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                                 UNITED STATES

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

                                   FORM 10-K

[X]   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
     SECURITIES EXCHANGE ACT OF 1934

                  FOR THE FISCAL YEAR ENDED DECEMBER 31, 1997

                                       OR

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

                        COMMISSION FILE NUMBER: 0-20711

                         VIRUS RESEARCH INSTITUTE, INC.
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

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<TABLE>
<S>                                            <C>
                   DELAWARE                                      22-3098869
       (STATE OR OTHER JURISDICTION OF                        (I.R.S. EMPLOYER
        INCORPORATION OR ORGANIZATION)                      IDENTIFICATION NO.)

              61 MOULTON STREET                                    02138
                CAMBRIDGE, MA                                    (ZIP CODE)
   (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
</TABLE>

       REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (617) 864-6232

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

          SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

<TABLE>
<CAPTION>
                                                           NAME OF EACH EXCHANGE
             TITLE OF EACH CLASS                            ON WHICH REGISTERED
<S>                                            <C>
                     None                                           None
</TABLE>

          SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

                    Common Stock, $0.001 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.  [ ]

     The aggregate market value of the voting stock held by non-affiliates of
the Registrant, based upon the closing sale price of the Common Stock on
February 2, 1998 as reported on the Nasdaq National Market, was approximately
$22,484,000. Shares of Common Stock held by each officer and director and by
each person who owns 5% or more of the outstanding Common Stock have been
excluded in that such persons may be deemed to be affiliates. This determination
of affiliate status is not necessarily a conclusive determination for other
purposes.

     As of February 2, 1998, Registrant had outstanding 8,928,314 shares of
Common Stock.

                      DOCUMENTS INCORPORATED BY REFERENCE

     Portions of the Proxy Statement for Registrant's 1998 Annual Meeting of
Stockholders to be held on May 7, 1998 are incorporated by reference in Part III
of this Form 10-K.

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FORWARD-LOOKING STATEMENTS:

     In addition to historical information, this Form 10-K includes
forward-looking statements. These statements involve risks and uncertainties
that could cause actual results to differ from those reflected in the
forward-looking statements. Certain factors that might cause such a difference
are discussed in the second paragraph of the section entitled "Management's
Discussion and Analysis of Financial Condition and Results of Operations" on
Page 15 of this Form 10-K.

                                     PART I

ITEM 1.  BUSINESS

GENERAL

     Virus Research Institute, Inc. (the "Company") is engaged in the discovery
and development of systems for the delivery of vaccines and immunotherapeutics,
and improved and novel vaccines for adults and children. The Company is
developing a portfolio of proprietary vaccine delivery systems designed to
improve the efficacy, lower the cost of administration and improve patient
compliance for a variety of vaccine products. As part of the Company's strategy
to bring its vaccine delivery technologies to market, the Company collaborates
with corporate partners that offer substantial market presence, unique antigens
and/or complementary technologies. The Company and its collaborators currently
are applying the Company's vaccine delivery systems to develop vaccines for the
prevention of influenza, Lyme disease, respiratory syncytial virus (RSV) and H.
pylori infections. The Company has entered into agreements with Pasteur Merieux
Connaught ("PMC"), Pasteur Merieux-OraVax ("PM-O") and CSL, Ltd., Australia
("CSL") pursuant to which these companies may utilize the Company's vaccine
delivery systems in developing a number of vaccines. During 1997, the Company
entered into a collaboration with SmithKline Beecham (SB) for the development
and commercialization of the Company's oral rotavirus vaccine. Rotavirus
infection causes acute diarrhea and dehydration in infants. The Company is also
developing its own proprietary vaccines utilizing antigens licensed exclusively
by the Company, including a vaccine for HSV2, the virus that causes genital
herpes. In addition, the Company is engaged in the research and development of
Therapore(TM), a novel system for the delivery of immunotherapeutics for chronic
viral infections and cancers.

     While vaccines have proven to be safe and effective for the prevention of
certain infectious diseases, the Company believes that there is significant
potential for improvement, including: enhancement of the immune response;
reduction in the number of doses required for an effective immune response;
increase in the percentage of the population responding to certain vaccines;
delivery of vaccines through methods other than by injection; and stimulation of
a mucosal immune response. To address these shortcomings, the Company is
developing vaccine delivery systems that may lead to more effective and less
costly vaccines, increased patient compliance and the introduction of new
vaccines.

     The Company's strategy is to utilize its expertise in the design and
application of vaccine delivery systems to develop vaccine products for
infectious diseases that have significant and growing market potential. The
Company is developing three vaccine delivery systems. The Adjumer(TM) vaccine
delivery system utilizes a novel polymer, which is a synthetic polyphosphazene
derivative ("PCPP"), as an adjuvant for use with a variety of antigens
administered by injection. The Company believes that Adjumer(TM)-formulated
vaccines will be capable of producing an enhanced and longer-lived immune
response with fewer injections. In preclinical studies, Adjumer(TM)-formulated
vaccines elicited an immune response that was greater than either vaccines
formulated with alum, the only approved adjuvant for commercial use in humans,
or non-adjuvanted vaccines. The Micromer(TM) vaccine delivery system utilizes a
mixture of PCPP and antigens formed into hydrogel microparticles for the
intranasal and oral delivery of vaccines. Mucosal vaccine delivery has potential
advantages over conventional delivery by injection, including ease of
administration and the generation of immunity at the mucosal surfaces, where
most infectious organisms enter the body, as well as the generation of systemic
(blood and other organs) immunity. The VibrioVec(TM) vaccine delivery system
utilizes a recombinant bacterial vector for the oral delivery of antigens to the
gastrointestinal tract. The Company believes that VibrioVec(TM)-delivered
vaccines will be capable of inducing both a systemic and a mucosal immune
response.

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     The Company is developing Therapore(TM) for the treatment and prevention of
certain persistent viral infections and cancers. Early stage research studies
indicate that Therapore(TM) is distinguished from other systems by its ability
to deliver large proteins and peptides with high efficiency. Therapore(TM)
transports these therapeutic polypeptides into the cell where normal cellular
processes induce potent cell mediated immune responses. The Company believes
that Therapore(TM)-delivered antigens will be capable of producing an enhanced
cell mediated response with fewer injections.

VACCINE OVERVIEW

     The Vaccine Market.  Vaccines have long been recognized as a safe and
cost-effective method for preventing infection caused by certain bacteria and
viruses. The Centers for Disease Control and Prevention (the "CDC") have
estimated that every dollar spent on vaccination saves $16 in healthcare costs.
There are currently 16 vaccines in routine use in the United States against such
life-threatening infectious organisms as tetanus, diphtheria, poliovirus,
hepatitis A virus, hepatitis B virus, Haemophilus influenzae B, measles, mumps
and rubella. From 1990 to 1996, annual worldwide vaccine sales increased from
$1.6 billion to $4.0 billion, a compound annual growth rate of approximately
16.5%. The Company believes that this growth may be accelerated as a result of
advances in vaccine technologies and formulations that address the shortcomings
of existing vaccines. Areas of potential improvement include enhancement of
immune responses, which could lead to a reduction in the number of doses
required for effective protection as well as effective immunization in a higher
percentage of the population, and delivery of vaccines through methods other
than injection. The vaccine market may also expand due to the introduction of
new purified antigens, produced as a result of advances in molecular biology.
The Company also believes that the growing awareness and incidence of certain
infectious diseases, such as H. pylori, hepatitis C virus, HIV1 and HSV2
infection, could further expand the vaccine market.

     The Immune System and Vaccines.  The function of the human immune system is
to respond to pathogens, including infectious bacteria and viruses, that enter
the body. However, a pathogen may establish an infection and cause disease
before it is eliminated by an immune response. Antibodies are produced as part
of the immune response to antigens, which are components of the pathogen. These
antibodies can continue to circulate in the human body for many years, providing
continued protection against reinfection by the same pathogen.

     Protective antibodies can be produced in both the systemic and mucosal
branches of the immune system. The systemic immune system produces IgG
antibodies to protect against infection occurring in blood and deep tissue. The
mucosal immune system produces IgA antibodies that protect against infection
occurring in the mucosal layer lining the digestive, respiratory and
genitourinary tracts. Mucosal immunity may act as a first line of defense, by
attacking pathogens at the point of entry into the body, prior to systemic
penetration, as well as by targeting certain pathogens such as H. pylori,
influenza and rotavirus that propagate exclusively at the mucosal layer.

     Vaccines are a pre-emptive means of generating a protective antibody
response. A vaccine consists of either a weakened pathogen or pathogen-specific,
non-replicating antigens which are deliberately administered to induce the
production of antibodies. When weakened pathogens are used as a vaccine, they
replicate in the body, extending presentation to the immune system and inducing
the production of antibodies without causing the underlying disease. When
non-replicating antigens are used as a vaccine, they must be delivered in
sufficient quantity and remain in the body long enough to generate an effective
antibody response. To achieve this goal, many vaccines require multiple
administrations. Of the 16 vaccines currently in routine use, 14 are delivered
by injection and stimulate only systemic immunity. Only polio and typhoid
vaccines can be administered orally and induce both a mucosal and a systemic
immune response. Both of these vaccines are live, weakened pathogens that
localize in the intestines and do not require a separate vaccine delivery
system.

     Adjuvants.  The antigens contained in many injectable vaccines will not
produce an immune response sufficient to confer protection against infection and
require the use of an adjuvant to sustain the presentation of the antigens to
the human immune system. Alum (aluminum hydroxide) is the only adjuvant
currently approved by the FDA for commercial use in humans. While alum has
gained widespread use, it does not

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sufficiently enhance the immune response to permit administration of many
existing injected vaccines in a single dose. In the case of certain vaccines,
such as influenza, alum is ineffective as an adjuvant.

     The Company believes that alum will not prove to be sufficiently effective
for use with many of the new purified recombinant antigens being developed.
Further, alum cannot be used for mucosal delivery of vaccines. Accordingly, the
Company believes that there is a significant need for a new adjuvant that is
safe, works with a wide variety of antigens, induces a protective immune
response with only one or two injections and can be administered mucosally.
These attributes could result in certain benefits, including cost savings and
improved patient compliance.

COMPANY VACCINE DELIVERY SYSTEMS

     The Company is developing a portfolio of proprietary vaccine delivery
systems designed to improve the efficacy, lower the cost of administration and
improve patient compliance for a variety of vaccine products. The following
summarizes the Company's three main vaccine delivery systems:

<TABLE>
<CAPTION>
      DELIVERY SYSTEM             COMPOSITION         DELIVERY METHOD     POTENTIAL BENEFITS(1)
      ---------------             -----------         ---------------     ---------------------
<S>                          <C>                      <C>                <C>
Adjumer(TM)................  Water Soluble Polymer    Injectable         Enhanced systemic immune
                                                                         response; fewer
                                                                         injections
Micromer(TM)...............  Polymer                  Mucosal            Systemic and mucosal
                             Microparticles                              immune responses; no
                                                                         injections
VibrioVec(TM)..............  Genetically              Oral               Systemic and mucosal
                             Engineered Bacterial                        immune responses;
                             Vector                                      targeted delivery; no
                                                                         injection; single dose
</TABLE>

---------------
(1) Based upon preclinical studies conducted by the Company. The Company's
    vaccine delivery systems are in various stages of development. The summary
    information included in the above table is qualified in its entirety by the
    detailed discussion of each of the vaccine delivery systems that follows.

     Adjumer(TM).  The Company is developing Adjumer(TM), a proprietary vaccine
delivery system as an adjuvant to enhance the immune response to injected
vaccines. Adjumer(TM) is a water soluble, synthetic derivative of the polymer
polyphosphazene (PCPP). The water soluble nature of PCPP facilitates a simple
aqueous-based manufacturing process for vaccines, thereby preserving the
integrity of the antigen.

     In preclinical studies conducted by the Company, Adjumer(TM) demonstrated
sustained presentation of influenza, hepatitis B, HSV2, HIV1 and tetanus
antigens to the immune system. In those preclinical studies, single
intramuscular injections of Adjumer(TM)-formulated vaccines elicited a higher
immune response than both alum-formulated vaccines and non-adjuvanted vaccines
as measured by resulting IgG antibody levels. In additional preclinical studies,
an Adjumer(TM)-formulated influenza vaccine using lower antigen doses sustained
higher antibody levels over a longer time period than both alum-formulated
vaccines and non-adjuvanted vaccines. In certain other preclinical studies
Adjumer(TM)-formulated vaccines produced an effective immune response in a
higher percentage of animals than in animals receiving existing vaccine
formulations. Furthermore, in these studies, as well as tests conducted using
Adjumer(TM) alone, the Company observed no material adverse reactions when
Adjumer(TM) was administered at effective levels.

     Based on these preclinical results, the Company believes that an
Adjumer(TM)-formulated vaccine may provide a number of benefits over existing
injected vaccines. These benefits include reducing the number of doses required
for an effective immune response, thereby improving compliance; providing cost
savings as a result of the reduction in the number of doses and the amount of
antigen required; and increasing the time period over which immune protection
can be sustained. In addition, based on the results of these preclinical
studies, the Company believes that an Adjumer(TM)-formulated vaccine may be able
to induce an immune response in a number of subjects who would not otherwise
respond to existing vaccines. The first human

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clinical trials of a vaccine using Adjumer(TM) as a delivery system commenced in
1996. See "Product Development Programs."

     Micromer(TM).  The Company is conducting ongoing research on Micromer(TM),
a proprietary vaccine delivery system designed to facilitate the mucosal
(intranasal or oral) delivery of antigens and stimulate both the systemic and
mucosal branches of the immune system. The focus of the Company's current
efforts are on intranasal delivery. Micromer(TM) is synthesized utilizing a
manufacturing process in which PCPP and an antigen are formulated into hydrogel
microparticles. The Company believes that the physical characteristics of these
microparticles will facilitate absorption by mucosal surfaces.

     In preclinical studies conducted by the Company, several
Micromer(TM)-formulated antigens delivered intranasally elicited both a mucosal
(IgA) immune response and a systemic (IgG) immune response. IgA antibodies were
detected at all mucosal sites, and the level of IgG antibodies was comparable to
the level obtained through Adjumer(TM)-formulated injections of the same
antigen. A Micromer(TM)-formulated influenza vaccine required only a single,
intranasal dose to provide an immune response sufficient to protect the animals
against subsequent infection by the influenza virus. In addition to conducting
further research on the Micromer(TM) vaccine delivery system, the Company has
commenced research on additional Micromer(TM)-formulated vaccines.

     VibrioVec(TM).  The Company is developing VibrioVec(TM), a proprietary
vaccine delivery system that uses a bacterial vector for the oral delivery of
antigens. This vector is a live organism that has been genetically altered to
make it non-virulent, incapable of reacquiring virulence and capable of
delivering selected antigens. VibrioVec(TM) is an attenuated form of the
bacterium Vibrio cholerae.

     In preclinical studies conducted by the Company, single, oral doses of
VibrioVec(TM) engineered to express genes encoding antigens from selected
bacteria have generated systemic and mucosal immune responses that protected
against infection from the virulent organism. In addition, in 1995 the Company
completed Phase II human clinical studies involving more than 100 subjects
administering VibrioVec(TM) as a potential cholera vaccine. The subjects in this
study showed no clinically significant vaccine-related side effects. Separate
clinical trials will be needed to test each antigen proposed to be delivered by
VibrioVec(TM).

     Based on its preclinical studies, the Company believes that VibrioVec(TM)
will be an effective oral delivery system that can deliver antigens to the
gastrointestinal tract where the VibrioVec(TM) vector will grow and express the
antigens for a limited period of time. The Company is currently inserting the
genes which encode certain H. pylori antigens into VibrioVec(TM) to determine if
the vector containing these genes can grow and express the antigen.

STRATEGY

     The Company's strategy is to utilize its expertise to design and develop
vaccine and immunotherapeutic products that have significant and growing market
potential; to establish commercial alliances that permit funding of clinical
development and rapid commercialization; and to retain rights to important
market opportunities.

     Develop Novel Vaccine Delivery Systems.  The Company is developing a
portfolio of vaccine delivery systems to address shortcomings in currently
available delivery methods, as well as to provide new methods of vaccine
delivery. The Company's vaccine delivery systems, which are based on a novel
polymer and on bacterial vectors, have the potential to improve existing
injectable vaccines and to permit intranasal and oral delivery of vaccines.
These systems may be applicable to most of the vaccines in routine use and may
enable the introduction of new vaccines to prevent bacterial or viral diseases
for which there is currently no adequate treatment or prevention. The Company
intends to pursue the broad application of its current vaccine delivery systems,
as well as to continue to invest in the development of new vaccine delivery
technologies.

     Develop Proprietary Vaccines.  The Company is currently developing several
proprietary vaccines believed to have significant near-term commercial promise.
The Company is continuing to seek exclusive licenses for suitable antigens to be
used to develop vaccines with a significant market potential. The Company
believes that the development of its own proprietary vaccines complements its
development of novel vaccine

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delivery systems. The Company believes that its ability to combine its vaccine
delivery technology with its own proprietary antigens may lead to the
introduction of new vaccines with competitive advantage.

     Develop Immunotherapeutic Products.  The Company is developing
Therapore(TM), a proprietary technology that uses a bacterial protein system for
the injectable delivery of proteins and peptides to generate potent
cell-mediated immune responses. The bacterial protein system is a bacterial
toxin that has been genetically altered to make it non-toxic, and capable of
transporting certain antigens. Based on research conducted to date, the Company
believes that Therapore(TM) will be able to introduce both peptide and protein
antigens into human cells leading to the development of potent cell-mediated
immune responses. The Company believes Therapore(TM) will be a core technology
in the development of novel immunotherapeutic products and that the development
of these products complements its development of novel vaccine delivery systems
and proprietary vaccines. The Company intends to pursue the broad application of
Therapore(TM) across the field of persistent viral infections and cancers.

     Establish Collaborations for Product Development and Commercialization.
The Company has entered into and intends to seek additional collaborative
agreements with established vaccine companies to develop vaccines utilizing the
Company's vaccine delivery systems and its collaborators' antigens. By entering
into these collaborations, the Company believes it will benefit from the
antigen development work already performed by its collaborators and from access
to their extensive clinical testing capabilities, wide distribution and
marketing infrastructure and market presence. This strategy may permit the
Company to take advantage of the expertise of its collaborators and thereby
expedite commercialization of products incorporating the Company's technologies.

     With respect to the proprietary vaccines and immunotherapeutics being
developed, the Company generally intends to seek collaborators who will be
responsible for completing the clinical testing and for the manufacturing and
marketing of the product. However, the Company intends to develop such
proprietary vaccines and immunotherapeutics to the point at which it believes it
can establish the most commercially favorable collaborations. The Company
believes that this strategy will allow the successful market introduction of
products incorporating the Company's technologies without the Company incurring
the substantial costs associated with Phase II and III clinical development.

     One of the Company's significant collaborative arrangements is with PMC.
The Company is a party to two license agreements entered into in December 1994
and August 1995 with PMC relating to Adjumer(TM)- and Micromer(TM)-formulated
vaccines, respectively, for the prevention of a variety of infectious diseases.
Under the agreements, PMC has been granted the exclusive right to make, use and
sell Adjumer(TM)- and Micromer(TM)-formulated vaccines for prevention of
influenza, Lyme disease and diseases caused by meningococcus and the
co-exclusive right (exclusive, except for the right of the Company or one other
person licensed by the Company) to make, use and sell Adjumer(TM)- and
Micromer(TM)-formulated vaccines directed against five other pathogens,
including pneumococcus and RSV. The licenses to PMC apply to specified
territories, including North and South America, Europe, Africa, Thailand and the
countries of the former Soviet Union. The Company has retained rights to make,
use, sell and license Adjumer(TM)- and Micromer(TM)-formulated vaccines against
the subject infections in most of the Far East, including China and Japan,
subject to certain geographical extension rights available to PMC.

     PMC made a $3.0 million equity investment in the Company in December 1994
upon the execution of the agreement relating to Adjumer(TM). In addition, in
connection with this collaboration, in 1996 PMC made milestone payments of $4.5
million to the Company and an additional equity investment of $1.0 million in
the Company. Contingent upon achieving certain milestones, PMC has agreed to pay
the Company up to an additional $6.2 million in connection with the development
of Adjumer(TM)-formulated vaccines for influenza and Lyme disease. Contingent
upon achieving certain milestones, PMC has also agreed to make payments, on a
product by product basis with respect to the development of other Adjumer(TM)-
and Micromer(TM)-formulated vaccines. PMC is required to fund all costs
associated with the development and commercialization, including the costs of
clinical trials, of any vaccines it elects to develop utilizing the Company's
technology. In addition, the Company will be entitled to royalties based on net
sales of any vaccine products developed and sold by PMC pursuant thereto.

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     In connection with its agreement relating to Micromer(TM), the Company
agreed to conduct research through 1997 to develop Micromer(TM)-formulated
vaccines directed against influenza and PIV. Through December 31, 1997, PMC has
paid the Company $2.5 million to fund this research. The Company will fund the
costs associated with any Phase I clinical trial of a Micromer(TM)-formulated
influenza vaccine (see "Product Development Programs").

     Under the agreement relating to Adjumer(TM), the Company was required to
use commercially reasonable efforts to establish a process capable of yielding
quantities of clinical grade PCPP for use by PMC in clinical studies. The
Company has satisfied this requirement. In addition, the Company has facilitated
the production of commercial grade PCPP in a contractor's cGMP manufacturing
facility according to agreed upon specifications. The PMC agreement, while
reserving to PMC the right to manufacture PCPP, anticipates that the Company
will supply PCPP under a cost-plus supply agreement.

     The Company also has a collaborative arrangement with Pasteur
Merieux-OraVax for the use of the Company's vaccine delivery system,
VibrioVec(TM), to develop vaccines against H. pylori infections. The agreement
grants to PM-O a worldwide license to use VibrioVec(TM) for the delivery of
specific H. pylori antigens. A license issue fee as well as research support
payments totalling $1.0 million has been earned under this agreement through
December 31, 1997. The agreement also provides for future milestone payments and
royalties on net sales of any future products developed by PM-O. The option
previously granted to PM-O for the use of PCPP in the delivery of H. pylori
vaccines has expired.

     During 1997, the Company entered into an agreement with SmithKline Beecham
(SB) to collaborate on the development and commercialization of the Company's
oral rotavirus vaccine. Rotavirus infection causes acute diarrhea and
dehydration in infants. Under the terms of the agreement, SB will receive an
exclusive worldwide license to commercialize the Company's rotavirus vaccine.
The Company will be responsible for continuing the Phase II clinical efficacy
study of the rotavirus vaccine which was initiated in 1997 (see "Product
Development Programs"). Upon successful completion of the Phase II study, SB
will assume responsibility for all subsequent clinical and other development
activities. SB made an initial license payment in 1997 upon execution of the
agreement and has agreed to make further payments upon the achievement of
certain milestones. In addition, the Company will be entitled to royalties based
on net sales of the rotavirus vaccine.

     In January 1998, the Company entered into an agreement with Heska
Corporation whereby Heska will have the right to use PCPP in certain animal
health vaccines. The agreement provides for the payment of license fees,
milestone and royalties based on net sales of PCPP-formulated animal vaccines.

PRODUCT DEVELOPMENT PROGRAMS

     The Company and its collaborators are engaged in research and development
efforts on vaccine programs using the Company's technologies. The Company and
PMC, the leading worldwide supplier of influenza vaccines, are currently
collaborating on the development of an Adjumer(TM)-formulated vaccine for
influenza. The Company is conducting research on the mucosal administration of
an influenza vaccine using its Micromer(TM) vaccine delivery system. Influenza
accounts for an average of 20,000 deaths annually in the United States; the
greatest number of fatalities occur among the elderly. In preclinical studies
conducted by the Company and PMC, an Adjumer(TM)-formulated influenza vaccine
produced a significantly enhanced and longer-lived immune response than one of
the influenza vaccines currently on the market. PMC completed Phase I human
clinical trials of this Adjumer(TM)-formulated influenza vaccine in France
during 1997. A total of 48 young and 41 elderly adults participated in this
study, which was designed to measure the safety and level of immune response to
the vaccine. Based on the results of the study, which showed the Adjumer(TM)-
formulated vaccine was well tolerated and elicited improved responses, a Phase
II safety and immunogenicity study was initiated by PMC during 1997. A total of
430 elderly adults participated in the Phase II study, which was conducted in
Peru. Preliminary results of the Phase II clinical trial confirmed that the
Adjumer(TM)-formulated vaccine was well tolerated. However, results of the Phase
II study appear to be inconsistent in certain respects with Phase I results. The
degree of improvement in immune responses elicited by the Adjumer(TM) influenza
vaccine was less in comparison to the control group than was elicited in the
Phase I study. At the same time, certain control group results also appear to be
significantly higher in Phase II than in

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Phase I. The Company and PMC are currently analyzing and assessing the results
of the Phase II study to determine the appropriate next steps to take with the
clinical development of the product.

     PMC is continuing to investigate the use of Adjumer(TM) in other vaccines.
The Company understands that Phase I trials of Adjumer(TM)-formulated vaccines
for Lyme disease and for RSV will be initiated by PMC during 1998.

     The Company is also developing a novel vaccine against rotavirus infection.
Rotavirus, a major cause of diarrhea and vomiting in infants, affects
approximately 80% of the approximately 4 million infants born each year in the
United States. As a result, on an annual basis, about 500,000 infants require
medical attention and 50,000 are hospitalized. The economic burden in the United
States is estimated at over $1 billion in direct and indirect costs. The Company
anticipates a vaccine against rotavirus disease will become a universal
pediatric vaccine. The Company has completed Phase I clinical trials of an
orally delivered live human rotavirus vaccine selected to elicit a broadly
protective immune response to the most prevalent strains of rotavirus. During
1997 the Company completed a Phase I/II clinical trial designed to define the
optimal vaccine dose and optimal age for immunization. Based on the assessment
of the safety and immunogenicity of the vaccine, the Company initiated a Phase
II efficacy study in 1997. The results of this study are expected to be
available by mid-1998 and depending upon the outcome of this study, the Company
anticipates that the product will advance to Phase III clinical studies in 1999.
As discussed in the preceding section, following the successful completion of
the Phase II clinical trial, SB will assume financial responsibility for all
subsequent clinical and development activities.

     The Company is developing a vaccine against HSV2, a sexually transmitted
virus which causes genital herpes. HSV2 has an estimated incidence of 500,000
new cases occurring in the United States each year. At present, there is no
approved vaccine for prevention of HSV2 infection. The Company plans to initiate
Phase I clinical trials of the vaccine for the prevention of genital herpes
during 1998. In addition, the Company is currently conducting animal studies in
preparation for a Phase I trial of a Micromer(TM)-formulated influenza vaccine
during the second half of 1998.

     During 1997, the Company received an exclusive worldwide license from
Harvard College to Therapore(TM), which the Company believes to be the core of a
novel technology for the development of immunotherapeutics. The system is
initially being evaluated in therapies to treat chronic viral infections such as
Hepatitis B, Hepatitis C and HIV, and cancers including melanoma.

COMPETITION

     Competition in the biotechnology and vaccine industries is intense. The
Company faces competition from many companies in the United States and abroad,
including a number of large pharmaceutical companies, firms specialized in the
development and production of vaccines, adjuvants and vaccine delivery systems
and major universities and research institutions. Most of the Company's
competitors have substantially greater resources, more extensive experience in
conducting preclinical studies and clinical testing and obtaining regulatory
approvals for their products, greater operating experience, greater research and
development and marketing capabilities and greater production capabilities than
those of the Company. There can be no assurance that the Company's competitors
will not develop technologies and products that are safer or more effective than
any which are being developed by the Company or which would render the Company's
technology and products obsolete and noncompetitive, and the Company's
competitors may succeed in obtaining FDA approval for products more rapidly than
the Company. There can be no assurance that the vaccines under development by
the Company and its collaborators 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
United States or elsewhere. The Company believes that the principal competitive
factors in the vaccine market are product quality, measured by efficacy and
safety, ease of administration and price.

                                        7
<PAGE>   9

     The Company's competitive position will also depend upon its ability to
attract and retain qualified personnel, obtain patent protection or otherwise
develop proprietary products or processes and secure sufficient capital
resources for the often lengthy period between technological conception and
commercial sales.

MANUFACTURING

     The Company has no manufacturing facilities, no experience in volume
manufacturing and plans to rely upon collaborators or contract manufacturers to
manufacture its proposed products for both clinical and commercial purposes. The
Company believes that there is currently sufficient capacity worldwide for the
production of its potential products by the Company's collaborators or through
contract manufacturers.

     To date, the Company has been arranging on a purchase order basis with
contract manufacturers for the manufacture of PCPP and vaccines in quantities
sufficient for preclinical studies and for clinical trials of the Company's
rotavirus vaccine candidate. The Company has a contract for the development and
initial supply of the starting materials for PCPP but does not yet have a
written contract with a manufacturer for production of PCPP or for any other
components of its vaccine delivery systems or vaccine candidates. The
manufacturing processes for the Company's vaccine delivery systems and vaccines
utilize known technologies. The Company believes that the vaccine delivery
systems and vaccines it currently has under development can be readily scaled up
to permit manufacture in commercial quantities. However, there can be no
assurance that the Company will not encounter difficulties in scaling up the
manufacturing processes.

     In addition, the Company has facilitated the production of commercial grade
PCPP in a contractor's cGMP manufacturing facility according to agreed upon
specifications. The PMC agreement, while reserving to PMC the right to
manufacture PCPP, anticipates that the Company will supply PCPP under a
cost-plus supply agreement.

     The Company intends to establish manufacturing arrangements with
manufacturers that comply with the FDA's requirements and other regulatory
standards, although there can be no assurance that the Company will be able to
do so. In the future, the Company may, if it becomes economically attractive to
do so, establish its own manufacturing facilities to produce any vaccine
products that it may develop. In order for the Company to establish a
manufacturing facility, the Company will require substantial additional funds
and will be required to hire and retain significant additional personnel and
comply with the extensive cGMP regulations of the FDA applicable to such
facility. The product manufacturing facility would also need to be licensed for
the production of vaccines by the FDA.

MARKETING

     Under the terms of existing and future collaborative agreements, the
Company relies and expects to continue to rely on the efforts of its
collaborators for the sale and marketing of any vaccine products. There can be
no assurance that the Company's collaborators will market vaccine products
incorporating the Company's technologies, or, if marketed, that such efforts
will be successful. The failure of the Company's collaborators to successfully
market products will have an adverse effect on the Company's business.

     The Company has retained, and in the future intends to retain, marketing
rights to certain of its vaccine delivery systems and vaccine candidates in
selected geographic areas. The Company intends to seek marketing and
distribution agreements and/or co-promotion agreements for the distribution of
vaccines in such territories. The Company believes that these arrangements could
enable the Company to generate a higher level of financial return than might be
obtained from early stage licensing and collaboration agreements for its vaccine
candidates. The Company has no marketing and sales staff and limited experience
relating to vaccine marketing. If the Company determines in the future to engage
in direct marketing of vaccine products, it will be required to recruit an
experienced marketing group and incur significant additional expenditures. There
can be no assurance that the Company will be able to establish a successful
marketing force.

                                        8
<PAGE>   10

PATENTS, LICENSES AND PROPRIETARY RIGHTS

  Licenses

     The Company has entered into several significant license agreements
relating to technology which is being developed by the Company or its
collaborators, including licenses from: Massachusetts Institute of Technology
covering certain proprietary technologies for vaccine delivery related to PCPP
microparticles; Penn State Research Foundation covering the production of
polyphosphazene polymer; Harvard College relating to proprietary technology
involving genetically altered Vibrio and Salmonella typhi strains; Cincinnati
Children's Hospital involving proprietary rights and technologies relating to an
attenuated rotavirus strain for a rotavirus vaccine; Harvard College and the
Dana Farber Cancer Institute relating to a genetically-altered HSV2 virus for
herpes virus vaccines; and Harvard College for a novel immunotherapy delivery
system to be developed to deliver products for the treatment of chronic viral
infections and cancers. In general, these institutions have granted the Company
an exclusive worldwide license (with right to sublicense) to certain proprietary
technologies (including rights to patents and patent applications) to make, use
and sell products using the licensed technology, subject to the reservation by
the licensor of a non-exclusive right to use the technologies for non-commercial
purposes. Generally, the term of each license is through the expiration of the
last of the patents issued with respect to the technologies covered by such
license. The Company has generally agreed to use its reasonable efforts to
develop and commercialize products and achieve certain milestones and pay
license fees, milestone payments and royalties based on the net sales of the
licensed products or to pay a percentage of sublicense income. If the Company
breaches its obligations, the licensor has the right to terminate the license,
and, in some cases, convert the license to a non-exclusive license.

  Patents and Proprietary Rights

     The Company's policy is to protect its technology by filing patent
applications. In addition to filing patent applications in the United States,
the Company has filed, and intends to file, patent applications in foreign
countries on a selective basis. The Company also relies on trade secrets,
unpatented know-how and technological innovation to develop and maintain its
competitive position.

     The Company owns an issued United States patent which expires on July 12,
2013, and corresponding foreign applications, directed to the use of vaccines
which incorporate the Company's Adjumer(TM) vaccine delivery technology. In
addition, the Company owns an issued United States patent which expires
September 21, 2013, and corresponding foreign applications, directed to the use
of vaccines incorporating the Company's Micromer(TM) vaccine delivery
technology. Further, the Company owns and has licensed other United States
patents and patent applications which are directed to technology which may be
useful for the Company's Micromer(TM) and Adjumer(TM) vaccine delivery systems
and corresponding foreign applications. The Company has an exclusive license to
a United States patent application, and corresponding foreign applications,
directed to a vector construct which is used in the Company's VibrioVec(TM)
vaccine delivery system. The Company has an exclusive license to an issued
United States patent which expires on December 12, 2012, directed to a rotavirus
antigen which forms a part of the Company's rotavirus vaccine and to a United
States patent application, and corresponding foreign applications, directed to a
defective HSV2 virus for use in the Company's vaccine directed against genital
herpes. The Company has an exclusive license to a United States patent
application which is directed to technology which may be useful for the
Company's Therapore(TM) system.

     Although a patent has a statutory presumption of validity in the United
States, the issuance of a patent is not conclusive as to such validity or as to
the enforceable scope of the claims of the patent. There can be no assurance
that the Company's issued patents or any patents subsequently issued to or
licensed by the Company will not be successfully challenged in the future. The
validity or enforceability of a patent after its issuance by the patent office
can be challenged in litigation. If the outcome of the litigation is adverse to
the owner of the patent, third parties may then be able to use the invention
covered by the patent without payment. There can be no assurance that the
Company's patents will not be infringed or successfully avoided through design
innovation.

                                        9
<PAGE>   11

     There can be no assurance that patent applications owned by or licensed to
the Company will result in patents being issued or that, if issued, the patents
will afford protection against competitors with similar technology. It is also
possible that third parties may obtain patent or other proprietary rights that
may be necessary or useful to the Company. In cases where third parties are
first to invent a particular product or technology, it is possible that those
parties will obtain patents that will be sufficiently broad so as to prevent the
Company from using certain technology or from further developing or
commercializing certain vaccine delivery systems and vaccine candidates. If
licenses from third parties are necessary but cannot be obtained,
commercialization of the vaccine candidates would be delayed or prevented.

     The Company is aware of a domestic patent and a foreign patent which cover
claims that could conflict with the Company's vaccine candidates and delivery
systems. The Company believes that the relevant claim under the domestic patent
is invalid and that the relevant claim under the foreign patent does not extend
to or restrict the Company's activities. There can be no assurance that the
applicable patent office or court would reach the same conclusions. In addition
to the patents and the patent applications referred to in the previous two
paragraphs, there may be other patent applications and issued patents belonging
to competitors that may require the Company to alter its vaccine candidates and
vaccine delivery systems, pay licensing fees or cease certain activities. If the
Company's vaccine candidates conflict with patents that have been or may be
granted to competitors, universities or others, such other persons could bring
legal actions against the Company claiming damages and seeking to enjoin
manufacturing and marketing of the affected products. If any such actions are
successful, in addition to any potential liability for damages, the Company
could be required to obtain a license in order to continue to manufacture or
market the affected products. There can be no assurance that the Company would
prevail in any such action or that any license required under any such patent
would be made available on acceptable terms or at all. The Company believes that
there may be significant litigation in the industry regarding patent and other
intellectual property rights. If the Company becomes involved in such
litigation, it could consume substantial resources.

     The Company also relies on unpatented technology, trade secrets and
information and no assurance can be given that others will not independently
develop substantially equivalent information and techniques or otherwise gain
access to the Company's technology or disclose such technology, or that the
Company can meaningfully protect its rights in such unpatented technology, trade
secrets and information. The Company requires each of its employees, consultants
and advisors to execute a confidentiality agreement at the commencement of an
employment or consulting relationship with the Company. The agreements generally
provide that all inventions conceived by the individual in the course of
employment or in providing services to the Company and all confidential
information developed by, or made known to, the individual during the term of
the relationship shall be the exclusive property of the Company and shall be
kept confidential and not disclosed to third parties except in limited specified
circumstances. There can be no assurance, however, that these agreements will
provide meaningful protection for the Company's information in the event of
unauthorized use or disclosure of such confidential information.

GOVERNMENT REGULATION

     The Company's activities and products are significantly regulated by a
number of governmental entities, especially by the FDA in the United States and
by comparable authorities in other countries. These entities regulate, among
other things, the manufacture, testing, safety, effectiveness, labeling,
documentation, advertising and sale of the Company's products. Product
development within this regulatory framework takes a number of years and
involves the expenditure of substantial resources. Many products that initially
appear promising ultimately do not reach the market because they are found to be
unsafe or ineffective when tested.

     In the United States, vaccines for human use are subject to FDA approval as
"biologics" under the Public Health Service Act and "drugs" under the Federal
Food, Drug and Cosmetic Act. The steps required before a new product can be
commercialized include: preclinical studies in animals, clinical trials in
humans to determine safety and efficacy, and FDA approval of the product for
commercial sale.

     The FDA provides that human clinical trials may begin thirty (30) days
after receipt and review of an Investigational New Drug application (IND),
unless the FDA requests additional information or changes to

                                       10
<PAGE>   12

the study protocol within that period. The IND summarizes the preclinical
testing and outlines the plan for the clinical trial. Authorization to conduct a
clinical trial in no way assures that the FDA will ultimately approve the
product. Clinical trials are conducted in three sequential phases; in Phase I,
the product is given to a small number of healthy volunteers to test for safety
(adverse effects). Phase II trials are conducted on a limited group of the
target patient population; safety, optimal dosage and efficacy are studied. A
Phase III is performed in a large patient population over a wide geographic area
to prove that significant efficacy exists. The FDA has ongoing oversight over
all these trials and can order a temporary or permanent discontinuation if that
action is warranted. Such an action could materially and adversely affect the
company.

     The results of the clinical trials and all supporting data are submitted to
the FDA for approval. A Biologics License Application (BLA) is submitted for a
biologic product; a New Drug Application (NDA) for a drug product. The interval
between IND filing and BLA/NDA filing is usually at least several years due to
the length of the clinical trials; and the BLA/NDA review process can take over
a year. During this time the FDA may request further testing, additional trials
or may turn down the application. Even with approval, the FDA frequently
requires post-marketing safety studies (known as Phase IV trials) to be
performed.

     The FDA requires that the manufacturing facility that produces a licensed
product meet certain standards, undergo an inspection and obtain an
establishment license prior to commercial marketing of a vaccine.

     The Advisory Committee on Immunization Practices (ACIP) of the CDC has a
role in setting the public market in the United States for most of the products
the Company intends to develop. The Committee makes recommendations on the
appropriate use of vaccines and related products and the CDC develops
epidemiologic data relevant to vaccine requirements and usage.

     To market its products abroad, the Company is subject to varying foreign
regulatory requirements. Although international efforts are being made to
harmonize these requirements, applications must currently be made in each
country. The data necessary and the review time varies significantly from one
country to another. Approval by the FDA does not ensure approval by the
regulatory bodies of other countries.

     The Company's collaborators are subject to all of the above-described
regulations in connection with the commercialization of products utilizing the
Company's technology.

PRODUCT LIABILITY

     The testing and marketing of vaccines entail an inherent risk of product
liability attributable to unwanted and potentially serious health effects. If
and when the Company manufactures vaccines which are recommended for routine
administration to children, the Company will be required to participate in the
National Vaccine Injury Compensation Program. This program compensates children
having adverse reactions to certain routine childhood immunizations with funds
collected through an excise tax from the manufacturers of these vaccines.

     The Company has clinical trial liability insurance coverage in the amount
of $2 million. However, there can be no assurance that such insurance coverage
is or will continue to be adequate or available. The Company intends to seek
product liability insurance coverage prior to commercialization of its product
candidates but there can be no assurance that insurance will be available at all
or in sufficient amounts to protect the Company at a reasonable cost.

HUMAN RESOURCES

     As of December 31, 1997, the Company had 54 employees, 45 of whom were
engaged in research and development activities, including 15 Ph.D.'s. The
Company's employees are not governed by any collective bargaining agreement and
the Company believes that its relationship with its employees is good.

                                       11
<PAGE>   13

ITEM 2.  PROPERTIES

     The Company currently leases approximately 17,800 square feet of laboratory
and office space in Cambridge, Massachusetts. The lease has a five year term,
which commenced on December 1, 1996, and is extendable at the Company's option
for an additional five years.

ITEM 3.  LEGAL PROCEEDINGS

     The Company is not a party to any legal proceedings.

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

     No matters were submitted to a vote of security holders during the fourth
quarter of fiscal year 1997.

  Executive Officers of the Registrant

     The executive officers of the Company are as follows:

<TABLE>
<CAPTION>
NAME                                     AGE                        POSITION
----                                     ---                        --------
<S>                                      <C>    <C>
J. Barrie Ward, Ph.D. .................  59     Chief Executive Officer and Chairman of the Board
William A. Packer......................  63     President, Chief Financial Officer
Bryan E. Roberts, Ph.D. ...............  50     Executive Vice President
Lendon Payne, Ph.D., M.D. .............  49     Vice President of Research
Dale R. Spriggs, Ph.D. ................  46     Vice President of Development
Lisa P. McGillis.......................  38     Director of Finance
</TABLE>

     J. Barrie Ward, Ph.D. has served as Chairman of the Board of Directors and
Chief Executive Officer since joining the Company in July 1994. From 1984 to
June 1994, Dr. Ward served as Director of the Microbiology Division of Glaxo
Research and Development Ltd., a pharmaceutical company, with responsibility for
infectious disease research. Dr. Ward received a Ph.D. in microbial biochemistry
from the University of Bath, England.

     William A. Packer joined the Company in 1992 as President and a Director
and was also elected Chief Financial Officer in March 1996. Prior to joining the
Company, Mr. Packer held various senior management positions with SmithKline
Beecham plc, a pharmaceutical company, from 1964 to 1991, most recently as
Senior Vice President, Biologicals, where he was responsible for the direction
of SB's global vaccine business. Mr. Packer is a Fellow of the Institute of
Chartered Accountants in England and Wales.

     Bryan E. Roberts, Ph.D. joined the Company in 1991. Dr. Roberts served as
Research Director from 1991 to 1993 and as Vice President of Research from 1993
until March 1996, when he was appointed Executive Vice President. From 1984 to
1990, Dr. Roberts was the Research Director of Applied BioTechnology, Inc., a
biotechnology company he co-founded. From 1978 to 1986, Dr. Roberts was an
Associate Professor of Biological Chemistry at the Harvard Medical School. Dr.
Roberts received a D.Phil. from the University of Oxford.

     Lendon Payne, Ph.D., M.D. joined the Company in 1991 and in January 1997
became an officer of the Company. Dr. Payne served as a Research Director from
1993 to 1995, and since 1996, was the Vice President of Research. Dr. Payne
received his Ph.D. in virology and his M.D. from Karolinska Institute School of
Medicine, Stockholm, Sweden. Dr. Payne terminated his employment with the
Company on January 30, 1998.

     Dale R. Spriggs, Ph.D. joined the Company in May 1993, and became an
officer of the Company in January 1997. Dr. Spriggs served as the Director of
Clinical Research and Development until May 1995, and as Director of Clinical
and Regulatory Affairs from May 1995 to March 1996, when he was appointed Vice
President of Development. From 1987 to 1993, Dr. Spriggs held several positions
at the National Institute of Allergy and Infectious Diseases. Dr. Spriggs
received a Ph.D. in microbiology from the University of Cincinnati College of
Medicine.

                                       12
<PAGE>   14

     Lisa P. McGillis joined the Company in 1994. In 1996, Ms. McGillis was
appointed Director of Finance. Ms. McGillis became an officer of the Company in
January 1997. Prior to joining the Company, Ms. McGillis served as Controller at
ISI Systems, Inc. and as a Certified Public Accountant at Price Waterhouse. Ms.
McGillis received a B.A. from Williams College and an M.S. in Accounting from
Northeastern University.

  Scientific Advisory Board

     The Company's Scientific Advisory Board currently consists of seven
individuals who have extensive experience in the field of polymer chemistry,
virology, infectious disease, immunology, microbiology and molecular genetics.
At the Company's request, the scientific advisors review and evaluate the
Company's research programs and advise the Company about technical matters in
the scientific fields in which the Company is involved. The Company's Scientific
Advisory Board generally meets as a group at least once a year to review and
discuss the Company's progress in research and development, and certain members
of the Scientific Advisory Board meet informally in smaller groups or
individually with Company scientists on a more frequent basis. Each member of
the Scientific Advisory Board has entered into a consulting agreement with the
Company. The consulting agreements are for varying terms and provide for each of
the members to render advice to the Company in the area of the Company's
business and such member's expertise. Members of the Scientific Advisory Board
are entitled to receive annual compensation of up to $10,000 for their services
and may receive options to purchase Common Stock under the Plan. In addition,
Drs. Essex and Mekalanos have separate consulting agreements with the Company
pursuant to which they receive additional compensation. It is possible that any
inventions or processes discovered by the scientific advisors will remain the
property of such person or of such persons' employers. In addition, the
institutions with which the scientific advisors are affiliated may make
available the research services of their personnel, including the scientific
advisors, to competitors of the Company pursuant to sponsored research
agreements.

     The following table sets forth the name and current position of each
scientific advisor:

<TABLE>
<CAPTION>

NAME                                                             POSITION
----                                                             --------
<S>                                    <C>
Barry Bloom, M.D. ...................  Retired (Former Executive Vice President, Pfizer, Inc.)
Robert Langer, Ph.D. ................  The Germeshausen Professor, Department of Chemical
                                         Engineering, Massachusetts Institute of Technology
Myron Essex, D.V.M., Ph.D. ..........  Chairman, Department of Cancer Biology, Harvard School of
                                         Public Health, Chairman of Harvard AIDS Institute
Brian Mahy, Ph.D., Sc.D. ............  Director of Viral and Rickettsial Diseases, the Centers for
                                         Disease Control and Prevention
John Mekalanos, Ph.D. ...............  Chairman, Department of Microbiology and Molecular Genetics,
                                         Harvard Medical School
Morton Swartz, M.D. .................  Chief, James Jackson Firm Medical Services & Infectious
                                         Disease Unit of Massachusetts General Hospital, Professor,
                                         Harvard Medical School
Hans Wigzell, Ph.D. .................  President, Karolinska Institute, Stockholm
</TABLE>

                                       13
<PAGE>   15

                                    PART II

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

     (a) The Common Stock of the Company began trading in June 1996 (subsequent
to the initial public offering) on the NASDAQ National Market under the symbol
"VRII". The following table lists the high and low sales prices for each quarter
the common stock traded during 1996 and 1997. Prior to the offering in June
1996, no established public trading market existed.

<TABLE>
<CAPTION>

1997 QUARTER                   HIGH   LOW            1996 QUARTER                    HIGH      LOW
------------                   ----   ---            ------------                    ----      ---
<S>                            <C>    <C>            <C>                             <C>       <C>
First........................   8 3/4  5             First........................   N/A       N/A
Second.......................   8      4 3/4         Second.......................   12 1/4    9
Third........................   7 1/8  5             Third........................    9 1/4    5 7/8
Fourth.......................   9 1/2  3 1/4         Fourth.......................    8 1/4    4 3/4
</TABLE>

     As of February 2, 1998, the approximate number of common shareholders of
record was 81. Many of these shares of Common Stock are held by brokers and
other institutions on behalf of stockholders. Consequently, the Company is
unable to estimate the total number of stockholders represented by these record
holders.

     The Company has not paid a dividend with respect to its Common Stock nor
does the Company anticipate paying dividends in the foreseeable future.

     (b)  Use of Proceeds from the Company's Initial Public Offering (the "IPO")

     (1)  Effective date of Registration Statement on Form S-1: June 5, 1996;
          Commission file number: 333-3378

     (2)  The Offering commenced on June 6, 1996.

     (3)  Not applicable.

     (4)  (i)    All securities registered in the Offering were sold.

          (ii)   The managing underwriters of the Offering were:
                    Oppenheimer & Company, Inc.
                    Pacific Growth Equities, Inc.

          (iii)  Common Stock, par value $.001 per share

          (iv)   Issuer:
                 Amount registered -- 2,300,000 shares
                 Aggregate purchase price of the Offering amount
                 registered -- $27,600,000
                 Amount sold -- 2,300,000 shares
                 Aggregate Offering price of the amount sold -- $27,600,000

                 Selling Security holder: Not applicable

          (v)    $1,932,000 in underwriting discounts and expenses paid to
                 underwriters;
                 $925,000 of other expenses incurred; and
                 $2,857,000 in total underwriting discounts and expenses

          (vi)   Net offering proceeds to the Company: $24,743,000

          (vii)  Use of Proceeds:
                 Purchase and installation of machinery and equipment: $417,000
                 Repayment of indebtedness: $1,000,000
                 Working Capital -- $9,117,000
                 Temporary investments (money market account and short-term
                 instruments): $14,209,000

          (viii) Use of proceeds does not represent a material change in the
                 use of proceeds described in the Offering prospectus.

                                       14
<PAGE>   16

ITEM 6.  SELECTED FINANCIAL DATA

     The selected financial information presented below has been derived from
the audited financial statements of the Company, and should be read in
conjunction with the Company's Financial Statements and related Notes thereto.

STATEMENT OF OPERATIONS DATA:

<TABLE>
<CAPTION>
                                                 YEAR ENDED DECEMBER 31,                          FEBRUARY 11, 1991
                           -------------------------------------------------------------------   (INCEPTION) THROUGH
                              1997          1996          1995          1994          1993        DECEMBER 31, 1997
                           -----------   -----------   -----------   -----------   -----------   -------------------
<S>                        <C>           <C>           <C>           <C>           <C>           <C>
REVENUE:
Licensing and option
  revenue................  $   905,556   $ 4,520,000   $   770,000   $   700,000   $        --      $  6,895,556
Research and development
  revenue................    1,599,982     1,476,449     1,067,480        21,269            --         4,165,180
Interest income..........    1,298,857       851,082       126,249       163,591        83,610         2,523,389
                           -----------   -----------   -----------   -----------   -----------      ------------
         Total revenue...    3,804,395     6,847,531     1,963,729       884,860        83,610        13,584,125
EXPENSES:
Research and
  development............    7,557,055     5,262,507     5,734,427     5,756,042     4,205,781        31,566,535
General and
  administrative.........    2,344,638     2,328,204     1,854,732     1,887,512     1,452,344        11,308,997
Depreciation.............      401,085       673,436       583,654       517,756       268,391         2,518,916
Interest and other
  expense................       65,971       165,320        87,944        52,332        84,315           719,199
                           -----------   -----------   -----------   -----------   -----------      ------------
         Total
           expenses......   10,368,749     8,429,467     8,260,757     8,213,642     6,010,831        46,113,647
                           -----------   -----------   -----------   -----------   -----------      ------------
         Net loss........  $(6,564,354)  $(1,581,936)  $(6,297,028)  $(7,328,782)  $(5,927,221)     $(32,529,522)
                           ===========   ===========   ===========   ===========   ===========      ============
Basic and diluted net
  loss per common
  share..................  $      (.74)
Shares used in computing
  basic and diluted net
  loss per common
  share..................    8,897,784
Pro forma basic and
  diluted net loss per
  common share...........                $     (0.21)  $     (1.03)
Shares used in computing
  pro forma basic and
  diluted net loss per
  common share...........                  7,639,726     6,104,671
</TABLE>

BALANCE SHEET DATA:

<TABLE>
<CAPTION>
                                                                       DECEMBER 31,
                                          ----------------------------------------------------------------------
                                             1997          1996           1995           1994           1993
                                          -----------   -----------   ------------   ------------   ------------
<S>                                       <C>           <C>           <C>            <C>            <C>
Cash and cash equivalents...............  $ 2,488,963   $15,209,180   $  1,180,176   $  5,669,490   $    954,134
Total assets............................   20,878,339    27,437,531      2,727,905      7,667,363      2,742,301
Notes payable...........................           --            --        923,315             --             --
Lease obligation payable, less current
  portion...............................           --        64,351        210,842         46,838        220,028
Redeemable convertible preferred
  stock.................................           --            --     24,527,073     24,508,053     12,581,906
         Total stockholders' equity
           (deficit)....................  $19,409,847   $25,950,856   $(24,248,340)  $(18,043,081)  $(10,751,850)
</TABLE>

     The Company has paid no cash dividends since inception.

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

     The following discussion of the financial condition and results of
operations of the Company for the years ended December 31, 1997, 1996 and 1995
should be read in conjunction with the accompanying audited financial statements
and the related notes thereto.

                                       15
<PAGE>   17

     This report may contain certain forward looking statements which involve
risks and uncertainties. Such statements are made in reliance upon safe harbor
provisions of the Private Securities Litigation Reform Act of 1995 and are
subject to certain factors which may cause the Company's plans and results to
differ significantly from the plans and results discussed in forward looking
statements. Factors that may cause such differences include, but are not limited
to: (i) the scope and results of preclinical and clinical testing, including the
progress and results of the Phase II rotavirus clinical trial and the further
review of the Phase I and Phase II Adjumer(TM)-formulated influenza vaccine
results and further clinical or preclinical testing after evaluation of the
results; (ii) the progress of the Company's research and development programs,
including further development of the Adjumer(TM) delivery system; (iii) changes
in existing and potential relationships with corporate collaborators; (iv) the
Company's ability to compete successfully with larger companies; (v) risks of
failure inherent in product development based on new technologies and novel
delivery systems; (vi) the Company's ability to attract and retain qualified
personnel; (vii) the time and costs of obtaining regulatory approvals, patents,
proprietary rights and licenses; (viii) the ability of the Company to establish
development and commercialization capacities or relationships; (ix) the costs of
manufacturing; and (x) the Company's ability to secure future funding.

OVERVIEW

     Virus Research Institute, Inc. (the "Company") is engaged in the discovery
and development of systems for the delivery of vaccines and immunotherapeutics,
and improved and novel vaccines for adults and children. The Company is
developing a portfolio of proprietary vaccine delivery systems designed to
improve the efficacy, lower the cost of administration and improve patient
compliance for a variety of vaccine products. The Company and its collaborators
currently are applying the Company's vaccine delivery systems to develop
vaccines for the prevention of influenza, Lyme disease, respiratory syncytial
virus (RSV), and H. pylori infections. The Company has entered into long-term
collaboration agreements with Pasteur Merieux Connaught (PMC), Pasteur
Merieux-OraVax (PM-O) and CSL, Ltd. pursuant to which they may utilize the
Company's vaccine delivery systems in developing a number of vaccines. During
1997, the Company entered into a collaboration with SmithKline Beecham (SB) for
the development and commercialization of the Company's oral rotavirus vaccine.
The Company is also developing its own proprietary vaccine, utilizing antigens
licensed exclusively by the Company, for the virus causing genital herpes, HSV2.
In addition, the Company has acquired the exclusive license to Therapore(TM), a
novel delivery system for the delivery of immunotherapeutics for chronic viral
infections and cancers.

     The Company is in the development stage and has devoted substantially all
of its resources to the research and development of its vaccine delivery systems
and vaccine candidates and general and administrative expenses. Through December
31, 1997 the Company has not generated any revenue from product sales, but has
received an aggregate of $13,584,000 in revenues from licensing and option
agreements, research and development agreements and grants, and interest income.
There can be no assurance that the Company will receive such revenue in the
future.

     The Company has realized losses in every year since inception, principally
as a result of expenditures incurred in its research and development programs.
The Company expects to continue to incur significant operating losses over the
next several years due primarily to expanded research and development efforts,
preclinical and clinical testing of its product candidates, investment in new
technologies, investment in production capabilities for certain product
candidates and expenditures for commercialization activities. The Company's
results of operations may vary significantly from quarter to quarter and year to
year due to the timing of license and milestone payments, development
expenditures and other factors.

                                NEW DEVELOPMENTS

     Preliminary results from the Company's Phase I/II clinical trial of its
rotavirus vaccine candidate became available during the first quarter of 1997.
Rotavirus infections are a major cause of acute diarrhea and dehydration in
infants. The clinical trial was a double-blinded, placebo controlled study
designed to define the optimal vaccine dose and optimal age for immunization.
The results demonstrated that the vaccine was

                                       16
<PAGE>   18

generally well tolerated in younger infants and elicited broad immune responses
in all infants. Based on these findings and the results of an earlier Phase I
study, the Company initiated a Phase II efficacy study during the second quarter
of 1997. This trial, which is being conducted at four U.S. medical centers, is
designed to examine the vaccine's ability to prevent rotavirus disease and to
further study the safety of the vaccine. A total of 215 infants were enrolled in
the study and have been immunized with the vaccine. Results from the study are
expected to be available during 1998. The Company cautions investors that the
presence of statistically significant results in one clinical trial does not
ensure that these results will be repeated in subsequent trials.

     During 1997, the Company established a collaboration with SB to develop and
commercialize the Company's rotavirus vaccine. The Company will be responsible
for the continuation of the Phase II efficacy study as discussed above.
Following successful completion of the Phase II trial, SB will assume
responsibility for and fund all subsequent clinical and other development
activities. The Company will be entitled to receive milestone payments and
royalties on vaccine sales under the agreement which grants SB exclusive
worldwide marketing rights to the rotavirus vaccine.

     Based on the results of an earlier Phase I clinical trial, the Company's
collaborator, PMC, conducted a Phase II safety and immunogenicity clinical trial
of an Adjumer(TM)-formulated influenza vaccine during 1997. In the Phase I study
conducted in France, 48 young and 41 elderly adults were given single injections
of either the vaccine formulated with Adjumer(TM) or the same vaccine without
Adjumer(TM). A total of 430 elderly adults participated in the Phase II study,
which was conducted in Peru. Preliminary results of the Phase II clinical trial
confirmed that the Adjumer(TM)-formulated vaccine was well tolerated. However,
results of the Phase II study appear to be inconsistent in certain respects with
Phase I results. The degree of improvement in immune responses elicited by the
Adjumer(TM) influenza vaccine was less in comparison to the control group than
was elicited in the Phase I study. At the same time, certain control group
results also appear to be significantly higher in Phase II than in Phase I. The
Company and PMC are currently analyzing and assessing the results of the Phase
II study to determine the appropriate next steps to take with the clinical
development of the product. The Adjumer(TM) research and development program
with PMC, which encompasses a number of additional vaccine products, continues.

     During 1997, the Company was granted an exclusive worldwide license by
Harvard University to Therapore(TM), a novel immunotherapeutic delivery system.
Therapore(TM) will initially be evaluated in therapies to deliver products for
the treatment of chronic viral infections and cancers. Under the terms of the
agreement, the Company will be obligated to pay license fees, milestone payments
and royalties to Harvard.

     In January 1998, the Company entered into a license agreement with Heska
Corporation (Heska) to collaborate on the development and commercialization of a
number of Heska's animal health vaccines through the use of Adjumer(TM). Under
the terms of the agreement, based on progress in development, the Company will
be entitled to receive license fees, milestone payments and royalties.

                             RESULTS OF OPERATIONS

REVENUE

<TABLE>
<CAPTION>
                                                            YEAR ENDED DECEMBER 31,
                                                           --------------------------
                                                            1997      1996      1995
                                                           ------    ------    ------
                                                                 (IN THOUSANDS)
<S>                                                        <C>       <C>       <C>
Licensing and option.....................................  $  906    $4,520    $  770
Research and development.................................   1,600     1,477     1,068
Interest income..........................................   1,299       851       126
                                                           ------    ------    ------
          Total revenue..................................  $3,805    $6,848    $1,964
                                                           ======    ======    ======
</TABLE>

     Total revenue declined by $3,043,000 to $3,805,000 in 1997 from $6,848,000
in 1996 and increased by $4,884,000 in 1996 from $1,964,000 in 1995. Licensing
and option revenue declined by $3,614,000 from $4,520,000 in 1996 to $906,000 in
1997 due to the receipt in 1996 of $4,500,000 for the achievement of


                                       17
<PAGE>   19

milestones pursuant to the agreement with PMC. Revenue in 1997 consisted
primarily of $650,000 related to agreements with PM-O. Revenue from licensing
and option sources in 1995 consisted primarily of $750,000 received under a
collaboration agreement with Chiron Corporation. Research and development
revenue increased by $123,000 to $1,600,000 in 1997 from $1,477,000 in 1996.
During 1997, the greater part of research and development revenue was generated
from agreements with PMC and PM-O. The Company's research and development
revenue in 1996 included $1,250,000 received from PMC while research and
development revenue in 1995 consisted primarily of a payment of $625,000
received in conjunction with the PMC agreement. Interest income increased by
$448,000 to $1,299,000 in 1997 from $851,000 in 1996 and by $725,000 in 1996
from $126,000 in 1995. The increase is due to an increase in cash, cash
equivalents and investments derived principally from the proceeds of the
Company's initial public offering.

EXPENSES

<TABLE>
<CAPTION>
                                                            YEAR ENDED DECEMBER 31,
                                                          ---------------------------
                                                           1997       1996      1995
                                                          -------    ------    ------
                                                                (IN THOUSANDS)
<S>                                                       <C>        <C>       <C>
Research and development................................  $ 7,557    $5,263    $5,734
General and administrative..............................    2,345     2,328     1,855
Depreciation............................................      401       673       584
Interest and other......................................       66       165        88
                                                          -------    ------    ------
          Total expenses................................  $10,369    $8,429    $8,261
                                                          =======    ======    ======
</TABLE>

     The Company's total expenses increased by $1,940,000 to $10,369,000 in 1997
from $8,429,000 in 1996 and increased by $168,000 in 1996 from $8,261,000 in
1995. Research and development expenses increased by $2,294,000 to $7,557,000 in
1997 from $5,263,000 in 1996. The increase is primarily attributable to costs
associated with the polyphosphazene manufacturing and scale up process and to an
increase in rotavirus clinical trial costs. Research and development expenses
declined by $471,000 to $5,263,000 in 1996 from $5,734,000 in 1995 principally
due to a reduction in outside consulting costs, the conclusion of certain
sponsored research agreements and a reduction in polyphosphazene manufacturing
costs. General and administrative expenses increased slightly, by $17,000, to
$2,345,000 in 1997 from $2,328,000 in 1996. A reduction in foreign withholding
taxes associated with milestone payments from PMC was offset by higher investor
relations and other costs associated with being a public company. General and
administrative costs increased by $473,000 to $2,328,000 in 1996 from $1,855,000
in 1995 principally due to an increase in compensation and recruiting costs, and
the payment of $250,000 in foreign withholding taxes associated with milestone
payments from PMC. These increases were partially offset by reductions in
consulting and legal costs. Depreciation expense declined $272,000 to $401,000
in 1997 from $673,000 in 1996 as a result of the full depreciation of various
leasehold improvements. From 1995 to 1996, depreciation expense increased
$89,000 to $673,000 in 1996 from $584,000 in 1995 due to the Company's increased
investment in laboratory equipment and leasehold improvements during that time..
Interest and other expense declined $99,000 to $66,000 in 1997 from $165,000 in
1996 and increased by $77,000 in 1996 from $88,000 in 1995. Interest and other
expense in 1996 reflects the increased costs associated with short term loans
entered into in 1995 and 1996. These short term loans were either repaid or
converted into common stock upon completion of the Company's initial public
offering.

                        LIQUIDITY AND CAPITAL RESOURCES

     From inception (February 11, 1991) through December 31, 1997, the Company's
cash expenditures have exceeded revenues. The Company's operations have been
funded principally through the sale of equity, loans from stockholders,
equipment lease financing and payments under licensing, option and research and
development agreements. Net cash used by the Company's operations since
inception was $30,088,000, primarily to fund research and development efforts
and general and administrative expenses. Since inception the Company has
incurred $3,149,000 in capital expenditures, primarily for leasehold
improvements and equipment for the Company's laboratories. During the year ended
December 31, 1997 the Company incurred

                                       18
<PAGE>   20

$235,000 in capital expenditures primarily on expenditures required for the
polyphosphazene manufacturing process and on improvements to its laboratory
facilities. The Company anticipates incurring approximately $400,000 in capital
expenditures during 1998, primarily on equipment necessary for the
polyphosphazene manufacturing process.

     From inception through December 31, 1997, the Company raised net proceeds
of approximately $51,829,000 through the sale of equity securities. Included in
this amount are net proceeds of $24,743,000 from the Company's initial public
offering in 1996 and the conversion to common stock of an aggregate of
$7,974,000 in notes payable to certain stockholders. In addition, from inception
the Company has funded $751,000 of capital expenditures through sale and
leaseback transactions.

     In December 1994, PMC made a $3,000,000 equity investment in the Company in
connection with the execution of a collaboration agreement relating to
Adjumer(TM). In January 1996, PMC and OraVax, Inc. each made an equity
investment of $250,000 in connection with the execution of an option agreement
relating to VibrioVec(TM). PMC made an additional equity investment of
$1,000,000 in April 1996 associated with the Adjumer(TM) collaboration
agreement. These amounts are included in the $51,829,000 referenced above.

     As of December 31, 1997 the Company's federal net operating loss
carryforwards were approximately $12,480,000. If not used, the tax loss
carryforwards will expire at various dates through 2012. The Company's ability
to use these carryforwards is subject to limitations resulting from an ownership
change as defined in Internal Revenue Code Sections 382 and 383. See Note H of
Notes to Financial Statements.

     The Company has undertaken an assessment of the cost and impact on
operations of addressing the Year 2000 issue in connection with its computer
systems. As a result of such assessment, the Company believes that all of its
major software will be Year 2000 compliant and the Company does not believe the
Year 2000 issue will have a material impact on its business, operations or
financial condition.

     The Company expects to incur substantial additional costs, including those
related to research and development activities, preclinical studies, clinical
trials, obtaining regulatory approvals, process scale up and manufacture and the
expansion of its facilities. The Company anticipates that its existing funds,
which include the proceeds from its initial public offering and interest earned
thereon, should be sufficient to fund its operating and capital requirements as
currently planned for the next twenty months. However, the Company's cash
requirements may vary materially from those now planned, due to many factors,
including, but not limited to, the progress of the Company's research and
development programs, the scope and results of preclinical and clinical testing,
changes in existing and potential relationships with corporate collaborators,
the time and cost in obtaining regulatory approvals, the costs involved in
obtaining and enforcing patents, proprietary rights and any necessary licenses,
the ability of the Company to establish development and commercialization
capacities or relationships, the costs of manufacturing and other factors. In
the future, the Company may need to raise substantial additional funds through
further financing, including public or private equity offerings and
collaborations with corporate partners. There can be no assurance that funds
will be available on terms acceptable to the Company, if at all. If adequate
funds are not available, the Company may be required to delay, scale back, or
eliminate certain of its product development programs or to license to others
the right to commercialize products or technologies the Company would otherwise
seek to develop and commercialize itself, any of which could have a material
adverse effect on the Company.

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

     The response to this item is submitted as a separate section of this Form
10-K. See Item 14.

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

     Not applicable.

                                       19
<PAGE>   21

                                    PART III

ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

     The information regarding Directors required by this Item is incorporated
by reference to the Section entitled "Proposal 1: Election of Directors" of the
Company's Proxy Statement for the 1998 Annual Meeting of Stockholders (the
"Proxy Statement"). The information regarding Executive Officers is included in
Part I of this Form 10-K.

     The information regarding Compliance with Section 16(a) of the Exchange Act
required by this Item is incorporated by reference to the Section entitled
"Section 16(a) Beneficial Ownership Reporting Compliance" of the Company's Proxy
Statement.

ITEM 11.  EXECUTIVE COMPENSATION

     The information required by this Item is incorporated by reference to the
Section entitled "Compensation of Executive Officers" of the Company's Proxy
Statement.

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

     The information required by this Item is incorporated by reference to the
Section entitled "Security Ownership of Management and Certain Beneficial
Owners" of the Company's Proxy Statement.

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     The information required by this Item is incorporated by reference to the
Section entitled "Certain Relationships and Related Transactions" of the
Company's Proxy Statement.

                                    PART IV

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

(a)  1.  Financial Statements

     The following financial statements are filed as part of this Form 10-K.

<TABLE>
<CAPTION>
                                                                   PAGE
                                                                   ----
     <S>                                                           <C>
     Report of Independent Auditors..............................   24
     Balance Sheets as of December 31, 1997 and 1996.............   25
     Statements of Operations for the years ended December 31,
       1997, 1996 and 1995, and for the period February 11, 1991
       (Inception) through December 31, 1997.....................   26
     Statement of Changes in Stockholders' Equity (Deficit) for
       the period February 11, 1991 (Inception) through
       December 31, 1997.........................................   27
     Statements of Cash Flows for the years ended December 31,
       1997, 1996 and 1995, and for the period February 11, 1991
       (Inception) through December 31, 1997.....................   28
     Notes to Financial Statements...............................   29
</TABLE>

     2.  Financial Statement Schedule and Auditors' Report

     Schedules are omitted since the required information is inapplicable or
because the information required is shown in the Financial Statements or Notes
thereto.

                                       20
<PAGE>   22

     3.  Exhibits

     The following exhibits are filed herewith or are incorporated by reference
to exhibits previously filed with the Commission.

<TABLE>
<CAPTION>
  EXHIBIT NO.                          DESCRIPTION
  -----------                          -----------
  <S>          <C>
   3.1(2)      Amended and Restated Certificate of Incorporation of Virus
               Research Institute, Inc.
   3.2(2)      Amended and Restated By-Laws of Virus Research
               Institute, Inc.
  10.1(1)      Virus Research Institute, Inc. 1992 Equity Incentive Plan,
               as amended and restated.
  10.2(1)      Form of Stock Option Agreement.
  10.3(3)      Lease dated December 1, 1996, between the Registrant and
               Moulton Realty Company.
  10.4(1)      Series D Convertible Preferred Stock Purchase Agreement
               dated December 20, 1994.
  10.5(1)      Series D Convertible Preferred Stock Purchase Agreement
               dated January 5, 1996.
  10.6(1)      Second Amended and Restated Stockholders Agreement dated
               April 8, 1994 and amendments.
  10.7(1)      Form of Warrant Agreement dated as of February 10, 1994.
  10.8(1)      Form of Warrant to purchase shares of Common Stock dated
               February 10, 1994 issued pursuant to Exhibit 10.7.
  10.9(1)      Loan Agreement dated as of September 14, 1995 between the
               Registrant and certain stockholders, with forms of
               Convertible Promissory Note and Warrant Agreement attached.
  10.10(1)     Form of Warrant to purchase shares of Common Stock dated
               December 14, 1995 issued pursuant to Exhibit 10.9.
  10.11(1)     Warrants issued to Comdisco, Inc. ("Comdisco") to purchase
               shares of Series A Preferred Stock and Series C Preferred
               Stock.
  10.12(1)     Master Lease Agreement dated as of August 31, 1992, between
               the Registrant and Comdisco.
  10.13(1)     License Agreement, dated as of May 1, 1992, between the
               Registrant and the President and Fellows of Harvard College
               ("Harvard") as amended.
  10.14(1)     License and Clinical Trials Agreement, dated as of February
               27, 1995, between the Registrant and The James N. Gamble
               Institute of Medical Research (assigned to Children's
               Hospital of Cincinnati).
  10.15(1)     License Agreement, dated as of March 12, 1995, between the
               Registrant, Harvard and Dana-Farber Cancer Institute.
  10.16(1)     License Agreement, dated December 6, 1991, between the
               Registrant and Massachusetts Institute of Technology.
  10.17(1)     License Agreement, dated March 8, 1995, between the
               Registrant and The Penn State Research Foundation.
  10.18(1)     License Agreement, dated as of December 13, 1994, between
               the Registrant and Pasteur Merieux Serums & Vaccins S.A.
               ("Pasteur Merieux").
  10.19(1)     License Agreement, dated as of August 2, 1995, between the
               Registrant and Pasteur Merieux.
  10.20(1)     Option Agreement, dated as of November 22, 1995, among the
               Registrant, Pasteur Merieux, OraVax, Inc., OraVax Merieux
               Co. and Merieux OraVax S.N.C. relating to PCPP.
  10.21(1)     Option Agreement dated as of November 22, 1995, among the
               Registrant, Pasteur Merieux, OraVax, Inc., OraVax Merieux
               Co. and Merieux OraVax S.N.C. relating to VibrioVec(TM).
</TABLE>

                                       21
<PAGE>   23

<TABLE>
<CAPTION>

  EXHIBIT NO.                          DESCRIPTION
  -----------                          -----------
  <S>          <C>
  10.22(1)     Research Agreement, dated January 10, 1996, between the
               Registrant and CSL Limited.

  10.23(1)     Collaborative Research and License Agreement, dated as of
               June 22, 1995, between the Registrant and SmithKline
               Beecham plc.

  10.24(1)     Research and Development License and Option for Commercial
               License Agreement, dated as of December 28, 1995, between
               the Registrant and Chiron Corporation.

  10.25(4)     License Agreement, dated as of December 1, 1997, between the
               Registrant and SmithKline Beecham PLC.

  10.26(4)     License Agreement, dated as of March 25, 1997, among the
               Registrant, Pasteur Merieux, OraVax, Inc., OraVax Merieux
               Co. and Merieux OraVax S.N.C.

  10.27(4)     License Agreement, dated as of March 28, 1997, among the
               Registrant and Harvard.

  10.28(4)     License Agreement, dated as of December 1, 1997, among the
               Registrant, Pasteur Merieux, OraVax, Inc., OraVax Merieux
               Co. and Merieux OraVax S.N.C.

  11.1         Statement Regarding Computation of Earnings Per Share.

  23.1         Consent of Richard A. Eisner & Company, LLP.

  27.1         Financial Data Schedule.
</TABLE>

---------------
(1) Incorporated by reference to the relevant exhibit to Virus Research
    Institute, Inc.'s Registration Statement on Form S-1 (File No. 333-3378) as
    filed with the SEC on June 6, 1996.

(2) Incorporated by reference to the relevant exhibit to Virus Research
    Institute, Inc.'s Form 10-Q for the quarter ended June 30, 1996 as filed
    with the SEC on August 8, 1996.

(3) Incorporated by reference to the relevant exhibit to Virus Research
    Institute, Inc.'s Form 10-K for the year ended December 31, 1996 as filed
    with the SEC on March 26, 1997.

(4) Confidential treatment requested.

(b)  Reports on Form 8-K

     No reports on Form 8-K were filed by the Company during the fourth quarter
of fiscal 1997.

                                       22
<PAGE>   24

                                   SIGNATURES

     Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized, in the City of
Cambridge, Commonwealth of Massachusetts on the 17th day of March, 1998.

                                          VIRUS RESEARCH INSTITUTE, INC.

                                          By:   /s/ J. BARRIE WARD, PH.D.
                                            ------------------------------------
                                                    J. Barrie Ward, Ph.D.
                                                Chief Executive Officer and
                                                   Chairman of the Board

                                   SIGNATURE

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

<TABLE>
<CAPTION>
                      SIGNATURE                                     TITLE                    DATE
                      ---------                                     -----                    ----
<C>                                                      <S>                            <C>

              /s/ J. BARRIE WARD, PH.D.                  Chief Executive Officer and    March 17, 1998
-----------------------------------------------------      Chairman of the Board
                J. Barrie Ward, Ph.D.                      (principal executive
                                                           officer)

                /s/ WILLIAM A. PACKER                    President, Chief Financial     March 17, 1998
-----------------------------------------------------      Officer and Director
                  William A. Packer                        (principal financial
                                                           officer)

                /s/ LISA P. MCGILLIS                     Director of Finance            March 17, 1998
-----------------------------------------------------      (principal accounting
                  Lisa P. McGillis                         officer)

                                                         Director                       March 17, 1998
-----------------------------------------------------
                 John W. Littlechild

                /s/ ALAN M. MENDELSON                    Director                       March 17, 1998
-----------------------------------------------------
                  Alan M. Mendelson

                /s/ FREDERICK W. KYLE                    Director                       March 17, 1998
-----------------------------------------------------
                  Frederick W. Kyle

               /s/ ROBERT J. HENNESSEY                   Director                       March 17, 1998
-----------------------------------------------------
                 Robert J. Hennessey
</TABLE>

                                       23
<PAGE>   25

                         REPORT OF INDEPENDENT AUDITORS

The Board of Directors and Stockholders
Virus Research Institute, Inc.
Cambridge, Massachusetts

     We have audited the accompanying balance sheets of Virus Research
Institute, Inc. (a development stage company) as at December 31, 1997 and
December 31, 1996, and the related statements of operations, changes in
stockholders' equity and cash flows for each of the years in the three-year
period ended December 31, 1997, and for the period from February 11, 1991
(inception) through December 31, 1997. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.

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

     In our opinion, the financial statements enumerated above present fairly,
in all material respects, the financial position of Virus Research Institute,
Inc. at December 31, 1997 and December 31, 1996, and the results of its
operations and its cash flows for each of the years in the three-year period
ended December 31, 1997, and the period from February 11, 1991 (inception)
through December 31, 1997 in conformity with generally accepted accounting
principles.

                                          RICHARD A. EISNER & COMPANY, LLP

Cambridge, Massachusetts
January 30, 1998

                                       24
<PAGE>   26

                         VIRUS RESEARCH INSTITUTE, INC.
                         (A DEVELOPMENT STAGE COMPANY)

                                 BALANCE SHEETS

<TABLE>
<CAPTION>
                                                             DECEMBER 31, 1997    DECEMBER 31, 1996
                                                             -----------------    -----------------
<S>                                                          <C>                  <C>
CURRENT ASSETS:
  Cash and cash equivalents (Note E).......................    $  2,488,963         $ 15,209,180
  Marketable securities (Note E)...........................      15,968,923           10,339,985
  Contract receivable (Note C).............................       1,000,000                   --
  Interest receivable......................................         352,186              218,285
  Prepaid expenses.........................................         273,224              220,534
  Other current assets.....................................          42,616                  659
                                                               ------------         ------------
     Total current assets..................................      20,125,912           25,988,643
NONCURRENT ASSETS:
  Marketable securities (Note E)...........................               0              499,891
  Leasehold improvements and equipment (net of accumulated
     depreciation and amortization of $2,416,568 at
     December 31, 1997 and $2,015,483 at December 31, 1996)
     (Note D)..............................................         715,234              881,363
  Other assets.............................................          37,193               67,634
                                                               ------------         ------------
     Total noncurrent assets...............................         752,427            1,448,888
                                                               ------------         ------------
          Total assets.....................................    $ 20,878,339         $ 27,437,531
                                                               ============         ============
CURRENT LIABILITIES:
  Accounts payable.........................................    $     24,769         $     43,809
  Accrued consulting and research fees.....................         709,295              810,677
  Accrued employee benefits................................          91,636               71,636
  Accrued legal............................................         192,453              112,000
  Other accrued expenses...................................         377,987              229,123
  Current portion of lease obligation payable (Note
     F(2)).................................................          72,352              155,079
                                                               ------------         ------------
     Total current liabilities.............................       1,468,492            1,422,324
Lease obligation payable, less current portion (Note
  F(2))....................................................              --               64,351
Commitments (Notes C and F)
Stockholders' equity (Notes A and G):
  Preferred stock -- $.001 par value; 5,000,000 shares
     authorized, none issued...............................              --                   --
  Common stock -- $.001 par value; 30,000,000 shares
     authorized; 8,928,314 shares issued at December 31,
     1997 and 8,845,027 shares issued at December 31,
     1996..................................................           8,928                8,845
  Additional paid-in capital...............................      51,930,441           51,907,179
  Deficit accumulated during the development stage.........     (32,529,522)         (25,965,168)
                                                               ------------         ------------
     Total stockholders' equity............................      19,409,847           25,950,856
                                                               ------------         ------------
          Total liabilities and stockholders' equity.......    $ 20,878,339         $ 27,437,531
                                                               ============         ============
</TABLE>

                       See Notes to Financial Statements


                                       25
<PAGE>   27

                         VIRUS RESEARCH INSTITUTE, INC.
                         (A DEVELOPMENT STAGE COMPANY)

                            STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
                                            YEAR ENDED DECEMBER 31,              FEBRUARY 11, 1991
                                   -----------------------------------------    (INCEPTION) THROUGH
                                      1997           1996           1995         DECEMBER 31, 1997
                                   -----------    -----------    -----------    -------------------
<S>                                <C>            <C>            <C>            <C>
REVENUE (NOTE B(1)):
Licensing and option revenue.....  $   905,556    $ 4,520,000    $   770,000       $  6,895,556
Research and development
  revenue........................    1,599,982      1,476,449      1,067,480          4,165,180
Interest income..................    1,298,857        851,082        126,249          2,523,389
                                   -----------    -----------    -----------       ------------
          Total revenue..........    3,804,395      6,847,531      1,963,729         13,584,125
EXPENSES:
Research and development (Note
  C).............................    7,557,055      5,262,507      5,734,427         31,566,535
General and administrative.......    2,344,638      2,328,204      1,854,732         11,308,997
Depreciation.....................      401,085        673,436        583,654          2,518,916
Interest and other expense.......       65,971        165,320         87,944            719,199
                                   -----------    -----------    -----------       ------------
          Total expenses.........   10,368,749      8,429,467      8,260,757         46,113,647
                                   -----------    -----------    -----------       ------------
          Net loss...............  $(6,564,354)   $(1,581,936)   $(6,297,028)      $(32,529,522)
                                   ===========    ===========    ===========       ============
Basic and diluted net loss per
  common share...................  $     (0.74)
                                   ===========
Shares used in computing basic
  and diluted net loss per common
  share..........................    8,897,784
Pro forma basic and diluted net
  loss per common share..........                      $(0.21)   $     (1.03)
                                                  ===========    ===========
Shares used in computing pro
  forma basic and diluted net
  loss per common share..........                   7,639,726      6,104,671
</TABLE>

                       See Notes to Financial Statements

                                       26
<PAGE>   28

                         VIRUS RESEARCH INSTITUTE, INC.
                         (A DEVELOPMENT STAGE COMPANY)

                  STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY

<TABLE>
<CAPTION>
                                                                                 DEFICIT
                                              COMMON STOCK                     ACCUMULATED
                                          --------------------   ADDITIONAL       DURING
                                                         PAR       PAID-IN     DEVELOPMENT
                                            SHARES      VALUE      CAPITAL        STAGE          TOTAL
                                          ----------   -------   -----------   ------------   ------------
<S>                                       <C>          <C>       <C>           <C>            <C>
Sale of common stock....................       1,667   $     2   $       498   $         --   $        500
Net loss -- February 11, 1991
  (inception) through December 31,
  1991..................................                                           (862,597)      (862,597)
                                          ----------   -------   -----------   ------------   ------------
Balance December 31, 1991...............       1,667         2           498       (862,597)      (862,097)
  Sale of common stock..................         607         1         1,819                         1,820
  Recapitalization: 1,000 for 1 stock
    split...............................   2,271,060     2,271        (2,271)                           --
  Surrender of common stock by HCV II...  (1,291,667)   (1,292)          905                          (387)
  Sale of common stock..................      48,275        48         7,193                         7,241
  Net loss for the year.................                                         (3,967,604)    (3,967,604)
                                          ----------   -------   -----------   ------------   ------------
Balance December 31, 1992...............   1,029,942     1,030         8,144     (4,830,201)    (4,821,027)
  Cancellation of shares pursuant to
    founders' plan amendment............    (282,000)     (282)         (564)                         (846)
  Purchase and cancellation of treasury
    shares..............................    (105,917)     (106)       (2,662)                       (2,768)
  Stock options exercised...............          83        --            12                            12
  Net loss for the year.................                                         (5,927,221)    (5,927,221)
                                          ----------   -------   -----------   ------------   ------------
Balance December 31, 1993...............     642,108       642         4,930    (10,757,422)   (10,751,850)
  Stock options exercised...............       1,475         2           321                           323
  Founder option exercised..............      43,333        43        37,007                        37,050
  Stock warrants exercised..............         185        --           178                           178
  Net loss for the year.................                                         (7,328,782)    (7,328,782)
                                          ----------   -------   -----------   ------------   ------------
Balance December 31, 1994...............     687,101       687        42,436    (18,086,204)   (18,043,081)
  Stock options exercised...............       2,903         3         1,766                         1,769
  Common stock warrants issued in
    conjunction with notes payable......                              90,000                        90,000
  Net loss for the year.................                                         (6,297,028)    (6,297,028)
                                          ----------   -------   -----------   ------------   ------------
Balance December 31, 1995...............     690,004       690       134,202    (24,383,232)   (24,248,340)
  Conversion of notes payable to
    investors...........................     217,927       218       987,874                       988,092
  Cashless exercise of stock warrants...      17,363        17           (17)                           --
  Conversion of redeemable convertible
    preferred stock.....................   5,553,579     5,554    26,003,825                    26,009,379
  Stock options exercised...............      66,154        66        40,900                        40,966
  Shares issued at Initial Public
    Offering............................   2,300,000     2,300    27,597,700                    27,600,000
  Costs of offering.....................                          (2,857,305)                   (2,857,305)
  Net loss for the year.................                                         (1,581,936)    (1,581,936)
                                          ----------   -------   -----------   ------------   ------------
Balance December 31, 1996...............   8,845,027     8,845    51,907,179    (25,965,168)    25,950,856
  Cashless exercise of stock warrants...      20,924        21           (21)                           --
  Stock options exercised...............      62,363        62        23,283                        23,345
  Net loss for the year.................                                         (6,564,354)    (6,564,354)
                                          ----------   -------   -----------   ------------   ------------
Balance December 31, 1997...............   8,928,314   $ 8,928   $51,930,441   $(32,529,522)  $ 19,409,847
                                          ==========   =======   ===========   ============   ============
</TABLE>

                       See Notes to Financial Statements


                                       27
<PAGE>   29

                         VIRUS RESEARCH INSTITUTE, INC.
                         (A DEVELOPMENT STAGE COMPANY)

                            STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
                                                YEAR ENDED DECEMBER 31,             FEBRUARY 11, 1991
                                       -----------------------------------------   (INCEPTION) THROUGH
                                           1997           1996          1995        DECEMBER 31, 1997
                                       ------------   ------------   -----------   -------------------
<S>                                    <C>            <C>            <C>           <C>
Cash flows from operating activities:
  Net loss...........................  $ (6,564,354)  $ (1,581,936)  $(6,297,028)     $(32,529,522)
  Adjustments to reconcile net loss
     to net cash used in operating
     activities:
     Depreciation and amortization...       409,077        700,188       599,435         2,569,442
     Conversion of accrued interest
       to preferred stock............            --         46,026            --            58,373
     Changes in operating assets and
       liabilities:
       Contract receivable...........    (1,000,000)            --            --        (1,000,000)
       (Increase) decrease in prepaid
          expenses and other
          assets.....................      (198,108)      (164,869)      112,784          (582,093)
       Increase in accounts payable
          and accrued expenses.......       128,896        127,320       157,611         1,396,140
                                       ------------   ------------   -----------      ------------
          Net cash used in operating
            activities...............    (7,224,489)      (873,271)   (5,427,198)      (30,087,660)
Cash flows from investing activities:
  Purchases of marketable securities,
     net of redemptions..............    (5,129,047)   (10,839,876)           --       (15,968,923)
  Capital expenditures...............      (234,955)      (349,312)     (129,561)       (3,149,247)
  Other..............................            --             --            --           (46,182)
                                       ------------   ------------   -----------      ------------
          Net cash used in investing
            activities...............    (5,364,002)   (11,189,188)     (129,561)      (19,164,352)
Cash flows from financing activities:
  Proceeds from notes payable........            --             --     1,000,000         7,973,668
  Sale and leaseback related to
     capital acquisitions............            --             --       250,000           751,311
  Principal payments on lease
     obligations.....................      (155,070)      (174,503)     (183,344)         (839,265)
  Sale of common stock...............        23,344     27,640,966         1,769        27,713,203
  Sale of preferred stock............            --      1,500,140            --        19,258,613
  Offering costs.....................            --     (2,875,140)         (980)       (3,112,941)
  Founders' shares reacquired........            --             --            --              (846)
  Purchase of treasury stock.........            --             --            --            (2,768)
                                       ------------   ------------   -----------      ------------
          Net cash provided by (used
            in) financing
            activities...............      (131,726)    26,091,463     1,067,445        51,740,975
Net increase (decrease) in cash and
  cash equivalents...................   (12,720,217)    14,029,004    (4,489,314)        2,488,963
Cash and cash equivalents, beginning
  of period..........................    15,209,180      1,180,176     5,669,490                --
                                       ------------   ------------   -----------      ------------
Cash and cash equivalents, end of
  period.............................  $  2,488,963   $ 15,209,180   $ 1,180,176      $  2,488,963
                                       ============   ============   ===========      ============
Supplemental disclosure of cash flow
  information:
  Interest paid during the period....  $     27,530   $     63,473   $    61,915      $    258,193
</TABLE>

See Notes E, F and G with respect to noncash financing and leasing transactions.

                       See Notes to Financial Statements

                                       28
<PAGE>   30

                         VIRUS RESEARCH INSTITUTE, INC.
                         (A DEVELOPMENT STAGE COMPANY)

                         NOTES TO FINANCIAL STATEMENTS
                               DECEMBER 31, 1997

(NOTE A) -- THE COMPANY:

     Virus Research Institute, Inc. (the "Company") is a development stage
company engaged in the discovery and development of systems for the delivery of
vaccines and immunotherapeutics, and improved and novel vaccines for adults and
children.

     The Company has incurred substantial losses since inception while it has
been in the development stage and such losses are expected to continue. In June
1996, the Company completed an initial public offering of 2,300,000 shares of
common stock for $12.00 per share, resulting in net proceeds of approximately
$24,743,000. The Company anticipates that the proceeds from the initial public
offering in conjunction with payments received from collaborative partners will
allow the Company to meet its obligations through December 31, 1999.

(NOTE B) -- SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

  (1)  Revenue recognition:

     Nonrefundable, noncreditable licensing and option fees and milestone
payments are recognized when they are earned in accordance with the performance
requirements and contractual terms. Research and development revenues and grants
are recognized over the period of performance under the terms of the related
agreements.

     Licensing revenue represents amounts paid by companies for the use of or
access to the Company's proprietary technology. Option revenue represents
payments for the right to evaluate the Company's proprietary technology which
may or may not result in a licensing or collaborative development agreement.
Research and development revenue represents amounts earned by the Company from
several collaborative partners for sponsored research activities. Certain of the
Company's collaborators are also stockholders of the Company.

  (2)  Depreciation and amortization:

     Depreciation is computed using the straight-line method over the estimated
useful lives of the assets. Leasehold improvements are amortized using the
straight-line method over the life of the lease.

  (3)  Patent and licensing costs:

     As a result of research and development efforts conducted by the Company,
it has received and applied for, and is in the process of applying for, a number
of patents to protect proprietary inventions and licenses to use certain
intellectual property. Costs incurred in connection with patent applications and
licenses have been expensed as incurred and are reflected as general and
administrative expenses.

  (4)  Cash and cash equivalents:

     The Company considers all highly liquid investments with maturities of
three months or less, when acquired, to be cash equivalents. Cash equivalents
are recorded at cost, which approximates fair value.

  (5)  Investments in marketable securities:

     In addition to cash equivalents, the Company has investments in corporate
and municipal debt securities that are classified in the balance sheet as
held-to-maturity in accordance with the provisions of Statement of Financial
Accounting Standard No. 115 (SFAS No. 115), "Accounting for Certain Instruments
in Debt and Equity Securities." Held-to-maturity investments are securities the
Company has the positive intent and

                                       29
<PAGE>   31
                         VIRUS RESEARCH INSTITUTE, INC.
                         (A DEVELOPMENT STAGE COMPANY)

                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

ability to hold to maturity. These securities are accounted for at amortized
cost, which approximates fair value.

  (6)  Income taxes:

     Deferred income taxes are recognized for the tax consequences in future
years for differences between the tax bases of assets and liabilities and their
financial reporting amounts at each year end based on enacted tax laws and
statutory tax rates applicable to the periods in which the differences are
expected to affect taxable income. Valuation allowances are established when
necessary to reduce deferred tax assets to the amount expected to be realized.
Income tax expense is the tax payable for the period and the change during the
period in deferred tax assets and liabilities.

  (7)  Use of estimates:

     The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates. Estimates
are used when accounting for depreciation and amortization, taxes and
contingencies.

  (8)  Stock-based compensation:

     In October 1995, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standard No. 123, "Accounting for Stock-Based
Compensation." The Company adopted this standard in 1996 by making the required
note disclosures only. Therefore, the adoption of this standard has not had an
effect on the Company's financial position or results of operations.

  (9)  Net loss per share:

     During 1997, the Company adopted Statement of Financial Accounting Standard
No. 128, "Earnings per Share" requiring certain changes in the calculation of
per share results. As the Company has reported net losses from operations in the
years presented, the computation for basic and diluted earnings per share is
identical.

     Pro forma net loss per common share is based on the pro forma weighted
average number of common shares outstanding during the periods presented as
adjusted to reflect the conversion of all preferred stock on a retroactive basis
as of January 1, 1995 or date of issuance, if later.

(NOTE C) -- RESEARCH, LICENSE AND CONSULTING AGREEMENTS:

     The Company has entered into various research, license and consulting
agreements to support its research and development activities. These agreements
generally expire over several future years although some are automatically
renewable on an annual basis unless cancelled by either party. Amounts charged
to operations in connection with these agreements for the years ended December
31, 1997, 1996 and 1995 amounted to approximately $705,000, $650,000 and
$1,255,000, respectively. The Company expects to incur similar expenses in
future years. Some of the above agreements contain provisions for future
royalties to be paid on sales of products developed under the agreements.

     During 1997, the Company entered into an agreement pursuant to which the
Company licensed certain patents and technology to a collaborator. Under the
terms of the agreement, the collaborator is required to pay the Company $400,000
for licensing rights and $600,000 for research which was completed as of Decem-

                                       30
<PAGE>   32
                         VIRUS RESEARCH INSTITUTE, INC.
                         (A DEVELOPMENT STAGE COMPANY)

                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

ber 31, 1997. The total $1,000,000 is recorded as a contract receivable at
December 31, 1997. The agreement also provides for future payments contingent
upon the achievement of certain milestones.

(NOTE D) -- LEASEHOLD IMPROVEMENTS AND EQUIPMENT:

     Leasehold improvements and equipment, including approximately $413,000
acquired under capital leases, are stated at cost and are summarized as follows:

<TABLE>
<CAPTION>
                                                                    DECEMBER 31,
                                                              ------------------------
                                                                 1997          1996
                                                              ----------    ----------
<S>                                                           <C>           <C>
Laboratory furniture, fixtures and equipment................  $1,537,121    $1,366,074
Office furniture, fixtures and equipment....................     291,963       246,800
Leasehold improvements......................................   1,302,718     1,283,972
                                                              ----------    ----------
          Total.............................................   3,131,802     2,896,846
Less accumulated depreciation and amortization..............   2,416,568     2,015,483
                                                              ----------    ----------
          Balance...........................................  $  715,234    $  881,363
                                                              ==========    ==========
</TABLE>

(NOTE E) -- INVESTMENTS IN DEBT SECURITIES:

     As of December 31, 1997 and 1996, the aggregate fair value of the
held-to-maturity securities was $15,966,179 and $16,866,045, respectively. These
amounts include an unrealized loss of $2,744 at December 31, 1997 and an
unrealized gain of $26,056 at December 31, 1996.

     These securities are reflected in the balance sheet as follows:

<TABLE>
<CAPTION>
                                                                   DECEMBER 31,
                                                            --------------------------
                                                               1997           1996
                                                            -----------    -----------
<S>                                                         <C>            <C>
Cash equivalents..........................................  $        --    $ 6,000,113
Marketable securities, maturing within one year...........  $15,968,923    $10,339,985
Marketable securities, long term..........................  $        --    $   499,891
</TABLE>

(NOTE F) -- COMMITMENTS:

  (1)  Operating lease:

     The Company has an operating lease for office and research facilities which
expires in December 2001. The Company has the option to renew the lease for an
additional five years. The lease also provides that the Company pay all real
estate taxes levied against the premises. The lease requires minimum annual
rentals in 1998 through 2001 of $294,000.

     Rent expense for 1997, 1996 and 1995 amounted to approximately $332,000,
$267,000 and $269,000, respectively.

  (2)  Capital lease:

     The Company has entered into several capital leases for equipment,
including sale and leaseback transactions. Future minimum payments under these
leases at December 31, 1997 amount to $72,352.

                                       31
<PAGE>   33
                         VIRUS RESEARCH INSTITUTE, INC.
                         (A DEVELOPMENT STAGE COMPANY)

                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

(NOTE G) -- CAPITALIZATION:

  (1)  Warrants:

     The Company has issued warrants to purchase common and preferred stock in
connection with the issuance of notes payable and the establishment of capital
leases.

     Warrants outstanding at December 31, 1997 are as follows:

<TABLE>
<CAPTION>
                                                          EXERCISE
                                             NUMBER OF      PRICE
SECURITY                                      SHARES      PER SHARE     EXPIRATION DATE
--------                                     ---------    ---------    -----------------
<S>                                          <C>          <C>          <C>
Common stock...............................   23,006        $ .96      February 9, 2004
Common stock...............................   49,578         1.95      December 14, 2005
Common stock...............................   11,000         9.60      April 12, 2001
</TABLE>

     The warrant agreements contain antidilution provisions related to future
issuances of stock.

  (2)  Common stock options:

     The Company has adopted an equity incentive plan providing for the issuance
of restricted stock and the granting of options to purchase up to a combined
total of 1,751,176 shares of common stock. The plan provides for the granting of
both incentive stock options and nonstatutory stock options. The exercise price
for any incentive stock options cannot be less than the fair market value on the
date of grant, while the exercise price for nonstatutory options will be
determined by the Board of Directors. The vesting periods for all options are
determined by the Board of Directors. The Company had the following option
activity during 1995, 1996 and 1997:

<TABLE>
<CAPTION>
                                                                        WEIGHTED AVERAGE
                                                           NUMBER OF      OPTION PRICE
                                                            SHARES         PER SHARE
                                                           ---------    ----------------
<S>                                                        <C>          <C>
Balance -- December 31, 1994.............................    750,220         $ .80
  Granted................................................     12,142         $1.85
  Exercised..............................................     (2,903)        $ .61
  Cancelled..............................................    (11,584)        $ .96
                                                           ---------
Balance -- December 31, 1995.............................    747,875         $ .82
  Granted................................................    325,172         $6.36
  Exercised..............................................    (66,154)        $ .62
  Cancelled..............................................    (14,515)        $1.45
                                                           ---------
Balance -- December 31, 1996.............................    992,378         $2.64
  Granted................................................    104,412         $6.97
  Exercised..............................................    (62,363)        $ .37
  Cancelled..............................................     (1,765)        $5.09
                                                           ---------
Balance -- December 31, 1997.............................  1,032,662         $3.23
                                                           ---------
</TABLE>

     Options for 539,569 shares are exercisable at December 31, 1997 at a
weighted average option price of $1.90 per share, with a weighted average
remaining contractual life of approximately 7 years. At December 31, 1997, there
were 585,545 shares available for future grant.


                                       32
<PAGE>   34
                         VIRUS RESEARCH INSTITUTE, INC.
                         (A DEVELOPMENT STAGE COMPANY)

                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

  (3)  Stock-based compensation:

     The Company has adopted the disclosure-only provisions of SFAS No. 123,
"Accounting for Stock-Based Compensation" but applies Accounting Principles
Board Opinion No. 25 and related interpretations in accounting for its plan.
There was no compensation expense recognized in 1997, 1996 or 1995. If the
Company had elected to recognize compensation cost for the plan based on the
fair value at the grant date for awards under the plan, consistent with the
method prescribed by SFAS No. 123, net loss per share would have been changed to
the pro forma amounts indicated below:

<TABLE>
<CAPTION>
                                                        YEAR ENDED DECEMBER 31,
                                               -----------------------------------------
                                                  1997           1996           1995
                                               -----------    -----------    -----------
<S>                             <C>            <C>            <C>            <C>
Net loss......................  As reported    $(6,564,354)   $(1,581,936)   $(6,297,028)
                                Pro forma       (6,776,699)    (1,729,019)    (6,297,309)
Net loss per share............  As reported    $      (.74)   $     ( .21)   $     (1.03)
                                Pro forma             (.76)          (.23)         (1.03)
</TABLE>

     The fair value of the Company's stock options used to compute pro forma net
loss and net loss per share disclosures is the estimated present value at grant
date using the Black-Scholes option-pricing model with the following weighted
average assumptions for 1997, 1996 and 1995: dividend yield of 2.5%; expected
volatility of 45%; a risk free interest rate of 7.3%; and an expected holding
period of nine years.

     The weighted average grant date fair value of options granted was $2.37 per
share, $3.21 per share, and $3.07 per share for the years ended December 31,
1997, 1996 and 1995, respectively.

(NOTE H) -- INCOME TAXES:

     Through December 31, 1993, pursuant to provisions of the Internal Revenue
Code, the Company was deferring all start-up costs because operations, as
defined by the Internal Revenue Code, had not commenced. In addition, the
Company elected to defer all research and development costs until revenues were
generated. Effective January 1994, the Company began generating revenues and
commenced operations for tax purposes and is amortizing all costs deferred
through December 31, 1993 over 60 months. From January 1994 forward, the Company
continues to defer internal research and development costs and amortizes such
costs over 60 months for tax purposes.

     At December 31, 1997 and 1996, the Company had no current or deferred tax
liability.

     The components of the Company's net deferred tax asset and the tax effects
of the primary differences giving rise to the Company's deferred tax asset are
as follows:

<TABLE>
<CAPTION>
                                                              YEAR ENDED DECEMBER 31,
                                                     ------------------------------------------
                                                         1997           1996           1995
                                                     ------------    -----------    -----------
<S>                                                  <C>             <C>            <C>
Net operating loss carryforwards...................  $  4,900,000    $ 3,100,000    $ 3,000,000
Deferred start-up costs............................       200,000        380,000        550,000
Deferred research and development costs............     6,800,000      5,944,000      5,415,000
Depreciation.......................................       315,000        250,000        164,000
Research and development credit....................       561,000        227,000        110,000
Other..............................................        47,000         36,000        171,000
                                                     ------------    -----------    -----------
Deferred tax asset.................................    12,823,000      9,937,000      9,410,000
Valuation allowance................................   (12,823,000)    (9,937,000)    (9,410,000)
                                                     ------------    -----------    -----------
Net deferred tax asset.............................  $         --    $        --    $        --
                                                     ============    ===========    ===========
</TABLE>

                                       33
<PAGE>   35
                         VIRUS RESEARCH INSTITUTE, INC.
                         (A DEVELOPMENT STAGE COMPANY)

                  NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)

     At December 31, 1997, the Company's net operating loss carryovers for
federal income tax purposes amount to approximately $12,480,000 and expire
through 2012. The Company's ability to use these carryforwards is subject to
limitations resulting from an ownership change as defined in Internal Revenue
Code Sections 382 and 383.

                                       34