million in 1999, 1998 and
1997, respectively.

     In 1999, the Company was awarded a grant from the National Institutes of
Health to support the development of novel vaccines for tuberculosis based on
the CD1 immune enhancement technology. The grant will provide funding of
$870,000 over a two year period. Aquila recorded $0.2 million in research and
development revenues to reimburse costs incurred under this grant during 1999.

     Aquila entered into a license agreement with Neuralab Limited, a wholly
owned subsidiary of Elan Corporation, p.l.c., that grants exclusive, worldwide
rights to use its lead Stimulon adjuvant ("QS-21") with an undisclosed antigen
in the field of Alzheimer's Disease. Aquila also signed a supply agreement for

                                       41
<PAGE>   43
                        AQUILA BIOPHARMACEUTICALS, INC.

           NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

the adjuvant. Aquila recorded $0.5 million in license fees under the agreement
during 1999 and could receive additional license fees and royalties on future
product sales.

18. ACQUISITION OF VACTEX

     In 1998, with the acquisition of VacTex, Aquila issued 1,150,000 shares of
common stock and $1.3 million in notes payable for all the outstanding shares of
VacTex. The notes payable carry interest at 7% and were callable April 14, 1999.
The acquisition has been accounted for using the purchase method.

     VacTex was a development stage company advancing the recent discovery of a
novel antigen presentation system. At the date of acquisition, research had been
conducted in animals only and the linkage to protection in a human vaccine had
not been established. This remains an active area of pre-clinical research. The
time to human clinical trials and product approval is expected to be typical for
a biological development project and to entail the typical risks. The
tuberculosis project will require several hundreds of millions of dollars over
ten to fifteen years. It is Aquila's intent to establish the proof of principle
that this system provides protection from tuberculosis and then to partner the
program. Though we expect to expend a substantial portion of its resources to
develop this technology over the next several years, the pace and level of
development will largely be determined by the science, which is complex, and by
Aquila's ability to obtain research partners to share the development expense.
Due to the early stage of the technology and the expected efforts to develop it,
the entire purchase price of $9.9 million, which included stock, notes payable
and assumed liabilities was charged to purchased incomplete technology.

     The following summary represents unaudited pro forma results of operations
as if the VacTex acquisition had occurred at the beginning of 1997. These pro
forma results have been prepared for comparative purposes only and do not
purport to be indicative of the results of operations that would have actually
resulted had the combination been in effect and are not intended to be
indicative of future results.

<TABLE>
<CAPTION>
                                                               UNAUDITED PRO FORMA
                                                                    YEAR ENDED
                                                              ----------------------
                                                                 1998         1997
                                                              ----------    --------
                                                              (DOLLARS IN THOUSANDS
                                                                 EXCEPT PER SHARE
                                                                     AMOUNTS)
<S>                                                           <C>           <C>
Revenues....................................................   $  5,597      $6,928
Net loss....................................................   $(14,790)     $  (74)
Basic loss per share........................................   $  (2.25)     $(0.01)
</TABLE>

19. SUBSEQUENT EVENTS

     In February 2000, Aquila received $0.6 million in license fees from two of
its corporate partners pursuant to license agreements that allow the partners to
use Aquila's lead Stimulon(TM) adjuvant QS-21 in their product development
programs. Aquila also sold 11,250 shares of Progenics common stock for $0.6
million. These shares were carried at a cost of $0.1 million and were classified
as available-for-sale. The Company received $0.5 million from the exercise of
employee stock options and redeemed $0.3 million of VacTex debentures including
accrued interest. In March 2000, the Company sold 500,000 shares of Common Stock
to the State of Wisconsin Investment Board in a self-directed private placement
for proceeds of $3.0 million.

                                       42
<PAGE>   44

                                  SIGNATURES:

     Pursuant to the requirements of Section 13 and 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.

                                          AQUILA BIOPHARMACEUTICALS, INC.

<TABLE>
<S>                                                      <C>
March 27, 2000                                                         By: /s/ ALISON TAUNTON-RIGBY
                                                           ----------------------------------------------------
                                                                           Alison Taunton-Rigby
                                                                 President, (Principal Executive Officer)

March 27, 2000                                                           By: /s/ JAMES L. WARREN
                                                           ----------------------------------------------------
                                                                             James L. Warren
                                                                 Vice President -- Finance, Treasurer and
                                                                         Chief Financial Officer
                                                                      (Principal Financial Officer)

March 27, 2000                                                          By: /s/ MELISSA J. PACKARD
                                                           ----------------------------------------------------
                                                                            Melissa J. Packard
                                                                               (Controller)
</TABLE>

     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/ ALISON TAUNTON-RIGBY                Director  March 27, 2000
---------------------------------------------------
               Alison Taunton-Rigby

            /s/ ELLIOT D. HILLBACK, JR.              Director  March 27, 2000
---------------------------------------------------
             Elliott D. Hillback, Jr.

              /s/ ROBERT J. CARPENTER                Director  March 27, 2000
---------------------------------------------------
                Robert J. Carpenter

              /s/ KEITH J. DORRINGTON                Director  March 27, 2000
---------------------------------------------------
                Keith J. Dorrington

               /s/ JEFFREY T. BEAVER                 Director  March 27, 2000
---------------------------------------------------
                 Jeffrey T. Beaver
</TABLE>

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