<PAGE>
 
                                 UNITED STATES
                      SECURITIES AND EXCHANGE COMMISSION
                             Washington, DC 20549
 
                               ----------------
 
                                   FORM 10-K
 
                               ----------------
 
  Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934 for the fiscal year ended December 31, 1998.
 
                                AUTOIMMUNE INC.
            (Exact name of registrant as specified in its charter)
 
               Delaware                              13-348-9062
    (State or other jurisdiction of               (I.R.S. Employer
    incorporation or organization)             Identification Number)
 
   128 Spring Street, Lexington, MA                     02421
    (Address of principal executive                  (Zip Code)
               offices)
 
                                (781) 860-0710
             (Registrant's telephone number, including area code)
 
          Securities registered pursuant to Section 12(b) of the Act:
 
          Title of each Class              Name of each exchange on which
                                                     registered.
                                     None
 
          Securities registered pursuant to Section 12(g) of the Act:
                         Common Stock, $.01 par value
                               (Title of Class)
 
  Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [_]
 
  Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
 
  On March 5, 1999, the aggregate market value of the voting stock held by
non-affiliates of the registrant was $24,755,640.93. As of March 5, 1999,
there were outstanding 16,555,949 shares of the registrant's Common Stock,
$0.01 par value.
 
                      Documents Incorporated by Reference
 
  Portions of the Company's definitive Proxy Statement for its annual meeting
of shareholders which the Company intends to file within 120 days after the
end of the Company's fiscal year ended December 31, 1998 are incorporated by
reference into Part III hereof as provided therein.
<PAGE>
 
                                    PART I
 
Item 1. Business.
 
Overview
 
  AutoImmune Inc. (the "Company" or "AutoImmune") is a biopharmaceutical
company developing a new class of orally administered pharmaceutical products
for the treatment of autoimmune and other cell-mediated inflammatory diseases
and conditions. The Company is currently conducting clinical trials for the
following products: Colloral(R), for the treatment of rheumatoid arthritis,
and AI 502, for the treatment of chronic transplant rejection. A third
product, AI 401, for the treatment of Type 1 diabetes, is in Phase II clinical
trials supported by Eli Lilly and Company ("Lilly") and the National
Institutes of Health ("NIH"). The Company believes, based on preclinical and
clinical data, that its proprietary approach to therapy can induce tissue-
specific immunosuppression without toxicity or significant side effects.
Additional clinical and commercial advantages of this approach include the
ability to administer products orally (the preferred method of treating
chronic diseases) and the potential for application to a variety of
inflammatory diseases and conditions.
 
  All of the Company's products are based upon the principles of oral
tolerance. Oral tolerance utilizes natural immune system mechanisms associated
with the gut (the small intestine). These mechanisms allow the body to accept
orally ingested proteins by suppressing the immune response that would
otherwise arise against a foreign substance. This suppression can be directed
toward a tissue under attack by the body's own immune system, which occurs in
an autoimmune disease, through appropriate selection and dosing of the protein
in an orally delivered product.
 
  AutoImmune believes it is the leading company developing pharmaceutical
products based upon the principles of oral tolerance. The status of each of
AutoImmune's principal products is as follows:
 
  Colloral(R)--To date, AutoImmune has completed eight human clinical trials
of Colloral in over 1,200 patients to investigate its use in treating
rheumatoid arthritis. The Company met with the United States Food and Drug
Administration ("FDA") in November 1997 to review data from its Phase II
program. At the conclusion of that meeting the FDA supported the Company's
plan for Phase III. A Phase III trial is currently underway and is expected to
be completed this summer.
 
  AI 401--In December 1994, the Company entered into a collaborative agreement
with Lilly under which Lilly has provided support for clinical testing of the
Company's autoimmune-mediated (Type 1) diabetes product. This agreement was
terminated in the first quarter of 1999 as a result of Lilly's failure to make
a required milestone payment. Lilly is contractually obligated to complete the
trials now underway and to provide the Company with full access to the data
therefrom. Lilly sponsored investigators have completed enrollment in three
different Phase II clinical trials to demonstrate human proof of principle for
AI 401 in patients newly diagnosed with Type 1 diabetes. The results of these
studies are expected to be available within the next 18 months. In addition,
Lilly is providing AI 401 for the Diabetes Prevention Trial (DPT-1) being
conducted by the NIH. The oral arm of this trial, which is expected to enroll
490 patients, is designed to determine whether AI 401 can delay or prevent the
clinical onset of Type 1 diabetes. Patient enrollment in the oral arm of DPT-1
is approximately 40% complete.
 
  AI 502--In January 1997, the Company initiated a clinical trial of
tolerizing peptides for the prevention of organ transplant rejection. The open
label study, which is being conducted in patients at The Brigham and Women's
Hospital, is designed to assess the safety and immunological effects of oral
peptides in laboratory measures of chronic transplant rejection. Enrollment
continued in 1998 and results are expected to be available in late 1999.
 
  AI 301--The Company is developing AI 301, a recombinant human protein, for
the treatment of uveitis, an inflammatory disease of the eye. Using its first
generation product based on animal protein, AI 300, the Company conducted a
Phase I/II clinical trial in 45 patients in conjunction with the National Eye
Institute of the NIH. Results of the trial were judged by the Company to be
encouraging and were published in the American Journal of Ophthalmology in May
of 1997. The Company expects that future clinical trials for uveitis will use
AI 301,
 
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<PAGE>
 
due to the expected lower cost of manufacturing this recombinant product
compared to product based on animal protein.
 
  Products for Multiple Sclerosis and Myasthenia Gravis--The Company has
entered into an exclusive agreement with Teva Pharmaceutical Industries, Ltd.
("Teva"). This agreement covers the development by Teva of an oral formulation
of Copaxone(R) (glatiramer acetate), Teva's currently available injectable
drug for multiple sclerosis. The new formulation would use the Company's
proprietary technology for oral tolerance and is expected to be in efficacy
trials before the end of 1999. The agreement also covers an orally delivered
formulation of a product to treat myasthenia gravis developed by Teva. It is
anticipated that the myasthenia gravis product will enter Phase I clinical
trials before the end of 1999.
 
  Autoimmune diseases represent a major worldwide health care problem in terms
of the number of people affected. The Company believes that each of these
products under development offers the potential for a therapeutic
breakthrough.
 
  The Company was incorporated in Delaware in September 1988 as AutoImmune
Technologies, Inc. The Company changed its name to AutoImmune Inc. in July
1991. The executive offices of AutoImmune are located at 128 Spring Street,
Lexington, Massachusetts 02421, and its telephone number is (781) 860-0710.
 
Strategy
 
  The Company's objective is to become a leading provider of therapeutic
products to treat immune system disorders. The key elements of the Company's
strategy include the following:
 
  Focusing on Colloral. The Company is concentrating a significant portion of
its resources on its most advanced product, Colloral, for the treatment of
rheumatoid arthritis. More than six million people worldwide suffer from
rheumatoid arthritis and current therapies have significant limitations. The
Company has retained all rights to Colloral. AutoImmune currently plans to
evaluate all of its options for this product, including independently
developing and marketing or seeking to enter into licensing arrangements,
exclusive marketing agreements in specific foreign markets or joint ventures
with established pharmaceutical companies.
 
  Leveraging the Company's Technology Platform. The Company believes its
technology is applicable to a variety of autoimmune and other cell-mediated
diseases and conditions. In addition to Colloral, the Company has several
other products in various stages of development, including products to treat
Type 1 diabetes, chronic transplant rejection and uveitis. The Company has,
and plans to continue to seek, licensing arrangements, joint ventures or other
collaborative agreements to assist in financing the development and
commercialization of one or more of these products. This strategy resulted in
the Company's collaboration with Lilly for clinical testing of its products to
treat autoimmune-mediated diabetes. More recently, it resulted in the
Company's agreement with Teva relating to the development of an oral
formulation of Copaxone and an orally delivered formulation of Teva's product
to treat myasthenia gravis.
 
  The Company continues to develop the technology underlying oral tolerance
therapy through research conducted primarily at The Brigham and Women's
Hospital, a teaching hospital affiliated with Harvard Medical School. This
research is designed to further the Company's understanding of the mechanisms
of oral tolerance with the goals of increasing the effectiveness of the
Company's products and exploring new therapeutic applications for this
technology.
 
  Protecting the Company's Competitive Position. From its inception, the
Company has sought to establish a strong proprietary position. As of December
31, 1998, the Company had pending 34 original and continuation-in-part United
States patent applications and numerous foreign counterparts. The Company has
received or has exclusive rights to 49 U.S. and foreign patents, including
five U.S. patents covering the use of oral Type I, II, or III collagen to
treat rheumatoid arthritis in humans; five U.S. patents covering the treatment
of cell-mediated autoimmune disease by nasal or by inhalation administration
of autoantigens, and in particular covering treatment
 
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of multiple sclerosis or rheumatoid arthritis using nasal or by inhalation
administration of compositions containing myelin basic protein or collagen,
respectively, or active fragments thereof; three U.S. patents covering
suppression of allograft rejection by oral administration of a major
histocompatibility complex Class II antigen or an active fragment thereof;
three U.S. patents covering the treatment, or prevention of the onset of, Type
1 diabetes by oral or nasal administration of a composition containing insulin
or a fragment of insulin; one U.S. patent covering treatment of multiple
sclerosis by oral administration of bovine myelin; and one U.S. patent
covering a method for preparing Type II collagen. The European and Japanese
Patent Offices have each granted a patent to the Company covering the use of
compositions containing autoantigens to treat a group of human autoimmune
diseases, but oppositions (proceedings challenging their validity) have been
filed against these patents by a third party. The Japanese Patent Office has
issued a decision adverse to the patent, but the Company has filed a response,
and that decision is under review at present. A number of the pending U.S.
patent applications which the Company owns or to which it has exclusive rights
have been allowed and are expected to issue in the near future.
 
  In addition, the Company expects that Orphan Drug status may provide
increased proprietary protection for certain of its products in the United
States. The Company has received Orphan Drug status for Colloral for the
treatment of juvenile rheumatoid arthritis. The Company also anticipates that
the FDA will classify its products as "biologics." If the Company's products
are so classified, there is currently no provision for rapid approval of
generic competitors after the expiration of any proprietary protection the
Company receives.
 
  Minimizing Costly Infrastructure and Capital Investment. From its inception,
the Company has sought to conserve its financial resources. The Company's
early research was conducted at The Brigham and Women's Hospital, and the
Company did not begin to hire employees in significant numbers until 1993. The
Company has made extensive use of external resources, such as clinical
research organizations and consultants. The Company believes it will be able
to minimize costly infrastructure by continuing the use of external resources
where appropriate.
 
Autoimmune Diseases
 
  The human immune system is the major biological defense mechanism
responsible for recognizing and fighting disease. The immune system
distinguishes foreign substances (antigens) from the body's tissue and rids
the body of a wide variety of disease-causing antigens such as bacteria and
viruses. T cells, which circulate in the blood, are a major component of this
system. There are several types of T cells, which play a critical role in
recognizing antigens, carrying out the immune response, and regulating the
resulting chain of events. These include "helper" T cells, which release
factors to amplify the immune response, "killer" T cells, which attack and
destroy other cells displaying the targeted antigen, and "regulatory" T cells,
which release factors to down-regulate or suppress the immune response and
keep it in control.
 
  Autoimmune diseases are generally believed to be a result of an
inappropriate response of the immune system. In many autoimmune diseases, the
helper and killer T cells go awry and attack the body's healthy tissues. T
cells which act in this manner are called autoreactive T cells. These T cells
appear to target the antigenic substances present in specific tissues
(autoantigens). The antigenic substances differ depending upon the disease and
may change over the course of a disease. In some diseases, the antigenic
substances have not been characterized, while in others a number of substances
have been found, but the particular role of each has not been identified.
 
  Autoimmune diseases, which may be crippling or fatal, can strike virtually
any tissue or organ. The particular disease that occurs depends upon which
healthy tissue is attacked. For example, if the tissue attacked is the brain,
multiple sclerosis results; if synovial tissue in joints is the target,
rheumatoid arthritis results. Type 1 diabetes occurs when certain pancreatic
cells are the target, and uveitis occurs when cells of the uvea, the middle,
vascular layer in the eye, are attacked.
 
  There is currently no method known for curing autoimmune diseases. They are
chronic and require lifelong treatment. Treatments tend to fall into two major
categories. The first category involves compounds for palliative
 
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<PAGE>
 
treatment, such as anti-inflammatory agents and pain killers for rheumatoid
arthritis or insulin for diabetics. In some forms of the diseases, there is no
acceptable method of treating even the symptoms. The second category involves
the administration of non-specific immunosuppressants, which indiscriminately
shut down multiple parts of the immune system. These immunosuppressants
usually have serious toxicity and side effect problems with long-term use.
 
  While there are numerous cell-mediated autoimmune diseases, the Company at
present is developing products for three: rheumatoid arthritis, Type 1
diabetes, and uveitis (or uveoretinitis). Rheumatoid arthritis is a chronic
disease in which the body's immune system attacks synovial tissue in joints,
resulting in a progressive, painful inflammation of the joints, along with
crippling deformation of the hands, feet, hips, knees and shoulders. In
advanced phases of the disease, symptoms include severe pain, body
disfiguration and loss of mobility. The autoimmune form of diabetes (Type I,
also known as juvenile or insulin-dependent diabetes) is the result of the
body's immune system destroying the insulin-producing islet cells in the
pancreas. Although the administration of insulin controls the metabolic
abnormalities of the disease, it does not always prevent major debilitating
effects, which can include neural degeneration, chronic pain,
arteriosclerosis, loss of limbs due to peripheral vascular disease, blindness
and kidney failure. In its most severe form, diabetes can result in death. The
autoimmune form of uveitis is a chronic, degenerative eye disease, resulting
in inflammation, discoloration and ultimately blindness.
 
  In addition, AutoImmune is developing a product for the treatment of chronic
transplant rejection which, while not an autoimmune disease, involves similar
mechanisms of action. Due to the similarity, the Company believes that its
oral tolerance approach may provide an effective therapy for this clinical
condition.
 
  The Company has directed its efforts in these areas because each of these
diseases and conditions is mediated by the T cells in the immune system, and
thus is well suited to AutoImmune's oral tolerance approach. No completely
satisfactory treatment currently exists for any of these conditions.
 
The Company's Technology
 
  AutoImmune's products are based upon the principles of oral tolerance. Oral
tolerance utilizes the natural immune system mechanisms associated with the
gut (the small intestine). These mechanisms allow the body to accept
("tolerate") orally ingested proteins (antigens) absorbed through the
intestine without stimulating an immune response that would otherwise arise
against a foreign substance. In a series of extensive research studies
directed by Dr. Howard Weiner, who is one of the Company's principal
scientific advisors, it was shown that, when properly activated, these
mechanisms can be used to treat autoimmune disorders by selectively
suppressing the immune system. This discovery forms the basis of the Company's
products and patent claims. See "Patents and Proprietary Rights."
 
  The Company's method uses therapeutic substances--antigenic proteins or
derivatives thereof found in the organs attacked by each disease--which are
delivered orally and disassembled in the gut by the normal digestive
processes. Specific fragments of these substances (peptides) attach to
antigen-presenting cells on the surface of the gut. The cells involved are
those associated with Peyer's Patches, which are groupings of immune system
cells surrounding the gut that have been reported to induce immune tolerance.
This triggers the immune system to initiate a chain of events that results in
the creation of regulatory T cells that migrate through the blood and lymph
system to suppress or down-regulate the immune response at the targeted organ,
thereby mitigating the disease. This suppression can be directed toward the
tissue under attack in an autoimmune disease by appropriate selection and
dosing of the protein in an orally-delivered product.
 
  AutoImmune has completed a wide range of human, animal and in vitro tests
relating to the oral administration of its products in a variety of disease
indications. The Company believes these experiments have demonstrated that
selective immune system tolerance can be induced by oral administration of
antigens, suppressing undesirable immune system attacks against healthy tissue
without suppressing the entire immune system.
 
 
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<PAGE>
 
  AutoImmune's research has indicated that identification of the precise
autoantigen for a disease may not be necessary to develop an effective
treatment based on oral tolerance. Research has shown that oral tolerance
induced by one organ-specific protein is capable of suppressing autoreactive T
cells that are attacking a different protein in the same organ. The Company
refers to this phenomenon as "bystander suppression," and has filed patents to
protect its rights to this discovery. In particular, bystander suppression
allows an oral tolerance treatment to be effective even if the autoantigen is
not precisely identified or changes during the course of a disease (an effect
known as "determinant spreading").
 
  In contrast to existing treatments, which are limited to treating only the
symptoms of autoimmune disease or which run the risks and side effects of
shutting down the entire immune system, the Company's products are intended to
interrupt the disease process and be specific to each disease. Moreover,
because of the apparent freedom from significant side effects enjoyed by
AutoImmune's products, the Company believes they may be prescribed earlier in
the disease process than is now customary, and thus may allow patients to
avoid most or all of the debilitating effects of autoimmune diseases. The
Company believes its approach of developing products to induce the activation
of regulatory T cells in order to suppress disease distinguishes it from most
others currently conducting autoimmune disease research.
 
  The Company's approach offers a number of important clinical and commercial
advantages:
 
  Adverse Reactions Unlikely. The Company believes that since the therapeutic
substances it is developing are protein-based products taken in small
quantities, are digested like normal foodstuffs and stimulate natural
functions, they are unlikely to cause adverse reactions. AutoImmune's human
studies to date have shown a lack of both toxicity and significant side
effects, which the Company believes may expedite the regulatory process.
 
  Tissue-Specific Immunosuppression. The Company's oral tolerance technique
utilizes the immune system itself to generate natural immunosuppression in the
specific tissue(s) attacked by a disease. It does not down-regulate the entire
immune system.
 
  Oral Delivery. AutoImmune's products are administered orally, the preferred
method of treating chronic diseases. Other forms of immunotherapy which are
being marketed or are known by the Company to be in development by competitors
are likely to require chronic intravenous, sub-cutaneous or intra-muscular
administration.
 
  Broad Application. The Company believes that, in addition to the diseases
and conditions on which it has been working to date, its oral tolerance
approach potentially could be applied to the treatment of a variety of other
inflammatory diseases and other clinical conditions, including psoriasis,
Alzheimer's disease, and atherosclerosis.
 
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Principal Products in Development
 
  AutoImmune has products in various stages of development for treating
rheumatoid arthritis, Type 1 diabetes, chronic transplant rejection and
uveitis. The chart set forth below describes the stage of development of each
of the Company's principal products.
 
 
                       PRINCIPAL PRODUCTS IN DEVELOPMENT
 
<TABLE>
<CAPTION>
   Product      Disease/Condition   Development Status
   -------      ------------------- ------------------------------------------------
   <S>          <C>                 <C>
   Colloral(R)  Rheumatoid          Phase III trial enrollment completed in the
                 Arthritis          first quarter of 1999; results expected in the
                                    third quarter of 1999
 
   AI 401       Type 1 diabetes     Phase II trials in progress
 
   AI 502       Transplant
                 Rejection          Phase I/II trial in progress
 
   AI 301       Uveitis             Research
</TABLE>
 
  Rheumatoid Arthritis. Colloral, AutoImmune's proprietary oral formulation of
Type II collagen, is currently in a Phase III human clinical trial. This 772
patient study is designed as the final pivotal trial for regulatory approval.
More than 1,200 patients have been involved in the five Phase II Colloral
trials completed to date. Integrated data analysis from these five trials
showed that Colloral is significantly more efficacious than placebo, the
optimum dose is 60 micrograms, and the safety profile is unsurpassed. The
Company expects to have results from the Phase III trial in late summer of
1999.
 
  Drugs for rheumatoid arthritis are given chronically and, as a result, long-
term safety data are required for approval of all new drugs. AutoImmune has
begun to generate long-term safety data on Colloral through open label
continuation trials with patients who have participated in the development
program. As of December 31, 1998, more than 1,300 patient years of safety data
have been collected. Some patients have received Colloral for more than four
years.
 
  Colloral is also being developed for juvenile rheumatoid arthritis ("JRA").
The results from a 10 patient pilot trial for this indication were published
in the April 1996 issue of Arthritis and Rheumatism. AutoImmune has received
Orphan Drug designation for Colloral for the treatment of JRA.
 
  It is estimated that 1% of the worldwide population suffers from rheumatoid
arthritis. In the United States, there are 2.1 million patients with
rheumatoid arthritis, including more than 70,000 patients with JRA. There is
no known cure, but several approaches are used in an attempt to alleviate two
major symptoms of the disorder, pain and inflammation. A number of pain
relievers are widely used, but most have undesirable side effects. Similarly,
a wide variety of anti-inflammatory agents, ranging from aspirin to NSAIDs,
are used with varying degrees of success. The NSAIDs used to alleviate pain
and inflammation have undesirable gastrointestinal side effects that limit
their use. None of the available NSAIDs work with consistent efficacy on all
types of patients. Several companies are working on a new class of NSAIDs
described as COX-2 inhibitors. These products, which began to enter the market
in 1999, may alleviate some of the gastrointestinal side effects currently
seen with traditional NSAIDS. Broad immunosuppressants are also used to treat
rheumatoid arthritis but toxicity limits their use. A new product in this
category is leflunomide, which can be characterized as methotrexate-like, but
with an additional indication for slowing disease progression. Additionally,
there are two biologic products, one of which, Enbrel, was approved in 1998.
The other product, Remicade, is awaiting approval by the FDA. Both products,
which are injectables, are anti-TNF (tumor necrosis factor) inhibitors.
 
  Type 1 Diabetes. In December 1994, the Company entered into a collaborative
agreement with Lilly under which Lilly provided support for clinical testing
of the Company's autoimmune-mediated (Type 1) diabetes product. This agreement
was terminated in the first quarter of 1999 as a result of Lilly's failure to
make a required milestone payment. Lilly is obligated to complete the trials
now underway and to provide the Company with full access to the data
therefrom, including the right to use such data for any purpose. Lilly
sponsored investigators have completed enrollment in three different Phase II
clinical trials to demonstrate human proof of principle for AI 401. The U.S.
study is a one-year, double-blind, placebo-controlled trial with 200+
patients,
 
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designed to measure immunological changes, preservation of pancreatic function
and time to insulin dependence. The second Phase II trial involves
approximately 150 patients and is being conducted in France. The third trial
is in Italy with approximately 80 patients. The results of these trials are
expected to be available within the next 18 months. In addition, Lilly is
providing AI 401 for the Diabetes Prevention Trial (DPT-1) being conducted by
the NIH. This trial, which began in September 1996 and is expected to enroll
490 patients, is designed to determine whether AI 401 can delay or prevent the
clinical onset of Type 1 diabetes. Enrollment in DPT-1 is approximately 40%
complete.
 
  Approximately 1,000,000 people in the United States suffer from Type 1
diabetes. It is estimated that worldwide there are 180,000 new patients
diagnosed with this disease each year. There is no known way of curing Type 1
diabetes; at best it can be controlled. In addition, because insulin is a
large protein that is not appreciably absorbed through the gut, it must be
administered intravenously or intra-muscularly, rather than orally. The
limitations of the treatment delivery system and the inconsistency of the
therapeutic results have led to major efforts to discover effective new
methods of treatment. The Company believes that the preferred therapeutic
approach would be an oral treatment such as the Company's which could prevent
the onset of the disease (and the related destruction of the insulin-producing
cells) in susceptible populations. Methods to pre-screen persons who are
genetically susceptible to Type 1 diabetes are being developed by others.
AutoImmune expects that individuals who have been diagnosed in the early
stages of Type 1 diabetes, as well as those who may be identified through such
pre-screening, will constitute the primary market for AutoImmune's diabetes
product.
 
  Transplant Rejection. In January 1997, the Company initiated a clinical
trial of tolerizing peptides for the prevention of organ transplant rejection.
The open label study, which is being conducted in patients at The Brigham and
Women's Hospital, is designed to assess the safety and immunological effects
of oral peptides in laboratory measures of chronic transplant rejection. The
results of this trial are expected to be available in late 1999. Prior to the
initiation of AutoImmune's human clinical program in chronic transplant
rejection, the Company conducted several preclinical studies at The Brigham
and Women's Hospital which achieved positive results in the suppression of the
rejection reaction using peptides.
 
  Although not an autoimmune disease, the rejection of a transplanted organ by
its new host is of interest to the Company because this phenomenon involves a
similar cell-mediated mechanism of action. For certain diseases such as end-
stage kidney, heart and liver failure, transplantation of donated organs is
the only means of keeping the patient alive. Two factors, however, have served
to limit the effectiveness of this approach. One factor is lack of donor
organs, while the other is the rejection of the transplanted organ as a
foreign body by the patient's immune system. The availability of the drug
cyclosporin, which suppresses the host's entire immune system, has
significantly changed the nature of organ transplantation in recent years.
While this drug has allowed transplantation to become a much more widespread
clinical procedure, cyclosporin is a powerful, non-specific immunosuppressant
that has severe side effects, especially in the kidneys, and exposes the
patient to attacks from other diseases and opportunistic infections. The
Company believes that its approach offers selective immunosuppression with a
lack of toxicity or significant side effects. Approximately 35,000 organ
transplants are performed annually worldwide.
 
  Uveitis. The Company is developing AI 301, a recombinant human protein, for
the treatment of uveitis, an inflammatory disease of the eye. Using its first
generation, non-recombinant product, AI 300, the Company completed a 45-
patient placebo-controlled Phase I/II clinical trial in January 1996. This
trial was conducted under the sponsorship of the Company pursuant to a
Collaborative Research and Development Agreement ("CRADA") with the National
Eye Institute of the NIH. The results of the Phase I/II trial demonstrate that
treatment with purified bovine S-antigen is safe and may facilitate the
withdrawal of systemic immunosuppressants. The results of the trial were
published in the American Journal of Ophthalmology in May of 1997. The Company
expects to move forward in its program for the treatment of uveitis using AI
301, a recombinant form of S-antigen. The Company believes that a recombinant
product for this disease is likely to be manufactured at a significantly lower
cost than a product based on animal protein.
 
                                       8
<PAGE>
 
  Although uveitis can be caused by other factors such as external irritants,
the autoimmune form of the disease is particularly severe. Doctors have used
non-specific immunosuppressants, such as corticosteroids and cyclosporin, on
uveitis patients. Results, however, have not been consistent and serious side
effects may occur.
 
  Multiple Sclerosis and Myasthenia Gravis. In the second quarter of 1997, the
Company ceased independent efforts to develop a product for the treatment of
multiple sclerosis and began evaluating opportunities to collaborate with
third parties in the development of such a product. In this regard, the
Company entered into an exclusive agreement with Teva. The agreement covers
the development by Teva of an oral formulation of Copaxone(R) (glatiramer
acetate), Teva's currently available injectable drug for multiple sclerosis.
This oral formulation would use the Company's proprietary technology for oral
tolerance and is expected to be in efficacy trials before the end of 1999. The
agreement also covers an orally delivered product to treat myasthenia gravis
developed by Teva. It is anticipated that the myasthenia gravis product will
enter Phase I clinical trials before the end of 1999. AutoImmune will receive
up to $20 million in milestone payments upon product approvals, and escalating
royalties on cumulative sales for all products covered by the agreement.
 
  Approximately 350,000 persons in the United States suffer from multiple
sclerosis. Approximately one-third of individuals with multiple sclerosis
stabilize and never reach a severe stage; others have multiple acute attacks
as frequently as two to three times a year. In its most severe form, the
disease is relentlessly progressive and can result in complete disability
within ten years. Since the early 1980s, non-specific immunosuppressants, such
as cyclophosphamide and azothioprine, have been used with occasional success
to slow the progression of this disease in some patients. None of these
treatments is capable of stopping multiple sclerosis attacks or halting the
progression of the disease without exposing patients to potentially serious
side effects. Since 1993, three products have been approved by the FDA for the
treatment of relapsing/remitting multiple sclerosis. All three are indicated
for reduction of the frequency of multiple sclerosis exacerbations (one is
also approved for slowing the progression of disability associated with
sclerosis). Each of these drugs is administered by injection and each has side
effects, including injection site reactions and flu-like symptoms or shortness
of breath.
 
  Approximately 45,000 persons in the United States suffer from myasthenia
gravis, a chronic neuromuscular disease that produces weakness and abnormally
rapid fatigue of voluntary muscles, especially those that control the eyes,
face, tongue and limbs. Patients are currently treated with immunosuppressives
and anticholinesterase compounds.
 
Additional Products and Research Programs
 
  The Company's additional research and development efforts are focused on two
primary objectives: (i) developing ways to enhance the therapeutic effect of
the Company's existing products by combining its products with other compounds
or drugs; and (ii) expanding the applications of oral tolerance therapy.
 
  There are two basic approaches under study by the Company to enhance the
therapeutic effect of existing products. The first is through the
contemporaneous administration of agents such as beta-interferon, interleukin-
4, or interleukin-10, which have been demonstrated to predispose the immune
system toward the production of regulatory T cells. The second approach is
through the contemporaneous administration of agents such as methotrexate
which can impact the disease process through its effect on autoreactive T
cells. Both methods have been shown in animal studies to increase the
effectiveness of oral tolerance therapy.
 
  In addition to the products it currently is developing, AutoImmune has
several research programs involving possible future products. The Company
believes its oral tolerance approach may lead to treatments for cell-mediated
inflammatory diseases in addition to those it is currently studying. For
example, the Company has conducted research on products to treat other
diseases, including Alzheimer's disease and atherosclerosis.
 
Manufacturing
 
  All of the Company's products for clinical and commercial use must be
produced under controlled conditions and under current FDA Good Manufacturing
Practices ("GMP"). To ensure compliance with GMP
 
                                       9
<PAGE>
 
requirements, the Company will be required to maintain sufficient technical
staff to oversee all production operations, including quality control, quality
assurance, technical support and manufacturing management. To the extent the
Company relies upon contract manufacturing arrangements, the Company will
depend upon third parties to produce and deliver products in accordance with
GMP.
 
  The Company is producing Colloral in bulk form for use in its clinical
trials from a pilot facility it constructed in 1996. The Company is currently
meeting its filling, labeling and packaging requirements for Colloral through
arrangements with third parties. The Company will continue to evaluate whether
to manufacture bulk product and finished dosage forms for all of its products
through contract suppliers, by leasing space in an existing facility or by
establishing its own facility on a product-by-product basis.
 
Marketing and Sales
 
  In order to market any of its products directly, the Company must develop a
marketing and sales organization. However, the Company may elect to enter into
agreements with established pharmaceutical companies with respect to the
marketing of one or more of its products. Such agreements may be exclusive or
non-exclusive and may provide for marketing rights worldwide or in specific
markets.
 
Collaborative Research Agreements
 
  During the early stages of its development, the Company chose to operate
through a variety of agreements with medical research institutions.
AutoImmune's agreements with The Brigham and Women's Hospital and other
leading medical research institutions, together with the advantages of the
oral tolerance mechanism, have allowed the Company to conduct pilot human
studies and demonstrate the potential utility of its technique in a number of
diseases at a comparatively early stage of the Company's development.
 
  The Brigham and Women's Hospital. The Brigham and Women's Hospital, Inc.
("BWH"), a teaching hospital affiliated with Harvard Medical School, has been
performing sponsored research for the Company since 1988. The current
agreement extends until June 30, 2000 and is automatically renewed for
successive two-year periods unless one year's prior written notice is given.
The current research budget at BWH provides for expenditures by AutoImmune of
approximately $537,000 during the twelve months ending June 30, 1999. Under
certain circumstances, the Company may reduce its level of expenditures. The
Company will own or have exclusive rights to all inventions, improvements and
discoveries made at BWH and resulting from the research program, subject to
certain rights retained by the U.S. government in any patentable invention
conceived or first reduced to practice using federal funds. The Company will
pay to BWH (i) a royalty on all products sold by the Company that are subject
to a patent covering an invention developed under the research program or as
to which rights were acquired by the Company from BWH, and (ii) a percentage
of any royalties received by AutoImmune with respect to sales of such products
by others. BWH also will receive a percentage of any milestone payments which
the Company is entitled to receive from licensees or other transferees of such
a patent after the first commercial sale of a product covered by a patent. If
the Company defaults in the payment of any amount due to BWH, BWH will have an
option to purchase all technology developed under the research program at a
purchase price equal to the sum of all amounts previously paid by the Company
to BWH.
 
  BWH is a shareholder of the Company. Both of the scientists who made the
discoveries which led to the founding of AutoImmune are affiliated with BWH.
 
  National Eye Institute. The National Eye Institute ("NEI") was party to a
CRADA with AutoImmune and BWH pursuant to which clinical trials of
AutoImmune's uveitis product were conducted. The agreement expired June 30,
1996. The NEI is a co-owner with AutoImmune of a patent application directed
to the use of oral tolerance to treat uveitis. The NEI has granted BWH an
exclusive commercialization license for any and all products or processes
developed pursuant to the CRADA (including the uveitis patent application) in
exchange for one-half of any royalties with respect to uveitis products
collected by BWH pursuant to its agreement with the Company. BWH has in turn
granted the Company an exclusive commercialization license with respect to all
 
                                      10
<PAGE>
 
such technology. The Company and NEI are in continuing discussions regarding a
potential collaboration to develop the Company's second generation product for
uveitis, AI 301.
 
Patents and Proprietary Rights
 
  The establishment of a strong proprietary position is an important element
of AutoImmune's strategy. As of December 31, 1998, the Company had pending 34
original and continuation-in-part United States patent applications and
numerous foreign counterparts. The Company has received or has exclusive
rights to 49 U.S. and foreign patents, including five U.S. patents covering
the use of oral Type I, II, or III collagen to treat rheumatoid arthritis;
five U.S. patents covering the treatment of cell-mediated autoimmune disease
by nasal or by inhalation administration of autoantigens, and in particular
covering treatment of multiple sclerosis or rheumatoid arthritis using nasal
or by inhalation administration of compositions containing myelin basic
protein or collagen, respectively, or active fragments thereof; three U.S.
patents covering suppression of allograft rejection by oral administration of
a major histocompatibility complex Class II antigen or an active fragment
thereof; three U.S. patents covering the treatment, or prevention of the onset
of, Type 1 diabetes by oral or nasal administration of a composition
containing insulin or a fragment of insulin; one U.S. patent covering
treatment of multiple sclerosis by oral administration of bovine myelin; and
one U.S. patent covering a method for preparing Type II collagen. The European
and Japanese Patent Offices have each granted a patent to the Company covering
the use of compositions containing autoantigens to treat a group of human
autoimmune diseases, but oppositions (proceedings challenging their validity)
have been filed against these patents by a third party. The Japanese Patent
Office has issued a decision adverse to the patent, but the Company has filed
a response, and that decision is under review at present. A number of the
pending U.S. patent applications which the Company owns or to which it has
exclusive rights have been allowed and are expected to issue in the near
future.
 
  The Company owns a patent application originally filed by BWH for the
treatment of autoimmune diseases by oral administration of autoantigens,
including a number of specific patent claims directed to the treatment of
multiple sclerosis. The disclosure contained in this initial patent
application has been significantly expanded in a chain of successor
applications. There can be no assurance, however, that patents will be granted
on these applications or that the Company will succeed in developing
additional products that are patentable.
 
  The Company has applied for patents, or acquired rights to patent
applications, covering oral tolerance methods of treating or preventing other
specific autoimmune diseases and related conditions, including uveitis, Type 1
diabetes, transplant rejection, Alzheimer's disease and various skin
disorders, including psoriasis. It has filed applications that claim
tolerization treatment of autoimmune diseases by inhalation of autoantigens in
aerosol form, use of synergizing compounds to enhance the treatment of
autoimmune disorders, specific peptides thought to be involved in multiple
sclerosis, and bystander suppression, by which oral tolerance can be induced
without identifying the specific antigen causing an autoimmune disease.
 
  There can be no assurance that patent applications owned by, or licensed to,
the Company will issue as patents or that, if issued, the Company's patents
will be valid or that they will provide the Company with meaningful protection
against competitors or with a competitive advantage. There can be no assurance
that the Company will not need to acquire licenses under patents belonging to
others for technology potentially useful or necessary to the Company and there
can be no assurance that such licenses will be available to the Company, if at
all, on terms acceptable to the Company. Moreover, there can be no assurance
that any patent issued to or licensed by the Company will not be infringed or
circumvented by others. In particular, if the Company is unable to obtain
issuance of a patent with broad claims with respect to oral tolerance
treatment of autoimmune diseases or if the Company is unable to prevail in
oppositions against foreign patents of the Company with similar claim scope a
competitor may be able to design around the Company's patent rights by
employing a treatment that is not covered by the Company's subsisting patents.
 
  Much of the Company's know-how and technology may not be patentable. To
protect its rights, the Company requires employees, consultants, advisors and
collaborators to enter into confidentiality agreements.
 
                                      11
<PAGE>
 
There can be no assurance, however, that these agreements will provide
meaningful protection for the Company's trade secrets, know-how or other
proprietary information in the event of any unauthorized use or disclosure. In
addition, the Company's business may be adversely affected by competitors who
independently develop competing technologies, especially if the Company
obtains no, or only narrow, patent protection.
 
  Lastly, there can be no assurance that third-parties will not bring suit
against the Company for patent infringement or for declaratory judgment to
have the Company's patents declared invalid.
 
Competition
 
  The pharmaceutical industry is highly competitive, and research on the
causes of and possible treatments for autoimmune diseases is developing
rapidly. The Company competes with a number of pharmaceutical and
biotechnology companies which have financial, technical and marketing
resources significantly greater than those of the Company. Some companies with
established positions in the pharmaceutical industry may be better equipped
than the Company to develop and market products based on the application of
new technologies to the treatment of autoimmune diseases. A significant amount
of research in the field is also being conducted at universities and other
not-for-profit research organizations. These institutions are becoming
increasingly aware of the commercial value of their findings and are becoming
more active in seeking patent protection and licensing arrangements to collect
royalties for use of technology that they have developed. These institutions
may also market competitive commercial products on their own or through joint
ventures and will compete with the Company in recruiting highly qualified
scientific personnel.
 
  The Company is pursuing areas of product development in which there is a
potential for extensive technological innovation in relatively short periods
of time. The Company's competitors may succeed in developing products that are
more effective than those of the Company. Rapid technological change or
developments by others may result in the Company's potential products becoming
obsolete or non-competitive.
 
  For additional information concerning products developed and under
development by the Company's competitors to treat rheumatoid arthritis, see
"Principal Products in Development--Rheumatoid Arthritis."
 
Government Regulation
 
  The manufacturing and marketing of the Company's products and certain areas
of its research are subject to regulation for safety and efficacy by numerous
government authorities in the United States and other countries. Domestically,
the Federal Food, Drug and Cosmetic Act, the Public Health Service Act, and
other federal and state statutes and regulations govern the testing,
manufacture, safety, efficacy, labeling, storage, record keeping, approval,
advertising and promotion of the Company's products. There can be no assurance
that the Company will ever obtain the government approval necessary to make
commercial sales of any of its products.
 
  Further, the FDA may grant Orphan Drug status, under the Orphan Drug Act, to
therapeutic agents which are intended to treat a "rare disease or condition,"
which is generally described as a disease or condition that affects fewer than
200,000 individuals in the United States, but also includes multiple sclerosis
and certain other diseases. Orphan Drug status confers upon the sponsor tax
credits for the amounts expended on clinical trials, as well as marketing
exclusivity for the proposed therapeutic indication for a period of seven
years following approval of a New Drug Application ("NDA") or Biologics
License Application ("BLA"). This status does not convey any advantage during
regulatory review, but it is possible that products may qualify both for
Orphan Drug status and also for fast-track regulatory review. Colloral for
juvenile rheumatoid arthritis has been designated as an Orphan Drug. The
Company also expects to apply for Orphan Drug status on AI 301, its product
for uveitis. To receive the benefits of Orphan Drug designation, however, the
Company must be first to receive FDA approval of the product for the
particular indication.
 
  AutoImmune believes that many of its products under development will be
classified by the FDA as "biologic products," while others may be classified
as "drug products." As part of its regulatory strategy, the
 
                                      12
<PAGE>
 
Company intends to direct some of its products into the Biologics Divisions of
the FDA. While both biologics and drugs can qualify for Orphan Drug status,
biologics, once approved, have no current provision for subsequent competitors
to market generic versions. Each biologic, even if it has the same composition
and is for the same indication, must undergo the entire development process in
order for a competitive firm to obtain FDA approval.
 
  New drug or biological products require several steps in order to receive
regulatory approval, including (i) preclinical laboratory and animal tests;
(ii) submission by the Company or an individual physician to the FDA of an
application for an IND, or submission to a research institution of an
Institutional Review Board approval for intrastate trials, one of which must
become effective before human clinical trials may start; (iii) the performance
of well-controlled clinical trials; and (iv) the submission of an NDA or BLA
containing the results of clinical trials and methods of manufacture of the
product prior to commercial sale or shipment of the product. During the
approval process, the FDA must confirm that good laboratory and clinical
practices were maintained during product testing as well as good manufacturing
practices were employed in product manufacture.
 
  Preclinical tests include laboratory evaluation of product chemistry and
animal studies to assess potential product safety and efficacy. The results of
the preclinical tests are submitted to the FDA as part of an IND, and, unless
the FDA objects, the IND becomes effective, and clinical trials may begin, 30
days after the FDA receives the filing.
 
  The initial clinical evaluation, Phase I trials, generally involve
administration of a product to a small number of persons. The product is
tested for safety, dosage tolerance, metabolism, and pharmacokinetic
properties. Phase II trials generally involve administration of a product to a
limited number of patients with a particular disease to determine dose level,
efficacy and safety. Phase III trials generally examine the clinical efficacy
and safety in an expanded patient population at multiple clinical sites. The
FDA reviews the clinical plans and the results of trials and can discontinue
the trials at any time if there are significant safety issues or if there is
convincing evidence that a drug is not effective for the purpose for which it
is being investigated. Each of AutoImmune's clinical trials will be conducted
with the approval of an Institutional Review Board at the institution where
the trial will be conducted. The Institutional Review Board considers, among
other things, ethical factors, the safety of human subjects and the possible
liability of the institution. Pivotal Phase III trials are designed to
demonstrate definitive efficacy. More than one trial is usually required for
FDA approval to market a drug. The results of the preclinical and clinical
trials are submitted after completion of the pivotal Phase III trials in the
form of a BLA or NDA for approval to commence commercial sales. The approval
process is affected by several factors, including the severity of the disease,
the availability of alternative treatments and the risks and benefits
demonstrated in clinical trials. The FDA may also require post-marketing
surveillance to monitor potential adverse effects of the product. The
regulatory process can be modified by Congress or the FDA in specific
situations.
 
  The length of the regulatory review process cannot be predicted with
certainty for new individual products. The Drug Price Competition and Patent
Term Restoration Act, however, defines the original period of enforceability
for a product or use patent to be 17 years from issuance or 20 years from
filing. Under certain circumstances, to compensate the patent holder for the
time required for FDA regulatory review, this period may be extended for up to
5 years. This Act also establishes a period following FDA approval of a
product during which the FDA may not accept or approve short-form applications
for generic versions of the drug from other sponsors.
 
  The Company also will be subject to government regulations enforced under
the Occupational Safety and Health Act, the Environmental Protection Act, the
United States Atomic Energy Act, the Clean Air Act, the Clean Water Act, the
National Environmental Policy Act, the Toxic Substances Control Act, the
Resource Conservation and Recovery Act, and other national, state or local
restrictions.
 
  In addition, the Company's ability to successfully commercialize human
therapeutic products may depend in part on the extent to which reimbursement
for the cost of such products and related treatment will be available from
government health administration authorities, private health coverage insurers
and other organizations. Significant uncertainty exists as to the
reimbursement status of newly approved health care products, and there
 
                                      13
<PAGE>
 
can be no assurance that adequate third-party coverage will be available for
the Company to maintain price levels sufficient for realization of an
appropriate return on its investment in product development.
 
Employees
 
  As of March 5, 1999, AutoImmune employed 23 individuals full-time, 4 of whom
hold Ph.D. degrees. Of its total work force, 17 employees are engaged in
research and development activities and 6 are devoted to support and
administrative activities. AutoImmune believes it maintains good relations
with its employees.
 
Factors To Be Considered
 
  The parts of this Annual Report on Form 10-K titled "Item 1--Business" and
"Item 7--Management's Discussion and Analysis of Financial Condition and
Results of Operations" contain forward-looking statements which involve risks
and uncertainties. Set forth below is a discussion of certain factors that
could cause the Company's actual results to differ materially from the results
projected in such forward-looking statements.
 
  Developmental Stage of the Company's Products. The Company has not completed
the development of any products. The Company's products require significant
additional clinical testing and investment prior to commercialization.
Products for therapeutic use in human health care must be evaluated in
extensive human clinical trials to determine their safety and efficacy as part
of a lengthy process to obtain government approval. The Company has a number
of products in clinical development, including Colloral, AI 401 and AI 502.
Positive results for a product in a clinical trial do not necessarily assure
that future clinical trials will yield positive results or that the government
will approve the commercialization of the product. Clinical trials may be
terminated at any time for many reasons, including toxicity or a lack of
efficacy based upon mid-trial examinations of clinical trial data or adverse
event reporting. There can be no assurance that the Company will successfully
develop any product or that the Company's products will prove to be safe and
efficacious in clinical trials, meet applicable regulatory standards, receive
required regulatory approvals, be capable of being produced in commercial
quantities at reasonable costs or be successfully marketed. The Company also
may encounter problems in clinical trials that will cause the Company to delay
or suspend product development. The Company does not expect that its products
will be commercially available in 1999.
 
  History of Operating Losses; Lack of Product Revenues. From its inception in
1988 through December 31, 1998, the Company accumulated net losses of
$100,801,000. The Company expects to continue to incur losses for a number of
years as the Company continues its research, development and clinical trial
programs. The Company's ability to achieve profitable operations depends on
the Company successfully completing the development of its products, obtaining
required regulatory approvals and manufacturing and marketing its products.
There can be no assurance that the Company will achieve profitable operations
at any time.
 
  The Company's revenues to date have been earned in connection with
collaborative agreements and the granting of short term rights. The Company
has granted to Teva exclusive worldwide patent rights to the multiple
sclerosis and myasthenia gravis applications of its technology. These rights
were granted in return for payments if certain milestones are achieved and
royalties based on sales, if any. There can be no assurance that the Company
will derive any revenues from the Teva agreement. At present, there are no
other agreements that entitle the Company to receive revenues.
 
  Additional Financing Requirements and Access to Capital. Since inception,
the Company has raised net proceeds of $116,000,000 from the sale of equity
securities in private placements and public stock offerings. The Company will
require substantial funds for further research and development, existing and
planned clinical trials, regulatory approvals, establishment of commercial-
scale manufacturing capabilities and the marketing of its products. Based upon
its current plans, the Company believes that current cash and marketable
securities and the interest earned from the investment thereof will be
sufficient to meet the Company's operating expenses and capital requirements
through the Phase III clinical program for Colloral. Thereafter, the Company
will need to raise substantial additional capital to fund its operations,
including clinical trials and commercialization efforts.
 
                                      14
<PAGE>
 
  The Company intends to seek such additional funding through public or
private equity or debt financings, collaborative arrangements with
pharmaceutical companies or other sources. There can be no assurance that
additional financing will be available on acceptable terms, if at all. If
adequate funds are not available, the Company will have to reduce certain
areas of research, product development, manufacturing or marketing activity or
otherwise modify its business strategy, and its business will be materially
adversely affected.
 
  Dependence on Collaborative Agreements. One of the Company's historic
objectives has been to enter into licensing agreements or joint ventures with
established pharmaceutical companies for products to be sold in foreign
markets or for products to treat diseases which involve large physician
audiences and/or which are expected to have longer regulatory approval cycles.
The Company has an agreement with Teva with respect to multiple sclerosis and
myasthenia gravis products. There can be no assurance that the Company will be
able to negotiate other acceptable arrangements in the future, to the extent
the Company desires to do so, or that such arrangements will be successful.
 
  The majority of the Company's basic research to date has been done through
agreements with The Brigham and Women's Hospital and other medical research
institutions. Since 1993, the Company has conducted some research and most of
its development activities internally. Currently the Company has 17 full-time
employees engaged in research and product development. Nevertheless, the
Company expects to continue to be at least partially dependent upon research
performed under contract with The Brigham and Women's Hospital. If the Company
is unable to maintain this relationship, the Company would be adversely
affected and the Company's ability to commercialize future products would be
delayed.
 
  Manufacturing and Marketing. The Company has not yet introduced any products
and has limited manufacturing experience. To be successful, the Company's
products must be manufactured in commercial quantities in compliance with
regulatory requirements and at acceptable costs. The Company currently has
facilities for bulk manufacturing of its product Colloral in commercial
quantities. FDA approval has not yet been obtained for this facility and there
can be no assurance that it will meet regulatory requirements without
additional investments. The Company has contract manufacturers perform filling
and packaging of Colloral for clinical trials. To the extent the Company
relies upon contract manufacturers, there can be no assurance that such
parties will perform their obligations in a timely fashion. The failure by
third parties to perform their obligations in a timely fashion could delay
clinical trials or commercialization of a product and could adversely affect
the Company's ability to supply the market. There can be no assurance that the
Company will be able to enter into agreements to manufacture its products, if
the Company desires to do so, on favorable terms, if at all.
 
  If the Company chooses to expand its manufacturing facilities to include
filling and packaging, there can be no assurance that the Company will be
successful in doing so. Developing its own full-scale manufacturing facilities
will require substantial additional funds. All manufacturing facilities must
comply with applicable regulations of the FDA. No assurance can be given that
the Company's products will not require raw materials for which the sources
and amount of supply are limited. An inability to obtain adequate supplies of
such raw materials could significantly delay the development, regulatory
approval and marketing of the Company's products.
 
  The Company has no sales organization or marketing force. In order to market
any of its products directly, the Company must develop a marketing and sales
force with sufficient technical expertise to generate demand for its products.
There can be no assurance that the Company will be able to establish effective
sales and distribution capabilities or be successful in gaining market
acceptance for its products.
 
  Patents and Proprietary Rights. The Company's success will depend, in part,
on its ability to obtain patents and Orphan Drug protection, maintain trade
secret protection and operate without infringing on the proprietary rights of
third parties or having third parties circumvent the Company's rights. The
Company has received or has exclusive rights to 49 U.S. and foreign patents.
The Company has filed and is actively pursuing numerous applications for
additional U.S. and foreign patents, and is an assignee or licensee of the
rights to other
 
                                      15
<PAGE>
 
patent applications. The patent positions of biotechnology and pharmaceutical
companies can be highly uncertain and involve complex legal and factual
questions. For example, no consistent policy has emerged regarding the breadth
of biotechnology patent claims that are granted by the United States Patent
Office or enforced by the federal courts. Thus, there can be no assurance that
any patents issued to the Company will provide the Company with any
competitive advantages or will not be challenged by any third parties, that
the patents of others will not impede the ability of the Company to do
business or that third parties will not be able to circumvent the Company's
patents, that any of the Company's patent applications will result in the
issuance of patents or that the Company will develop additional proprietary
products that are patentable. Certain of the Company's foreign patents are
currently subject to or under opposition, a proceeding which, if resolved
adversely to the Company, can result in revocation of a patent or curtailment
of its claim scope. See "Strategy--Protecting the Company's Competitive
Position." There can be no assurance that the Company will prevail in such
oppositions. Furthermore, there can be no assurance that others will not
develop independently similar products, duplicate any of the Company's
products, or, if patents are issued to the Company, design around the patented
products developed by the Company. Although the Company has obtained Orphan
Drug status in the United States for some of its products, it also must be the
first to market an effective treatment for a particular disease in order to
obtain the protections afforded to Orphan Drugs.
 
  The Company may be required to obtain licenses from third parties to avoid
infringing patents or other proprietary rights. No assurance can be given that
any licenses required under any such patents or proprietary rights would be
available, if at all, on terms acceptable to the Company. If the Company does
not obtain such licenses, it could encounter delays in product introductions,
or could find that the development, manufacture or sale of products requiring
such licenses could be prohibited. In addition, the Company could incur
substantial costs in defending itself in suits brought against the Company on
patents it might infringe or in filing suits against others to have such
patents declared invalid.
 
  Much of the Company's know-how and technology may not be patentable. To
protect its rights, the Company requires employees, consultants, advisors and
collaborators to enter into confidentiality agreements. There can be no
assurance, however, that these agreements will provide meaningful protection
for the Company's trade secrets, know-how or other proprietary information in
the event of any unauthorized use or disclosure. Furthermore, the Company's
business may be adversely affected by competitors who independently develop
competing technologies, especially if the Company obtains no, or only narrow,
patent protection.
 
  Technological Change and Competition. The biotechnology and pharmaceutical
industries are subject to rapid and significant technological change. The
Company's competitors are numerous and include, among others, major
pharmaceutical companies, biotechnology firms, universities and other research
institutions in the United States and abroad. There can be no assurance that
the Company's competitors will not develop technologies and products that are
more effective than any being developed by the Company or that would render
the Company's technology and products obsolete or noncompetitive. Many of
these competitors have substantially greater financial and technical resources
and production and marketing capabilities than the Company. In addition, many
of the Company's competitors have significantly greater experience than the
Company in conducting preclinical testing and clinical trials of
pharmaceutical products and obtaining FDA and other regulatory approvals of
products for use in health care. Accordingly, the Company's competitors may
obtain FDA approval for products more rapidly than the Company. If the Company
commences significant commercial sales of its products, it will also compete
with other companies with respect to manufacturing efficiency and marketing
capabilities, areas in which it has limited experience.
 
  Government Regulation. The Company's production and marketing of its
products and ongoing research and development activities are subject to
regulation by numerous government authorities in the United States and other
countries. Prior to marketing, any therapeutic product developed by the
Company must undergo rigorous preclinical testing and clinical trials, as well
as an extensive regulatory approval process mandated by the FDA and foreign
regulatory agencies. These processes can take many years and require the
expenditure of substantial resources. The Company has limited experience in
conducting and managing the preclinical and
 
                                      16
<PAGE>
 
clinical trials necessary to obtain government approvals. Delays in obtaining
regulatory approvals would adversely affect the marketing of the Company's
products and its ability to receive product revenues or royalties. There can
be no assurance that the Company will be able to obtain the clearances and
approvals necessary for the clinical testing or manufacturing and marketing of
its products. Existing or additional government regulation could prevent or
delay regulatory approval of the Company's products or affect the pricing or
marketing of such products.
 
  Year 2000 Issues. Certain computer programs use only two digits to identify
a year in the date field. As a result, many computer applications may fail or
create erroneous results by or at the Year 2000. The Company's business is not
dependent on its computer programs and does not electronically interact in any
significant manner with suppliers, customers, creditors, borrowers and
financial service organizations. The impact on the Company of Year 2000 issues
is expected to be minimal, but there can be no assurance that the Company will
not be adversely affected by such issues.
 
Item 2. Properties.
 
  AutoImmune's administrative offices and research facilities occupy
approximately 11,000 square feet of leased space in Lexington, Massachusetts.
The lease runs through November 1999 and includes renewal clauses. The Company
believes that its facilities are adequate for its present and anticipated
purposes, except that additional facilities may be needed if the Company
expands its manufacturing operations.
 
Item 3. Legal Proceedings.
 
  The Company is not a party to any litigation or legal proceedings.
 
Item 4. Submission of Matters to a Vote of Security Holders.
 
  No matters were submitted to a vote of the Company's shareholders during the
fourth quarter of fiscal 1998.
 
                                      17
<PAGE>
 
                                    PART II
 
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
 
  The Company's Common Stock is traded on the Nasdaq National Market under the
symbol AIMM. The following table shows the quarterly high and low closing
price on Nasdaq for a share of the Company's common stock for the fiscal years
ended December 31, 1997 and 1998.
 
<TABLE>
<CAPTION>
                                      Price range of
                                       common stock
                                      ---------------
                                       High     Low
                                      ------- -------
<S>                                   <C>     <C>
Fiscal year ending December 31, 1997
  First quarter                       $ 18.25 $ 11.00
  Second quarter                      $ 14.50 $  1.63
  Third quarter                       $  2.88 $  1.69
  Fourth quarter                      $  3.50 $  2.56
Fiscal year ending December 31, 1998
  First quarter                       $  3.44 $  2.25
  Second quarter                      $  3.06 $  2.31
  Third quarter                       $  2.62 $  1.62
  Fourth quarter                      $  2.56 $  1.56
</TABLE>
 
  As of March 5, 1999, there were 259 record holders of the Company's Common
Stock.
 
  AutoImmune has never declared or paid any cash dividends on its capital
stock. The Company currently intends to retain its earnings, if any, and
therefore does not anticipate paying any cash dividends on its capital stock
in the foreseeable future.
 
                                      18
<PAGE>
 
Item 6. Selected Financial Data.
 
  The selected financial data set forth below are derived from financial
statements that have been audited by PricewaterhouseCoopers LLP, independent
accountants. The balance sheet at December 31, 1997 and 1998 and the related
statements of operations and of cash flows for the three years ended December
31, 1998 and notes thereto appear elsewhere in this Form 10-K. The data set
forth below should be read in conjunction with "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and the Company's
financial statements and related notes included elsewhere in this Form 10-K.
 
<TABLE>
<CAPTION>
                                       For the year ended December 31,
                       --------------------------------------------------------------------
                           1994          1995          1996          1997          1998
                       ------------  ------------  ------------  ------------  ------------
<S>                    <C>           <C>           <C>           <C>           <C>
Statement of
 Operations Data:
Revenue:
 Option fees           $        --   $  1,500,000  $        --   $        --   $        --
 Research and
  development revenue
  under collaborative
  agreements                    --            --            --            --            --
                       ------------  ------------  ------------  ------------  ------------
   Total revenue                --      1,500,000           --            --            --
                       ------------  ------------  ------------  ------------  ------------
Costs and expenses:
 Research and
  development:
  Related party           2,257,000     2,294,000     2,158,000     1,880,000     1,314,000
  All other              11,381,000    12,554,000    22,029,000    15,426,000    11,496,000
 General and
  administrative          1,662,000     2,213,000     2,414,000     2,214,000     1,712,000
                       ------------  ------------  ------------  ------------  ------------
   Total costs and
    expenses             15,300,000    17,061,000    26,601,000    19,520,000    14,522,000
                       ------------  ------------  ------------  ------------  ------------
Loss from operations    (15,300,000)  (15,561,000)  (26,601,000)  (19,520,000)  (14,522,000)
Interest income, net        623,000     1,968,000     3,117,000     1,995,000     1,337,000
                       ------------  ------------  ------------  ------------  ------------
Net loss               $(14,677,000) $(13,593,000) $(23,484,000) $(17,525,000) $(13,185,000)
                       ============  ============  ============  ============  ============
Net loss per share--
 basic and diluted(1)  $      (1.44) $      (1.01) $      (1.44) $      (1.07) $      (0.80)
                       ============  ============  ============  ============  ============
Weighted average
 common shares
 outstanding--basic
 and diluted(1)          10,205,567    13,522,091    16,303,051    16,385,629    16,491,701
                       ============  ============  ============  ============  ============
<CAPTION>
                                                 December 31,
                       --------------------------------------------------------------------
                           1994          1995          1996          1997          1998
                       ------------  ------------  ------------  ------------  ------------
<S>                    <C>           <C>           <C>           <C>           <C>
Balance Sheet Data:
Cash, cash
 equivalents and
 marketable
 securities            $ 15,568,000  $ 70,453,000  $ 49,310,000  $ 30,025,000  $ 17,528,000
Working capital          13,825,000    68,791,000    45,453,000    28,983,000    16,325,000
Total assets             18,218,000    72,981,000    52,462,000    31,498,000    18,326,000
Capital lease
 obligations less
 current maturities       1,031,000       569,000       627,000       193,000           --
Deficit accumulated
 during development
 stage                  (33,018,000)  (46,611,000)  (70,095,000)  (87,620,000) (100,805,000)
Total stockholders'
 equity                  15,102,000    70,418,000    47,341,000    29,880,000    16,917,000
</TABLE>
--------
(1) Basic net loss per share is calculated by dividing net loss by the
    weighted average number of common shares outstanding during the year in
    accordance with the provisions of Statement of Financial Accounting
    Standards No. 128, Earnings Per Share. For each of the periods presented,
    basic and diluted net loss per share are the same due to the antidilutive
    effect of potential common shares.
 
                                      19
<PAGE>
 
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
 
Results of Operations
 
Overview
 
  Since its inception through December 31, 1998, the Company has incurred
ongoing losses from operations and has cumulative losses as of December 31,
1998 totaling $100,801,000. To date, the Company has not recorded any revenue
from the sale of products. Revenue recorded through December 31, 1998 was
earned in connection with contract research and the granting of certain short-
term rights.
 
  The Company expects to remain in the development stage for the foreseeable
future and accordingly expects to continue to incur substantial losses.
 
 Years Ended December 31, 1997 and 1998
 
  No revenues were earned in the years ended December 31, 1997 and 1998.
 
  Research and development expenses were $17,306,000 in 1997, as compared with
$12,810,000 for the year ended December 31, 1998. The decrease is due to lower
levels of research and clinical trial activity in 1998 and restructuring costs
recorded in 1997.
 
  General and administrative expenses were $2,214,000 in 1997, as compared
with $1,712,000 for the year ended December 31, 1998. The decrease is due
primarily to decreased personnel costs and corporate activity and
restructuring costs recorded in 1997.
 
  Net interest income was $1,995,000 in 1997, as compared with $1,337,000 for
the year ended December 31, 1998. The decrease is due to a lower balance of
cash available for investment.
 
  The net loss was $17,525,000 in 1997, as compared with $13,185,000 for the
year ended December 31, 1998. The net loss per share decreased from $1.07 for
the year ended December 31, 1997 to $0.80 for the year ended December 31,
1998. The change reflects a decrease in personnel costs and research and
development activity levels and restructuring costs recorded in 1997.
 
 Years Ended December 31, 1996 and 1997
 
  No revenues were earned in the years ended December 31, 1996 and 1997.
 
  Research and development expenses were $24,187,000 in 1996, as compared with
$17,306,000 for the year ended December 31, 1997. The decrease reflects
overall reduced research and clinical trial activity levels partially offset
by restructuring costs incurred as a result of a corporate downsizing.
 
  General and administrative expenses were $2,414,000 in 1996, as compared
with $2,214,000 for the year ended December 31, 1997. The decrease is due
primarily to increased corporate activity and restructuring costs in the first
half of 1997 offset by reduced corporate activity in the second half of 1997
after the restructuring occurred.
 
  Net interest income was $3,117,000 in 1996, as compared with $1,995,000 for
the year ended December 31, 1997. The decrease is due to a lower balance of
cash available for investment.
 
  The net loss was $23,484,000 in 1996, as compared with $17,525,000 for the
year ended December 31, 1997. The net loss per share decreased from $1.44 for
the year ended December 31, 1996 to $1.07 for the year ended December 31,
1997. This reflects the recent decrease in research and development activity
levels partially offset by restructuring costs incurred as a result of a
corporate downsizing.
 
                                      20
<PAGE>
 
  In April 1997, the Company announced disappointing results from the Phase
III trial of Myloral(R), its product for multiple sclerosis. Very soon
thereafter, the Company also announced a corporate downsizing by eliminating
23 positions directly related to the Myloral program and an increased focus of
resources on the development of Colloral for rheumatoid arthritis. The Company
recorded a charge during the second quarter of 1997 of approximately $618,000
relating primarily to employee severance costs and costs associated with
terminating Myloral manufacturing and clinical trial functions. This estimated
charge was adjusted to $615,000 during the third quarter of 1997 to reflect
actual costs incurred.
 
  In May 1997, the Company announced preliminary results from two Phase II
trials of Colloral for rheumatoid arthritis. Both trials demonstrated positive
trends for Colloral, although statistical significance was not demonstrated
versus placebo. A restructuring plan was announced in June 1997, to further
focus the Company's efforts to the clinical program for Colloral. This
resulted in a further workforce reduction of 30 positions. The Company
recorded a charge during the second quarter of 1997 of approximately
$2,689,000 relating to employee severance, costs associated with vacating
leased space and equipment disposal and write-offs. This estimated charge was
adjusted to $1,636,000 during the third quarter of 1997 to reflect the
sublease of 22,000 square feet of space and actual costs incurred.
 
Liquidity and Capital Resources
 
  The Company's needs for funds have historically increased from period to
period as it has increased the scope of its research and development
activities although its current needs have been reduced as a result of the
restructuring plan which occurred during the first half of 1997. Since
inception, the Company has funded these needs almost entirely through sales of
its equity securities.
 
  The Company's working capital and capital requirements will depend on
numerous factors, including the progress of the Company's research and
development activities, the level of resources that the Company devotes to the
development, clinical, regulatory and marketing aspects of its products, the
extent to which it proceeds by means of collaborative relationships with
pharmaceutical companies and its competitive environment. Based upon its
current plans, the Company believes that current cash and marketable
securities and the interest earned from the investment thereof will be
sufficient to meet the Company's operating expenses and capital requirements
through the Phase III clinical program of Colloral. At the appropriate time,
the Company intends to seek additional funding through public or private
equity or debt financings, collaborative arrangements with pharmaceutical
companies or from other sources. If additional funds are necessary but not
available, the Company will have to reduce certain areas of research, product
development, manufacturing or marketing activity, or otherwise modify its
business strategy, and its business will be materially adversely affected.
 
  In order to preserve principal and maintain liquidity, the Company's funds
are invested in U.S. Treasury obligations and other short-term instruments. As
of December 31, 1998, the Company's cash and cash equivalents and marketable
securities totaled $17,528,000. Current liabilities at December 31, 1998 were
$1,409,000.
 
Year 2000 Preparedness
 
  The Company's management has completed its review of Year 2000 issues and
believes that Year 2000 issues will not have a material effect on the
Company's business, results of operations or financial condition. The major
functions of the Company that utilize computers and could be susceptible to
Year 2000 issues are manufacturing, clinical data and analysis, financial and
general office. The scope of the Year 2000 issues for each of these functions
is described below.
 
  Manufacturing. The Company's internal bulk manufacturing process is a
mechanical process. Neither the process nor the raw materials used in the
process are expected to be affected by Year 2000 issues. The Company maintains
data relating to its manufacturing processes on databases using standard
software packages that are Year 2000 compliant. It also maintains all data in
hard copy format. The Company has been upgrading its
 
                                      21
<PAGE>
 
hardware systems used to maintain manufacturing data as system requirements
have changed and these upgrades have included Year 2000 solutions. The Company
anticipates that its hardware systems will be fully upgraded and Year 2000
compliant before December 31, 1999. The Company uses outside vendors to
perform filling, labeling and distribution services in connection with its
manufacturing process. The Company maintains data relating to such services
both in hard copy format and on databases. The vendor that the Company
anticipates using for these services has represented that it will be Year 2000
compliant before December 31, 1999. In any event, hard copy records can be
used and will meet the Company's requirements.
 
  Clinical Data and Analysis. The firm AutoImmune has contracted with to
manage and analyze clinical data has represented to the Company that it is
Year 2000 compliant. In addition, the data that the Company intends to submit
to the FDA will be based on patient activity occurring prior to January 1,
2000 and is in a format that can be accessed with standard programs.
 
  Financial. The Company has been upgrading its financial systems as its
requirements have changed and these upgrades have included Year 2000
solutions. The final component is expected to be upgraded in the second
quarter of 1999 and will be Year 2000 compliant. These upgrades would have
occurred regardless of Year 2000 concerns.
 
  General Office. The Company's office computers have been updated as the
Company's requirements have increased. As a result, almost all are Year 2000
compliant. The Company's network and phone systems require Year 2000 software
upgrades that are scheduled for installation in the last quarter of 1999. The
estimated cost of these upgrades is $20,000.
 
  Impact of Year 2000. The Company's exposure to Year 2000 is limited by the
nature of its operations. The Company is not electronically dependent on its
vendors. Its software packages, other than its network and phone system
packages, are standard and the Company's hardware is already Year 2000
compliant or is scheduled to be upgraded before December 31, 1999. These
upgrades to the Company's hardware systems would have occurred regardless of
the Year 2000. In the worst case scenario, the Company could easily revert to
using hard copies. This scenario would be more time consuming, but would not
be expected to result in revenue losses or liability to third parties.
 
Item 8. Financial Statements and Supplementary Data.
 
  Information with respect to the Company's financial statements and financial
statement schedules filed with this report is set forth in Item 14 of Part IV.
 
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
 
  None.
 
 
                                      22
<PAGE>
 
                                   PART III
 
Item 10. Directors and Executive Officers of the Registrant.
 
  Director information is incorporated by reference to the Company's proxy
statement which the Company intends to file with the Securities and Exchange
Commission and mail to shareholders within 120 days of the Company's fiscal
year ended December 31, 1998.
 
Executive officer information is as follows:
 
  Robert C. Bishop, Ph.D., age 56, became a director of the Company in May
1992, when he was also elected President and Chief Executive Officer. For more
than five years prior to joining the Company, Dr. Bishop held senior
management positions at Allergan, Inc., an eye and skin care company,
including President of Allergan Medical Optics from 1986 to 1988, Senior Vice
President, Corporate Development of Allergan, Inc. from 1988 to 1989,
President of Allergan Pharmaceuticals, Inc. from 1989 to 1991 and Group
President, Therapeutics for Allergan's worldwide pharmaceutical, surgical and
neurotoxin businesses from February 1991 to May 1992. From 1976 through 1986,
Dr. Bishop served as an executive of American Hospital Supply Corporation. Dr.
Bishop received his B.A. degree and a Ph.D. in biochemistry from the
University of Southern California and his M.B.A. from the University of Miami.
Dr. Bishop is a director of Quintiles Transnational Corp., a contract
research, sales and marketing company serving the health care industry. Dr.
Bishop is also a director of Millipore Corporation, a purification
technologies/systems company serving the microelectronics, biopharmaceutical
and analytical laboratories markets.
 
  Heather A. Ellerkamp, CPA, age 34, joined the Company in February 1994.
Since June 1997, Ms. Ellerkamp has been Director of Finance and Treasurer of
the Company, and from February 1994 to June 1997, she held various financial
positions with the Company, including controller. From 1992 to 1994, she was
employed by Kendall Square Research Corporation, most recently as Corporate
Accounting Manager and Assistant Controller. Ms. Ellerkamp received her B.A.
degree in Management Science from the University of California, San Diego and
her M.B.A. from the University of Michigan.
 
  Jo Ann Wallace, age 44, joined the Company in October 1994. In January 1999,
Ms. Wallace became Senior Vice President of the Company. From October 1994 to
January 1999, she was Vice President, Corporate Development of the Company.
From 1993 to 1994, she was Vice President, Sales and Marketing at Greenwich
Pharmaceuticals, Inc. From 1981 to 1993, Ms. Wallace was employed by G.D.
Searle & Co., most recently as Senior Director in U.S. Marketing. Ms. Wallace
received her B.S. degree in microbiology from the University of Texas.
 
Item 11. Executive Compensation.
 
  Incorporated by reference to the Company's proxy statement which the Company
intends to file with the Securities and Exchange commission and mail to
shareholders within 120 days of the Company's fiscal year ended December 31,
1998.
 
Item 12. Security Ownership of Certain Beneficial Owners and Management.
 
  Incorporated by reference to the Company's proxy statement which the Company
intends to file with the Securities and Exchange Commission and mail to
shareholders within 120 days of the Company's fiscal year ended December 31,
1998.
 
Item 13. Certain Relationships and Related Transactions.
 
  Not applicable.
 
                                      23
<PAGE>
 
                                    PART IV
 
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
 
(a)(1) Financial Statements
 
<TABLE>
<CAPTION>
                                                                         Page
                                                                         ----
<S>                                                                      <C>
Report of Independent Accountants                                        F-2
 
Balance Sheet at December 31, 1997 and 1998                              F-3
 
Statement of Operations for the three years ended December 31, 1998 and
 for the period from inception (September 9, 1988) through December 31,
 1998                                                                    F-4
 
Statement of Changes in Stockholders' Equity for the period from
 inception (September 9, 1988) through December 31, 1998                 F-5
 
Statement of Cash Flows for the three years ended December 31, 1998 and
 for the period from inception (September 9, 1988) through December 31,
 1998                                                                    F-6
 
Notes to the Financial Statements                                        F-7
</TABLE>
 
(a)(2) Financial Statement Schedule
 
  All schedules are omitted because they are not applicable or the required
information is shown in the financial statements.
 
(a)(3) Exhibits
 
<TABLE>
<CAPTION>
 Exhibit
 Number  Exhibit Description
 ------- -------------------
 <C>     <S>
  3.1    --Restated Certificate of Incorporation(1)
 
  3.2    --By-Laws(2)
 
  4.1    --Specimen Common Stock Certificate(2)
 
 10.1    --Amended and Restated 1988 Stock Option Plan effective December 14,
          1992(1)
 
 10.2    --Agreement, dated March 18, 1992, between AutoImmune Inc. and
          Schering Corporation(2)+
 
 10.3    --Lease Agreement, dated November 1992, between AutoImmune Inc. and
          Ledgemont Realty Trust(2)
 
 10.4    --Amended and Restated Research and Development Agreement, dated July
          1, 1992, between AutoImmune Inc. and The Brigham and Women's
          Hospital, Inc.(2)
 
 10.5    --Research Agreement, dated October 21, 1992, and Royalty Agreement,
          dated 1992, between AutoImmune Inc. and Joslin Diabetes Center(2)
 
 10.6    --Research Agreement, dated July 1, 1992, Royalty Agreement, dated
          June 6, 1990, and Research Agreement, dated July 1990, between
          AutoImmune Inc. and the Beth Israel Hospital(2)
 
 10.7    --Cooperative Research and Development Agreement, effective July 1,
          1990, among the National Eye Institute of the National Institutes of
          Health, The Brigham and Women's Hospital and AutoImmune Inc.(2)
 
 10.8    --Retainer Agreement, dated June 1, 1992, between AutoImmune Inc. and
          Cato Research Ltd.(2)
 
 10.9    --Employment Agreement, dated April 2, 1992, between AutoImmune Inc.
          and Robert C. Bishop(2)
 
 10.10   --Amended Consulting Agreement, dated July 1992, and Amended and
          Restated Consulting Agreement, dated November 1988, between
          AutoImmune Inc. and Howard L. Weiner, M.D.(2)
 
 10.11   --Amended Consulting Agreement, dated July 1992, and Amended and
          Restated Consulting Agreement, dated November 1988, between
          AutoImmune Inc. and David A. Hafler, M.D.(2)
 
</TABLE>
 
 
                                       24
<PAGE>
 
<TABLE>
<CAPTION>
 Exhibit
 Number  Exhibit Description
 ------- -------------------
 <C>     <S>
 10.13   --Consulting Agreement, dated February 1, 1989, between AutoImmune
          Inc. and James P. Tam, Ph.D.(2)
 
 10.14   --Scientific Advisory Board Agreement, dated August 5, 1992, and
          Consulting Service Agreement, dated August 5, 1992, between
          AutoImmune Inc. and Jack L. Strominger, M.D.(2)
 
 10.15   --Scientific Advisory Board Agreement, dated August 11, 1992, between
          AutoImmune Inc. and Herman N. Eisen, M.D.(2)
 
 10.16   --Scientific Consultant Agreement, dated July 16, 1992, between
          AutoImmune Inc. and Henry Oettinger, Ph.D.(2)
 
 10.17   --Nonemployee Director Stock Option Plan(3)
 
 10.18   --Employee Stock Purchase Plan(4)
 
 10.19   --License and Collaboration Agreement dated December 1, 1994 between
          AutoImmune Inc. and Eli Lilly and Company(5)+
 
 10.20   --First Amendment to Lease dated October 31, 1993 between AutoImmune
          Inc. and Ledgemont Realty Trust(6)
 
 10.21   --Second Amendment to Lease dated February 1, 1996 between AutoImmune
          Inc. and Ledgemont Realty Trust(6)
 
 10.22   --Third Amendment to Lease, dated October 23, 1996 between AutoImmune
          Inc. and Ledgemont Realty Trust(7)
 
 10.23   --Sublease agreement, dated November 1, 1997 between AutoImmune Inc.
          and Antigenics, LLC(7)
 
 10.24   --Consent to Sublease Agreement, dated November 1, 1997 between
          AutoImmune Inc., Antigenics, LLC, and Ledgemont Realty Trust(7)
 
 10.25   --1998 Stock Option Plan(8)
 
 10.26   --Development and License Agreement dated as of December 4, 1998
          between AutoImmune Inc. and Teva Pharmaceutical Industries Ltd.++
 
 10.27   --Sublease Termination Agreement, dated June 15, 1998 between
          AutoImmune Inc. and Antigenics, LLC
 
 10.28   --Fourth Amendment to Lease, dated July 17, 1998 between AutoImmune
          Inc. and Ledgemont Realty Trust
 
 23      --Consent of PricewaterhouseCoopers LLP
</TABLE>
--------
(1) Incorporated by reference to the Company's Annual Report on Form 10-K for
    the year ended December 31, 1992 (File No. 0-20948).
(2) Incorporated by reference to the Company's Registration Statement on Form
    S-1 (File No. 33-55430).
(3) Incorporated by reference to Appendix A to the Company's definitive Proxy
    Statement dated April 6, 1994 for the Annual Meeting of Shareholders held
    on May 18, 1994 filed pursuant to Section 14 of the Exchange Act.
(4) Incorporated by reference to the Company's Registration Statement on Form
    S-8 filed with the Securities and Exchange Commission on August 17, 1994
    (Registration No. 33-82972).
(5) Incorporated by reference to the Company's Annual Report on Form 10-K for
    the year ended December 31, 1994, as amended.
(6) Incorporated by reference to the Company's Annual Report on Form 10-K for
    the year ended December 31, 1995.
(7) Incorporated by reference to the Company's Annual Report on Form 10-K for
    the year ended December 31, 1997.
(8) Incorporated by reference to the Company's Registration Statement on Form
    S-8 filed with the Securities and Exchange Commission on December 3, 1998
    (Registration No. 333-68309).
 
                                      25
<PAGE>
 
 + The Company has been granted confidential treatment of the redacted
   portions of this exhibit pursuant to Rule 24b-2 under the Securities
   Exchange Act of 1934, as amended, and has separately filed a complete copy
   of this exhibit with the Securities and Exchange Commission.
++ The Company has requested confidential treatment of the redacted portions
   of this exhibit pursuant to Rule 24b-2 under the Securities Exchange Act of
   1934, as amended, and has separately filed a complete copy of this exhibit
   with the Securities and Exchange Commission.
 
(b) Reports on Form 8-K
 
  No reports on Form 8-K were filed by the Company during the last quarter of
1998.
 
                                      26
<PAGE>
 
                                  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, on the 12th day
of March, 1999.
 
                                          AUTOIMMUNE INC.
 
                                             /s/ Robert C. Bishop
                                          By: _________________________________
                                             Robert C. Bishop,
                                             President and Chief Executive
                                             Officer
 
  Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
 
 
<TABLE>
<S>                                    <C>                        <C>
/s/ Robert C. Bishop                   President and Chief          March 12, 1999
______________________________________  Executive Officer
Robert C. Bishop
(Principal Executive Officer)
 
/s/ Heather A. Ellerkamp               Director of Finance and      March 12, 1999
______________________________________  Treasurer
Heather A. Ellerkamp
(Principal Financial and Accounting
Officer)
 
/s/ Barry Weinberg                     Chairman of the Board of     March 12, 1999
______________________________________  Directors
Barry Weinberg
 
/s/ Allan R. Ferguson                  Director                     March 12, 1999
______________________________________
Allan R. Ferguson
 
/s/ R. John Fletcher                   Director                     March 12, 1999
______________________________________
R. John Fletcher
 
/s/ Henri A. Termeer                   Director                     March 12, 1999
______________________________________
Henri A. Termeer
 
/s/ Hugh A. D'Andrade                  Director                     March 12, 1999
______________________________________
Hugh A. D'Andrade
</TABLE>
 
                                      27
<PAGE>
 
AutoImmune Inc.
(a development stage company)
 
Index to Financial Statements
 
<TABLE>
<CAPTION>
                                                                          Page
                                                                          ----
<S>                                                                       <C>
Financial Statements:
 
  Report of Independent Accountants                                       F-2
 
  Balance Sheet at December 31, 1997 and 1998                             F-3
 
  Statement of Operations for the three years ended December 31, 1998 and
   for the period from inception (September 9, 1988) through December 31,
   1998                                                                   F-4
 
  Statement of Changes in Stockholders' Equity for the period from
   inception (September 9, 1988) through December 31, 1998                F-5
 
  Statement of Cash Flows for the three years ended December 31, 1998 and
   for the period from inception (September 9, 1988) through December 31,
   1998                                                                   F-6
 
  Notes to the Financial Statements                                       F-7
</TABLE>
 
                                      F-1
<PAGE>
 
                       Report of Independent Accountants
 
To the Board of Directors and Stockholders
of AutoImmune Inc.
 
In our opinion, the financial statements listed in the accompanying index
present fairly, in all material respects, the financial position of AutoImmune
Inc. (a development stage company) at December 31, 1997 and 1998, and the
results of its operations and its cash flows for each of the three years in
the period ended December 31, 1998 and for the period from inception
(September 9, 1988) through December 31, 1998, in conformity with generally
accepted accounting principles. These financial statements are the
responsibility of the Company's management; our responsibility is to express
an opinion on these financial statements based on our audits. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management,
and evaluating the overall financial statement presentation. We believe that
our audits provide a reasonable basis for the opinion expressed above.


/s/ PricewaterhouseCoopers LLP

PRICEWATERHOUSECOOPERS LLP
 
Boston, Massachusetts
February 5, 1999
 
                                      F-2
<PAGE>
 
AutoImmune Inc.
(a development stage company)
 
Balance Sheet
 
<TABLE>
<CAPTION>
                                                         December 31,
                                                      1997          1998
<S>                                               <C>           <C>
Assets
Current assets:
 Cash and cash equivalents                        $ 13,833,000  $   4,801,000
 Marketable securities                              16,192,000     12,727,000
 Interest receivable                                   240,000         77,000
 Prepaid expenses and other current assets             143,000        129,000
                                                  ------------  -------------
  Total current assets                              30,408,000     17,734,000
Fixed assets, net                                    1,060,000        538,000
Other assets                                            30,000         54,000
                                                  ------------  -------------
                                                  $ 31,498,000  $  18,326,000
                                                  ============  =============
Liabilities and Stockholders' Equity
Current liabilities:
 Accounts payable                                 $    476,000  $     677,000
 Accrued expenses                                      664,000        539,000
 Current portion of obligations under capital
  leases                                               285,000        193,000
                                                  ------------  -------------
  Total current liabilities                          1,425,000      1,409,000
                                                  ------------  -------------
Obligations under capital leases                       193,000            --
                                                  ------------  -------------
Commitments and contingencies (Notes 6 and 14)
                                                  ------------  -------------
Stockholders' equity:
 Common stock, $.01 par value: 25,000,000 shares
  authorized; 16,392,896 and 16,548,995 shares
  issued and outstanding at December 31, 1997 and
  1998, respectively                                   164,000        166,000
 Additional paid-in capital                        117,330,000    117,551,000
 Deficit accumulated during the development stage  (87,620,000)  (100,805,000)
 Net unrealized gain on marketable securities            6,000          5,000
                                                  ------------  -------------
                                                    29,880,000     16,917,000
                                                  ------------  -------------
                                                  $ 31,498,000  $  18,326,000
                                                  ============  =============
</TABLE>
 
 
   The accompanying notes are an integral part of these financial statements.
 
                                      F-3
<PAGE>
 
AutoImmune Inc.
(a development stage company)
 
Statement of Operations
 
<TABLE>
<CAPTION>
                                                                     Period from
                                                                      inception
                                                                 (September 9, 1988)
                          For the year ended December 31,              through
                           1996          1997          1998       December 31, 1998
<S>                    <C>           <C>           <C>           <C>
Revenue:
 Option fees           $        --   $        --   $        --      $   2,200,000
 Research and
  development revenue
  under collaborative
  agreements                    --            --            --            955,000
                       ------------  ------------  ------------     -------------
    Total revenue               --            --            --          3,155,000
                       ------------  ------------  ------------     -------------
Costs and expenses:
 Research and
  development:
   Related party          2,158,000     1,880,000     1,314,000        18,162,000
   All other             22,029,000    15,426,000    11,496,000        83,106,000
 General and
  administrative          2,414,000     2,214,000     1,712,000        13,239,000
                       ------------  ------------  ------------     -------------
    Total costs and
     expenses            26,601,000    19,520,000    14,522,000       114,507,000
                       ------------  ------------  ------------     -------------
Interest income           3,191,000     2,063,000     1,344,000        10,852,000
Interest expense            (74,000)      (68,000)       (7,000)         (301,000)
                       ------------  ------------  ------------     -------------
                          3,117,000     1,995,000     1,337,000        10,551,000
                       ------------  ------------  ------------     -------------
Net loss               $(23,484,000) $(17,525,000) $(13,185,000)    $(100,801,000)
                       ============  ============  ============     =============
Net loss per share--
 basic and diluted     $      (1.44) $      (1.07) $      (0.80)
                       ============  ============  ============
Weighted average
 shares outstanding--
 basic and diluted       16,303,051    16,385,629    16,491,701
                       ============  ============  ============
</TABLE>
 
 
   The accompanying notes are an integral part of these financial statements.
 
                                      F-4
<PAGE>
 
AutoImmune Inc.
(a development stage company)
 
Statement of Changes In Stockholders' Equity
For the period from inception (September 9, 1988) through December 31, 1998
 
<TABLE>
<CAPTION>
                                                                              Deficit
                                                                            accumulated    Accumulated
                              Common Stock      Additional                  during the        other         Total
                             Number     Par      paid-in    Comprehensive   development   comprehensive stockholders'
                           of shares   value     capital        loss           stage         income        equity
 <S>                       <C>        <C>      <C>          <C>            <C>            <C>           <C>
 Issuance of common stock
  during 1988                 168,750 $  2,000 $        --                 $      (1,000)   $    --     $      1,000
 Conversion of junior
  convertible preferred
  stock to common stock
  during 1991                 506,250    5,000                                    (3,000)                      2,000
 Issuance of common stock
  during 1992                  91,116    1,000      100,000                                                  101,000
 Conversion of
  mandatorily redeemable
  convertible preferred
  stock to common stock
  during 1993               6,353,568   63,000   12,496,000                                               12,559,000
 Issuance of common
  stock, net of issuance
  costs during 1993         3,022,000   30,000   35,669,000                                               35,699,000
 Issuance of common stock
  during 1994                  67,500    1,000        2,000                                                    3,000
 Comprehensive loss:
 Net loss for the period
  from inception
  (September 9, 1988)
  through December 31,
  1995                                                      $(46,607,000)    (46,607,000)                (46,607,000)
 Other comprehensive
  income (loss):
  Net unrealized gain on
   marketable securities
   during 1994 and 1995
   (Note 2)                                                       69,000                      69,000          69,000
                                                            ------------
   Comprehensive loss                                        (46,538,000)
                                                            ============
 Issuance of common
  stock, net of issuance
  costs during 1995         6,072,883   61,000   68,530,000                                               68,591,000
                           ---------- -------- ------------                -------------    --------    ------------
 Balance at December 31,
  1995                     16,282,067  163,000  116,797,000                  (46,611,000)     69,000      70,418,000
 Comprehensive loss:
 Net loss                                                    (23,484,000)    (23,484,000)                (23,484,000)
 Other comprehensive
  income (loss):
  Net unrealized loss on
   marketable securities
   (Note 2)                                                      (35,000)                    (35,000)        (35,000)
                                                            ------------
   Comprehensive loss                                        (23,519,000)
                                                            ============
 Issuance of common stock      75,978    1,000      441,000                                                  442,000
                           ---------- -------- ------------                -------------    --------    ------------
 Balance at December 31,
  1996                     16,358,045  164,000  117,238,000                  (70,095,000)     34,000      47,341,000
 Comprehensive loss:
 Net loss                                                    (17,525,000)    (17,525,000)                (17,525,000)
 Other comprehensive
  income (loss):
  Net unrealized loss on
   marketable securities
   (Note 2)                                                      (28,000)                    (28,000)        (28,000)
                                                            ------------
   Comprehensive loss                                        (17,553,000)
                                                            ============
 Issuance of common stock      34,851                92,000                                                   92,000
                           ---------- -------- ------------                -------------    --------    ------------
 Balance at December 31,
  1997                     16,392,896  164,000  117,330,000                  (87,620,000)      6,000      29,880,000
 Comprehensive loss:
 Net loss                                                    (13,185,000)    (13,185,000)                (13,185,000)
 Other comprehensive
  income (loss):
  Net unrealized loss on
   marketable securities
   (Note 2)                                                       (1,000)                     (1,000)         (1,000)
                                                            ------------
   Comprehensive loss                                       $(13,186,000)
                                                            ============
 Issuance of common stock     156,099    2,000      221,000                                                  223,000
                           ---------- -------- ------------                -------------    --------    ------------
 Balance at December 31,
  1998                     16,548,995 $166,000 $117,551,000                $(100,805,000)   $  5,000    $(16,917,000)
                           ========== ======== ============                =============    ========    ============
</TABLE>
 
   The accompanying notes are an integral part of these financial statements.
 
                                      F-5
<PAGE>
 
AutoImmune Inc.
(a development stage company)
 
Statement of Cash Flows
 
<TABLE>
<CAPTION>
                                                                         Period from
Increase (Decrease) in                                                    inception
Cash and Cash Equivalents     For the year ended December 31,        (September 9, 1988)
Cash flows from operating                                                  through
activities:                    1996          1997          1998       December 31, 1998
<S>                        <C>           <C>           <C>           <C>
 Net loss                  $(23,484,000) $(17,525,000) $(13,185,000)    $(100,801,000)
 Adjustments to reconcile
 net loss to net cash
 used by operating
 activities:
 Interest expense related
 to demand notes
 converted into
 mandatorily redeemable
 convertible preferred
 stock                              --            --            --             48,000
 Patent costs paid with
 junior convertible
 preferred and common
 stock                              --            --            --              3,000
 Depreciation and
  amortization                  961,000       960,000       567,000         4,153,000
 Loss on sale/disposal of
  fixed assets                      --        604,000         2,000           606,000
 Decrease in patent costs           --            --            --            563,000
 (Increase) decrease in
  interest receivable            19,000       (99,000)      163,000           (77,000)
 (Increase) decrease in
  prepaid expenses and
  other current assets         (324,000)      353,000        14,000          (129,000)
 Increase (decrease) in
  accounts payable            2,053,000    (2,521,000)      201,000           677,000
 Increase (decrease) in
  accrued expenses              194,000      (118,000)     (125,000)          539,000
                           ------------  ------------  ------------     -------------
  Net cash used by
   operating activities     (20,581,000)  (18,346,000)  (12,363,000)      (94,418,000)
                           ------------  ------------  ------------     -------------
Cash flows from investing
 activities:
 Purchase of available-
  for-sale marketable
  securities                (44,563,000)  (30,592,000)  (23,878,000)     (257,404,000)
 Proceeds from
 sale/maturity of
 available-for-sale
 marketable securities       43,016,000    57,250,000    27,342,000       233,671,000
 Proceeds from maturity
  of held-to-maturity
  marketable securities             --            --            --         11,011,000
 Proceeds from sale of
  equipment                         --         64,000         1,000            65,000
 Purchases of fixed
  assets                     (1,280,000)     (203,000)      (48,000)       (5,237,000)
 Increase in patent costs           --            --            --           (563,000)
 Increase in other assets           --            --        (24,000)         (179,000)
                           ------------  ------------  ------------     -------------
  Net cash provided
   (used) by investing
   activities                (2,827,000)   26,519,000     3,393,000       (18,636,000)
                           ------------  ------------  ------------     -------------
Cash flows from financing
 activities:
 Proceeds from sale-
  leaseback of fixed
  assets                      1,039,000           --            --          2,872,000
 Payments on obligations
  under capital leases         (728,000)     (864,000)     (285,000)       (2,679,000)
 Net proceeds from
  issuance of mandatorily
 redeemable convertible
  preferred stock                   --            --            --         10,011,000
 Proceeds from bridge
  notes                             --            --            --            300,000
 Proceeds from issuance
  of common stock               442,000        92,000       223,000       105,151,000
 Proceeds from issuance
  of convertible notes
  payable                           --            --            --          2,200,000
                           ------------  ------------  ------------     -------------
  Net cash provided
   (used) by financing
   activities                   753,000      (772,000)      (62,000)      117,855,000
                           ------------  ------------  ------------     -------------
  Net increase (decrease)
   in cash and cash
   equivalents              (22,655,000)    7,401,000    (9,032,000)        4,801,000
  Cash and cash
   equivalents at
   beginning of period       29,087,000     6,432,000    13,833,000               --
                           ------------  ------------  ------------     -------------
  Cash and cash
   equivalents at end of
   period                  $  6,432,000  $ 13,833,000  $  4,801,000     $   4,801,000
                           ============  ============  ============     =============
</TABLE>
 
See Note 2 for supplemental disclosure of non-cash financing activities.
 
   The accompanying notes are an integral part of these financial statements.
 
                                      F-6
<PAGE>
 
AutoImmune Inc.
(a development stage company)
 
Notes to the Financial Statements
 
1.Formation and Operations of the Company
 
  AutoImmune Inc. (the "Company") was incorporated in Delaware on September
  9, 1988. The Company is dedicated to the development of innovative
  pharmaceutical products to treat people who suffer from immune systems
  disorders. The Company's therapeutic approach is based upon "oral
  tolerance," a method designed to control disease by using the body's
  natural immunosuppressive mechanisms. The Company is considered a
  development stage company as defined in Statement of Financial Accounting
  Standards ("SFAS") No. 7, Accounting and Reporting by Development Stage
  Enterprises.
 
  The Company has not yet completed the development of any products. The
  Company's products will require significant additional clinical testing and
  investment prior to commercialization. To date the Company has been
  dependent on collaborative agreements for the majority of its basic
  research and has primarily used contract manufacturers to produce its
  products for clinical trials.
 
2.Summary of Significant Accounting Policies
 
Cash Equivalents and Marketable Securities
  The Company considers all highly liquid debt instruments purchased with an
  original maturity of three months or less to be cash equivalents. The
  Company invests primarily in U.S. Government debt securities. These
  investments are subject to minimal credit and market risks. The Company
  specifically identifies securities for purposes of determining gains and
  losses on the sale of cash equivalents and marketable securities. At
  December 31, 1997 and 1998, the Company has classified all of its
  marketable securities as available-for-sale as defined in SFAS No. 115,
  Accounting for Certain Investments in Debt and Equity Securities.
  Accordingly, unrealized gains and losses on available-for-sale securities
  are recorded as a separate component of stockholders' equity.
 
Fair Value of Financial Instruments
  At December 31, 1998, the Company's financial instruments consist of cash
  equivalents, marketable securities and interest receivable, accounts
  payable and accrued expenses. The carrying amount of these instruments
  approximate their fair values.
 
Fixed Assets
  Fixed assets are stated at cost and depreciated using the straight-line
  method over the estimated useful life of the assets. Assets under capital
  leases and leasehold improvements are amortized over the shorter of their
  estimated useful lives or the term of the respective leases by use of the
  straight-line method.
 
Contingent Stock Purchase Warrants
  The value of contingent stock purchase warrants issued by the Company in
  connection with clinical research agreements is determined on the date that
  the Company estimates that it is probable that such contingencies will be
  met. The fair value of the warrants on the measurement date is recorded as
  compensation expense. The Company periodically assesses whether it is
  probable and estimable that the compensation related to contingent warrants
  will be earned.
 
Revenue Recognition
  Revenue from research and development arrangements is recognized pursuant
  to the related agreements as work is performed or defined milestones are
  attained. Payments received under these arrangements prior to the
  completion of the related work or attainment of milestones are recorded as
  deferred revenue. Option
 
                                      F-7
<PAGE>
 
AutoImmune Inc.
(a development stage company)
 
Notes to the Financial Statements
 
  fees representing payments to be made to the Company for a right to
  evaluate and negotiate the terms of a potential licensing arrangement are
  recognized as the options are granted as such fees are non-refundable and
  the Company has no further obligations.
 
Stock Compensation
  The Company's employee stock option plans are accounted for in accordance
  with Accounting Principles Board Opinion ("APB") No. 25, Accounting for
  Stock Issued to Employees. The Company applies the disclosure requirements
  of SFAS No. 123, Accounting for Stock-Based Compensation.
 
Comprehensive Income
  The Company adopted SFAS No. 130, Reporting Comprehensive Income in 1998.
  SFAS No. 130 requires that a full set of general purpose financial
  statements be expanded to include the reporting of "comprehensive income."
  Comprehensive income is comprised of two components, net income and other
  comprehensive income. The adoption of SFAS No. 130 resulted in revised and
  additional disclosures but had no effect on the financial position or
  results of operations.
 
Net Loss Per Share--Basic and Diluted
  In February 1997, the FASB issued SFAS No. 128, Earnings Per Share, which
  establishes standards for computing and presenting earnings per share. The
  standard replaces the presentation of primary earnings per share prescribed
  by APB No. 15, Earnings Per Share, with a presentation of basic earnings
  per share and also requires dual presentation of basic and diluted earnings
  per share on the face of the statement of operations for all entities with
  complex capital structures. Basic earnings per share excludes dilution and
  is computed by dividing income available to common stockholders by the
  weighted-average number of common shares outstanding for the period.
  Diluted earnings per share is computed similarly to fully diluted earnings
  per share pursuant to APB No. 15. The Company adopted SFAS No. 128 in the
  fourth quarter of fiscal 1997. The basic and diluted net loss per share
  under SFAS No. 128 is not different from the previous computation and
  presentation. Potential common shares from stock options and warrants are
  excluded from the computation of diluted net loss per share as their effect
  is antidilutive.
 
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 these
  estimates.
 
Statement of Cash Flows
 
Disclosure of Non-Cash Investing and Financing Activities
  In 1988, 168,750 shares of common stock and 168,750 shares of junior
  convertible preferred stock were issued to the Brigham and Women's Hospital
  in exchange for patent rights and technology contributed or licensed in
  connection with the formation of the Company.
 
  Notes payable to stockholders totaling $2,200,000 and related interest of
  $48,000 were converted into Series A mandatorily redeemable convertible
  preferred stock in 1991.
 
                                      F-8
<PAGE>
 
AutoImmune Inc.
(a development stage company)
 
Notes to the Financial Statements
 
 
  Bridge notes of $300,000 were converted into Series C mandatorily
  redeemable convertible preferred stock in 1991.
 
  In 1991, 168,750 shares of junior convertible preferred stock were
  converted into 506,250 shares of common stock.
 
  In 1993, 2,117,856 shares of mandatorily redeemable convertible preferred
  stock were converted into 6,353,568 shares of common stock in connection
  with the Company's initial public offering of common stock.
 
Supplemental Disclosure of Cash Flow Information
  The Company has paid interest of $74,000, $68,000 and $7,000 in 1996, 1997
  and 1998, respectively, and $253,000 since inception. The Company has paid
  income taxes of $11,000 in 1996 and since inception.
 
3.Cash Equivalents and Marketable Securities
 
  The following is a summary of cash equivalents held by the Company. Cash
  equivalents are carried at fair market value, which approximated amortized
  cost at December 31, 1997 and 1998.
 
<TABLE>
<CAPTION>
                                         December 31,
                                       1997        1998
   <S>                              <C>         <C>
   Money market                     $    71,000 $  924,000
   U.S. Government debt securities   12,391,000  2,441,000
                                    ----------- ----------
                                    $12,462,000 $3,365,000
                                    =========== ==========
</TABLE>
 
  The following is a summary of available-for-sale marketable securities held
  by the Company at December 31, 1997 and 1998 which are carried at fair
  market value:
 
<TABLE>
<CAPTION>
                                                      Unrealized Unrealized  Amortized
                          Maturity term   Fair Value    gains      losses      cost
<S>                     <C>               <C>         <C>        <C>        <C>
  December 31, 1997:
   U.S. Government debt
    securities          within 1 year     $10,935,000   $5,000    $(1,000)  $10,931,000
   U.S. Government debt
    securities          between 1-5 years   5,257,000    2,000        --      5,255,000
                                          -----------   ------    -------   -----------
                                          $16,192,000   $7,000    $(1,000)  $16,186,000
                                          ===========   ======    =======   ===========
  December 31, 1998:
   U.S. Government debt
    securities          within 1 year     $12,727,000   $6,000    $(1,000)  $12,722,000
                                          ===========   ======    =======   ===========
</TABLE>
 
  All of the Company's marketable securities are classified as current at
  December 31, 1997 and 1998 as these funds are highly liquid and are
  available to meet working capital needs and to fund current operations.
  Gross realized gains and losses on sales of marketable securities for the
  years ended December 31, 1997 and 1998 were not significant.
 
  Marketable securities which were purchased and sold in periods prior to
  adoption of SFAS No. 115 on January 1, 1994 other than held-to-maturity
  marketable securities, are included in the category available-for-sale
  marketable securities in the "period from inception" column of the
  statement of cash flows.
 
                                      F-9
<PAGE>
 
AutoImmune Inc.
(a development stage company)
 
Notes to the Financial Statements
 
 
4.Fixed Assets
 
  Fixed assets consist of the following:
 
<TABLE>
<CAPTION>
                                        Estimated
                                       useful life     December 31,
                                         (years)      1997       1998
   <S>                                 <C>         <C>        <C>
   Laboratory equipment                    2-5     $1,359,000 $1,394,000
   Office equipment                        4-5        425,000    434,000
   Leasehold improvements                  5-7        461,000    461,000
                                                   ---------- ----------
                                                    2,245,000  2,289,000
   Less--accumulated depreciation and
    amortization                                    1,185,000  1,751,000
                                                   ---------- ----------
                                                   $1,060,000 $  538,000
                                                   ========== ==========
</TABLE>
 
  Depreciation and amortization expense relating to fixed assets was
  $961,000, $960,000 and $567,000 for the years ended December 31, 1996, 1997
  and 1998, respectively. Assets held under capital leases consisted of
  $1,243,000 of laboratory equipment at December 31, 1997 and 1998.
  Accumulated amortization of these assets totaled $765,000 and $1,072,000 at
  December 31, 1997 and 1998, respectively. For the years ended December 31,
  1996, 1997 and 1998, amortization expense charged to operations on assets
  held under capital lease obligations was $630,000, $552,000 and $307,000,
  respectively. In 1997, fixed assets totaling $2,931,000 were disposed of or
  sold, of which $1,642,000 were held under capital leases. Accumulated
  depreciation and amortization relating to these assets was $923,000 and
  $1,341,000, respectively. Proceeds totaling $64,000 and $1,000 were
  received upon the sale of certain equipment in 1997 and 1998, respectively.
 
5. Accrued Expenses
 
  Accrued expenses consist of the following:
 
<TABLE>
<CAPTION>
                                                               December 31,
                                                               1997     1998
   <S>                                                       <C>      <C>
   Accrued employee costs                                    $289,000 $322,000
   Accrued professional                                       204,000  217,000
   Accrued restructuring                                      146,000      --
   Other                                                       25,000      --
                                                             -------- --------
                                                             $664,000 $539,000
                                                             ======== ========
</TABLE>
 
6. Related Party Transactions
 
  In connection with the formation of the Company and the issuance of 168,750
  shares of common stock and 168,750 shares of junior convertible preferred
  stock to The Brigham and Women's Hospital ("BWH"), the Company entered into
  related technology transfer and research and development agreements with
  BWH. The technology transfer agreement provides the Company with all rights
  and interests in certain BWH patented technology in exchange for the
  issuance of the aforementioned stock and the payment of royalties under
  certain conditions. The research and development agreement provides that
  certain research activities are performed by BWH on behalf of the Company.
 
                                     F-10
<PAGE>
 
AutoImmune Inc.
(a development stage company)
 
Notes to the Financial Statements
 
 
  The current research and development agreement terminates in June 2000. The
  agreement provides for automatic two-year renewal periods, subject to the
  Company's and BWH's mutual agreement annually, with respect to the budget
  for research to be performed and related minimum payments made to BWH for
  each following year. The Company has agreed to pay BWH minimum payments
  totaling $537,000 for the one-year period ending June 30, 1999. There is no
  guaranteed minimum payment for the one-year period ending June 30, 2000.
  This agreement also provides for payments to BWH for royalties on sales of
  related patented products by the Company, as well as for payments to BWH
  for a portion, as defined in the agreement, of any proceeds received by the
  Company in connection with the licensing of patented technology to, and
  royalty or milestone payments received from, third parties. Royalty
  payments to BWH begin upon the commercialization of the related products
  and will continue for the life of the underlying patent. For a period not
  to exceed three years after the first commercial sale of any product of the
  Company, the Company is required to make payments to BWH in each quarter
  only to the extent that the Company has a positive cash flow in such
  quarter with the balance deferred to the succeeding quarter. Deferred
  payments will be subject to interest. If the Company defaults in the
  payment of any amount due to BWH, BWH will have an option to purchase all
  technology developed under the research program at a purchase price equal
  to the sum of all amounts previously paid by the Company to BWH.
 
  In addition, certain expenses are paid by the Company for research
  conducted at BWH.
 
7.Income Taxes
 
  The components of deferred income tax benefit are as follows:
 
<TABLE>
<CAPTION>
                                       Year ended December 31,
                                     1996         1997         1998
   <S>                           <C>           <C>          <C>
   Income tax benefit:
     Federal                     $  9,328,000  $ 7,809,000  $ 4,557,000
     State                          1,964,000    1,821,000    1,262,000
                                 ------------  -----------  -----------
                                   11,292,000    9,630,000    5,819,000
   Deferred tax asset valuation
    allowance                     (11,292,000)  (9,630,000)  (5,819,000)
                                 ------------  -----------  -----------
                                 $        --   $       --   $       --
                                 ============  ===========  ===========
</TABLE>
 
  No significant federal or state taxes were payable in any years as a result
  of losses incurred and utilization of net operating losses and credits.
 
                                     F-11
<PAGE>
 
AutoImmune Inc.
(a development stage company)
 
Notes to the Financial Statements
 
 
  A reconciliation between the amounts of reported income tax (expense)
  benefit and the amount determined by applying the U.S. federal statutory
  rate of 35% for 1996, 1997 and 1998 to pre-tax loss is as follows:
 
<TABLE>
<CAPTION>
                                              Year ended December 31,
                                            1996         1997         1998
<S>                                     <C>           <C>          <C>
  Loss at statutory rate                $  8,219,000  $ 6,134,000  $ 4,615,000
  Nondeductible research and
   development expenses                   (1,015,000)  (1,190,000)    (265,000)
  Federal and state research and
  development, orphan drug, and
  investment tax credits                   3,184,000    3,576,000      843,000
  State tax benefit, net of federal tax
   liability                                 991,000    1,009,000      735,000
  Stock option compensation                  136,000      126,000       22,000
  Utilization of net operating losses       (203,000)         --           --
  Other                                      (20,000)     (25,000)    (131,000)
                                        ------------  -----------  -----------
                                          11,292,000    9,630,000    5,819,000
  Benefit of loss not recognized,
  increase in valuation allowance        (11,292,000)  (9,630,000)  (5,819,000)
                                        ------------  -----------  -----------
                                        $        --   $       --   $       --
                                        ============  ===========  ===========
</TABLE>
 
  Deferred tax assets are comprised of the following:
 
<TABLE>
<CAPTION>
                                                          December 31,
                                                        1997          1998
<S>                                                 <C>           <C>
  Research costs capitalized for tax purposes       $ 16,346,000  $ 21,087,000
  Research and development, orphan drug and
   investment tax credits                              9,905,000    10,749,000
  Loss carryforwards                                  15,561,000    15,792,000
  Net unrealized gain on investments available-for-
   sale                                                   (2,000)       (2,000)
  Other temporary differences                             79,000        82,000
                                                    ------------  ------------
  Gross deferred tax assets                           41,889,000    47,708,000
  Deferred tax asset valuation allowance             (41,889,000)  (47,708,000)
                                                    ------------  ------------
                                                    $        --   $        --
                                                    ============  ============
</TABLE>
 
  The Company has provided a full valuation allowance for net deferred tax
  assets since the realization of these future benefits is not sufficiently
  assured as of the end of each related year. As the Company achieves
  profitability, these deferred tax assets will be available to offset future
  income tax liabilities and expenses. Of the $47,708,000 valuation allowance
  at December 31, 1998, $618,000 relating to deductions for stock option
  compensation will be credited to additional paid-in capital upon
  realization.
 
                                     F-12
<PAGE>
 
AutoImmune Inc.
(a development stage company)
 
Notes to the Financial Statements
 
 
  At December 31, 1998, the Company had the following net operating loss,
  research and development, orphan drug and investment tax credit
  carryforwards available to reduce future tax liabilities, which expire as
  follows:
 
<TABLE>
<CAPTION>
                                                      Research and development,
                                  Net operating       orphan drug and investment
         Year of expiration     loss carryforward      tax credit carryforwards
         <S>                    <C>                   <C>
                2003                                         $    19,000
                2004                                              91,000
                2005                                             121,000
                2006                                             162,000
                2007                                             234,000
                2008                                             420,000
                2009               $    43,000                   960,000
                2010                                             728,000
                2011                                           3,895,000
                2012                38,859,000                 3,670,000
                2018                   578,000                   888,000
                                   -----------               -----------
                                   $39,480,000               $11,188,000
                                   ===========               ===========
</TABLE>
 
  Ownership changes, as defined in the Internal Revenue Code, resulting from
  the Company's initial public offering of stock in January 1993 and
  subsequent follow-on offerings in 1995, had no impact on the amount of net
  operating loss and tax credit carryforwards that can be utilized annually
  to offset future taxable income or tax liabilities. Subsequent significant
  ownership changes could, however, limit the utilization of these
  carryforwards in future years.
 
8.Preferred Stock
 
  Upon the closing of the Company's initial public offering on January 27,
  1993 each share of Series A, B and C convertible preferred stock
  automatically converted into three shares of common stock (Note 9). No
  dividends had been paid to the preferred stockholders.
 
  At December 31, 1998, the Company had authorized 5,000,000 shares of $.01
  par value preferred stock. Preferred stock may be issued at the discretion
  of the Board of Directors of the Company (without stockholder approval)
  with such designations, rights and preferences as the Board of Directors
  may determine from time to time. The preferred stock may have dividend,
  liquidation, redemption, conversion, voting or other rights which may be
  more expansive than the rights accorded to the common stock.
 
  On May 17, 1995, the Company's Board of Directors adopted a shareholder
  rights plan. The Board declared a distribution of one right for each share
  of common stock outstanding on June 1, 1994. Stock issued after that date
  will be issued with an attached right. Each right will entitle the holder,
  upon the occurrence of certain events, to purchase 1/100th of a share of
  preferred stock at an exercise price of $73. The Board may, at any time,
  redeem the rights until their expiration on June 1, 2005, and may amend the
  rights under certain circumstances until they become exercisable.
 
                                     F-13
<PAGE>
 
AutoImmune Inc.
(a development stage company)
 
Notes to the Financial Statements
 
 
9.Stockholders' Equity and Common Stock
 
  In December 1992, the Company effected a three-for-one stock split of the
  Company's common stock in the form of a stock dividend. All common shares
  and per share amounts have been adjusted to give retroactive effect to the
  common stock split for all years presented.
 
  In January 1993, the Company completed its initial public offering of
  3,000,000 shares of common stock. Proceeds to the Company, net of issuance
  costs, amounted to $35,690,000.
 
  In January 1995, the Company completed a private placement of 2,039,547
  shares of common stock. Proceeds to the Company, net of issuance costs,
  amounted to $9,136,000.
 
  In August and September 1995, the Company completed its second public
  offering of 3,925,000 shares of common stock. Proceeds to the Company, net
  of issuance costs, amounted to $58,878,000.
 
  As of December 31, 1998, the Company has reserved 3,560,194 shares of
  common stock for use in the Company's stock option plans and employee stock
  purchase plan (Note 10).
 
10.Stock Option and Employee Stock Purchase Plans
 
1988 Stock Option Plan
  The Company's 1988 Stock Option Plan (the "1988 Stock Option Plan"), as
  amended effective May 15, 1996, provided for the granting of incentive
  stock options and non-qualified stock options to employees and other
  individuals performing services on behalf of the Company. The Compensation
  Committee (the "Committee"), appointed by the Board of Directors, is
  responsible for the administration of the 1988 Stock Option Plan. The
  Committee determined the term of each option, option price, number of
  shares for which each option was granted, whether restrictions were imposed
  on the shares subject to options and the rate at which each option becomes
  exercisable. During 1997, the Board of Directors increased the maximum
  number of shares of common stock of the Company reserved for issuance in
  accordance with the terms of the 1988 Stock Option Plan from 3,100,000 to
  3,700,000.
 
  On June 19, 1997, the Company repriced 338,850 options with exercise prices
  ranging from $4.88 to $16.38 per share to 254,138 options at a price of
  $2.00 per share. Employees had the option not to reprice certain options
  previously granted. The repriced options were subject to the same vesting
  schedule as the previous options except that any vesting would be forfeited
  unless the optionee remains in the Company's employ through June 19, 1998.
 
  The 1988 Stock Option Plan expired on September 19, 1998.
 
1998 Stock Option Plan
  The Company's 1998 Stock Option Plan (the "1998 Stock Option Plan"),
  adopted by the shareholders on May 28, 1998, provides for the granting of
  incentive stock options and non-qualified stock options to employees,
  directors and other individuals performing services on behalf of the
  Company. The Committee is responsible for the administration of the 1998
  Stock Option Plan. The Committee determines the term of each option, option
  price, number of shares for which each option is granted, whether
  restrictions will be imposed on the shares subject to options and the rate
  at which each option is exercisable. The exercise price for stock options
  granted may not be less than 100% of the fair market value per share of the
  underlying common stock on the date granted (110% for options granted to
  holders of more than 10% of the voting stock of the Company). The term of
  options granted under the 1998 Stock Option Plan cannot exceed ten
 
                                     F-14
<PAGE>
 
AutoImmune Inc.
(a development stage company)
 
Notes to the Financial Statements
 
  years (five years for options granted to holders of more than 10% of the
  voting stock of the Company). The maximum number of shares of common stock
  of the Company reserved for issuance in accordance with the terms of the
  1998 Stock Option Plan is 1,300,000.
 
Director Stock Option Plan
  During 1993, the Company's Board of Directors approved a stock option plan
  for non-employee directors (the "Director Option Plan"). This plan was
  approved by the Company's shareholders in 1994 and an amendment to the plan
  was approved by the shareholders on May 15, 1996. Under the original
  Director Option Plan, each director who was eligible to participate in the
  plan on May 19, 1993 received, at fair market value on the date of grant,
  options to purchase 4,000 shares of common stock. Under the amended
  Director Option Plan, upon the first election of a non-employee to the
  Board of Directors, the director shall receive an option to purchase 25,000
  shares of common stock and will receive options to purchase an additional
  6,500 shares of common stock every year thereafter if the individual
  remains a member of the Board of Directors. In addition, an option to
  purchase 1,000 shares of common stock was granted to each director who was
  a member of a standing committee of the Board of Directors on May 19, 1993.
  An option for 1,000 shares will be granted automatically to each member of
  a standing committee following his first election to each such committee,
  and options to purchase 1,000 additional shares will automatically be
  granted every four years thereafter for each standing committee of which
  the individual remains a member. Options to purchase 129,500 shares of
  common stock have been granted under this plan. A maximum of 300,000 shares
  of common stock of the Company is reserved for issuance in accordance with
  the terms of this amended plan.
 
  A summary of option activity under the Stock Option Plans and the Director
  Option Plan for the years ended December 31, 1996, 1997 and 1998 is as
  follows:
 
<TABLE>
<CAPTION>
                                                              Weighted average
                                                    Shares     exercise price
   <S>                                            <C>         <C>
   Outstanding at December 31, 1995                2,167,636       $ 4.24
     Granted (weighted average fair value $5.90)     264,800        10.41
     Exercised                                       (45,100)        4.52
     Cancelled                                       (30,825)        8.75
                                                  ----------
   Outstanding at December 31, 1996                2,356,511         4.87
     Granted (weighted average fair value $2.97)   1,218,608         5.19
     Exercised                                       (31,198)        2.72
     Cancelled                                    (1,479,356)        9.47
                                                  ----------
   Outstanding at December 31, 1997                2,064,565         1.85
     Granted (weighted average fair value $1.51)     187,800         2.77
     Exercised                                      (129,688)        1.39
     Cancelled                                      (184,643)        3.27
                                                  ----------
   Outstanding at December 31, 1998                1,938,034         1.83
                                                  ==========
   Options exercisable at year end                 1,326,530       $ 1.56
                                                  ==========
</TABLE>
 
                                     F-15
<PAGE>
 
AutoImmune Inc.
(a development stage company)
 
Notes to the Financial Statements
 
 
  As of December 31, 1996 and 1997, 1,214,336 and 1,203,539 options were
  exercisable, respectively, under the 1988 Stock Option Plan and Director
  Option Plan.
 
  The following table summarizes information about stock options outstanding
  at December 31, 1998:
 
<TABLE>
<CAPTION>
                                 Options outstanding                Options exercisable
                     ------------------------------------------- --------------------------
                                     Weighted
                                     average         Weighted                   Weighted
     Range of          Number       remaining        average       Number       average
   exercise prices   outstanding contractual life exercise price Exercisable exercise price
   <S>               <C>         <C>              <C>            <C>         <C>
        $  .03          293,500     2.2 years         $ .03         293,500      $ .03
   $1.33-$ 2.00       1,319,798     5.8 years          1.61         939,194       1.50
   $2.06-$ 3.06         228,000       9 years          2.74          15,675       2.64
   $5.25-$ 7.75          39,736     5.8 years          5.89          38,411       5.84
   $8.13-$10.88          57,000     6.3 years          9.75          39,750       9.52
                      ---------                                   ---------
                      1,938,034                                   1,326,530
                      =========                                   =========
</TABLE>
 
Employee Stock Purchase Plan
  On July 20, 1994, the Board of Directors approved the 1994 Employee Stock
  Purchase Plan (the "Purchase Plan"). This plan enables eligible employees
  to purchase the Company's common stock at 85% of the fair market value of
  the stock on the date an offering commences or on the date an offering
  terminates, whichever is lower. The Purchase Plan is available to
  substantially all employees, subject to certain limitations. An eligible
  employee may elect to have up to 12% of his or her base pay withheld and
  applied toward the purchase of shares in such an offering (not to exceed
  $25,000 in any year). At December 31, 1998, 158,160 shares of common stock
  were reserved for purchases under the Purchase Plan. During 1997 and 1998,
  3,653 and 26,411 shares were purchased under the Purchase Plan at an
  average price of $2.12 and $1.59 per share, respectively.
 
Stock-Based Compensation
  The Company accounts for stock-based compensation using the intrinsic based
  method prescribed in APB No. 25. The Company has adopted the disclosure-
  only provisions of SFAS No. 123. Accordingly, no compensation cost has been
  recognized for the Company's stock option plans and employee stock purchase
  plan. Had compensation cost been determined based on the fair value at the
  grant dates for awards in 1996, 1997 and 1998 consistent with the
  provisions of SFAS No. 123, the Company's net loss and net loss per share
  would have been increased to the pro forma amounts indicated below:
 
<TABLE>
<CAPTION>
                                         Years ended December 31,
                                      1996          1997          1998
   <S>                            <C>           <C>           <C>
   Net loss:
     As reported                  $(23,484,000) $(17,525,000) $(13,185,000)
     Pro forma                     (24,540,000)  (18,059,000)  (13,989,000)
   Net loss per share--basic and
    diluted:
     As reported                  $      (1.44) $      (1.07) $      (0.80)
     Pro forma                           (1.51)        (1.10)        (0.85)
</TABLE>
 
  The fair value of each option grant is estimated on the date of grant using
  the Black-Scholes option pricing model with the following weighted average
  assumptions used for grants in 1996, 1997 and 1998: no dividend yield for
  all years; expected volatility of 65%, 65% and 62%, respectively; risk free
  interest rates ranging from 4.9% to 7.4% and a weighted average expected
  option term ranging from 3 to 6.5 years for
 
                                     F-16
<PAGE>
 
AutoImmune Inc.
(a development stage company)
 
Notes to the Financial Statements
 
  options granted during all years. Because additional option grants are
  expected to be made each year, the pro forma impact on the three years
  ended December 31, 1998 is not representative of the pro forma effects
  which may be expected in future years.
 
11.Accumulated Other Comprehensive Income
 
  In the first quarter of 1998, the Company adopted SFAS No. 130, Reporting
  Comprehensive Income. This statement requires disclosure of comprehensive
  income and its components in interim and annual reports. Comprehensive
  income includes all changes in stockholders' equity during a period except
  those resulting from investments by stockholders and distributions to
  stockholders. Accordingly, the components of comprehensive income include
  net income and unrealized gains and losses on available-for-sale
  securities.
 
  Net unrealized loss on marketable securities is comprised of the following:
 
<TABLE>
<CAPTION>
                                 For the period
                                January 1, 1994
                              through December 31,
                                      1995           1996      1997     1998
<S>                           <C>                  <C>       <C>       <C>
  Unrealized holding gain
   (loss) arising during the
   period                           $69,000        $(13,000) $ (6,000) $ 5,000
  Reclassification adjustment
   for (gain) loss included
   in net income                        --          (22,000)  (22,000)  (6,000)
                                    -------        --------  --------  -------
  Net unrealized gain (loss)
   on marketable securities         $69,000        $(35,000) $(28,000) $(1,000)
                                    =======        ========  ========  =======
</TABLE>
 
12.Employee Savings Plan
 
  In 1993, the Company initiated an employee savings plan (the "401(k) Plan")
  under Section 401(k) of the Internal Revenue Code. The 401(k) Plan is
  available to substantially all employees. The Company has made no
  contributions to the 401(k) Plan since inception.
 
13.Restructuring Costs
 
  In the second quarter of 1997, the Company recorded $3,307,000 of
  restructuring costs as a result of a corporate downsizing. This charge
  consisted of severance costs of $1,009,000 for 53 employees; lease costs of
  $1,510,000; equipment disposal and write-offs of $531,000; and the
  termination of certain contractual requirements of $257,000. During the
  third quarter of 1997, this estimated charge was adjusted to $2,251,000 to
  reflect the sublease of 22,000 square feet of space and actual costs
  incurred. The adjusted charge consists of severance costs of $1,138,000 for
  53 employees; lease costs of $261,000; equipment disposal and write-offs of
  $599,000; and the termination of certain contractual requirements of
  $253,000. As of December 31, 1998, all restructuring costs had been paid.
 
14.Commitments and Contingencies
 
Clinical Research Agreement
  The Company entered into an agreement with CATO Research ("CATO"),
  effective June 1993, to have a clinical investigational study performed on
  the Company's multiple sclerosis product. The agreement allowed for
  termination by either the Company or CATO, upon prior written notice. In
  1997, the Company
 
                                     F-17
<PAGE>
 
AutoImmune Inc.
(a development stage company)
 
Notes to the Financial Statements
 
  terminated the agreement, therefore CATO was entitled to a termination fee
  totaling $257,000. Additionally, CATO was granted a warrant to purchase
  30,000 shares of common stock of the Company at $10.50 per share which
  expires in June 2003. In 1998, the warrant to purchase 10,000 shares became
  exercisable upon the achievement of a specific milestone. The value
  ascribed to these shares was not significant. Given the uncertainty
  surrounding the achievement of the final milestone, the estimated fair
  value of the remaining contingent stock purchase warrants to purchase
  20,000 shares of common stock of the Company cannot be reasonably
  determined at December 31, 1998.
 
License Agreements
  In December 1994, the Company entered into a license agreement with Eli
  Lilly and Company ("Lilly"). Under the agreement, Lilly provided support
  for clinical testing of the Company's autoimmune mediated (Type 1) diabetes
  product in exchange for certain worldwide license rights for the
  manufacture, distribution and sale of the related products. This agreement
  was terminated in the first quarter of 1999 as a result of Lilly's failure
  to make a required milestone payment. Lilly is obligated to complete the
  trials now underway and to provide the Company with full access to the data
  therefrom, including the right to use the data for any purpose. The Company
  has regained all rights to the product.
 
Leases
  The Company leases its facilities under an operating lease which runs
  through November 1999 and includes renewal clauses. The operating lease for
  facilities provides for monthly rental payments and estimated monthly
  operating charges which cover building maintenance costs and real estate
  taxes. On November 1, 1997, the Company exercised its option to sublease
  22,000 square feet of the 33,000 square feet total through the end of the
  lease term. In 1997 and 1998, the Company received rent payments from the
  subtenant totaling $52,000 and $211,000, respectively. Effective October 1,
  1998, the sublease agreement was terminated and concurrently, the Company's
  operating lease was amended to include only the approximately 11,000 square
  feet occupied by the Company.
 
  Total rent expense was $421,000, $507,000 and $149,000 for the years ended
  December 31, 1996, 1997 and 1998, respectively. Future minimum lease
  commitments due under the non-cancelable operating lease, which expires in
  November 1999, total $161,000.
 
  During 1997, the Company disposed of equipment under various leases entered
  into prior to 1997 and combined the remaining assets from those various
  leases into one lease agreement. The term for the combined lease under the
  agreement is twenty-four months and bears interest at a rate determined on
  the lease date. Future minimum lease commitments due under the non-
  cancelable capital lease obligation, which expires in 1999, total $194,000,
  of which $1,000 represents interest. The Company is required to meet
  certain financial covenants during the lease term. If the Company violates
  any of the covenants the lessor may require additional cash collateral, not
  to exceed the amount of the remaining balance.
 
                                     F-18