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                                 UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                            ------------------------
 
                                   FORM 10-K
 
     [X]   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
        SECURITIES EXCHANGE ACT OF 1934
 
                  FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
 
                                       OR
 
     [ ]   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
        SECURITIES EXCHANGE ACT OF 1934
 
            FOR THE TRANSITION PERIOD FROM __________ TO __________
 
                          COMMISSION FILE NO. 0-19591
 
                               CYTEL CORPORATION
             (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
 
<TABLE>
<S>                                            <C>
                  DELAWARE                                      33-0245076
       (STATE OR OTHER JURISDICTION OF                       (I.R.S. EMPLOYER
       INCORPORATION OR ORGANIZATION)                       IDENTIFICATION NO.)
</TABLE>
 
                            9393 Towne Centre Drive
                          San Diego, California 92121
                    (Address of principal executive offices)
 
       Registrant's telephone number, including area code: (619) 450-7100
 
        Securities registered pursuant to Section 12(b) of the Act: None
 
          Securities registered pursuant to Section 12(g) of the Act:
                          COMMON STOCK, $.01 Par Value
                                (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 (Section 229.405 of this chapter) is not contained herein,
and will not be contained, to the best of Registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K.  [X]
 
    The aggregate market value of the voting stock (which consists solely of
shares of Common Stock) held by non-affiliates of the Registrant as of March 31,
1999 was approximately $13.7 million, based on the closing price on that date of
Common Stock on the Nasdaq National Stock Market.*
 
    The number of shares outstanding of the Registrant's Common Stock, $.01 par
value, was 4,997,322 as of March 31, 1999.
---------------
* Excludes 339,641 shares of Common Stock held by directors and officers and
  stockholders whose beneficial ownership exceeds 10% of the shares outstanding
  on March 31, 1999. Exclusion of shares held by any person should not be
  construed to indicate that such person possesses the power, direct or
  indirect, to direct or cause the direction of the management or policies of
  the Registrant, or that such person is controlled by or under common control
  with the Registrant.
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                                     PART I

ITEM 1.  BUSINESS

Except for the historical information contained herein, the following discussion
contains forward-looking statements that involve risks and uncertainties. The
Company's actual results could differ materially from those discussed here.
Factors that could cause or contribute to such differences include, without
limitation, those discussed in the description of the Company's business below
and the sections entitled "Risk Factors" and "Management's Discussion and
Analysis of Financial Condition and Results of Operations," as well as those
discussed in any documents incorporated herein by reference.

Unless otherwise indicated, all references to "Cytel" are to Cytel Corporation,
all references to "Epimmune" are to Epimmune Inc., a majority-owned subsidiary
of Cytel, and all references to the "Company" are to the combined entity of
Cytel and Epimmune.

Epimmune(TM), PADRE(TM), EpiGene(TM) and Cylexin(R) are trademarks of the
Company.

GENERAL

Cytel was founded in 1987 to develop therapeutic products for treatment of
immunological diseases. The Company's core business is the development of
vaccines to treat and prevent infectious diseases and cancer conducted by
Epimmune. Epimmune was formed in October 1997 and, as of March 31, 1999, Cytel
owned approximately 75% of the outstanding stock of Epimmune. Cytel's business
also included a therapeutic anti-inflammatory program based on cell adhesion
inhibitors and its Glytec business unit, encompassing proprietary manufacturing
technology for the enzymatic synthesis of bioactive complex carbohydrates. In
the first quarter of 1999, Cytel sold or discontinued its non-vaccine programs,
resulting in a significant modification to Cytel's focus of operations. This
modification resulted in significant adjustments to the Company's financial
results for both December 31, 1998 and March 31, 1999.

Epimmune's core technology capitalizes on the knowledge of how the immune system
is stimulated and which arms of the immune system need to be stimulated for
treatment or prevention of different infectious diseases and cancer. G.D. Searle
& Co. ("Searle"), a wholly-owned subsidiary of Monsanto Co., entered a
collaborative relationship with Epimmune in February 1998 to develop novel
vaccines for cancer. The collaborative efforts of Epimmune and Searle are
focused initially on the treatment of breast, colon and lung cancer. Epimmune
has received $16.5 million in equity financing from Searle and Cytel and, under
its agreement with Searle, may receive additional preclinical and clinical
milestone payments from Searle as products from the collaboration are developed
and launched.

Cytel completed its Phase II/III clinical trial of Cylexin, its lead cell
adhesion inhibitor compound, in March 1999. Cylexin showed no benefit over
placebo in the 138 patient trial for the treatment of reperfusion injury in
infants undergoing cardiopulmonary bypass ("CPB") to facilitate the surgical
repair of life threatening heart defects. Cytel has another class of cell
adhesion blockers, VLA-4 integrin blockers, directed toward the treatment of
chronic inflammatory diseases. This class of cell adhesion blockers has been
shown to be effective in accepted animal models of chronic inflammatory disease.
Cytel's lead integrin blocker exhibits potential for bronchial and oral
administration, essential for a chronic-use drugs. In light of the disappointing
results of the Phase II/III trial of Cylexin, Cytel has ended its pursuit of
cell adhesion therapeutics and expects to sell or dispose of its remaining cell
adhesion related assets.

Cytel's Glytec business unit was established to manufacture or enable the
manufacture by its partners of bioactive carbohydrates for consumer products and
medical products. Cytel recently announced the sale of its Glytec carbohydrate
synthesis and manufacturing intellectual property assets to Neose Technologies,
Inc. ("Neose") for an upfront cash payment of $3.5 million and certain
additional contingent cash consideration. Neose has acquired Cytel's
carbohydrate technology subject to



                                  Page 1 of 41

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Cytel's license to Baxter Healthcare Corporation's Nextran unit for
xenotransplantation completed in February 1999. Cytel received $4.0 million in
consideration for the Nextran transaction, which included the sale of certain
fixed assets, assignment of certain liabilities and license to certain Glytec
technology. Cytel expects to use the proceeds from the Glytec sale, together
with existing cash resources, to meet its financial obligations, including
corporate restructuring and termination costs of all of its non-vaccine
programs. There can be no assurance, however, that Cytel's cash resources will
be sufficient to satisfy all of its financial obligations.

None of the products under development by the Company have been approved for
their intended use, and the Company does not anticipate that such products will
be available for a number of years, if at all.

EPIMMUNE

BACKGROUND

Epimmune, established in October 1997, is currently a majority-owned subsidiary
of Cytel, operating under separate management and financing. Based on the
Company's substantial immunology expertise and scientific leadership in the
field of T-cell recognition and stimulation, Epimmune is focused on developing
novel vaccines to treat and prevent infectious diseases and cancer. Epimmune's
unique capabilities include a rapid Epitope Identification System ("EIS") for
identifying, from the sequences of tumor-associated antigens and infectious
agents, those antigen fragments ("epitopes") which are capable of eliciting a
potent immune response. Additionally, Epimmune has established a broad
proprietary position covering the EIS, numerous epitopes for cancer and
infectious disease vaccine targets and other vaccine technology.

In February 1998, Epimmune entered a collaborative research and development
agreement with Searle to develop immune stimulating products for the treatment
of cancer. The parties' collaborative cancer program is focused initially on the
treatment of breast, colon and lung cancer, and the first clinical trial is
expected to be initiated in 2000. Outside the Searle collaboration, Epimmune's
product targets include prophylactic vaccines for hepatitis C virus ("HCV"), HIV
and malaria and therapeutic vaccines for hepatitis B virus ("HBV"), HCV, human
papilloma virus ("HPV") and HIV.

 TECHNOLOGY PLATFORM

Overview. For treatment and prevention of certain infectious diseases and
tumors, eliciting a strong cellular immune response is critical. It has been
shown in individuals who spontaneously clear chronic viral infection, and in
cancer patients who respond to immunotherapy, that the cellular immune response
is associated with viral clearance and tumor regression. This cellular response
is comprised of activated cytotoxic T cells ("CTL") and helper T cells ("HTL")
which are directed toward multiple discrete and specific antigen fragments,
known as antigen-specific epitopes. Recreating this "multi-specific" CTL and HTL
response is the objective of a number of groups in the immunotherapy and vaccine
fields. Many have taken the approach of using whole antigens or genes and
letting the immune system "decide" which epitopes to recognize. This approach
has been successful for many prophylactic vaccines but has not been successful
for stimulating a sufficiently strong or broad cellular immune critical to treat
chronic infectious diseases and cancer and prevent certain diseases such as HCV,
HIV and malaria. By selecting and immunizing with an EpiGene vaccine, a DNA
vaccine encoding a set of specific epitopes to which the immune system is
capable of responding, Epimmune has shown that it can achieve a broader and
stronger cellular immune response than that obtained by using whole antigens or
genes.

Antigen-Specific Epitopes. Epimmune's approach to vaccine development is to
rationally create a multi-specific cellular response, causing the immune system
to be specifically stimulated against multiple, select epitopes which meet
stringent criteria. Accordingly, Epimmune has developed its EIS to rapidly
identify these antigen-specific epitopes from the genetic information of
tumor-associated antigens or infectious agents (viruses, bacteria and
parasites). Using EIS, Epimmune has





                                  Page 2 of 41
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already identified epitopes for a number of indications, including breast, lung
and colon cancers, as well as HCV, HBV, HPV, HIV and malaria. The identified
epitopes include CTL epitopes that bind MHC-I and are recognized by cytotoxic T
cells, and HTL epitopes that bind MHC-II and are recognized by helper T cells.

 Antigen-specific epitopes, or synthetic genes encoding these epitopes, are
 believed to offer a number of benefits over traditional vaccine approaches.

-    First, the epitopes are selected from conserved regions of viral or
     tumor-associated antigens, reducing the likelihood of escape mutants. When
     using whole antigens, there is evidence that the immune response is
     directed largely toward variable regions of the antigen, allowing immune
     escape due to mutations.

-    Second, the ability to combine selected epitopes (CTL and HTL) and to alter
     their composition to enhance immunogenicity allows for manipulation of the
     immune response, as appropriate, for the target disease. Similar
     engineering of the response is not possible with traditional approaches.

-    Third, a major benefit of epitope-based, immune-stimulating vaccines is
     their safety. The possible pathological side effects caused by infectious
     agents or whole protein antigens, which might have their own intrinsic
     biological activity, is eliminated.

-    Finally, in order to develop the most effective vaccines, multiple antigens
     should be targeted. Combining multiple epitopes into a single vaccine
     offers a simple alternative to traditional combination vaccines and enables
     the design of a well-characterized product which contains minimal
     extraneous biological material.

Rapid Epitope Identification System. Epimmune's EIS was developed and optimized
     by the Company's scientists based on extensive work over the past 10 years
     in the field of T-cell recognition and stimulation. Numerous patent
     applications owned or licensed by Epimmune cover the methods employed by
     the EIS, as well as the epitope compositions which result from its use.
     With the genetic sequence of a tumor-associated antigen, virus, bacteria or
     parasite as input, the EIS performs the following analysis to rapidly
     identify the antigen-specific epitopes which meet pre-determined criteria
     for conservancy, binding, population coverage and immunogenicity.

-    Computer algorithms analyze the sequence of all known antigens associated
     with the target indication for the presence of peptides which contain
     epitope motifs and meet sequence conservancy requirements (epitopes from
     variable regions of the antigen are avoided).

-    Peptides meeting the requirements of the computer screen are synthesized
     and in vitro HLA binding assays are performed.

-    Peptides are evaluated for superfamily binding (assessing their ability to
     bind broadly within a family of HLA molecules). Identifying epitopes which
     bind broadly within three superfamilies enables broad population coverage
     for the ultimate vaccine.

-    Peptides are then tested for immunogenicity, both in vivo in transgenic
     mice which express human MHC and in vitro against infected or transfected
     cells.

PADRE Carrier / Adjuvant. The PADRE technology consists of a family of
proprietary molecules which are potent, synthetic, "universal" immunostimulants.
When combined with epitopes, PADRE induces important "co-stimulatory" signals
which potentiate the antigen-specific immune response. If the epitopes are CTL
epitopes, PADRE increases the magnitude and duration of the immune response. If
the epitopes are antibody (or B-cell) epitopes, PADRE serves as an antigen
"carrier," inducing a long-term, high-titer antibody response. PADRE molecules
are easy to





                                  Page 3 of 41
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manufacture and provide many potential advantages over common antigen carriers
and broad immunostimulants.

PRODUCT CANDIDATE VACCINES

Epimmune has a number of vaccine product opportunities as described in the
following table:

<TABLE>
     <S>                         <C>                          <C>
      Indication                 Product Development Stage    Commercialization Rights

      Cancer
        Therapeutic Vaccines
           Breast                Preclinical                  Searle
           Colon                 Preclinical                  Searle
           Lung                  Preclinical                  Searle
           Prostate              Epitope/Antigen              Searle
                                   Identification
        Ex Vivo                  Preclinical                  Takara/Searle

      Infectious Diseases
        Therapeutic Vaccines
           Hepatitis B           Preclinical                  Epimmune
           Hepatitis C           Preclinical                  Epimmune
           HIV                   Preclinical                  Epimmune
           Papilloma virus       Epitope/Antigen              Epimmune
                                   Identification

      Prophylactic
        Vaccines
           Hepatitis C           Preclinical                  Epimmune
           HIV                   Preclinical                  Epimmune
           Malaria               Preclinical                  Epimmune
</TABLE>

INTELLECTUAL PROPERTY

Epimmune was founded with the vaccine technology patent estate developed by
Cytel over approximately 10 years. The scientific founders of Epimmune are
recognized leaders in the fields of T-cell recognition, epitope identification
and immune stimulation. With 10 issued United States patents, 19 issued foreign
patents, more than 160 pending applications worldwide and licenses to other
intellectual property relevant to epitope discovery, Epimmune has established a
broad intellectual property position directed toward processes of epitope
identification, epitope compositions and uses.

CORPORATE COLLABORATIONS

Epimmune expects to enter into research and development collaborations with
multiple pharmaceutical and biotechnology companies to commercialize therapeutic
and prophylactic vaccines in select infectious disease fields. Epimmune's unique
capabilities include expertise in identifying those epitopes from viral and
tumor-associated antigens which elicit the desired immune response and creating
and evaluating product candidates which elicit a potent immune response. The
Company's current partners include:

G.D. Searle & Co. The scope of the collaboration, established in February 1998,
is the treatment of cancer worldwide, excluding ex vivo cellular therapy in
Japan. The parties are combining Epimmune's proprietary cancer-specific epitope
and PADRE technologies with Searle's cytokine technology to develop a new class
of cancer therapies designed to induce highly specific immune responses. In
addition to the $15 million investment made to date in Epimmune and Cytel,
Searle will fund product development, make milestone payments upon achievement
of certain preclinical and clinical milestones which could exceed $100 million,
and pay royalties on product sales.

Takara Shuzo Co., Ltd. ("Takara"). In 1994, Cytel established a collaboration
with Takara, focused on ex vivo cellular therapy for treatment of cancer.
Cytel's rights and obligations were transferred to Epimmune during its formation
in October 1997. Takara, who is collaborating with Japanese investigators on the
evaluation and optimization of ex vivo cellular therapies, has rights to
Epimmune technology for ex vivo treatment of cancer in Japan. Under the terms of
the collaboration, Epimmune has a license to any patents or know-how developed
by Takara in the field. Takara will make payments upon achievement of certain
clinical milestones and pay Epimmune royalties on sales of any products
resulting from the collaboration.



                                  Page 4 of 41

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CELL ADHESION THERAPEUTIC PROGRAM

BACKGROUND

Cytel's cell adhesion therapeutic program was directed toward treating acute and
chronic inflammatory conditions by blocking specific cell adhesion molecules
responsible for the recruitment of white blood cells to sites of inflammation.
Cytel's scientists have been at the forefront in the identification and
characterization of cell adhesion molecules, including the receptors present on
one cell that bind to ligands on another cell and mediate cell adhesion. The
receptors and ligands operate in a lock-and-key manner to initiate an
inflammatory response. The adhesion of white blood cells to the cells lining the
blood vessel wall is a pivotal event in acute and chronic inflammatory
responses. Cytel pursued development of Cylexin, its lead cell-adhesion blocker,
for the prevention of reperfusion injury in infants undergoing CPB and has a
second class of cell adhesion blockers, VLA-4 integrin blockers, directed toward
the treatment of chronic inflammatory diseases. In March 1999, Cytel
discontinued its cell adhesion program based on disappointing results from its
Phase II/III clinical trial of Cylexin.

CYLEXIN

Cylexin, is a carbohydrate that blocks both P and E selectins. Based on results
from two relevant animal studies conducted with Cylexin by Harvard Medical
School researchers, together with clinical data from Cytel's Phase II trial of
Cylexin in reperfusion injury following CPB in adult patients undergoing surgery
to remove chronic blood clots from their lungs, Cytel initiated a Phase II/III
clinical trial of Cylexin for the prevention of reperfusion injury in infants
undergoing CPB to facilitate surgical repair of life threatening heart defects.

The Phase II/III trial was designed as a 250-patient double-blind,
placebo-controlled efficacy and safety study and was conducted at 11 leading
centers for pediatric cardiac surgery in the United States and Canada, including
Boston Children's Hospital, Children's Hospital of Philadelphia, The Cleveland
Clinic Foundation, Children's Hospital of Los Angeles and Cincinnati Children's
Hospital Medical Center. It was designed to evaluate efficacy and safety in two
groups of infants undergoing surgery to correct congenital heart defects. The
groups (a high-risk and a low-risk group) were defined based on expected
peri-operative mortality rates. The efficacy parameters that Cytel studied in
the trial included improvement in post-operative cardiac, pulmonary and renal
function and reduction in neurological sequelae. Cytel also focused on important
measures of pharmacoeconomic value, including reduction in ventilator time,
reduction in the use of drugs for cardiac stabilization, reduction in days in
the intensive care unit and reduction in overall hospital stay.

In March 1999, the trial was completed for the low-risk group and the data were
analyzed. One hundred thirty-eight patients were included in the analysis. There
were no clinically meaningful or statistically significant outcomes for any of
the primary endpoints (time in ICU, time to removal from ventilatory support or
amount of cardiac support drugs used) nor in any of the secondary endpoints
evaluated. Side effects were essentially equivalent in the Cylexin and placebo
treatment groups. Once this analysis was completed, the trial was halted.

From March 1991 through January 1997, Cytel and Sumitomo Pharmaceuticals Co.,
Ltd. ("Sumitomo") worked together to develop drugs based on Cytel's selectin
technology for the treatment of white blood cell-mediated diseases pursuant to
the terms of a technology development agreement. Sumitomo has licensed rights to
develop and commercialize compounds resulting from the collaboration in Pacific
Rim countries. Although Sumitomo has rights to Cylexin in the Pacific Rim, it
has informed Cytel that it will not pursue Cylexin for the CPB indication and
may not pursue Cylexin for any indication.



                                  Page 5 of 41
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INTEGRIN BLOCKERS

The migration of certain classes of white blood cells (lymphocytes, eosinophiles
and monocytes) into organs or tissues is central to the pathogenesis of a
variety of chronic inflammatory diseases. Integrins are a group of adhesion
receptors on the surface of these white blood cells which bind to ligands on
epithelial cells lining blood vessels in a lock-and-key manner and thereby
initiate a chronic inflammatory response. Integrin blockers should therefore
inhibit white blood cell infiltration and the resulting pathology in the target
tissues. Cytel scientists selected the VLA-4 integrin as the most relevant
molecular target for its integrin blocker program based on the Company's own
work and supporting data reported in the literature from a variety of animal
models of chronic inflammation including asthma, colitis, diabetes,
transplantation, multiple sclerosis and arteriopathy. Cytel has demonstrated
that its lead VLA-4 inhibitor compound is effective in several animal models
including multiple models of asthma. In vivo studies have shown: (i) a
protective effect against antigen-induced late responses and airway hyper
responsiveness in allergic sheep; (ii) a significant reduction in eosinophil
recruitment to the airways and airway hyperresponsiveness in antigen-challenged
mice; and (iii) an improvement in pulmonary function and reduction in white
blood cell recruitment in antigen-challenged rabbits.

Cytel has an exclusive license from the Fred Hutchinson Cancer Research Center
("FHCRC") to lymphocyte adhesion technology related to blocking the VLA-4/CS-1
interaction. A United States patent was granted to FHCRC covering the use of
antibodies directed at VLA-4 to treat or prevent inflammation. Additional claims
from this application are in prosecution for peptides and other agents. Cytel is
obligated to make milestone and royalty payments to FHCRC during the development
and commercialization of products that are covered by FHCRC patents. In July
1998, Cytel signed an exclusive sublicensing and option agreement with Elan
Corporation's subsidiary Elan International Services, Ltd. ("Elan"), granting it
rights under the FHCRC antibody patent. In addition, Elan has the option to
enter into a non-exclusive sublicense for rights to future patents resulting
from the FHCRC application. As part of the agreement, Elan made a $4 million
equity investment in Cytel and will make future milestone and royalty payments.

In conjunction with the announcement that clinical trials of Cylexin have been
halted, Cytel decided to end its pursuit of cell adhesion therapeutics and will
pursue the sale of its remaining cell adhesion related assets. The company 
believes it may still get revenues from Elan due to Elans development of the 
Licensed technology.

GLYTEC MANUFACTURING BUSINESS

In February 1999, Cytel licensed its proprietary carbohydrate synthesis and
manufacturing technology to Baxter Healthcare Corporation's Nextran unit for
exclusive use in xenotransplantation and sold Nextran certain related fixed
assets. Cytel received $4 million of consideration in the transaction. This
licensing arrangement replaced Cytel's exclusive agreements with Nextran for the
supply of a specific bioactive carbohydrate for use in xenotransplantion. In
connection with the license of rights to Cytel's carbohydrate synthesis and
manufacturing technology to Nextran for xenotransplantation and upon Cytel's
announcement that it halted clinical trials of Cylexin, Nextran assumed the
facility lease and certain personnel related to this manufacturing operation.

In March 1999, Cytel announced the sale of its carbohydrate synthesis and
manufacturing business assets to Neose Technologies, Inc. Neose paid Cytel $3.5
million in cash and paid an additional $1.5 million into escrow, the release of
which is conditioned on Cytel's satisfaction of certain matters relating to the
patents and licenses acquired by Neose. Neose may pay Cytel up to an additional
$1.6 million contingent on potential payments and revenues realized by Neose in
connection with certain future corporate collaborations. Under the agreement,
Neose acquired all of Cytel's carbohydrate synthesis and manufacturing
technology, including patent rights and rights under license agreements with The
Scripps Research Institute, The University of Michigan, The University of
Alberta, The University of California, Los Angeles and The University of
Arkansas and National Research Council of Canada. Neose acquired such technology
subject to the rights and licenses granted to Nextran in the field of
xenotransplantation. Cytel retains a license to pursue research and development
of glycosyltransferase inhibitors.





                                  Page 6 of 41
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PATENTS, PROPRIETARY RIGHTS AND LICENSES

The Company's success will depend in part on its ability to obtain patent
protection for its products, both in the United States and other countries. The
patent position of biotechnology and pharmaceutical companies is highly
uncertain and involves complex legal and factual questions. The Company files
patent applications as appropriate covering its proprietary technology.

EPIMMUNE

Epimmune was founded with the vaccine patent estate developed by Cytel over
approximately 10 years. With 10 issued United States patents, 19 issued foreign
patents, more than 160 pending applications worldwide, and licenses to other
intellectual property relevant to epitope discovery, Epimmune has established a
broad intellectual property position directed toward processes of epitope
identification, epitope compositions and uses. Epimmune's intellectual property
covers thousands of CTL and HTL epitopes relevant to stimulating a cellular
immune response to breast, lung, prostate, cervical and colorectal cancers and
melanoma, as well as HBV, HCV, HIV, malaria, HPV and tuberculosis. Covered in
the claims are peptide and nucleic acid compositions and related methods of use.
Epimmune's intellectual property also covers numerous processes of epitope
identification, including methods for identifying motif-bearing epitopes,
methods for modifying epitopes to increase population coverage and/or enhance
immunogenicity, in vitro MHC binding assays, methods of inducing CTL ex vivo,
transgenic animals and computer programs to identify epitopes and generate
analogs of motif-bearing molecules. Many of these methods, developed by Epimmune
scientists, have become standard practice in the field. Epimmune has issued
patents and pending applications covering the PADRE family of universal T helper
epitopes.

CYTEL

As of March 31, 1999, following the sale of certain assets to Neose, Cytel's
patent estate consisted of 28 United States and 70 international pending patent
applications, and 12 United States and 16 international issued patents.

These patent applications and patents are either owned by or are under exclusive
license to Cytel or Epimmune. There can be no assurance that patents will issue
from any of the applications the Company has filed or licensed; or that if
patents do issue, that claims allowed will be sufficiently broad to protect the
Company's technology. In addition, there can be no assurance that any patents
issued to the Company will not be challenged, invalidated or circumvented, or
that the rights granted thereunder will provide proprietary protection to the
Company.

As is typical in the biotechnology industry, the commercial success of the
Company will depend in part on the Company neither infringing patents issued to
competitors nor breaching the technology licenses upon which the Company's
products might be based. Failure by the Company to obtain a license to any
technology that it requires to commercialize its products, or to develop an
alternative compound and obtain FDA approval within an acceptable period of time
if required to do so, may have a material adverse impact on the Company.
Litigation, which could result in substantial costs to the Company, would also
be necessary to enforce any patents issued to the Company or to determine the
scope and validity of others' proprietary rights. In addition, the Company may
have to participate in interference proceedings declared by the U.S. Patent and
Trademark Office which could result in substantial costs to the Company.

The Company also protects its proprietary technology and processes in part by
confidentiality agreements with its collaborative partners, employees and
consultants. There can be no assurance that these agreements will not be
breached, that the Company will have adequate remedies for any breach, or that
the Company's trade secrets will not otherwise become known or be independently
discovered by competitors.





                                  Page 7 of 41
<PAGE>   9

MANUFACTURING

In June 1998, Cytel completed construction of a manufacturing facility that
complies with current Good Manufacturing Practices ("cGMP") regulations
promulgated by FDA and is licensed by the State of California for production of
carbohydrate products for use in clinical trials. The new facility is a 10,000
square foot cGMP manufacturing facility that meets regulatory requirements for
cGMP production of products. In connection with the license of rights to Cytel's
carbohydrate synthesis and manufacturing technology to Nextran for
xenotransplantation and upon Cytel's announcement that it has halted clinical
trials of Cylexin, Nextran has assumed the operations and the lease to this
facility.

To be successful, the Company's products and products of its partners must be
manufactured in commercial quantities in compliance with regulatory requirements
and at an acceptable cost. The Company has not commercialized any pharmaceutical
products, nor has it demonstrated its ability to manufacture commercial
quantities of its or its partners' product candidates in accordance with
regulatory requirements. If the Company is unable to develop itself or contract
with a third-party manufacturing capabilities to produce suitable quantities of
its or its partners' products in accordance with regulatory standards, the
ability of the Company or its partners to conduct clinical trials, obtain
regulatory approvals and market such products may be adversely affected, which
could adversely affect the Company's competitive position and its chances of
achieving profitability. There can be no assurance that such products can be
manufactured by the Company or any other party at a cost or in quantities which
are commercially viable. 

GOVERNMENT REGULATION

The Company's research and development activities and any future manufacturing
and marketing of products by the Company are subject to regulation for safety
and efficacy by numerous governmental authorities in the United States and other
countries. In the United States, drugs are subject to rigorous regulation by
FDA. The Federal Food, Drug and Cosmetic Act and the Public Health Service Act
govern the testing, manufacture, safety, efficacy, labeling, storage,
record-keeping, approval, advertising and promotion of the Company's products.
In addition to FDA regulations, the Company is also subject to other federal and
state regulations such as the Occupational Safety and Health Act and the
Environmental Protection Act. Product development and approval within this
regulatory framework takes a number of years and involves the expenditure of
substantial resources. In addition, there can be no assurance that this
regulatory framework will not change or that additional regulation will not
arise at any stage of the Company's product development which may affect
approval or delay an application or require additional expenditures by the
Company.

The steps required before a pharmaceutical agent may be marketed in the United
States include (i) preclinical laboratory and animal tests, (ii) the submission
to the FDA of an application for an Investigational New Drug Application
("IND"), which must become effective before human clinical trials may commence
in the United States, (iii) adequate and well-controlled human clinical trials
to establish the safety and efficacy of the drug, (iv) the submission of a New
Drug Application ("NDA") or Product License Application ("PLA") to the FDA and
(v) the FDA approval of the NDA or PLA prior to any commercial sale or shipment
of the drug. In addition to obtaining FDA approval for each product, each
domestic drug manufacturing establishment must be registered with, and approved
by, the FDA. Drug product manufacturing establishments located in California
also must be licensed by the State of California in compliance with separate
regulatory requirements.

Preclinical tests include laboratory evaluation of product chemistry and animal
studies to assess the safety and efficacy of the product and its formulation.
The results of the preclinical tests are submitted to the FDA as part of an IND
(and subsequently when additional non-clinical work is completed), and unless
the FDA objects, the IND will become effective 30 days following its receipt by
the FDA.

Clinical trials involve the administration of the drug under the supervision of
a qualified principal investigator to healthy volunteers or to patients
identified as ones with the condition for which the





                                  Page 8 of 41
<PAGE>   10

drug is being tested. Clinical trials are conducted in accordance with protocols
that detail the objectives of the study, the parameters to be used to monitor
safety and the efficacy criteria to be evaluated. Each protocol is submitted to
the FDA as part of the IND. Each clinical study is conducted under the auspices
of an independent Institutional Review Board ("IRB") at the institution at which
the study will be conducted. Prior to its approval for the study to be
conducted, the IRB will consider, among other things, ethical factors, the
safety of human subjects and the possible liability of the institution.

Clinical trials are typically conducted in three sequential phases prior to
product approval, but the phases may overlap. In Phase I, the initial
introduction of the drug into healthy human subjects and often into patients as
well, the drug is tested for safety (adverse effects), dosage tolerance,
metabolism, distribution, excretion and clinical pharmacology. Phase II involves
studies in a limited patient population to (i) determine the efficacy of the
drug for specific targeted indications, (ii) determine dosage tolerance and
optimal dosage and regimen and (iii) identify possible adverse side-effects and
safety risks. When a compound is found to be effective and to have an acceptable
safety profile in Phase II evaluations, Phase III trials are undertaken to
evaluate clinical efficacy further and to test further for safety within an
expanded patient population at multiple clinical study sites. Even after the NDA
approval, the FDA may require additional Phase IV clinical trials. The FDA
reviews both the clinical plans and the results of the trials and may
discontinue the trials at any time if there are significant safety issues.

The results of the preclinical tests and clinical trials are submitted to the
FDA in the form of an NDA or PLA for marketing approval. The testing and
approval process is likely to require substantial time and effort and there can
be no assurance that any approval will be granted on a timely basis, if at all.
The approval process is affected by a number of factors, including the severity
of the disease, the availability of alternative treatments and the risks and
benefits demonstrated in clinical trials. Additional animal studies or clinical
trials may be requested during the FDA review period and may delay marketing
approval. After FDA approval for the initial indications, further clinical
trials may be necessary to gain approval for the use of the product for
additional indications. The FDA mandates that adverse effects be reported to the
FDA and may also require post-marketing testing to monitor for adverse effects,
which can involve significant expense.

Among the conditions for NDA or PLA approval is the requirement that the
prospective manufacturer's quality control and manufacturing procedures conform
to good manufacturing practices prescribed by the FDA. Domestic manufacturing
facilities are subject to biennial FDA inspections and foreign manufacturing
facilities are subject to periodic FDA inspections or inspections by the foreign
regulatory authorities with reciprocal inspection agreements with the FDA.

The Prescription Drug Act of 1992 requires companies engaged in pharmaceutical
development, such as the Company, to pay user fees in the amount of at least
$100,000 upon submission of an NDA. The Company does not believe that this
requirement will have a material adverse effect on the Company's business.

For marketing outside the United States, the Company also is subject to foreign
regulatory requirements governing human clinical trials and marketing approval
for drugs. The requirements governing the conduct of clinical trials, product
licensing, pricing and reimbursement vary widely from country to country.

The time required for completing such testing and obtaining such approvals is
uncertain and approval itself may not be obtained. In addition, delays or
rejections may be encountered based upon changes in FDA policy during the period
of product development and FDA and/or HPB regulatory review of each submitted
new drug application or product license application. Similar delays may also be
encountered in foreign countries. There can be no assurance that even after such
time and expenditures regulatory approval will be obtained for any drugs
developed by the Company. Moreover, if regulatory approval of a drug is granted,
such approval may entail





                                  Page 9 of 41
<PAGE>   11

limitations on the indicated uses for which the drug may be marketed. Further,
even if such regulatory approval is obtained, a marketed drug, its manufacturer
and the facilities in which the drug is manufactured are subject to continual
review and periodic inspections. Later discovery of previously unknown problems
with a product, manufacturer or facility may result in restrictions on such
product or manufacturer, including withdrawal of the product from the market.

COMPETITION

The Company is engaged in a highly competitive industry. The Company competes
with many public and private companies, including pharmaceutical companies,
chemical companies, specialized biotechnology companies and academic
institutions. Many of the Company's competitors have substantially greater
financial, scientific and technical resources, and manufacturing and marketing
capabilities than the Company. In addition, many of the Company's competitors
have significantly greater experience conducting preclinical studies and
clinical trials of new pharmaceutical products, and in obtaining regulatory
approvals for pharmaceutical products. Competitors of the Company and its
collaborators may develop and commercialize such products more rapidly than the
Company and its collaborators. There can be no assurance that the Company's
competitors will not succeed in developing 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.

For some indications, the Company anticipates developing products which will be
competing with existing therapies for market share. In addition, a number of
companies are pursuing the development of novel pharmaceuticals which target the
same diseases that the Company is targeting. These companies include
pharmaceutical and biotechnology companies. Furthermore, academic institutions,
government agencies and other public and private organizations conducting
research may seek patent protection with respect to potentially competing
products or technologies and may establish collaborative arrangements with
competitors of the Company. The development by others of new treatment methods
for those indications for which the Company is developing pharmaceuticals could
render such pharmaceuticals noncompetitive or obsolete.

The Company's products under development are expected to address a range of
markets. The Company's competition will be determined in part by the potential
indications for which the Company's compounds are developed and ultimately
approved by regulatory authorities. For certain of the Company's potential
products, an important factor in competition may be the timing of market
introduction of its or competitive products. Accordingly, the relative speed
with which the Company or its collaborative partners can develop products,
complete the clinical trials and approval processes and supply commercial
quantities of the products to the market are expected to be important
competitive factors. The Company expects that competition among products
approved for sale will be based, among other things, on product effectiveness,
safety, reliability, availability, price and patent position.

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

EMPLOYEES

As of April 1, 1999, the Company employed 51 individuals full-time, of whom 26
were engaged in research and development, including 37 full-time employees of
Epimmune, 13 of whom hold Ph.D. or M.D. degrees. A significant number of the
Company's management and professional employees have had prior experience with
pharmaceutical, biotechnology or medical product companies. The Company believes
it has been highly successful in attracting skilled and experienced scientific
personnel; however, competition for such personnel is intensifying. None of the
Company's employees are covered by collective bargaining agreements, and
management considers relations with its employees to be good.





                                 Page 10 of 41
<PAGE>   12

EXECUTIVE OFFICERS

The executive officers of the Company and their ages as of March 31, 1999 are as
follows:

<TABLE>
<CAPTION>
Name                               Age        Position
----                               ---        --------
<S>                                <C>        <C>
Virgil Thompson                    59         President, Chief Executive Officer
                                              and Director

Robert L. Roe, M.D., F.A.C.P.      58         Executive Vice President, Chief
                                              Operating Officer, Acting Chief
                                              Financial Officer and Director

Jennifer L. Lorenzen               45         Vice President of Business
                                              Development


Deborah A. Schueren                35         Vice President of Cytel and
                                              President of Epimmune
</TABLE>

BUSINESS EXPERIENCE

Mr. Thompson joined Cytel in January 1996 as President and Chief Executive
Officer, and member of the Board of Directors. Previously he was President and
Chief Executive Officer for CIBUS Pharmaceutical, Inc., a privately held oral
drug delivery company from July 1994 to December 1995. He served as a consultant
to the pharmaceutical industry from 1993 to 1994. From 1969 to 1993, Mr.
Thompson was employed by Syntex Corporation ("Syntex"). During his tenure with
Syntex, he held several key executive positions including President, Syntex
Laboratories, Inc., Chief Operating Officer, Syntex Laboratories, Inc. and Vice
President, Corporate Regulatory Affairs. Mr. Thompson earned a Bachelor of
Science degree in Pharmacy from Kansas University and a Juris Doctor degree from
the George Washington University Law School. He also serves on the boards of
directors of Biotechnology General Corporation, Cypros Pharmaceutical
Corporation and Aradigm Corporation.

Dr. Roe joined Cytel in January 1996 as Executive Vice President and Chief
Operating Officer, and member of the Board of Directors. He was appointed as
Acting Chief Financial Officer and Secretary in December 1998. In his most
recent position prior to joining the Company, Dr. Roe served as Executive Vice
President, Chief Operating Officer, and member of the Board of Directors of
Chugai Biopharmaceuticals, Inc. ("CBI"), a San Diego based subsidiary of Chugai
Pharmaceuticals Co., Ltd. of Japan, from August 1995 to January 1996. From 1976
to 1995, Dr. Roe was employed by Syntex in senior-level positions in medical
research, pharmaceutical development and regulatory affairs, prior to becoming
President of Development Research and Senior Vice President of the corporation.
Dr. Roe earned his Doctor of Medicine degree from the University of California
at San Francisco, School of Medicine, and his Bachelor of Arts degree with
Honors from Stanford University, in Biological Sciences. He is a Fellow of the
American College of Physicians and the American College of Rheumatology. He
serves on the board of directors of CoCensys, Inc.

Ms. Lorenzen was elected Vice President of Business Development in February
1998. She joined Cytel in August 1996 as Director, Strategic Marketing and
Program Management and was elected Vice President and Development Program
Director in April 1997. Prior to joining Cytel, Ms. Lorenzen was with CBI where
she held the position of Vice President and Development Program Director. Before
joining CBI in 1995, she spent 10 years at Syntex, USA, Inc. where she held a
variety of marketing and management positions, including Vice President and
Program Director of





                                 Page 11 of 41
<PAGE>   13

Syntex' Ganciclovir Program. Ms. Lorenzen received her Bachelor of Arts degree
in Biological Sciences from the University of California at Davis. Ms. Lorenzen
resigned from Cytel effective March 31, 1999.

Ms. Schueren was elected President of Epimmune in October 1997 and has also
served as a Vice President of Cytel Corporation since March 1997. She joined
Cytel in October 1992 and has had responsibility at different times during that
period for a variety of functions including investor relations, business
development and finance. She served as Director, Business Development from 1994
until March 1997 and as Vice President, Finance and Chief Financial Officer from
March 1997 until October 1997. Prior to joining Cytel, Ms. Schueren was a
consultant with The Boston Consulting Group, a management consulting firm, from
1990 to 1992 and was with Lehman Brothers Investment Banking Division, Health
Care Corporate Finance from 1986 to 1988. She received her Bachelor of Science
in Chemical Engineering from Texas A&M University and an MBA from the Harvard
Business School.

All officers are elected annually by the Board of Directors. Each officer serves
at the discretion of the Board of Directors. There are no family relationships
among any of the directors, officers or key employees of the Company.

RISK FACTORS

The Company wishes to caution readers that the following important factors,
among others, in some cases have affected the Company's results and in the
future could cause actual results and needs of the Company to vary materially
from forward-looking statements made from time to time by the Company on the
basis of management's then-current expectations. The business in which the
Company is engaged is in rapidly changing and competitive markets and involves a
high degree of risk, and accuracy with respect to forward-looking projections is
difficult.

Disappointing results of the Phase II/III clinical trial of Cylexin, Cytel's
lead cell adhesion inhibitor compound, has led to the termination of the cell
adhesion therapeutic business. Accordingly, Cytel is terminating its employees,
selling its fixed assets and intellectual property, and focusing all subsequent
development efforts on Epimmune's vaccine technology. During the first quarter
of 1999, Cytel sold its Glytec carbohydrate synthesis and manufacturing business
and plans to use the proceeds from such sale, together with existing cash
resources, to meet its financial obligations, including corporate restructuring
and termination costs of all of its non-vaccine programs. There can be no
assurance, however, that Cytel's cash resources will be sufficient to satisfy
all of its financial obligations.

FUTURE CAPITAL NEEDS; UNCERTAINTY OF ADDITIONAL FUNDING

Excluding Epimmune, as of March 31, 1999, Cytel had approximately $5.2 million
of cash available. As of March 31, 1999, Epimmune had $10.3 million in cash,
cash equivalents, restricted cash and short-term investments. The Company is
considering various alternatives in light of its financial position and the
recent sale of its carbohydrate synthesis and manufacturing business and
decision to terminate the cell adhesion therapeutic anti-inflammatory program.
The Company's future capital requirements will depend on many factors,
including: the ability of the Company to establish and maintain collaborative
arrangements; progress with preclinical testing and clinical trials; the time
and costs involved in obtaining regulatory approvals; the costs involved in
filing, prosecuting and enforcing patent claims; competing technological and
market developments; changes in its existing research relationships; continued
scientific progress in its drug discovery programs; the magnitude of these
programs; the cost of manufacturing scale-up; and effective commercialization
activities and arrangements. Epimmune intends to seek additional funding through
collaborative arrangements or equity or debt financings. If additional financing
is not available, Epimmune anticipates its existing





                                 Page 12 of 41
<PAGE>   14

available cash, cash equivalents, restricted cash and short-term investments
will be adequate to fund its operations through the end of 2000. The estimate
for the period for which Epimmune expects its available cash balances,
investment income and estimated cash flow from collaborative agreements and
research grants to be sufficient to meet its capital requirements is a
forward-looking statement that involves risks and uncertainties as set forth
herein and in Item 7, "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and elsewhere in this Report on Form 10-K.
There can be no assurance that any financing or transaction through which the
Company seeks to obtain additional funding will be available on favorable terms,
if at all, or that any collaboration agreements to which the Company is or may
become a party will successfully reduce the Company's funding requirements. The
suspension or termination of the Company's collaborations with its existing
corporate partners or the inability to enter into new collaborations, the
failure of any such collaborations to be successful or the delay in their
development or commercialization of products could have a material adverse
effect on the Company's business, financial condition and results of operations.
If additional funds are raised by issuing securities, further dilution to
existing stockholders may result. If adequate funds are not available, the
Company will be required to delay, scale back or eliminate one or more of its
drug discovery or development programs; obtain funds through arrangements with
collaborative partners or others that may require the Company to relinquish
rights to or sell certain of its technologies, product candidates or products
that the Company would not otherwise relinquish or sell; sell itself or certain
of its technologies or other assets to a third party; cease operations; or
declare bankruptcy.

EARLY STAGE OF DEVELOPMENT; ABSENCE OF PRODUCTS

The Company is a research and development focused company. It has not completed
the development of any product and, accordingly, has not begun to market or
generate revenues from the commercialization of products. The Company does not
expect to market any therapeutic or prophylactic products for a number of years.
The Company's products under development will require significant time-consuming
and costly research, development, preclinical studies, clinical testing,
regulatory approval and significant additional investment prior to their
commercialization, which may never occur. There can be no assurance that the
Company's research and development programs will be successful. In particular,
Cytel completed its Phase II/III clinical trial of Cylexin, its lead cell
adhesion inhibitor compound, in March 1999. Based on disappointing results from
this Phase II/III clinical trial, Cytel announced that it has halted clinical
trials of Cylexin and is discontinuing its cell adhesion programs. Further,
there can be no assurance that the Company will be able to manufacture any
products in commercial quantities in compliance with regulatory requirements at
an acceptable cost, that any of its products under development will be
successfully commercialized or will prove to be safe and efficacious in clinical
trials or that the Company or its collaborators will be successful in obtaining
market acceptance of any of its products. The Company or its collaborators may
encounter problems and delays relating to research and development, regulatory
approval, manufacturing and marketing. The failure by the Company to address
such problems and delays successfully would have a material adverse effect on
the Company's business, financial condition and results of operations.

RELIANCE ON COLLABORATIVE PARTNERS

The Company expects to rely on collaborative arrangements both to develop and
commercialize pharmaceutical products. The Company has relied on certain
established pharmaceutical companies interested in its technology to fund a
portion of its research and development expenses for pharmaceutical product
candidates. There can be no assurance that the Company will be able to enter
into collaborative arrangements in the future, that any such collaborative
arrangements or its existing collaborative arrangements will continue or be
successful or that the Company will receive royalty revenues, license fees or
milestone payments from any of such collaborative arrangements. In addition,
collaborative partners may pursue alternative technologies or develop
alternative compounds either on their own or in collaboration with others,
including the Company's competitors, as a means of developing treatments for the
disease targeted by any collaborative program of the Company.



                                 Page 13 of 41
<PAGE>   15

Epimmune has entered into a research and development collaboration with Searle
with respect to the production, use and sale of pharmaceutical products derived
from Epimmune's cancer epitopes and the use thereof in ex vivo therapies and
therapeutic vaccines. Such collaboration is Epimmune's only significant
collaboration to date, and Epimmune is substantially dependent upon it. The
success of the collaboration will depend, in significant part, on Searle's
development, competitive marketing and strategic considerations, including the
relative advantages of alternative products being developed or marketed by
competitors. Epimmune expects that substantially all of its revenues for the
foreseeable future will result from payments under its existing, and any future,
collaborations, including royalties on product sales, and interest income. There
can be no assurance that Searle will perform its obligations as expected or that
any future milestone payments or other amounts will be received by Epimmune. The
suspension or termination of the Epimmune collaboration with Searle, the failure
of such collaboration to be successful or the delay in the development or
commercialization of pharmaceutical products pursuant to such collaboration
could have a material adverse effect on the Company's business, financial
condition and results of operations.

In addition, the Company may be required to enter into licenses or other
collaborative agreements with third parties in order to access technologies that
may be necessary to successfully develop certain of its products. There can be
no assurance that the Company will be able to successfully negotiate acceptable
licenses or other collaborative arrangements that allow it to access such
technology. In addition, there can be no assurance that any technology accessed
through such licenses or other collaborations will successfully meet the
Company's requirements.

CONTINUING OPERATING LOSSES; ACCUMULATED DEFICIT

The Company has experienced significant operating losses since its inception in
1987. As of December 31, 1998, the Company had an accumulated deficit of
approximately $128.7 million. The Company expects to incur substantial
additional operating losses as the Company's research and development and
clinical trial efforts continue. All of the Company's revenues to date have
consisted of contract research and development revenues, license and milestone
payments, research grants and interest income. To achieve profitable operations,
the Company, alone or with others, must identify, develop, register, manufacture
and market proprietary products. There can be no assurance that the Company will
be successful in its efforts to achieve profitable operations.

MANUFACTURING LIMITATIONS

To be successful, the Company's products and products of its partners must be
manufactured in commercial quantities in compliance with regulatory requirements
and at an acceptable cost. The Company has not commercialized any products, nor
has it demonstrated its ability to manufacture commercial quantities of its or
its partners' product candidates in accordance with regulatory requirements. If
the Company is unable to develop itself or contract with a third-party
manufacturing capabilities to produce suitable quantities of its or its
partners' products in accordance with regulatory standards, the ability of the
Company or its partners to conduct clinical trials, obtain regulatory approvals
and market such products may be adversely affected, which could adversely affect
the Company's competitive position and its chances of achieving profitability.
There can be no assurance that such products can be manufactured by the Company
or any other party at a cost or in quantities which are commercially viable.

GOVERNMENT REGULATION; UNCERTAINTY ASSOCIATED WITH CLINICAL TRIALS

The production and marketing of the Company's products and its ongoing research
and development activities are subject to regulation by numerous governmental
authorities in the United States, Canada and other countries. Before any drug
developed by the Company can be marketed, it will undergo rigorous preclinical
and clinical testing and an extensive regulatory approval process mandated by
the FDA and equivalent foreign authorities, including the Canadian HPB. These
processes can take a number of years and require the expenditure of substantial
resources. The time required for completing such testing and obtaining such
approvals is uncertain and approval itself




                                 Page 14 of 41
<PAGE>   16

may not be obtained. The FDA, the HPB or the Company and its collaborators may
decide to discontinue or suspend clinical trials at any time if the subjects or
patients who are participating in such trials are being exposed to unacceptable
health risks or if the results show no or limited benefit in patients treated
with the drug compared to patients in the control group. In particular, Cytel
completed its Phase II/III clinical trial of Cylexin, its lead cell adhesion
inhibitor compound, in March 1999. Cytel announced that it halted clinical
trials of Cylexin based on disappointing results that indicated that Cylexin
showed no benefit over placebo for the treatment of reperfusion injury in
infants undergoing CPB to facilitate the surgical repair of heart defects.

Cytel has recently discontinued human clinical testing of its lead product
candidate, Cylexin, in infants undergoing surgery to correct congenital heart
defects. This trial was terminated in March 1999 after a determination that the
drug was safe, but that there was no increased efficacy seen in patients treated
with Cylexin compared to those patients in the placebo control group. Testing of
the Company's other product candidates in research and development may reveal
undesirable and unintended side effects or other characteristics that may
prevent or limit their commercial use. There can be no assurance that the
Company will not encounter problems in clinical trials of other product
candidates that will cause the FDA, or the Company to delay or suspend clinical
trials. Furthermore, there can be no assurance that any of the Company's
products will be approved by the FDA or foreign regulatory agency for any
indication. Products, if any, resulting from the Company's research and
development programs are not expected to be commercially available for a number
of years. Even if regulatory approval of a drug is granted, such approval may
entail limitations on the indicated uses for which the drug may be marketed. In
addition, a marketed drug, its manufacturer and the facilities in which the drug
is manufactured are subject to continual review and periodic inspections. Later
discovery of previously unknown problems with a product, manufacturer or
facility may result in restrictions on such product or manufacturer, including
withdrawal of the product from the market.

TECHNOLOGICAL CHANGE AND COMPETITION

The Company is engaged in a highly competitive industry. The Company competes
with many public and private companies, including pharmaceutical companies,
chemical companies, specialized biotechnology companies and academic
institutions. Many of the Company's competitors have substantially greater
financial, scientific and technical resources, and manufacturing and marketing
experience and capabilities than the Company. In addition, many of the Company's
competitors have significantly greater experience conducting preclinical studies
and clinical trials of new pharmaceutical products, and in obtaining regulatory
approvals for pharmaceutical products. Competitors of the Company and its
collaborators may develop and commercialize such products more rapidly than the
Company and its collaborators. There can be no assurance that the Company's
competitors will not succeed in developing 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. The Company is
aware of companies that are pursuing the development of novel pharmaceuticals
which target the same diseases that the Company is targeting. There can be no
assurance that these and other efforts by potential competitors will not be
successful, or that other technologies will not be developed to compete with the
Company's technologies.

The Company's products under development address a range of markets. The
Company's competition will be determined in part by the potential indications
for which the Company's compounds are developed and ultimately approved by
regulatory authorities. For certain of the Company's potential products, an
important factor in competition may be the timing of market introduction of its
or competitive products. Accordingly, the relative speed with which the Company
can develop products, complete the clinical trials and approval processes and
supply commercial quantities of the products to the market are expected to be
important competitive factors. The Company expects that competition among
products approved for sale will be based, among other things, on product
effectiveness, safety, reliability, availability, price and patent position.





                                 Page 15 of 41
<PAGE>   17

PATENTS AND PROPRIETARY RIGHTS

The Company's success will depend in part on its ability to obtain patent
protection for its products and processes, both in the United States and other
countries. The patent position of biotechnology and pharmaceutical companies is
highly uncertain and involves complex legal and factual questions. There is no
consistent policy regarding the breadth of claims allowed in biotechnology
patents. The Company intends to file applications and pursue patent prosecution
as appropriate for patents covering both its products and processes. There can
be no assurance that patents will issue from any of the patent applications
owned or licensed by the Company or that, if patents do issue, that claims
allowed will be sufficiently broad to protect the Company's products and
processes. In addition, there can be no assurance that any patents issued to the
Company will not be challenged, invalidated or circumvented, or that the rights
granted thereunder will provide proprietary protection to the Company.

As is typical in the biotechnology industry, the commercial success of the
Company will depend in part on the Company neither infringing patents issued to
competitors nor breaching the technology licenses upon which the Company's
products might be based. Failure by the Company to obtain a license to any
technology that it requires to commercialize its products, or to develop an
alternative compound and obtain FDA approval within an acceptable period of time
if required to do so, would have a material adverse effect on the Company.
Litigation, which could result in substantial costs to the Company, may also be
necessary to enforce any patents issued to the Company or to determine the scope
and validity of others' proprietary rights. In addition, the Company may have to
participate in interference proceedings declared by the United States Patent and
Trademark Office which could result in substantial costs to the Company to
determine the priority of inventions.

The Company also protects its proprietary technology and processes in part by
confidentiality agreements with its collaborative partners, employees and
consultants. There can be no assurance that these agreements will not be
breached, that the Company will have adequate remedies for any breach, or that
the Company's trade secrets will not otherwise become known or be independently
discovered by competitors.

ABSENCE OF SALES AND MARKETING EXPERIENCE

The Company has no experience in sales, marketing or distribution. Before it can
market any of its products directly, the Company must develop a substantial
marketing and sales force with technical expertise and supporting distribution
capability. Alternatively, the Company may obtain the assistance of a
pharmaceutical company with a large distribution system and a large direct sales
force. Other than its agreements with Searle and Takara, the Company does not
have any existing distribution arrangements with any pharmaceutical company for
its products under development. There can be no assurance that the Company will
be able to establish sales and distribution capabilities or be successful in
gaining market acceptance for its products.

DEPENDENCE ON REIMBURSEMENT

The Company's ability to commercialize its products successfully 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 insurers and other organizations. Third-party payors
are increasingly challenging the price of medical products and services.
Significant uncertainty exists as to the reimbursement status of newly approved
health care products, and there can be no assurance that adequate third-party
coverage will be available to enable the Company to maintain price levels
sufficient to realize an appropriate return on its investment in product
development.





                                 Page 16 of 41
<PAGE>   18

DEPENDENCE ON KEY PERSONNEL

The Company is highly dependent on the principal members of its scientific and
management staff. The Company does not maintain key person life insurance on the
life of any employee. The Company's future success also will depend in part on
the continued service of its key scientific personnel and its ability to
identify, hire and retain additional qualified personnel.

There is intense competition for qualified personnel in the areas of the
Company's activities, and there can be no assurance that the Company will be
able to continue to attract and retain such personnel necessary for the
development of the Company's business. Because of the intense competition, there
can be no assurance that the Company will be successful in adding technical
personnel as needed to meet the staffing requirements of additional
collaborative relationships. Failure to attract and retain key personnel could
have a material adverse effect on the Company.

PRODUCT LIABILITY AND INSURANCE

The Company's business exposes it to potential product liability risks which are
inherent in the testing, manufacturing and marketing of human therapeutic
products. While the Company currently has product liability insurance, there can
be no assurance that it will be able to maintain such insurance on acceptable
terms or that insurance will provide adequate coverage against potential
liabilities.

USE OF HAZARDOUS MATERIALS

The Company's research and development involves the controlled use of hazardous
materials, chemicals and radioactive compounds. Although the Company believes
that its safety procedures for handling and disposing of such materials comply
with the standards prescribed by state and federal regulations, the risk of
accidental contamination or injury from these materials cannot be completely
eliminated. In the event of such an accident, the Company could be held liable
for any damage that results, which liability could exceed the resources of the
Company. The Company may incur substantial cost to comply with environmental
regulations if the Company develops commercial manufacturing capacity.

Although the Company believes that it is in compliance in all material respects
with applicable environmental laws and regulations and currently does not expect
to make material capital expenditures for environmental control facilities in
the near term, there can be no assurance that it will not be required to incur
significant costs to comply with environmental laws and regulations in the
future, or that the operations, business or assets of the Company will not be
materially, adversely affected by current or future environmental laws or
regulations.

VOLATILITY OF COMMON STOCK PRICE

The market price for securities of biotechnology companies, including the
Company, have historically been highly volatile, and the market from time to
time has experienced significant price and volume fluctuations that are
unrelated to the operating performance of such companies. Factors such as
announcements of technological innovations or new commercial therapeutic
products by the Company or others, governmental regulation, developments in
patent or other proprietary rights, developments in the Company's relationships
with its collaborative partners, public concern as to the clinical results
and/or, the safety of drugs developed by the Company or others and general
market conditions may have a significant effect on the market price of the
Company's common stock. Fluctuations in financial performance from period to
period also may have a significant impact on the market price of the common
stock.

ABSENCE OF DIVIDENDS

The Company has never paid any cash dividends and does not anticipate paying
cash dividends in the foreseeable future.





                                 Page 17 of 41
<PAGE>   19

ITEM 2.  PROPERTIES

The Company's administrative offices, research laboratory, manufacturing and
warehouse facilities are located in San Diego, California.

Cytel currently occupies three facilities for a total of 59,200 square feet. The
manufacturing and warehouse operations are in two buildings for a total of
17,200 square feet. In connection with the license of certain carbohydrate
synthesis and manufacturing technology to Nextran in February 1999, Nextran has
assumed the manufacturing and warehousing facility leases from Cytel and certain
equipment loan liabilities and related assets. Cytel has subleased approximately
23,000 square feet of its remaining office and research laboratory facility. The
sublease expires concurrent with the lease in 2000. As a result of Cytel's
restructuring announcement in March 1999, Cytel intends to sublease the
remainder of its existing office and laboratory space.

Epimmune currently occupies an 8,600 square foot facility in San Diego under a
lease which expires in 2002. In November 1998, Epimmune entered into a 10-year
lease of a new 24,000 square foot laboratory facility which it plans to occupy
in April 1999. Epimmune intends to sublease its current facility after
relocating to the new facility.

The Company believes its existing facilities will be adequate to meet the
Company's needs for the foreseeable future.

ITEM 3.  LEGAL PROCEEDINGS

The Company is not a party to any legal proceedings.

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

Cytel held a Special Meeting of Stockholders (the "Special Meeting") on October
30, 1998. At the Special Meeting, the stockholders of Cytel approved an
amendment to Cytel's Amended and Restated Certificate of Incorporation to
effect, at any time prior to the 1999 Annual Meeting of Stockholders, a reverse
stock split, whereby Cytel would issue one new share of Common Stock of Cytel in
exchange for between four and seven shares of outstanding Common Stock. Cytel
had 34,909,187 shares of Common Stock outstanding as of September 21, 1998, the
record date for the Special Meeting. At the Special Meeting, holders of a total
of 25,421,692 shares of Common Stock were present in person or represented by
proxy. In addition, 258,378 shares of a total 258,378 shares of Series B
Convertible Preferred Stock entitled to vote were represented in person or by
proxy at the meeting. The following sets forth information regarding the results
of the voting at the Annual Meeting:

Proposal 1: Approval of an Amendment of Cytel's Amended and Restated Certificate
of Incorporation

<TABLE>
         <S>                             <C>       
         Votes in favor:                 24,146,796
         Votes against:                   1,389,930
         Withheld:                           88,567
</TABLE>





                                 Page 18 of 41
<PAGE>   20

                                     PART II

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

The Company's common stock (NASDAQ symbol "CYTL") is traded publicly through the
National Market System. The following table presents quarterly information on
the price range of Cytel's common stock. This information indicates the high and
low sale prices reported by the National Market System. These prices do not
include retail markups, markdowns or commissions. All information set forth
below has been adjusted to reflect a one-for-seven reverse stock split of
Cytel's common stock effected on November 13, 1998.

<TABLE>
<CAPTION>
                                                  High                    Low
       <S>                <C>                     <C>                     <C>   
       1998               1st Quarter             $17.50                  $ 8.75
                          2nd Quarter             $15.47                  $ 9.17
                          3rd Quarter             $10.50                  $ 2.66
                          4th Quarter             $ 3.88                  $ 2.25

       1997               1st Quarter             $27.02                  $14.91
                          2nd Quarter             $19.25                  $ 9.66
                          3rd Quarter             $19.67                  $10.08
                          4th Quarter             $17.92                  $ 9.87
</TABLE>

As of March 31, 1999, there were approximately 235 stockholders of record of the
Company's common stock. The Company has never declared or paid dividends on its
common stock and does not anticipate the payment of dividends in the foreseeable
future.





                                 Page 19 of 41
<PAGE>   21


ITEM 6.   SELECTED FINANCIAL DATA

Statement of Operations Data:

<TABLE>
<CAPTION>
     (in millions except for net loss per share)
     Years Ended December 31        1998         1997         1996         1995         1994
                                  --------     --------     --------     --------     --------
     <S>                          <C>          <C>          <C>          <C>          <C>     
     Operating revenues           $    3.7     $    5.1     $   10.9     $   16.8     $    6.3
     Net loss                        (21.5)       (14.4)       (12.5)        (8.00)      (17.0)
     Net loss per share               (4.48)       (3.92)       (3.50)       (2.52)       (6.86)
</TABLE>


Balance Sheet Data:

<TABLE>
<CAPTION>
     (in millions)
     As of December 31              1998         1997         1996         1995         1994
                                  --------     --------     --------     --------     --------
     <S>                          <C>          <C>          <C>          <C>          <C>     
     Working capital              $    9.8     $   17.8     $   21.6     $   34.6     $   32.2
     Total assets                     21.0         28.1         34.3         48.1         45.0
     Long-term obligations
     under capital leases,             1.6          0.7          1.1          1.8          1.2
     equipment notes payable
     and line of credit
     Stockholders' equity         $   14.0     $   24.4     $   27.5     $   38.5     $   35.5
</TABLE>


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

Except for the historical information contained herein, the following discussion
contains forward-looking statements that involve risks and uncertainties. The
Company's actual results could differ materially from those discussed here.
Factors that could cause or contribute to such differences include, without
limitation, those discussed below and in the section entitled "Risk Factors".

Since its inception in July 1987, The Company has devoted substantially all of
its resources to the discovery and development of its potential therapeutic
products. To date, the Company has not received any revenues from the sale of
products. The Company has funded its research and development primarily from
equity-derived working capital and through strategic alliances with other
companies. The Company has been unprofitable since its inception and expects to
incur substantial operating losses for the next several years. As of December
31, 1998, the Company's accumulated deficit was approximately $128.7 million.

Disappointing results of the Phase II/III clinical trial of Cylexin, Cytel's
cell adhesion inhibitor compound, has led to the termination of the cell
adhesion therapeutic business. Accordingly, Cytel is terminating its employees,
selling its fixed assets and intellectual property, and focusing all subsequent
development efforts on Epimmune's vaccine technology. During the first quarter
of 1999, Cytel sold its Glytec carbohydrate synthesis and manufacturing business
and plans to use the proceeds from such sale, together with existing cash
resources, to meet its financial obligations, including corporate restructuring
and termination costs of all of its non-vaccine programs. There can be no
assurance, however, that Cytel's cash resources will be sufficient to satisfy
all of its financial obligations





                                 Page 20 of 41
<PAGE>   22

LIQUIDITY AND CAPITAL RESOURCES

Cytel and Epimmune on a Consolidated Basis

The following discussion reflects financial information for Cytel and Epimmune
on a consolidated basis. Financial information for Epimmune alone is provided in
the section entitled "Epimmune" below.

The Company has financed operations since inception primarily through private
placements of its equity securities, two public common stock offerings, revenues
under collaborative research and development agreements, grant revenues and
interest income. Through December 1998, the Company has raised approximately
$144.9 million from the sale of equity securities. The Company has financed its
laboratory equipment and research and office facilities primarily through
capital and operating lease arrangements.

The Company had net working capital of $9.8 million as of December 31, 1998
compared to $17.8 million as of December 31, 1997. As of December 31, 1998, the
Company's cash, cash equivalents, restricted cash and short-term investments
decreased to $12.3 million from $18.8 million at December 31, 1997. The decrease
was due to an increase in cash used in operations that resulted from reduced
research and development revenues from collaborators relative to expenditures
for the development of the Company's priority drug candidates and the Company's
research programs offset by the net proceeds from the sale of common and
preferred stock. Excluding Epimmune, as of March 31, 1999, Cytel had $5.2
million of cash available to fund its operations, which it plans to use to meet
its financial obligations, including corporate restructuring and termination
costs of all its non-vaccine programs. There can be no assurance, however, that
Cytel's cash resources will be sufficient to satisfy all of its financial
obligations.

Capital expenditures, primarily for manufacturing and laboratory equipment,
totaled $2.3 million in 1998 compared to $0.6 million in 1997. The increase was
due primarily to manufacturing and laboratory equipment expenditures for the
Company's carbohydrate manufacturing facility. The Company has sold its Glytec
carbohydrate synthesis and manufacturing business and has decided to terminate
its cell adhesion therapeutic business and will focus all resources on Epimmune.

The Company's cash, cash equivalents and short-term investments are expected to
decline primarily due to Epimmune's ongoing vaccine research programs and the
payments associated with the termination of Cytel's cell adhesion therapeutics
business. The Company raised approximately $6.2 million in the first quarter of
1999 through the sale of fixed and intangible assets, the proceeds of which will
be used to fund the restructuring efforts of the Company. While the Company's
investments may periodically reflect unrealized losses, management attempts to
schedule the maturities of the Company's investments to coincide with the
Company's expected cash requirements.

Epimmune

The following discussion reflects financial information for Epimmune alone.
Epimmune's financial information is also included on a consolidated basis with
Cytel in the preceding section.

Since inception in October 1997, Epimmune has financed its operations through
private offerings of its equity securities, NIH grant revenues, capital and
operating lease transactions and investment income. From inception through
December 1998, Epimmune has raised approximately $16.5 million from sales of
equity securities. Total cash proceeds of sales of private equity securities
since inception were $10.4 million and $6.1 million from Cytel and Searle,
respectively.

In February 1998, Epimmune and Searle entered into a collaborative research and
development agreement. As part of the agreement Searle purchased 1,032,149
shares of Epimmune's Series B convertible preferred stock for $6.1 million and
659,898 shares of Cytel's Series B convertible preferred stock for $3.9 million.
Cytel, simultaneously, purchased 659,898 shares of Epimmune's





                                 Page 21 of 41
<PAGE>   23

Series B-1 convertible preferred stock for $3.9 million. Searle has the right to
convert the Cytel Series B convertible preferred stock into Cytel common stock
after three years, or at any time to exchange the Cytel Series B convertible
preferred stock for Epimmune Series B-1 Preferred Stock owned by Cytel.

In August 1998, Epimmune entered into a $750,000 term credit Facility with
Silicon Valley Bank to provide secured financing for future laboratory, office
and tenant improvement additions. As of December 31, 1998, Epimmune had $511,000
available to finance future capital equipment and tenant improvements by August
1999. In addition, Epimmune leases its laboratory and office facilities under
operating leases. In November 1998, Epimmune entered into a 10-year lease
related to the construction of a new laboratory and office facility, which is
expected to be completed and occupied in April 1999.

Working capital balance increased to $10.7 million as of December 31, 1998 from
$5.0 million at the end of 1997. The increase is attributable to a $10.0 million
private equity sales transaction with Searle and Cytel partially offset by an
increase in accrued liabilities relating to the increase in operating expenses.

Cash, cash equivalents, short-term investments and restricted cash increased to
$11.1 million at December 31, 1998 from $5.0 million at December 31, 1997, due
to cash received from the Searle transaction partially offset by increases in
operating expenses. Epimmune primarily invests its cash in United States
government and investment grade corporate debt securities.

Epimmune believes that its available cash, cash equivalents, marketable
securities and existing sources of funding will be adequate to satisfy its
anticipated capital requirements through December 31, 2000. The estimate for the
period for which Epimmune expects its available cash balances, investment income
and estimated cash flow from collaborative agreements and research grants to be
sufficient to meet its capital requirements is a forward-looking statement that
involves risks and uncertainties as set forth herein and elsewhere in this
Report on Form 10-K.

Future Capital Needs

The Company expects to incur substantial additional research and development
expenditures, including costs related to preclinical testing, clinical trials
and manufacturing, as well as marketing and distribution expenses. It is the
Company's intention to seek additional collaborative research and development
relationships with suitable corporate partners. There can be no assurance that
any agreements that may result from these discussions will successfully reduce
the Company's funding requirements. Additional equity or debt financing will be
required, and there can be no assurance that these funds will be available on
favorable terms, if at all. If adequate funds are not available, the Company may
be required to delay, scale back or eliminate one or more of its drug discovery
or development programs or obtain funds through arrangements with collaborative
partners or others that may require the Company to relinquish rights to certain
of its technologies, product candidates or products that the Company would not
otherwise relinquish obligations, including restructuring costs, in terminating
its non-vaccine operations.

The Company's future capital requirements depend on many factors, including
continued scientific progress in its drug discovery programs, the magnitude of
these programs, progress with preclinical testing and clinical trials, the time
and costs involved in obtaining regulatory approvals, the costs involved in
filing, prosecuting and enforcing patent claims, competing technological and
market developments, changes in the existing collaborative research
relationships, the ability of the Company to establish and maintain development
arrangements, the cost of manufacturing scale-up and effective commercialization
activities and arrangements.

As is typical in the biotechnology industry, the commercial success of the
Company will depend in part on the Company neither infringing patents issued to
competitors nor breaching the technology licenses upon which the Company's
products might be based. The Company's business is also subject to other
significant risks, including the uncertainties associated with the lengthy
regulatory




                                 Page 22 of 41
<PAGE>   24

approval process and with potential competition from other products. Even if the
Company's products appear promising at an early stage of development, they may
not reach the market for a number of reasons. Such reasons include, but are not
limited to the Company's inability to fund clinical development of such
products, or the possibilities that the potential products will be found
ineffective during clinical trials, fail to receive necessary regulatory
approvals, be difficult to manufacture on a large scale, or be uneconomical to
market.

RESULTS OF OPERATIONS

The Company had total revenues of $3.7 million for the year ended December 31,
1998, compared to $5.1 million in 1997 and $10.9 million in 1996. Total revenues
decreased $1.4 million or 27% in 1998 from 1997 and decreased $5.8 million or
53% in 1997 from 1996, primarily due to a decline in research and development
revenues in each year. Revenues in each year consisted mainly of research and
development revenues, which were $2.0 million in 1998, $3.5 million in 1997 and
$8.6 million in 1996. Research and development revenues for 1998 consisted of
funding received under the Company's collaborative research and license
agreements with Elan and Nextran. Research grant revenues were $1.7 million in
1998, $1.6 million in 1997, and $2.3 million in 1996.

The Company had total operating expenses for the year ended December 31, 1998 of
$22.9 million, compared to $20.3 million in 1997 and $24.8 million in 1996.
Operating expenses increased $2.6 million or 13% in 1998 from 1997 and decreased
$4.5 million or 18% in 1997 from 1996.

Research and development expenses increased $1.9 million or 12% to $18.4 million
in 1998 from $16.5 million in 1997, and decreased $4.4 million or 21% to $16.5
million in 1997 from $20.9 million in 1996. The increase in 1998 from 1997 was
due to increased research activity performed by the Company's subsidiary,
Epimmune, and the decrease in 1997 from 1996 was due to a company-wide effort to
control costs and a reduction in the number of clinical trials the Company was
conducting.

General and administrative expenses increased to $4.6 million in 1998 from $3.7
million in 1997 and $3.9 million in 1996. The increase was due to the increase
in operating activity at Epimmune.

Net interest income was $0.9 million in 1998 compared to $0.8 million in 1997
and $1.4 million in 1996. Average cash balances were roughly comparable in 1998
and 1997 resulting in level net interest income year over year. The decreases in
1997 compared to 1996 were primarily attributable to lower average cash
balances.

The Company expects to incur operating losses over the next several years due to
continuing expenses associated with its research and development programs,
including preclinical testing and clinical trials. Operating losses may
fluctuate from quarter to quarter as a result of differences in the timing of
revenues received and expenses incurred, and such fluctuations may be
substantial. As a result of Cytel's announcements in March 1999 regarding the
sale of the Glytec carbohydrate synthesis and manufacturing business and the
decision to terminate the cell adhesion therapeutic business, the Company
expects to record in early 1999 a restructuring charge to operations of
approximately $3.7 million and will record a $3.3 million in gains from the
sales of assets. The restructuring charge primarily represents costs to be
incurred by Cytel for severance, write-off of unrealizable fixed assets and
remaining financial obligations under facility and operating leases held by
Cytel.

YEAR 2000

Many currently installed computer systems and software products are coded to
accept only two digit entries in the date code field. These date code fields
will need to accept four digit entries to distinguish 21st century dates from
20th century dates. As a result, many companies' software and computer systems
may need to be upgraded or replaced in order to comply with year 2000
requirements. The impact of the year 2000 issue may affect other systems that
utilize imbedded





                                 Page 23 of 41
<PAGE>   25

computer chip technology, including building controls, security systems or
laboratory equipment. It may also impact the ability to obtain products or
services if the provider encounters and fails to resolve year 2000 related
problems.

In 1999, the Company established an active program to identify and resolve year
2000 related issues. This program includes the review and assessment of our
information technology and non-information technology systems, as well as third
parties with whom we have a material relationships. This program consists of
four phases: inventory, risk assessment, problem validation and problem
resolution. The inventory phase identified potential risks we face. They include
among others computer software, computer hardware, telecommunications systems,
laboratory equipment, facilities systems (security, environment control, alarm),
service providers, and other third parties. The risk assessment phase
categorized and prioritizes each risk by its potential impact. The problem
validation phase tests each potential risk, according to priority, to determine
if an action risk exists. In the case of critical third parties, this step will
include a review of their year 2000 plans and activities. The problem resolution
phases will, for each validated risk, determine the method/strategy for
alleviating the risk. It may include anything from replacement of hardware or
solftware to process modification to selection of alternative vendors. This step
also includes the development of contingency plans.

The inventory and risk assessment phases will be completed in second calendar
quarter 1999. The problem validation phase will be completed in third calendar
quarter 1999 for all areas, except for evaluating specific pieces of research
equipment and the assessment of some protocol third parties. We expect that we
will complete the last portion of the problem validation and resolution phase by
the end of the third calendar quarter of 1999. Contingency plans are being
developed. We expect to have those plans completed by the end of the third
quarter 1999.

We are actively correcting problems as we identify them. These corrections
include the replacement of hardware and software systems, the identification of
alternative service providers and the creation of contingency plans. We
currently estimate that the cost of identified problems will be approximately
$130,000 for hardware and software upgrades or modifications. In addition, we
will incur approximately $10,000 of internal personnel costs to complete the
remaining phases of the project. We do not believe that the costs of these
actions will have a material adverse affect on our business. We expect to be
able to resolve any problems we identify of the project as part of normal
operating expenses.

Any failure to be year 2000 compliant within our internal computer systems or of
third party equipment or software we use, or of systems maintained by our
suppliers, may adversely affect our business.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS

The Company's investment portfolio consists of money market funds and
short-term, high quality debt securities. These securities are subject to
interest rate risk, and will decline in value if interest rates increase. An
immediate 10% change in interest rates would not have a material impact on our
financial condition or results of operations.

ITEM 8.  CONSOLIDATED FINANCIAL STATEMENTS

The Report of Ernst & Young LLP, Independent Auditors, the Consolidated
Financial Statements and Notes to Consolidated Financial Statements are included
in the report on pages F-1 through F-34.

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

None





                                 Page 24 of 41
<PAGE>   26

                                    Part III


ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

BOARD OF DIRECTORS


        The names of Cytel's current directors and certain information about
them are set forth below:

<TABLE>
<CAPTION>
                                                     PRINCIPAL OCCUPATION/POSITION
              NAME               AGE                         HELD WITH CYTEL
              ----               ---                 -----------------------------
<S>                               <C>   <C>
   Howard E. Greene, Jr.          56    Director and founder of Amylin Pharmaceuticals, Inc.
                                        and Chairman of the Board of Directors

   Virgil Thompson                59    President, Chief Executive Officer and Director

   Robert L. Roe, M.D.,           58    Executive Vice President, Chief Operating Officer,
   F.A.C.P.                             Acting Chief Financial Officer, Secretary and Director

   David L. Anderson              55    Managing Director, Sutter Hill Ventures/Director

   William T. Comer, Ph.D.        63    President and Chief Executive Officer of SIBIA
                                        Neurosciences, Inc./Director

   Nicole Vitullo                 42    Senior Vice President, Rothschild Asset Management
                                        Ltd./Director

   David L. Mahoney               44    Group President, Pharmaceutical Services and
                                        International Group, McKesson HBOC/Director

   Nancy D. Rasmussen             41    Vice President, Global New Business Franchise, G.D.
                                        Searle & Co./Director

   Lisabeth F. Murphy             42    Executive Vice President, Intellectual Property and
                                        Legal Affairs of Elan Corporation, plc/Director
</TABLE>

        Mr. Greene, a founder of Cytel, has served as a director since the
Company's inception. He was elected Chairman of the Board in January 1989 and
served as President from July 1987 to January 1989. Mr. Greene is a director and
founder of Amylin Pharmaceuticals, Inc., a biotechnology company involved in
research and development of medicines for treating diabetes and served as
Chairman of the Board from 1987 to 1998. He was a general partner of Biovest
Partners, a seed venture capital firm specializing in medical technology
companies from 1986 until 1993. Prior to Biovest, he was Chief Executive Officer
of Hybritech Incorporated, a biotechnology company acquired by Eli Lilly &
Company in 1986. Mr. Greene is a director of Amylin Pharmaceuticals, Inc,
Biosite Diagnostics Incorporated and International Biotechnology Trust plc.

        Mr. Thompson has served as a director and as President and Chief
Executive Officer since January 1996. From July 1994 to December 1995, he was
President and Chief Executive Officer of CIBUS Pharmaceutical, Inc. ("CIBUS"), a
drug delivery company. For the 25 years preceding his employment with CIBUS, he
was employed by Syntex Corporation, most recently as President, Syntex
Laboratories, Inc. Mr. Thompson is a director of Biotechnology General
Corporation, Cypros Pharmaceutical Corporation and Aradigm Corporation.

        Dr. Roe has served as a director and as Executive Vice President and
Chief Operating Officer since January 1996 and as Acting Chief Financial Officer
and Secretary since December 18, 1998. During 1995, Dr. Roe was Executive Vice
President and Chief Operating Officer of Chugai Biopharmaceuticals, Inc.
("Chugai"), a biopharmaceutical company. Prior to joining Chugai, Dr. Roe was
employed by Syntex Corporation from 1976 to 1995, most recently as President,
Development Research Division and as Senior Vice President. Dr. Roe is a member
of the Board of Directors of CoSensys.

        Mr. Anderson has been a director of Cytel since May 1988. He has been
managing director or general partner of the general partner of Sutter Hill
Ventures, a California Limited Partnership ("Sutter Hill"), a venture capital
investment firm, since 1974. Mr. Anderson is also a director of Dionex
Corporation, BroadVision, Inc., and Molecular Devices Corporation.





                                 Page 25 of 41
<PAGE>   27

        Dr. Comer has served as a director of Cytel since January 1994. He has
been President and Chief Executive Officer of SIBIA Neurosciences, Inc.
("SIBIA"), a biotechnology company, since April 1991. Dr. Comer is a member of
the Board of Directors of SIBIA.

        Ms. Vitullo has served as a director of Cytel since January 1995. Ms.
Vitullo has been with Rothschild Asset Management Ltd. ("Rothschild") since
November 1992, most recently serving as Senior Vice President. Rothschild
advises and manages two publicly traded biotechnology funds: Biotechnology
Investments Limited and International Biotechnology Trust plc. Ms. Vitullo is
also a member of the Board of Directors of Cadus Pharmaceuticals, Corvas
International and Onyx Pharmaceuticals.

        Mr. Mahoney has served as a director of Cytel since September 1996. He
has been Group President, Pharmaceutical Services and International Group,
McKesson HBOC ("McKesson") since September 1997 and served as President of
Pharmaceutical and Retail Services, McKesson from August 1996 to August 1997.
Mr. Mahoney served as President of Healthcare Delivery System ("HDS") from
September 1994 until December 1995, and as Vice President of strategic planning
at McKesson from July 1990 to September 1994.

        Ms. Rasmussen has served as a director of Cytel since March 1998. She
has been with G.D. Searle & Co. ("Searle") since 1985, most recently as Vice
President, Global New Business Franchise. Ms. Rasmussen's responsibilities
include membership on Searle's Priority Committee, Operations Management Team
and Portfolio Steering Committee. She is active in management of Searle's
collaborations serving on the Board of Directors of Lorex, a joint venture with
Synthelabo.

        Ms. Murphy has served as a director of Cytel since March 1999. She has
been with Elan Corporation, plc since July 1996, most recently as Executive Vice
President, Intellectual Property and Legal Affairs. From May 1991 to July 1996,
Ms. Murphy served as Vice President, General Counsel and Secretary.


MANAGEMENT

        For a list and biography of the Company's management, see
"Business-Executive Officers".



                                 Page 26 of 41
<PAGE>   28

COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT

        Section 16(a) of the Securities Exchange Act of 1934 requires Cytels
officers and directors and persons who own more than 10% of a registered class
of Cytel's equity securities, to file reports of ownership and changes in
ownership with the Securities and Exchange Commission ("SEC") and Nasdaq
National Market System. Officers, directors and greater than 10% beneficial
owners are required by SEC regulations to furnish Cytel with copies of all
Section 16(a) forms they file.

        Based solely on review of the copies of such forms furnished to Cytel or
written representations from certain reporting persons that no Forms 5 were
required, Cytel believes that, during the 1998 calendar year, all Section 16(a)
filing requirements applicable to its officers, directors and greater than 10%
beneficial owners were complied with.

ITEM 11.  EXECUTIVE COMPENSATION

COMPENSATION OF DIRECTORS

        Directors of Cytel who are not employees of Cytel are paid $2,000
per meeting attended in person and $500 per meeting attended by phone as
compensation for their service on the Board of Directors. Directors are not
compensated for actions taken by written consent. The members of the Board of
Directors are eligible for reimbursement of expenses incurred in connection with
their service on the Board. Under the Directors' Deferred Compensation Plan,
participating directors may elect on an annual basis, to defer all of their cash
compensation in a deferred stock account pursuant to which the deferred fees are
credited in the form of shares of Cytel's Common Stock, based on the market
price of the stock at the time the deferred fees are earned. Cytel will continue
to credit shares of Cytel's Common Stock to the participants' deferred stock
accounts on a quarterly basis. When a participant ceases serving as a director,
the participant shall be entitled to receive the value of his or her account
either in a single lump-sum payment or in equal annual installments, as
determined by Cytel in its sole discretion. No participant entitled to receive a
payment of benefits shall receive payment in the form of Cytel's Common Stock.

        Under the 1994 Non-Employee Directors' Stock Option Plan, on January 1
of each year, each director who is not an employee of Cytel and has served on
the Board for at least three months, is granted an option to acquire 714 shares
of Cytel's Common Stock. In addition, each new Non-Employee Director will be
granted an option to acquire 3,571 shares of Cytel's Common Stock upon initial
election to the Board of Directors. The exercise price of all such stock options
granted is equivalent to the fair market value on the date of each grant.





                                 Page 27 of 41
<PAGE>   29


COMPENSATION OF EXECUTIVE OFFICERS

        The following table shows for the fiscal years ended December 31, 1998,
1997 and 1996, compensation awarded or paid to, or earned by Cytel's Chief
Executive Officer, its other four most highly compensated executive officers at
December 31, 1998 and one former executive officer who departed from Cytel
during the last fiscal year (collectively, the "Named Executive Officers").
During the last three fiscal years, none of the executive officers received any
restricted stock awards or long-term incentive payouts.


                           SUMMARY COMPENSATION TABLE


<TABLE>
<CAPTION>
                                                                   LONG-TERM
                                                                  COMPENSATION
                                                                     AWARDS
                                       ANNUAL COMPENSATION         SECURITIES
                            -------------------------------------  UNDERLYING      ALL OTHER
  NAME AND PRINCIPAL                     SALARY          BONUS      OPTIONS     COMPENSATION
       POSITION              YEAR          ($)            ($)        (#)(1)         ($)(2)
----------------------      --------  --------------  -----------  -----------  -------------
<S>                         <C>       <C>             <C>          <C>          <C>  
Mr. Virgil Thompson          1998        325,900              0       114,463        5,644
  President and Chief        1997        315,000              0        28,571        5,426
  Executive Officer          1996        300,000         78,580(3)     71,428        4,950

Dr. Robert L. Roe            1998        294,862              0        95,399        5,082
  Executive Vice President   1997        286,000              0        25,714        4,874
  Chief Operating Officer,   1996        205,354         23,000(4)     57,142        3,525
  Acting Chief Financial
  Officer and Secretary

Ms. Deborah Schueren         1998        185,000         30,000        26,391          360
  Vice President, Cytel and  1997        133,572              0        17,142(5)       295
  President, Epimmune        1996              0              0             0            0

Jennifer Lorenzen(6)         1998        185,000              0        13,678        1,160
  Vice President, Business   1997        134,055              0        12,857          691
  Development                1996              0              0             0            0

Dr. James C. Paulson(7)      1998        266,500              0        63,339        2,898
  Former Vice President and  1997        257,578              0             0        1,674
  General Manager,           1996        216,324         28,988        11,428        1,333
    Glytec(TM)

Mr. Edward C. Hall   (8)     1998        115,696              0        14,285        1,594
  Former Vice President,     1997              0              0             0            0
  Finance, Chief Financial   1996              0              0             0            0
  Officer and Secretary
</TABLE>

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

(1) Options granted pursuant to an option exchange program approved by the
    stockholders on June 11, 1998 and implemented on June 15, 1998 in which
    employees were given the opportunity to exchange outstanding
    out-of-the-money stock options for a lesser number of new options priced at
    the market price of Cytel's common stock at the time of exchange (the
    "Exchange Program"). All option numbers and prices in this table Cytel's
    1-for-7 reverse stock split which occurred on November 13, 1998.

(2) Consists of life insurance premiums paid by Cytel.

(3) Represents relocation payments made by Cytel to Mr. Thompson.

(4) Represents reimbursement of Dr. Roe's relocation expenses which were paid by
    Cytel to Dr. Roe's previous employer.

(5) Does not include certain options to purchase shares of Epimmune Common Stock
    granted to Ms. Schueren. See "- Employment Agreements."





                                 Page 28 of 41
<PAGE>   30

(6) Ms. Lorenzen resigned from Cytel effective March 31, 1999.

(7) Dr. Paulson resigned from Cytel effective February 15, 1999.

(8) Mr. Hall resigned from Cytel effective November 20, 1998.


                        STOCK OPTION GRANTS AND EXERCISES

        Cytel grants options to its executive officers under Cytel's 1989 Stock
Option Plan (the "1989 Plan"). As of April 1, 1999, options to purchase a total
of 558,258 shares had been granted and were outstanding under the 1989 Plan, and
options to purchase 275,514 shares remained available for grant thereunder.
Material terms of options granted under the 1989 Plan are described generally in
footnotes 2 and 5 below.

        The following tables show for the fiscal year ended December 31, 1998,
certain information regarding options granted to, exercised by, and held at year
end by the Named Executive Officers:

                     OPTIONS GRANTED IN LAST FISCAL YEAR(1)

<TABLE>
<CAPTION>
                                       INDIVIDUAL GRANTS                  POTENTIAL REALIZABLE 
                       -------------------------------------------------     VALUE AT ASSUMED 
                        NUMBER OF      % TOTAL                                 ANNUAL RATES   
                       SECURITIES      OPTIONS                                OF STOCK PRICE  
                       UNDERLYING    GRANTED TO                               APPRECIATION FOR
                         OPTIONS      EMPLOYEES   EXERCISE OR                  OPTION TERM(4) 
                         GRANTED      IN FISCAL   BASE PRICE  EXPIRATION --------------------------
      NAME                 (2)         YEAR(3)      ($/SH)       DATE       5%($)          10%($)
      ----             ---------     -----------  ---------   ---------  -----------  -------------
<S>                    <C>           <C>          <C>         <C>        <C>          <C>          
 Mr. Virgil Thompson.    28,571          6.5%      11.15630    2/2/08    $200,458.05  $  508,000.07
                         85,892(5)      19.6%      10.71880    6/15/08    578,997.61   1,467,293.61
 Dr. Robert L. Roe...    25,714          5.9%      11.15630    2/2/08     180,412.95     457,201.84
                         69,685(5)      15.9%      10.71880    6/15/08    469,746.28   1,190,429.32
 Dr. James C. Paulson    11,428          2.6%      11.15630    2/2/08      80,180.42     203,192.91
                         51,911(5)      11.9%      10.71880    6/15/08    349,931.83     886,795.96
 Ms. Deborah Schueren    26,391(5)       6.0%      10.71880    6/15/08    177,901.62     450,837.63
 Ms. Jennifer Lorenzen    6,536(5)       1.5%      10.71880    6/15/08     44,059.15     111,654.53
                          7,142          1.6%      11.15630    2/2/08      50,109.25     126,986.68
 Mr. Edward C. Hall(6)   14,285(6)       3.3%      11.15630    2/2/08     100,225.52     253,991.14
</TABLE>


(1)  All numbers and prices in this table reflect Cytel's 1-for-7 reverse stock
     split which occurred on November 13, 1998.

(2)  Options granted prior to 1996 generally vested 20% at the end of the first
     year of the optionee's employment and thereafter daily at the rate of 20%
     per year during such period of employment. Options granted after November
     1996 generally vest 25% at the end of the first year of the optionee's
     employment and thereafter daily at the rate of 25% per year during such
     period of employment. Upon certain corporate events resulting in a change
     of control, at the discretion of Cytel's Board of Directors, (i) the
     acquiring company will assume the options or substitute similar options,
     (ii) the options will continue in full force and effect, or (iii) Cytel
     will pay a cash settlement for or accelerate such options.

(3)  Based on 437,671 options granted in 1998, including grants to executive
     officers. This figure includes 303,145 options granted to employees and
     executive officers in connection with the





                                 Page 29 of 41
<PAGE>   31

     Exchange Program approved by the stockholders on June 11, 1998 and
     implemented on June 15, 1998.

(4)  The potential realizable value is calculated based on the terms of the
     option at its time of grant (10 years in the case of all options). It is
     calculated by assuming that the stock price on the date of grant
     appreciates at the indicated annual rate, compounded annually for the
     entire term of the option and that the option is exercised and sold on the
     last day of its term for the appreciated stock price. These amounts
     represent certain assumed rates of appreciation, in accordance with rules
     of the SEC, and do not reflect Cytel's estimate or projection of future
     stock price performance. Actual gains, if any, are dependent on the actual
     future performance of Cytel's Common Stock, and no gain to the optionee is
     possible unless the stock price increases over the option term, which will
     benefit all stockholders.

(5)  Options granted pursuant to the Exchange Program approved by the
     stockholders on June 11, 1998 and implemented on June 15, 1998. These
     options vest over a six year period according to a schedule developed by
     the State of Wisconsin Investment Board, a major stockholder of Cytel (the
     "Wisconsin Board")

(6)  Mr. Hall's options were terminated in connection with his resignation from
     Cytel on November 20, 1998.

              AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND
                         FISCAL YEAR-END OPTION VALUES

<TABLE>
<CAPTION>
                                                   NUMBER OF SECURITIES
                                                  UNDERLYING UNEXERCISED     VALUE OF UNEXERCISED
                                                   OPTIONS AT FY-END(#)      IN-THE-MONEY OPTIONS
                                                     EXERCISABLE/                AT FY-END($)(1)
                           SHARES      VALUE      ----------------------     ---------------------
                          ACQUIRED    REALIZED          EXERCISABLE/                EXERCISABLE/
       NAME            ON EXERCISE(#)    ($)            UNEXERCISABLE               UNEXERCISABLE
       ----            -------------- --------          -------------               -------------
<S>                    <C>            <C>         <C>                        <C>
 Mr. Virgil Thompson        --           --             16,425/98,038                   ----
 Dr. Robert L. Roe          --           --             11,840/83,559                   ----
 Dr. James C. Paulson       --           --             25,840/39,885                   ----
 Ms. Deborah Schueren       --           --              9,621/16,770                   ----
 Ms. Jennifer Lorenzen      --           --              7,331,19,204                   ----
 Mr. Edward C. Hall         --           --                   ----                      ----
</TABLE>

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

(1) Fair market value of Cytel's Common Stock at December 31, 1998 ($2.25 per
    share) minus the exercise price of the options. As of December 31, 1998, all
    unexercised options held by the Named Executive Officers were
    out-of-the-money.

                              EMPLOYMENT AGREEMENTS

        In March 1990, Cytel entered into an employment agreement with Dr.
Paulson. The agreement may be terminated by either Cytel or Dr. Paulson. The
terms of the employment agreement are consistent with Cytel's executive
compensation policies. Mr. Paulson resigned from Cytel effective February 15,
1999.

        In January 1996, Cytel entered into an employment agreement with Mr.
Thompson. The agreement may be terminated by either Cytel or Mr. Thompson. The
terms of the employment agreement are consistent with Cytel's executive
compensation policies.

        In January 1996, Cytel entered into an employment agreement with Dr.
Roe. The agreement may be terminated by either Cytel or Dr. Roe. The terms of
the employment agreement are consistent with Cytel's executive compensation
policies.

        In October 1997, Cytel and Epimmune entered into an employment agreement
with Ms. Schueren. The agreement guaranteed Ms. Schueren a base salary of
$185,000 and a cash bonus of up to $50,000 at the discretion of the Board, if
certain objectives are met. In addition, pursuant to the agreement, Ms. Schueren
was granted an incentive stock option to purchase 385,000 shares of Epimmune
Common Stock at the fair market value as determined by the board of directors of
Epimmune. Shares subject to such option vest equally over 48 months, provided
that said option will be subject to acceleration with respect to up to two years
of vesting upon achievement of certain objectives. The option issued to Ms.
Schueren represents approximately 4% of the outstanding Epimmune Common Stock on
an as-converted, fully-diluted basis, assuming exercise of all options
outstanding and available for issuance under Epimmune's stock option plan. The
agreement may be terminated by either Cytel or Ms. Schueren.





                                 Page 30 of 41
<PAGE>   32
        In February 1998, Cytel entered into severance benefits agreements
covering the following officers of Cytel: Mr. Thompson, Dr. Roe, Dr. Paulson and
Ms. Lorenzen (collectively, the "Officers" and individually, the "Officer").
Under the agreements, in the event that an Officer is either terminated without
cause or within one year of a change of control of Cytel such Officer shall
receive a lump-sum payment equal to six months of such Officer's annual base
salary. If such Officer is terminated other than for cause, all unvested stock
options held by such Officer shall immediately accelerate by six months. If such
Officer is terminated following a change of control, 50% of all unvested stock
options held by such Officer shall immediately vest and become exercisable. Ms.
Schueren's employment agreement provides for similar severance benefits except
in the event of termination following a change in control all unvested Epimmune
stock options held by Ms. Schueren shall immediately vest and become
exercisable. In addition, generally, if Ms. Schueren is terminated without cause
or if Ms. Schueren terminates her employment under certain conditions, all
unvested stock options held by Ms. Schueren shall accelerate by six months

        In December of 1998, Cytel and Dr. Paulson entered into a agreement
regarding Dr. Paulson's severance arrangement. Cytel agreed to extend the
exercise period of Dr. Paulson's options for one year, and agreed that Dr.
Paulson would be entitled to accelerated vesting of his outstanding stock
options equal to 1) six months if his termination occurred on or after February
15, 1999 and Cytel had not sold its Glytec business unit by such date, or 2) 50%
of his outstanding unvested shares as of the date of his termination if the
termination followed the sale of Cytel's Glytec business unit. Dr. Paulson
voluntarily terminated his employment with Cytel on February 15, 1999, at which
time Cytel had not sold its Glytec business unit.

                        COMPENSATION COMMITTEE REPORT(1)

        The Compensation Committee of the Board of Directors (the "Committee")
consists of Mr. Howard E. Greene, Jr., Mr. David L. Anderson and Mr. David L.
Mahoney. The Committee is responsible for setting and administering the
Company's policies governing annual executive salaries, bonuses (if any) and
stock ownership programs. The Committee evaluates the performance of management
and determines the compensation of the Chief Executive Officer ("CEO") and the
other executive officers of Cytel based upon the accomplishment of defined
objectives in the Company's research and product development programs and
achievement of financial targets. The full Board of Directors reviews the
Committee's recommendations regarding the compensation of the CEO and the other
executive officers.

EXECUTIVE OFFICER COMPENSATION PROGRAM

        The Company's executive officer compensation program consists of base
salary and long-term compensation in the form of stock options. The Company's
executive officer compensation program is designed to achieve the following
objectives:

        -       Attract, retain and motivate quality executives who possess the
                necessary leadership and management skills.

        -       Provide an incentive to advance the research and development of
                the Company's therapeutic products.

        -       Emphasize stock-based compensation to provide longer-term
                motivation by aligning the executives' interests with those of
                the Company and its stockholders.

        Compensation is based on the level of job responsibility and the level
of the individual's performance as well as the Company's performance. The
Committee endeavors to set executive compensation within a range which the
Committee believes is comparable to the average range of compensation set by
companies of comparable size in the biotechnology industry. The group of
comparable companies is not necessarily the same as the companies reflected in
the market indices included in the performance graph on page 35 of this Annual 
Report on Form 10-K.

        The Committee believes that the Company's executive compensation program
reflects the principles described above and provides executives strong
incentives to maximize Company performance and enhance stockholder value. The
Committee believes that a stock option program to reward performance is an
appropriate method of executive compensation, with relatively modest increases
in base compensation.


                                 Page 31 of 41
<PAGE>   33
BASE SALARY

        Base salary levels for each of the Company's executive officers are
reviewed annually. The Company applies various subjective criteria, including
performance of the individual and the Company and relative responsibility and
experience, to determine appropriate base salaries. In evaluating Company
performance, the Committee considers the meeting of certain product milestones,
achieving certain corporate objectives (related to financings and
collaborations) and organizational effectiveness. In addition, the Company
compares its executives' base salaries to management salaries at companies in
the biotechnology industry, comparable geographic areas and at similar stages of
growth and considers industry surveys regarding executive compensation. The
Committee uses 




--------

(1) The material in this report is not "soliciting material," is not deemed
    filed with the SEC, and is not to be incorporated by reference into any
    filing of the Company under the Securities Act of 1933, as amended (the
    "1933 Act") or the 1934 Act, whether made before or after the date hereof
    and irrespective of any general incorporation language contained in such
    filing.

these criteria as a frame of reference for annual salary adjustments although
other factors are considered, as appropriate, and no specific weights are
ascribed to the factors considered by the Committee.

LONG-TERM INCENTIVE COMPENSATION

        The Company's long-term incentive program includes stock options and
other awards granted under the 1989 Plan, other stock options and the Company's
Employee Stock Purchase Plan. Stock options are an important part of the
Company's performance-based compensation. Option grants include vesting periods
(generally over four years) to encourage key employees to continue in the employ
of the Company. In 1998, the Company implemented a performance management system
(the "Performance Management System") for members of certain employee teams
organized under the Performance Management System. Under the Performance
Management System, options are subject to acceleration of vesting upon the
achievement of certain performance-based objectives by such teams. Prior to
December 1996, the time-based vesting period of option grants was five years,
but the Board of Directors changed such vesting schedule to four years to
facilitate the recruitment and retention of key employees. Through option
grants, executives receive significant equity incentives to build long-term
stockholder value Grants are generally made at 100% of fair market value on the
date of grant. Section 4(c) of the 1989 Plan limits the number of shares that
can be granted to any person in any calendar year to ensure that any income
recognized in connection with the exercise of options under the 1989 Plan would
qualify as "performance-based compensation" under Section 162(m) of the Code. As
set forth in Proposal 3, the Board has approved, and the stockholders are being
asked to approve, an amendment to the 1989 Plan to increase the limit on the
number of shares underlying options that can be granted to any person in a
calendar year from 500,000 shares to 950,000 shares.

        The Committee believes that providing management a substantial economic
interest in the long-term appreciation of the Company's Common Stock further
aligns the interests of stockholders and management. The size of option grants
to an individual is primarily determined by such individual's position within
management of the Company, as well as competitive practices at biotechnology
companies of comparable size. The Committee also considered the size of grants
to individuals in previous years and internal relativity.

        Section 162(m) of the Code limits the Company to a deduction for federal
income tax purposes of no more than $1 million paid to certain Named Executive
Officers in a taxable year. Compensation above $1 million may be deducted if it
is "performance-based compensation" within the meaning of the Code. The statute
containing this law and the applicable Treasury regulations offer a number of
transitional exceptions to this deduction limitation for preexisting
compensation plans, arrangements and binding contracts. As a result, the
Compensation Committee believes that at the present time it is unlikely that the
compensation paid to any Named Executive Officer in a taxable year which is
subject to the deduction limit will exceed $1 million. Therefore, the
Compensation Committee has not yet established a policy for determining which
forms of incentive compensation awarded to Named Executive Officers will be
designed to qualify as performance-based compensation.

        In each of fiscal 1998, 1997 and 1996 a pool of grants to a defined
management group was approved. Individual awards were based on an evaluation of
previous awards, vested status and retention goals.
<PAGE>   34
CEO COMPENSATION

        The total compensation program for Mr. Virgil Thompson, Chief Executive
Officer of the Company, is largely based on the same components as for other
senior executives. Each year the Committee reviews the Chief Executive Officer's
existing compensation arrangement, the individual performance for the calendar
year under review, as well as the Company's performance relative to its peers.

        In February 1998, the Committee reviewed the achievement of objectives
for 1997, and, based on the Company's performance in 1997 and Mr. Thompson's
significant efforts in planning and implementing strategic and financial
initiatives, the Committee approved a base salary for Mr. Thompson of $326,000
for 1998, an increase of 3.5% over Mr. Thompson's 1997 base salary. In addition,
based on such factors, the Board of Directors also granted Mr. Thompson an
option to purchase 28,571 shares of the Company's Common Stock under the 1989
Plan at an exercise price of $11.15630, the fair market value on the date of
grant.

        In June 1998, the Board approved the grant of options to purchase a
total of 85,892 shares of the Company's Common Stock at an exercise price of
$10.71880, the fair market value on the date of grant, in connection with the
option exchange program more fully described below in the "Report on Repricing
of Options."

        In December 1998, the Committee reviewed the achievement of objectives
for 1998 and determined not to increase Mr. Thompson's base salary for 1999.

REPORT ON REPRICING OF OPTIONS

        On June 11, 1998, at the 1998 Annual Meeting of Stockholders, the
stockholders approved an option exchange program whereby employees were given
the opportunity to exchange outstanding out-of-the-money stock options for a
lesser number of new options priced at the market price of the Company's Common
Stock at the time of exchange (the "Exchange Program"). All employees who held
out-of-the-money stock options were entitled to participate in the Exchange
Program. On June 15, 1998 the Company implemented the Exchange Program.

        Under the Exchange Program., outstanding out-of-the-money options were
exchanged for new options with an exercise price of $10.71880 (the fair market
value of the Company's Common Stock on June 15, 1998). The number of shares of
Common Stock underlying the new options was based on a formula developed by the
Wisconsin Board, and depended upon the exercise price of the out-of-the-money
options which were cancelled in conjunction with the exchange. Vesting of the
new options occurs over a six year period according to a formula developed by
the Wisconsin Board.

        The Board of Directors believes that out-of-the-money stock options have
little incentive value to employees and in fact undermine morale and motivation.
In addition, virtually all companies in the biotechnology industry use stock
options to attract and retain outstanding employees, and there is substantial
competition to obtain and/or retain skilled and experienced scientists and
managers in the industry. Many biotechnology companies also offer cash bonuses
to its employees, but Cytel does not. Accordingly, stock option-based
performance incentives are a particularly important part of a competitive
overall compensation package for employees of the Company.

        The Board of Directors approved the Exchange Program because it was
concerned that the Company may have been at risk of losing valued employees
because most of the then outstanding stock options were not providing incentives
to the Company's management team and other employees. After careful
consideration of market conditions, employee turnover, employee morale and the
challenges and opportunities facing the Company, the Board of Directors believed
that this situation was likely to be more damaging to the Company and its
stockholders than the effect of an option exchange program. As a result, in the
good faith judgment of the Board of Directors, it was in the best interests of
the stockholders of the Company to replace underwater stock options with options
having an exercise price equal to the then current fair market value of the
stock, thus restoring the opportunity for employees to receive value in the near
term by building the Company and causing the market value of the stock to
increase.

        No options held by members of the Compensation Committee were repriced
in the Exchange Program.
<PAGE>   35
                          TEN-YEAR OPTION REPRICINGS(1)

<TABLE>
<CAPTION>
                                    Number of   Market                               Length of
                                   Securities   Price of    Exercise                  Original
                                   Underlying   Stock at    Price at                 Option Term
                                     Options    Time of     time of        New       Remaining
                                    Repriced    Repricing   Repricing    Exercise     at Date of
         Name              Date        (#)         ($)        ($)       Price ($)    Repricing
-----------------------  -------     ------       --------    ------     --------   --------------
<S>                      <C>       <C>          <C>         <C>         <C>         <C>
Mr. Virgil Thompson....  6/15/98     60,235       10.71880    42.875     10.71880   7 yrs 202 days
 President and Chief     6/15/98     25,657       10.71880    28.00      10.71880   8 yrs 202 days
 Executive Officer

Dr. Robert L. Roe......  6/15/98     46,594       10.71880    52.50      10.71880   7 yrs 232 days
 Executive Vice          6/15/98     23,091       10.71880    28.00      10.71880   8 yrs 202 days
 President, Chief
 Operating Officer,
 Chief Financial
 Officer and Secretary

Ms. Deborah Schueren...  12/15/94     4,285       18.816      43.75      18.816     7 yrs 355 days
 Vice President, Cytel   12/15/94       184       18.816      54.25      18.816     8 yrs   7 days
 and President,          6/15/98      1,885       10.71880    32.375     10.71880   5 yrs 190 days
 Epimmune                6/15/98      1,640       10.71880    31.50      10.71880   7 yrs 184 days
                         6/15/98      1,923       10.71880    28.00      10.71880   8 yrs 181 days
                         6/15/98      3,331       10.71880    18.816     10.71880   6 yrs 185 days
                         6/15/98      1,203       10.71880    21.875     10.71880   6 yrs 202 days
                         6/15/98     16,409       10.71880    16.625     10.71880   8 yrs 280 days

Jennifer Lorenzen......  6/15/98      1,923       10.71880    28.00      10.71880   8 yrs 181 days
 Vice President,         6/15/98      4,613       10.71880    22.750     10.71880   8 yrs  60 days
 Business Development

Dr. James C. Paulson...  12/15/94    10,714       18.816      42.00      18.816     6 yrs 300 days
 Former Vice President   12/15/94     8,738       18.816      54.25      18.816     8 yrs   5 days
 and General Manager,    6/15/98      7,572       10.71880    31.50      10.71880   7 yrs 184 days
 Glytec(TM)              6/15/98     10,262       10.71880    28         10.71880   8 yrs 181 days
                         6/15/98     18,363       10.71880    18.816     10.71880   6 yrs 185 days
                         6/15/98     15,714       10.71880    32.375     10.71880   5 yrs 190 days

Mr. Edward C. Hall.....       --         --             --        --           --               --
 Former Vice
 President, Finance,
 Chief Financial
 Officer and Secretary
</TABLE>

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

(1) All numbers and prices in this table reflect the Company's 1:7 reverse stock
    split which occurred on November 13, 1998.


        From the members of the Compensation Committee of Cytel:

               Howard E. Greene, Jr.

               David L. Anderson

               David L. Mahoney

           COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION

        Mr. Greene, a member of the Compensation Committee, is Chairman of the
Board of the Company.
<PAGE>   36
                     PERFORMANCE MEASUREMENT COMPARISON (1)

        The following chart shows total shareholder return of the Nasdaq CRSP
Total Return Index ("Nasdaq Broad Index") for the Nasdaq Stock Market (US
Companies) and the Nasdaq CRSP Pharmaceutical Index ("Nasdaq Pharmaceutical
Index")(2) and for the Company as of the end of each year since December 31,
1993.


             COMPARISON OF TOTAL CUMULATIVE RETURN ON INVESTMENT(3)





                              [PERFORMANCE GRAPH]


<TABLE>
<CAPTION>
                              12/93     12/94     12/95     12/96     12/97     12/98
                              -----     -----     -----     -----     -----     -----
<S>                           <C>       <C>       <C>       <C>       <C>       <C>
CYTEL CORPORATION              100        66       129        72        32         7

NASDAQ STOCK MARKET (U.S.)     100        98       138       170       208       294

NASDAQ PHARMACEUTICAL          100        75       138       138       143       183
</TABLE>


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

(1) This Section is not "soliciting material," is not deemed filed with the SEC,
    and is not to be incorporated by reference into any filing of the Company
    under the 1933 Act or the 1934 Act, whether made before or after the date
    hereof and irrespective of any general incorporation language in such
    filing.
(2) The Nasdaq Pharmaceutical Index is made up of all companies with the
    Standard Industrial Classification (SIC) code 283 (category description
    "Drugs"). Information regarding the companies comprising this index is
    available upon written request to Secretary, Cytel Corporation, 9390 Towne
    Centre Drive, San Diego, California 92121.
(3) The total return on investment (including investment of dividends) assumes
    $100 invested on December 31, 1993 in Cytel's Common Stock, the Nasdaq CRSP
    Total Return Index for the Nasdaq Stock (U.S. Companies) Index and the
    NASDAQ CRSP Pharmaceutical Index.



ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

        The following table sets forth certain information regarding the
ownership of Common Stock of Cytel as of April 1, 1999 by (i) each director and
nominee; (ii) each Named Executive Officer (as defined below); (iii) all
executive officers and directors as a group; and (iv) all those known by Cytel
to be beneficial owners of more than five percent of its Common Stock:

<TABLE>
<CAPTION>

                                                                BENEFICIAL OWNERSHIP(1)
                                                                -----------------------
                                                                 NUMBER OF   PERCENT OF
          BENEFICIAL OWNER                                         SHARES       TOTAL
          ----------------                                      ----------   ----------
       <S>                                                      <C>          <C>  
       International Biotechnology Trust plc
         Five Arrows House, St. Swithin's Lane,
         London, England................................           467,992      6.93%
       State of Wisconsin Investment Board
         121 East Wilson Street
         Madison, WI 53702..............................           346,290      6.93%
       G.D. Searle & Co. (2)
         5200 Old Orchard Road
         Skokie, IL 60077...............................           317,460      6.35%
       Novartis Holding AG
         Lichstrasse 35, Basel Switzerland..............           309,528      6.19%
       Elan International Services Ltd.
        102 St. James Court
        Flatts Smiths, FL04 Bermuda.....................           285,714      5.72%
       Howard E. Greene, Jr. (3)(5).....................           113,817      2.28%
       Virgil Thompson (5)..............................            56,082      1.11%
       James C. Paulson (5).............................            54,987      1.09%
       Robert L. Roe (5)................................            34,727      *
       David L. Anderson (4)(5).........................            34,487      *
       Deborah Schueren (5).............................            17,198      *
       Jennifer Lorenzen (5)............................            14,729      *
       William T. Comer (5).............................             7,255      *
       David L. Mahoney.................................             5,474      *
       Nicole Vitullo (5)...............................               670      *
       Nancy D. Rasmussen (5)...........................                 0      *
       Lisabeth F. Murphy...............................               215      *
       Edward C. Hall...................................                 0      *
       All executive officers and directors
         as a group (12 persons)(6).....................           339,641       6.6%
</TABLE>

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

* Less than one percent.
<PAGE>   37

(1)  This table is based upon information supplied by officers, directors and
     principal stockholders and on any Schedules 13D or 13G filed with the SEC.
     Unless otherwise indicated in the footnotes to this table and subject to
     community property laws where applicable, each stockholder named in this
     table has sole voting and investment power with respect to the shares
     indicated as beneficially owned. Applicable percentage ownership is based
     on 4,997,322 shares of Common Stock outstanding on April 1, 1999.

(2)  Does not include 659,898 shares of Series B Preferred Stock issued to
     Searle in February 1998 pursuant to a collaboration between Epimmune and
     Searle. Searle has the right to convert the Series B Preferred Stock into
     Cytel Common Stock after three years, at a conversion rate of 0.1126 shares
     of Common Stock for each share of Series B Preferred Stock (for an
     aggregate of 74,285 shares of Common Stock) or to convert to Epimmune
     Common Stock at any time. In addition, Searle has the option to deliver
     shares of the Series B Preferred Stock in lieu of up to 50% of certain
     milestone payments to Epimmune.

(3)  Includes 109,745 shares held in trust for the benefit of Mr. Greene's
     family and 2,285 shares held in trust for the benefit of Mr. Greene's
     children. Mr. Greene is a trustee of both trusts. Mr. Greene acting as
     trustee has voting and investment power with respect to such shares and may
     be deemed to be the beneficial owner of such shares. In addition, Mr.
     Greene is a director of International Biotechnology Trust plc and disclaims
     beneficial ownership of shares held by such entity.

(4)  Includes 1,428 shares held by Anvest, L.P. of which Mr. Anderson is the
     general partner. Also includes 19,637 shares held of record by Sutter Hill,
     over which Mr. Anderson exercises voting and investing power as a managing
     director of Sutter Hill Ventures LLC, the general partner of Sutter Hill.
     Mr. Anderson disclaims beneficial ownership of shares held by Anvest, L.P.
     and Sutter Hill except to his proportionate partnership interest therein.

(5)  Includes shares which certain executive officers and directors of Cytel
     have the right to acquire within 60 days after the date of this table
     pursuant to outstanding options, as follows: Howard E. Greene, 1,787
     shares; Virgil Thompson, 38,337 shares; Robert L. Roe, 29,328 shares; David
     L. Anderson, 1,787 shares; Deborah Schueren, 16,921 shares; Jennifer
     Lorenzen, 14,729 shares; Lisabeth Murphy, 215 shares; James C. Paulson,
     35,628 shares; William T. Comer, 6,341 shares; David L. Mahoney, 2,617
     shares; Nicole Vitullo, 670 shares; and all executive officers and
     directors as a group, 148,360 shares.

(6)  Includes shares described in notes (3) through (5) above.



ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

        Cytel's Bylaws provide that Cytel will indemnify its directors and
executive officers and may indemnify its other officers, employees and other
agents to the fullest extent permitted by Delaware law. Cytel is also empowered
under its Bylaws to enter into indemnification contracts with its directors and
officers and to purchase insurance on behalf of any person whom it is required
or permitted to indemnify. Pursuant to this provision, Cytel has entered into
indemnity agreements with each of its directors and officers.

        In addition, Cytel's Certificate of Incorporation provides that to the
fullest extent permitted by Delaware law, Cytel's directors will not be liable
for monetary damages for breach of the directors' fiduciary duty of care to
Cytel and its stockholders. This provision in the Certificate of Incorporation
does not eliminate the duty of care, and in appropriate circumstances equitable
remedies such as an injunction or other forms of non-monetary relief would
remain available under Delaware law. Each director will continue to be subject
to liability for breach of the director's duty of loyalty to Cytel, for acts or
omissions not in good faith or involving intentional misconduct or knowing
violations of law, for acts or omissions that the director believes to be
contrary to the best





                                 Page 32 of 41
<PAGE>   38

interests of Cytel or its stockholders, for any transaction from which the
director derived an improper personal benefit, for acts or omissions involving a
reckless disregard for the director's duty to Cytel or its stockholders when the
director was aware or should have been aware of a risk of serious injury to
Cytel or its stockholders, for acts or omissions that constitute an unexcused
pattern of inattention that amounts to an abdication of the director's duty to
Cytel or its stockholders, for improper transactions between the director and
Cytel, and for improper distributions to stockholders and loans to directors and
officers. This provision also does not affect a director's responsibilities
under any other laws, such as the federal securities laws or state or federal
environmental laws.

        Cytel has entered into certain additional transactions with its
directors and officers, as described under the captions "Executive Compensation"
and "Employment Agreements."





                                 Page 33 of 41

<PAGE>   39

                                     Part IV

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

(a)(1) Index to Financial Statements

The consolidated financial statements required by this item are submitted in a
separate section beginning on page F-1 of this Report.

<TABLE>
<CAPTION>
                                                                                  Page
                                                                                  ----
<S>                                                                               <C>
Report of Ernst & Young LLP, Independent Auditors.................................F-1
Consolidated Balance Sheets as of December 31, 1998 and 1997......................F-2
Consolidated  Statements  of  Operations  for each of the  three
years in the period ended December 31, 1998.......................................F-3
Consolidated  Statement of Stockholders'  Equity for each of the
three years in the period ended December 31, 1998.................................F-4
Consolidated  Statements  of Cash  Flows  for each of the  three
years in the period ended December 31, 1998.......................................F-5 - F-6
Notes to Consolidated Financial Statements........................................F-7 - F-28
</TABLE>

(2)    INDEX TO FINANCIAL STATEMENT SCHEDULES

The consolidated financial statement schedules required by this item are omitted
because they are not applicable or the required information is shown in the
Financial Statements or the notes thereto.

(3)     LISTING OF EXHIBITS

<TABLE>
<CAPTION>

Exhibit
Number      Document Description
-------     --------------------
<S>         <C>
  3.1       Amended and Restated Certificate of Incorporation.(A)

  3.2       Bylaws of the Registrant.(A)

  3.3       Preferred Share Purchase Rights Plan.(B)

  3.4       Form of Certificate of Amendment to the Company's Amended and
            Restated Certificate of Incorporation.(E)

  3.5       Certificate of Designation of the Series B Convertible Preferred
            Stock.(J)

  3.6       Certificate of Amendment of Amended and Restated Certificate of
            Incorporation.(L)

  3.7       Certificate of Increase of Series A Junior Participating Preferred
            Stock.(L)

  3.8       Certificate of Amendment of Amended and Restated Certificate of
            Incorporation.(M)

  4.1       Reference is made to Exhibits 3.1 through 3.8.

  4.2       Specimen certificate of the Common stock.(A)

 10.1       Form of Indemnification Agreement entered into between the
            Registrant and its directors and officers.(A)

 10.3       Letter Agreement, between the Registrant and James C. Paulson, dated
            March 2, 1990.(A)

 10.5       Registrant's 1989 Stock Plan, as amended through June 12, 1998 (the
            "1989 Plan").(L)
</TABLE>







                                 Page 34 of 41
<PAGE>   40


<TABLE>
<CAPTION>

Exhibit
Number      Document Description
-------     --------------------
<S>         <C>

 10.6       Forms of Incentive Stock Option Agreement under the 1989 Plan.(A)

 10.7       Form of Nonstatutory Stock Option Agreement under the 1989 Plan.(A)

 10.8       Employee Stock Purchase Plan, as amended through June 12, 1998.(L)


 10.16      Industrial Lease, between the Registrant and COAST/USC I, dated as
            of May 17, 1990, as amended June 27, 1990 and July 13, 1990.(A)

 10.19      Research Agreement, between the Registrant and The Scripps Research
            Institute, formerly Scripps Clinic and Research Foundation
            ("Scripps"), dated as of September 1, 1990, as amended August 5,
            1991 (with certain confidential portions deleted).(A)(1)

 10.24      License Agreement, between the Registrant and Scripps, dated as of
            September 23, 1991 (with certain confidential portions
            deleted).(A)(1)

 10.25      Research and Option Agreement, between the Registrant and Scripps,
            dated October 1, 1991 (with certain confidential portions
            deleted).(A)(1)

 10.28      Technology Development Agreement, between the Registrant and
            Sumitomo Pharmaceuticals Co., Ltd. ("Sumitomo") dated as of October
            30, 1991 (with certain confidential portions deleted).(A)(1)

 10.29      Letter Agreement, between the Registrant and Sumitomo, dated as of
            October 30, 1992.(A)

 10.35      Amendment to License Agreement between the Registrant and Scripps
            dated as of June 17, 1992 (with certain confidential portions
            deleted).(C)(2)

 10.37      Registrant's Non-Employee Directors' Stock Option Plan, as amended
            through June 12, 1998.(L)

 10.38      Investment Agreement, between the Registrant and Sumitomo, dated as
            of December 22, 1993.(D)

 10.43      Amended and Restated Technology Development Agreement between the
            Registrant and Sumitomo, dated February 17, 1995 (with certain
            confidential portions deleted).(F)(2)

 10.48      Second Amendment to License Agreement between the Registrant and
            Scripps dated as of June 17, 1992 (with certain confidential
            portions deleted).(G)(2)

 10.49      Letter Agreement, between the Registrant and Virgil D. Thompson,
            dated December 19, 1995.(G)
</TABLE>






                                 Page 35 of 41
<PAGE>   41

<TABLE>
<CAPTION>

Exhibit
Number      Document Description
-------     --------------------
<S>         <C>
 10.50      Letter Agreement, between the Registrant and Robert L. Roe, M.D.,
            F.A.C.P., dated January 18, 1996.(G)

 10.51      Directors' Deferred Compensation Plan, effective as of March 17,
            1995, as amended September 20, 1996.(H)

 10.52      Letter of Intent between the Registrant and G.D. Searle & Co., dated
            September 5, 1997 (with certain confidential portions
            deleted).(I)(3)

 10.53      Stock Purchase Agreement between Registrant and G.D. Searle & Co.,
            dated September 18, 1997.(I)

 10.54      Employment agreement between Registrant, Epimmune Inc. ("Epimmune")
            and Deborah A. Schueren dated October 1, 1997.(J)

 10.55      Form of Severance Benefit Agreement between Registrant and the
            following executive officers: Virgil D. Thompson; Robert L. Roe,
            M.D.; James C. Paulson, Ph.D; Edward C. Hall; Jennifer Lorenzen.(K)

 10.56      License and Collaboration Agreement between Epimmune and Searle,
            dated February 27, 1998 (with certain confidential portions
            deleted).(K)(4)

 10.57      Series B Preferred Stock Purchase Agreement between Epimmune and
            Searle, dated February 27, 1998.(K)

 10.58      Series B-1 Preferred Stock Purchase Agreement between Registrant and
            Epimmune, dated February 27, 1998.(K)

 10.59      Stock Purchase Agreement between Registrant and Searle, dated
            February 27, 1998.(K)

 10.60      Sublease Agreement, between the Registrant and Amylin
            Pharmaceuticals, Inc., dated as of June 1, 1998.(M)

 10.61      Amended and Restated Sublicense and Option Agreement, between the
            Registrant and Elan International Services Ltd. ("Elan"), dated
            November 10, 1998 (the "Sublicense Agreement"), and side letter
            entered between the Registrant and Elan, dated November 10, 1998
            (with certain confidential portions of the Sublicense Agreement
            deleted).(M)(5)

 10.62      Two Letter Agreements between the Registrant and James C. Paulson,
            Ph.D. dated December 2, 1998 and December 23, 1998.

 10.63      Lease Agreement between Epimmune, Inc. and Nexus Equity LLC VIII,
            dated as of November 1, 1998, as amended February 1, 1999

 21.1       Subsidiaries of the Registrant.(J)

 23.1       Consent of Ernst & Young LLP, Independent Auditors.

 25.1       Power of Attorney. Reference is made to the signature page of this
            report on Form 10-K.
</TABLE>





                                 Page 36 of 41
<PAGE>   42

<TABLE>
<CAPTION>

Exhibit
Number      Document Description
-------     --------------------
<S>         <C>
 27.1       Financial Data Schedule

 (4)        EXECUTIVE COMPENSATION PLANS AND ARRANGEMENTS

 10.1       Form of Indemnification Agreement entered into between the
            Registrant and its directors and officers.(A)

 10.3       Letter agreement, between the Registrant and James C. Paulson, dated
            March 2, 1990.(A)

 10.5       Registrant's 1989 Stock Plan, as amended through June 12, 1998 (the
            "1989 Plan").(L)

 10.6       Forms of Incentive Stock Option Agreement under the 1989 Plan.(A)

 10.7       Form of Nonstatutory Stock Option Agreement under the 1989 Plan.(A)

 10.8       Employee Stock Purchase Plan, as amended through June 12, 1998.(L)

 10.37      Registrant's Non-Employee Directors' Stock Option Plan, as amended
            through June 12, 1998.(L)

 10.49      Letter Agreement, between the Registrant and Virgil D. Thompson,
            dated December 19, 1995.(G)

 10.50      Letter Agreement, between the Registrant and Robert L. Roe, M.D.,
            F.A.C.P., dated January 18, 1996.(G)

 10.51      Directors' Deferred Compensation Plan, effective as of March 17,
            1995 as amended September 20, 1996.(H)

 10.54      Employment agreement between Registrant, Epimmune and Deborah A.
            Schueren dated October 1, 1997.(J)

 10.55      Form of Severance Benefit Agreement between Registrant and the
            following executive officers: Virgil D. Thompson; Robert L. Roe,
            M.D.; James C. Paulson, Ph.D; Edward C. Hall; Jennifer Lorenzen.(K)

 10.62      Letter Agreement between the Registrant and James C. Paulson, Ph.D.
</TABLE>

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

(A)   Incorporated by reference to the Company's Form S-1 Registration Statement
      and Amendments thereto (File No. 33-43356)

(B)   Incorporated by reference to the Company's Form 8-K, dated March 19, 1993.

(C)   Incorporated by reference to the Company's Annual Report on Form 10-K, for
      the fiscal year ended December 31, 1992, filed on March 26, 1993.





                                 Page 37 of 41
<PAGE>   43

(D)   Incorporated by reference to the Company's Annual Report on Form 10-K, for
      the fiscal year ended December 31, 1993, filed on March 29, 1994.

(E)   Incorporated by reference to the Company's Annual Report on Form 10-K, for
      the fiscal year ended December 31, 1994, filed on March 31, 1995.

(F)   Incorporated by reference to the Company's Quarterly Report on Form
      10-Q/A, Amendment No. 1, for the quarterly period ended March 31, 1995,
      filed on August 17, 1995.

(G)   Incorporated by reference to the Company's Annual Report on Form 10-K, for
      the fiscal year ended December 31, 1995, filed on March 22, 1996.

(H)   Incorporated by reference to the Company's Annual Report on Form 10-K, for
      the fiscal year ended December 31, 1996, filed on March 31, 1997.

(I)   Incorporated by reference to the Company's Quarterly Report on Form 10-Q,
      for the quarterly period ended September 30, 1997, filed on November 14,
      1997.

(J)   Incorporated by reference to the Company's Annual Report on Form 10-K, for
      the fiscal year ended December 31, 1997, filed on March 31, 1998.

(K)   Incorporated by reference to the Company's Quarterly Report on Form 10-Q,
      for the quarterly period ended March 31, 1998, filed on May 15, 1998.

(L)   Incorporated by reference to the Company's Quarterly Report on Form 10-Q,
      for the quarterly period ended June 30, 1998, filed on August 14, 1998.

(M)   Incorporated by reference to the Company's Quarterly Report on Form 10-Q,
      for the quarterly period ended September 30, 1998, filed on November 16,
      1998.

(1)   Certain confidential portions deleted pursuant to Order Granting
      Application Under the Securities Act of 1933 and Rule 406 Thereunder
      Respecting Confidential Treatment dated November 21, 1991.

(2)   Certain confidential portions deleted pursuant to Order Granting
      Application Under the Securities Exchange Act of 1934 and Rule 24b-2
      Thereunder Respecting Confidential Treatment dated May 15, 1996.

(3)   Certain confidential portions deleted pursuant to Order Granting
      Application Under the Securities Exchange Act of 1934 and Rule 24b-2
      Thereunder Respecting Confidential Treatment dated December 17, 1997.





                                 Page 38 of 41
<PAGE>   44

(4)   Certain confidential portions deleted pursuant to Order Granting
      Application Under the Securities Exchange Act of 1934 and Rule 24b-2
      Thereunder Respecting Confidential Treatment dated July 15, 1998.

(5)   Certain confidential portions deleted pursuant to Order Granting
      Application Under the Securities Exchange Act of 1934 and Rule 24b-2
      Thereunder Respecting Confidential Treatment dated December 17, 1998.

(B)    REPORT ON FORM 8-K

       None

(C)   EXHIBITS

      The response to this portion of Item 14 is submitted as a separate section
      of his report.

(D)   FINANCIAL STATEMENT SCHEDULES

      The consolidated financial statement schedules required by this Item are
      listed under Item 14(a)(2).









                                 Page 39 of 41


<PAGE>   45


                                   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 this 15 day of April,
1999.


                                       CYTEL CORPORATION

                                       By  /s/ Virgil Thompson
                                          --------------------------------------
                                           Virgil Thompson
                                           President and Chief Executive Officer
                                           (Principal Executive Officer)

KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears below
constitutes and appoints Virgil Thompson and Robert L. Roe, and each of them,
his attorney-in-fact, with the full power of substitution, for him in any and
all capacities, to sign any amendments to this Report, and to file the same,
with exhibits thereto and other documents in connection therewith, with the
Securities and Exchange Commission, hereby ratifying and confirming all that
each of said attorneys-in-fact, or his or her substitute or substitutes, may do
or cause to be done by virtue hereof.

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>                                    <C>
 /s/ David L. Anderson           April 15, 1999    /s/ Robert L. Roe                      April 15, 1999
 ----------------------------                      ----------------------------------
 David L. Anderson                                 Robert L. Roe, M.D., F.A.C.P.
 Director                                          Executive Vice President, Chief
                                                   Operating Officer, Chief Financial
                                                   Officer and Director


 /s/ William T. Comer             April 15, 1999   /s/ David L. Mahoney                   April 15, 1999
 ----------------------------                      ----------------------------------
 William T. Comer, Ph.D.                           David L. Mahoney
 Director                                          Director


 /s/ Lisabeth F. Murphy           April 15, 1999   /s/ Nancy D. Rasmussen                 April 15, 1999
 ----------------------------                      ----------------------------------
 Lisabeth F. Murphy                                Nancy D. Rasmussen
 Director                                          Director


 /s/ Virgil Thompson             April 15, 1999    /s/ Howard E. Greene, Jr.              April 15, 1999
 ----------------------------                      ----------------------------------
 Virgil Thompson                                   Howard E. Greene, Jr.
 President, Chief Executive                        Chairman of the Board and Director
Officer and Director


 /s/ Nicole Vitullo               April 15, 1999
 ----------------------------
 Nicole Vitullo
 Director

</TABLE>



                                 Page 40 of 41

<PAGE>   46



                Report of Ernst & Young LLP, Independent Auditors

The Board of Directors and Stockholders
Cytel Corporation

We have audited the accompanying consolidated balance sheets of Cytel
Corporation as of December 31, 1998 and 1997, and the related consolidated
statements of operations, stockholders' equity and cash flows for each of the
three years in the period ended December 31, 1998. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.

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

In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Cytel Corporation
at December 31, 1998 and 1997, and the consolidated results of its operations
and its cash flows for each of the three years in the period ended December 31,
1998, in conformity with generally accepted accounting principles.



                                          ERNST & YOUNG LLP


San Diego, California
February 5, 1999
except for Notes 5, 9 and 11, as
to which the date is
March 29, 1999



                                      F-1
<PAGE>   47


                                Cytel Corporation

                           Consolidated Balance Sheets

<TABLE>
<CAPTION>
                                                                                              DECEMBER 31
                                                                                       1998                1997
                                                                                   -------------       -------------
<S>                                                                                <C>                 <C>          
ASSETS
Current assets:
   Cash and cash equivalents                                                       $   2,594,000       $   6,187,000
   Short-term investments                                                              9,217,000          11,616,000
   Current portion of restricted cash                                                         --             375,000
   Prepaids and other current assets                                                   1,657,000           1,312,000
                                                                                   -------------       -------------
Total current assets                                                                  13,468,000          19,490,000

Restricted cash                                                                          472,000             656,000
Property and equipment, net                                                            2,879,000           1,704,000
Patents                                                                                4,055,000           5,235,000
Deposits and other assets                                                                156,000           1,062,000
                                                                                   -------------       -------------
                                                                                   $  21,030,000       $  28,147,000
                                                                                   =============       =============

LIABILITIES AND STOCKHOLDERS' EQUITY 
Current liabilities:
   Accounts payable and accrued liabilities                                        $   2,289,000       $     755,000
   Deferred contract revenues                                                            515,000              78,000
   Accrued payroll and related expenses                                                  416,000             463,000
   Current portion of note payable to bank                                                    --             375,000
   Current portion of obligations under equipment
       loans and notes payable                                                           493,000              40,000
                                                                                   -------------       -------------
Total current liabilities                                                              3,713,000           1,711,000

Deferred rent                                                                                 --           1,388,000
Equipment loans and notes payable                                                      1,606,000             656,000

Commitments

Minority interest in consolidated subsidiary                                           1,735,000                  --

Stockholders' equity:
   Preferred stock, $.01 par value, 10,000,000 shares authorized, 659,898                  7,000                  --
      shares and zero shares issued and outstanding at December 31, 1998 and
      1997, respectively
   Common stock, $.01 par value, 75,000,000  and 50,000,000 shares authorized             50,000              46,000
      at December 31, 1998 and 1997, respectively; 4,987,453 shares and
      4,603,214 shares issued and outstanding at December 31, 1998 and 1997,
      respectively

   Additional paid-in capital                                                        142,642,000         131,564,000
   Accumulated deficit                                                              (128,723,000)       (107,188,000)
   Unrealized (loss) on available-for-sale securities                                         --             (30,000)
                                                                                   -------------       -------------
Total stockholders' equity                                                            13,976,000          24,392,000
                                                                                   =============       =============
                                                                                   $  21,030,000       $  28,147,000
                                                                                   =============       =============
</TABLE>

See accompanying notes. 



                                      F-2
<PAGE>   48



                                Cytel Corporation

                      Consolidated Statements of Operations


<TABLE>
<CAPTION>
                                                       YEARS ENDED DECEMBER 31
                                               1998               1997               1996
                                           ------------       ------------       ------------
<S>                                        <C>                <C>                <C>         

REVENUES
   Research and development                $  2,005,000       $  3,428,000       $  8,641,000
   Research grants and other income           1,692,000          1,623,000          2,251,000
                                           ------------       ------------       ------------
                                              3,697,000          5,051,000         10,892,000

COSTS AND EXPENSES:
   Research and development                  18,352,000         16,537,000         20,861,000
   General and administrative                 4,587,000          3,735,000          3,919,000
   Loss on permanent impairment of
     intangible assets                        3,400,000                 --                 --
                                           ------------       ------------       ------------
   Total costs and expenses                  26,339,000         20,272,000         24,780,000
                                           ------------       ------------       ------------
  Loss from operations                      (22,642,000)       (15,221,000)       (13,888,000)

   Minority interest in net loss of
       consolidated subsidiary                  441,000                 --                 --
   Interest income, net                         860,000            825,000          1,437,000
   Loss on sales and disposal
       of assets                               (194,000)                --                 --
                                           ------------       ------------       ------------

   Net loss                                $(21,535,000)      $(14,396,000)      $(12,451,000)
                                           ============       ============       ============

   Net loss per share-basic and
      diluted                              $      (4.48)      $      (3.92)      $      (3.50)
                                           ============       ============       ============
   Shares used in computing net
      loss per share-basic and
      diluted                                 4,801,872          3,668,221          3,552,258
                                           ============       ============       ============
</TABLE>


See accompanying notes.


                                      F-3
<PAGE>   49


                                Cytel Corporation

                Consolidated Statements of Stockholders' Equity

        For each of the three years in the period ended December 31, 1998

<TABLE>
<CAPTION>
                                                                                                                               
                                                                                                                               
                                                                                              Additional                       
                                     Preferred Stock            Common Stock                    Paid-in       Accumulated      
                                   Shares     Amount     Shares              Amount            capital          Deficit        
                                 ---------   --------   ----------          ---------       -------------   ----------------   
<S>                              <C>                    <C>                 <C>             <C>             <C>                
Balance at December 31, 1995      $     -           -    3,508,057           $35,000        $118,960,000     $(80,341,000)     
   Issuance of common stock             -           -       76,416             1,000           1,367,000                 -     
   Amortization of deferred
      compensation, net                 -           -            -                 -            (17,000)                 -     
   Unrealized losses on
      available-for-sale                -                                                                                -
      securities                                    -            -                 -                   -                       
   Net loss                             -           -            -                 -                   -      (12,451,000)     
                                  -------     -------    ---------           -------        ------------    -------------      
Balance at December 31, 1996            -           -    3,584,473            36,000         120,310,000      (92,792,000)     
                                                                                                                               
   Issuance of common stock             -           -    1,018,741            10,000          11,254,000                 -     
   Unrealized gains on
      available-for-sale                -           -            -                 -                   -                 -
      securities                                                                                                               
   Net loss                             -           -            -                 -                   -      (14,396,000)     
                                  -------     -------    ---------           -------        ------------    -------------      
Balance at December 31, 1997            -           -    4,603,214            46,000         131,564,000     (107,188,000)     
                                                                                                                               
   Issuance of common stock             -           -      299,764             3,000           2,692,000                 -     
      for cash
   Issuance of common stock             -           -                                                                    -     
      for technology                                        84,475             1,000             899,000                       
   Issuance of Cytel Series B     659,898       7,000            -                 -           3,593,000                 -     
      preferred stock, net of
      issuance costs
   Investment by Searle in                                       -                 -           3,894,000                 -     
      Epimmune
   Unrealized gains on
      available-for-sale                -           -            -                 -                   -                 -     
      securities
   Net loss                             -           -            -                 -                   -      (21,535,000)     
                                  -------     -------    ---------           -------        ------------    -------------      
Balance at December 31, 1998      659,898      $7,000    4,987,453           $50,000        $142,642,000    $(128,723,000) 
                                  =======     =======    =========           =======        ============    =============      
</TABLE>


<TABLE>
<CAPTION>
                                                   Unrealized
                                                  Gains (losses)
                                                  On available-       Total
                                   Deferred         For-sale       stockholders'   Comprehensive
                                 Compensation      Securities        equity           Income
                                ---------------  ---------------  ---------------  --------------
<S>                             <C>                 <C>            <C>             <C>
Balance at December 31, 1995       $(161,000)        $ 31,000      $ 38,524,000
   Issuance of common stock                -                          1,368,000
   Amortization of deferred
      compensation, net              161,000                            144,000
   Unrealized losses on
      available-for-sale                   -
      securities                                      (95,000)          (95,000)         (95,000)
   Net loss                                -                        (12,451,000)     (12,451,000)
                                                       -------     ------------    -------------
Balance at December 31, 1996               -          (64,000)       27,490,000      (12,546,000)
                                                                                   =============
   Issuance of common stock                -                         11,264,000
   Unrealized gains on
      available-for-sale        
      securities                           -            34,000           34,000           34,000
   Net loss                                                         (14,396,000)     (14,396,000)
                                                       -------     ------------    -------------
Balance at December 31, 1997               -          (30,000)       24,392,000      (14,362,000)
                                                                                   =============
   Issuance of common stock                -                          2,695,000
      for cash
   Issuance of common stock     
      for technology                       -                            900,000
   Issuance of Cytel Series B              -                          3,600,000
      preferred stock, net of
      issuance costs
   Investment by Searle in                 -                          3,894,000
      Epimmune
   Unrealized gains on
      available-for-sale                   -            30,000           30,000           30,000
      securities
   Net loss                                -                        (21,535,000)     (21,535,000)
                                   ----------         --------     ------------    -------------
Balance at December 31, 1998       $       -          $     -       $13,976,000     $(21,505.000)
                                   ==========         ========     ============    =============
</TABLE>

See accompanying notes. 


                                      F-4
<PAGE>   50



                                Cytel Corporation

                      Consolidated Statements of Cash Flows

<TABLE>
<CAPTION>
                                                                                YEARS ENDED DECEMBER 31
                                                                      1998                1997                1996
                                                                  -------------       -------------       -------------
<S>                                                               <C>                 <C>                 <C>           

OPERATING ACTIVITIES
Net loss                                                          $ (21,535,000)      $ (14,396,000)      $ (12,451,000)
Adjustments to reconcile net loss to net cash used in
   operating activities:
      Depreciation and amortization                                     811,000             786,000           1,620,000
      Deferred rent                                                    (225,000)           (252,000)           (192,000)
      Amortization of deferred compensation                                  --                  --             144,000
      Deferred revenue                                                  437,000            (654,000)         (2,025,000)
      Loss on permanent impairment of intangible assets               3,400,000                  --                  --
      Minority interest in consolidated subsidiary                     (441,000)                 --                  --
      (Gain) loss on sale of equipment                                  194,000                  --                  --
      Changes in operating assets and liabilities:
        Receivable under collaborative agreement                             --                  --           2,000,000
        Other current assets                                           (375,000)            110,000             135,000
        Accounts payable and accrued liabilities                      1,534,000          (1,236,000)            371,000
        Accrued payroll and related expense                             (47,000)           (187,000)             (7,000)
                                                                  -------------       -------------       -------------
Net cash used in operating activities                               (16,247,000)        (15,829,000)        (10,405,000)

INVESTING ACTIVITIES
Purchases of available-for-sale securities                          (18,909,000)        (33,612,000)       (110,774,000)
Maturities of available-for-sale securities                          14,145,000          21,875,000          64,787,000
Sales of available-for-sale securities                                7,193,000          20,800,000          53,143,000
Proceeds from the sale of equipment                                     109,000              55,000                  --
Proceeds from the sale of assets of subsidiary                               --             161,000                  --
Principal payments on note receivable                                   100,000              50,000                  --
Purchases of property and equipment                                  (2,274,000)           (644,000)         (2,067,000)
Assets transferred to subsidiary at net book value                           --              84,000                  --
Expenditures related to early lease termination                        (226,000)                 --                  --
Patents                                                              (1,320,000)           (878,000)         (1,186,000)
Deposits and other assets                                               574,000             (29,000)            163,000
                                                                  -------------       -------------       -------------
Net cash provided by (used in) investing activities                    (608,000)          7,862,000           4,066,000

FINANCING ACTIVITIES
Principal payments under equipment notes payable                       (176,000)           (341,000)           (841,000)
Principal payments on note payable to bank                           (1,031,000)           (375,000)            (94,000)
Restricted cash released as note payable collateral                   1,031,000             375,000              94,000
Restricted cash for building lease agreement                           (472,000)                 --                  --
Proceeds from the issuance of equipment notes payable                 1,515,000                  --                  --
Net proceeds from issuance of Cytel Series B preferred stock          3,600,000                  --                  --
Net proceeds from Searle investment in Epimmune                       6,100,000                  --                  --
Net proceeds from issuance of common stock                            2,695,000          11,264,000           1,368,000
                                                                  -------------       -------------       -------------
Net cash provided by financing activities                            13,262,000          10,923,000             527,000
                                                                  -------------       -------------       -------------

Increase (decrease) in cash and cash equivalents                     (3,593,000)          2,956,000          (5,812,000)
Cash and cash equivalents at beginning of year                        6,187,000           3,231,000           9,043,000
                                                                  -------------       -------------       -------------

Cash and cash equivalents at end of year                          $   2,594,000       $   6,187,000       $   3,231,000
                                                                  =============       =============       =============
</TABLE>

                                      F-5
<PAGE>   51


                                Cytel Corporation
                Consolidated Statements of Cash Flows (continued)



<TABLE>
<CAPTION>
                                                                               YEARS ENDED DECEMBER 31
                                                                       1998                1997                1996
                                                                  -------------       -------------       -------------
<S>                                                               <C>                 <C>                 <C>          

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Interest paid                                                     $     122,000       $     119,000       $     199,000
                                                                  =============       =============       =============

SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING
AND FINANCING ACTIVITIES

Issuance of common stock for patent rights                        $     900,000       $          --       $          --
                                                                  =============       =============       =============
Early lease termination - net debt
   extinguishment and asset abandonment
                                                                  $     153,000       $          --       $          --
                                                                  =============       =============       =============

Promissory note and stock received for
      sale of assets of subsidiary                                $          --       $     800,000       $          --
                                                                  =============       =============       =============
</TABLE>


See accompanying notes.



                                      F-6
<PAGE>   52

                                Cytel Corporation

                   Notes to Consolidated Financial Statements

                                December 31, 1998



1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

ORGANIZATION AND BUSINESS ACTIVITY

Cytel Corporation was incorporated in Delaware on July 10, 1987. Cytel was
established to design and develop a new class of drugs for the more effective
treatment of acute and chronic inflammatory diseases, infectious diseases and
cancer.

Unless otherwise indicated, all references to "Cytel" are to Cytel Corporation,
all references to "Epimmune" are to Epimmune Inc., a majority-owned subsidiary
of Cytel, and all references to the "Company" are to the combined entity of
Cytel and Epimmune.

PRINCIPLES OF CONSOLIDATION

The consolidated financial statements include the accounts of Cytel, Cytel
Acquisition Subsidiary, Inc. from its inception in October 1991 through its
dissolution in June 1996, Receptor Laboratories, Inc. from its purchase in July
1995 to its sale in January 1997 and Epimmune Inc. (Epimmune) from its formation
in October 1997. All significant intercompany accounts and transactions have
been eliminated.



                                      F-7
<PAGE>   53

                                Cytel Corporation

                   Notes to Consolidated Financial Statements

                                December 31, 1998



1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

The minority interest calculation is based on G.D. Searle & Co.'s (Searle), a
wholly-owned subsidiary of Monsanto Co., actual ownership percentage in Epimmune
of 13.4% at December 31, 1998. The calculation does not include the potential
additional ownership interest that would result from the conversion of Searle's
investment in Cytel's preferred stock which is convertible into Epimmune common
stock.

MANAGEMENT'S PLAN FOR FUTURE OPERATIONS

As more fully disclosed in Note 11, disappointing results of the Phase II/III
clinical trial of Cylexin, Cytel's cell adhesion inhibitor compound, have led to
the termination of its anti-inflammatory therapeutics business. Accordingly,
Cytel is terminating its employees, selling its fixed assets and intellectual
property, and focusing all subsequent development efforts on Epimmune's vaccine
technology. During the first quarter of 1999, Cytel sold its Glytec carbohydrate
synthesis and manufacturing business. Cytel plans to use the proceeds from such
sales, together with existing cash resources, to meet its financial obligations,
including corporate restructuring and termination costs of all of its
non-vaccine programs. There can be no assurance, however, that Cytel's available
cash will be sufficient to satisfy all of its financial obligations.

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 the disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.

CASH AND CASH EQUIVALENTS

Cash and cash equivalents consist of primarily of cash, certificates of deposit,
treasury securities and repurchase agreements with original maturities at the
date of acquisition of less than three months.



                                      F-8
<PAGE>   54


                                Cytel Corporation

             Notes to Consolidated Financial Statements (continued)

                                December 31, 1998



1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

SHORT-TERM INVESTMENTS

The Company has classified its investments as available-for-sale and accordingly
carries them at fair value. Unrealized holding gains or losses on these
securities are carried as a separate component of stockholders' equity. The
amortized cost of debt securities in this category is adjusted for amortization
of premiums and accretion of discounts to maturity. Such amortization is
included in interest income. Realized gains and losses and declines in value
judged to be other than temporary on available-for-sale securities are also
included in interest income. The cost of securities sold is based on the
specific identification method.

CONCENTRATION OF CREDIT RISK

The Company invests its excess cash in U.S. government securities and debt
instruments of financial institutions and corporations with strong credit
ratings. The Company has established guidelines relative to diversification and
maturities that maintain safety and liquidity. These guidelines are periodically
reviewed and modified to take advantage of trends in yields and interest rates.
Management attempts to schedule the maturities of the Company's investments to
coincide with the Company's expected cash requirements.

PROPERTY AND EQUIPMENT

Furniture and equipment is stated at cost and depreciation is computed using the
straight-line method over the estimated useful lives of the assets. Leasehold
improvements are amortized using the straight-line method over the shorter of
the estimated useful life of the assets or the lease term.

IMPAIRMENT OF LONG-LIVED ASSETS

The Company records impairment losses on long-lived assets used in operations
when indicators of impairment are present and the undiscounted cash flows
estimated to be generated by those assets are less than the assets' carrying
amount. As more fully disclosed in Note 11, management determined that certain
patent assets were impaired, and recorded a $3.4 million loss on permanent
impairment of these assets in 1998.



                                      F-9
<PAGE>   55

                                Cytel Corporation

             Notes to Consolidated Financial Statements (continued)

                                December 31, 1998



1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

DEFERRED RENT

Rent expense is recognized on a straight-line basis over the terms of the
leases. Accordingly, rent expense incurred in excess of rent paid is reflected
as deferred rent.

ACCOUNTING FOR STOCK-BASED COMPENSATION

The Company accounts for stock-based compensation in accordance with Accounting
Principles Board ("APB") 25, Accounting for Stock Issued to Employees. In 1997,
the Company adopted the disclosure requirements of SFAS 123, Accounting for
Stock-Based Compensation. Under APB 25, compensation expense relating to
employee stock options is determined based on the excess of the market price of
the Company's stock over the exercise price on the date of grant and does not
require the recognition of compensation expense for stock issued under plans
defined as noncompensatory. Adoption of SFAS 123 requires recognition of
compensation expense for virtually all options based on their computed "fair
value" on the date of the grant.

RESEARCH AND DEVELOPMENT REVENUES AND EXPENSES

Research and development revenues are recorded as earned based on the
performance requirements of the contracts. Research and development costs are
expensed as incurred. Expenses under research and development contracts were
approximately $4,500,000, $3,500,000 and $13,100,000 for 1998, 1997 and 1996,
respectively.

RESEARCH GRANTS

Research grants represent research and development revenues primarily from
National Institutes of Health.

NET LOSS PER SHARE

Basic and diluted net loss per share is computed using the weighted average
number of common shares outstanding during the period. All potential common
shares have been excluded from the diluted net loss per share calculations as
they are antidilutive to earnings.



                                      F-10
<PAGE>   56

                                Cytel Corporation

             Notes to Consolidated Financial Statements (continued)

                                December 31, 1998




1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

NEW ACCOUNTING STANDARDS

Effective January 1, 1998, the Company adopted the Statement of Financial
Accounting Standards No. 130 (SFAS No. 130), "Reporting Comprehensive Income".
SFAS No. 130 requires that all components of comprehensive income, including net
income, be reported in the financial statements in the period in which they are
recognized. Comprehensive income is defined as the change in equity during a
period from transactions and other events and circumstances from non-owner
sources. Net income and other comprehensive income, including foreign currency
translation adjustments and unrealized gains and losses on investments shall be
reported, net of their related tax effect, to arrive at comprehensive income.

Effective January 1, 1998, the Company adopted the Statement of Standards No.
131, (SFAS No. 131), "Disclosure about Segments of an Enterprise and Related
Information". SFAS No. 131 amends the requirements for public enterprises to
report financial and descriptive information about its reportable operating
segments. Operating segments, as defined by SFAS No. 131, are components of an
enterprise for which financial information is available and evaluated regularly
by the Company in deciding how to allocate resources and in assessing
performance. The financial information is required to be reported on the basis
that is used internally for evaluating the segment performance. The adoption of
SFAS No. 131 did not affect results of operations or financial position, but
does require disclosure of segment information.



                                      F-11
<PAGE>   57


                                Cytel Corporation

             Notes to Consolidated Financial Statements (continued)

                                December 31, 1998


2.         SHORT-TERM INVESTMENTS

The following tables summarize available-for-sale securities:

<TABLE>
<CAPTION>
                                                 AVAILABLE-FOR-SALE SECURITIES
                                ----------------------------------------------------------------
                                                    GROSS             GROSS   
                                                 UNREALIZED        UNREALIZED        UNREALIZED
                                   COST             GAINS             LOSSES         FAIR VALUE
                                -----------      -----------       -----------       -----------
<S>                             <C>              <C>               <C>               <C>        
DECEMBER 31, 1998
U.S. Government Securities      $ 2,018,000      $     2,000       $    (1,000)      $ 2,019,000
Corporate Obligations             7,199,000            5,000            (6,000)        7,198,000
                                -----------      -----------       -----------       -----------
                                $ 9,217,000      $     7,000       $    (7,000)      $ 9,217,000
                                ===========      ===========       ===========       ===========
</TABLE>


<TABLE>
<CAPTION>
                                                AVAILABLE-FOR-SALE SECURITIES
                                ----------------------------------------------------------------
                                                    GROSS             GROSS   
                                                 UNREALIZED        UNREALIZED        UNREALIZED
                                   COST             GAINS             LOSSES         FAIR VALUE
                                -----------      -----------       -----------       -----------
<S>                             <C>              <C>               <C>               <C>        

DECEMBER 31, 1997
U.S. Government Securities      $ 2,523,000      $     1,000       $    (5,000)      $ 2,519,000
Corporate Obligations             9,123,000            3,000           (29,000)        9,097,000
                                -----------      -----------       -----------       -----------
                                $11,646,000      $     4,000       $   (34,000)      $11,616,000
                                ===========      ===========       ===========       ===========
</TABLE>

The above tables exclude an aggregate of $1,000,000 and $5,477,000 in U.S.
government securities and corporate obligations which are classified as cash
equivalents in the accompanying balance sheets at December 31, 1998 and 1997,
respectively, due to the contractual maturity of these assets.

The amortized cost and estimated fair value of debt securities at December 31,
1998, by contractual maturity, are shown below. Expected maturities will differ
from contractual maturities because the issuers of the securities may have the
right to prepay obligations without prepayment penalties.


<TABLE>
<CAPTION>
                                      DECEMBER 31, 1998                 DECEMBER 31, 1997
                                ----------------------------       -----------------------------
                                                STIMATED                             ESTIMATED 
                                   COST          FAIR VALUE           COST           FAIR VALUE
                                -----------      -----------       -----------       -----------
<S>                             <C>              <C>               <C>               <C>        

Due in one year or less         $ 4,037,000      $ 4,037,000       $10,127,000       $10,096,000
Due after one year
   Through three years            5,180,000        5,180,000         1,519,000         1,520,000
                                -----------      -----------       -----------       -----------
                                $ 9,217,000      $ 9,217,000       $11,646,000       $11,616,000
                                ===========      ===========       ===========       ===========
</TABLE>



                                      F-12
<PAGE>   58

                                Cytel Corporation

             Notes to Consolidated Financial Statements (continued)

                                December 31, 1998


3. ARGONEX HOLDINGS, INC.

In January 1997, Cytel sold certain assets to Argonex Holdings, Inc. (Argonex)
for aggregate consideration valued at approximately $950,000. In conjunction
with the sale, Cytel maintained certain nonexclusive rights to technology
licensed from the University of Virginia, which license has been assigned to
Epimmune.

In January 1999, Cytel and Argonex completed a Stock Purchase Agreement whereby
Argonex bought back their Class C Preferred Stock and paid in full their
promissory note and accrued interest for $525,000. Cytel recorded a loss of
$231,000 based on the net realizable value of the assets in 1998.


4. BALANCE SHEET INFORMATION

Other current assets consist of the following:

<TABLE>
<CAPTION>
                                                            DECEMBER 31
                                                       1998            1997
                                                    ----------      ----------
<S>                                                 <C>             <C>       
Investment income and grant revenue receivable      $  864,000      $  852,000
Prepaid expenses                                       268,000         360,000
Note receivable - current portion                      525,000         100,000
                                                    ----------      ----------
                                                    $1,657,000      $1,312,000
                                                    ==========      ==========
</TABLE>

Property and equipment consist of the following:

<TABLE>
<CAPTION>
                                                            DECEMBER 31
                                                       1998            1997
                                                    ----------      ----------
<S>                                                 <C>             <C>       
Furniture and equipment                             $7,344,000      $6,362,000
Leasehold improvements                               1,451,000       1,597,000
Construction in progress                                23,000         138,000
                                                    ----------      ----------
                                                     8,818,000       8,097,000
Less accumulated depreciation and amortization      (5,939,000)     (6,393,000)
                                                    ----------      ----------
                                                    $2,879,000      $1,704,000
                                                    ==========      ==========
</TABLE>



                                      F-13
<PAGE>   59


                                Cytel Corporation

             Notes to Consolidated Financial Statements (continued)

                                December 31, 1998


4. BALANCE SHEET INFORMATION (CONTINUED)


Deposits and other assets consist of the following:

<TABLE>
<CAPTION>
                                                           DECEMBER 31
                                                       1998            1997
                                                    ----------      ----------
<S>                                                 <C>             <C>       
Note receivable - long-term portion                 $       --      $  750,000
Deposits                                               156,000         312,000
                                                    ----------      ----------
                                                    $  156,000      $1,062,000
                                                    ==========      ==========
</TABLE>


5. ADDITIONAL SEGMENT AND RELATED INFORMATION

As a result of the subsequent events described in Note 11, the Company is 
presenting additional information related to the operations and financial 
position of Epimmune and Cytel.


                                      F-14
<PAGE>   60

                                Cytel Corporation

             Notes to Consolidated Financial Statements (continued)

                                December 31, 1998


5.         SEGMENT AND RELATED INFORMATION (CONTINUED)

Epimmune was formed in October 1997 as a wholly-owned subsidiary with separate
management and financing. As of March 31, 1999 Cytel owns approximately 75% of
the outstanding stock of Epimmune.

                 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
                          YEAR ENDED DECEMBER 31, 1998

<TABLE>
<CAPTION>
                                              CYTEL                             CONSOLIDATING
                                           CORPORATION        EPIMMUNE INC.        ENTRIES           TOTAL
                                           ------------       ------------      -------------      ------------
<S>                                        <C>                <C>                <C>               <C>         

REVENUES
   Research and development revenues       $  2,013,000       $  1,684,000       $         --      $  3,697,000
   Intersegment revenues                             --                 --                 --                --
                                           ------------       ------------       ------------      ------------
                                              2,013,000          1,684,000                 --         3,697,000

COSTS AND EXPENSES:
   Research and development                  13,540,000          4,812,000                 --        18,352,000
   General and administrative                 3,429,000          1,158,000                 --         4,587,000
   Loss on permanent impairment of
     intangible assets                        3,400,000                 --                 --         3,400,000
                                           ------------       ------------       ------------      ------------
   Total costs and expenses                  20,369,000          5,970,000                 --        26,339,000
                                           ------------       ------------       ------------      ------------
  Loss from operations                      (18,356,000)        (4,286,000)                --       (22,642,000)

   Minority interest in net loss of
       consolidated subsidiary                       --                 --            441,000           441,000
   Interest income, net                         262,000            598,000                 --           860,000
   Loss on sales and disposal
       of assets                               (194,000)                --                 --          (194,000)
                                           ------------       ------------       ------------      ------------

   Net loss                                $(18,288,000)      $ (3,688,000)      $    441,000      $(21,535,000)
                                           ============       ============       ============      ============
</TABLE>



                                      F-15
<PAGE>   61

                                Cytel Corporation

             Notes to Consolidated Financial Statements (continued)

                                December 31, 1998


5. SEGMENT AND RELATED INFORMATION (CONTINUED)

                      CONDENSED CONSOLIDATED BALANCE SHEET
                                DECEMBER 31, 1998

<TABLE>
<CAPTION>
                                                          CYTEL                           CONSOLIDATING
                                                       CORPORATION       EPIMMUNE INC.       ENTRIES             TOTAL
                                                       ------------      ------------     -------------       ------------
<S>                                                    <C>               <C>              <C>                <C>         
Assets
   Cash, cash equivalents and short-term               $  1,191,000      $ 10,620,000      $          0       $ 11,811,000
   investments
   Other current assets                                   1,098,000           593,000           (33,000)         1,657,000

   Restricted cash                                                0           472,000                 0            472,000
   Property and equipment, net                            2,412,000           467,000                 0          2,879,000
   Investment in consolidated subsidiary                 11,742,000                 0       (11,742,000)                 0
   Patents and other non-current assets                   1,999,000         2,211,000                 0          4,211,000

                                                       ------------      ------------      ------------       ------------
Total assets                                             18,442,000        14,363,000       (11,775,000)        21,030,000

Liabilities and stockholders' equity

Current Liabilities
   Accounts payable and accrued liabilities               1,705,000         1,033,000           (33,000)         2,705,000
   Deferred revenue                                         500,000            15,000                 0            515,000
   Current portion of obligations under equipment           465,000            28,000                 0            493,000
   loans and notes payable
                                                       ------------      ------------      ------------       ------------
Total current liabilities                                 2,670,000         1,076,000           (33,000)         3,713,000

Long-term obligations under equipment loans and           1,395,000           211,000                 0          1,606,000
notes payable

Minority interest in consolidated subsidiary                      0                 0         1,735,000          1,735,000

Stockholders equity                                      14,377,000        13,076,000       (13,477,000)        13,976,000

                                                       ------------      ------------      ------------       ------------
Total liabilities and stockholders equity              $ 18,442,000      $ 14,363,000      $(11,775,000)      $ 21,030,000
                                                       ============      ============      ============       ============
</TABLE>




                                      F-16
<PAGE>   62

                                Cytel Corporation

                   Notes to Consolidated Financial Statements

                                December 31, 1998


6. STOCKHOLDERS' EQUITY

CHANGES IN CAPITALIZATION

A one-for-seven reverse split of Cytel's common stock was effected on November
13, 1998. The reverse split was approved by Cytel's Board of Directors on
November 2, 1998 pursuant to authority granted to the Board of Directors by
Cytel's stockholders at a special meeting held on October 30, 1998. All common
share balances and net loss per share amounts presented in these financial
statements have been retroactively adjusted to reflect the reverse stock split.

EMPLOYEE STOCK PURCHASE PLAN

In October 1991, Cytel adopted an Employee Stock Purchase Plan (the Stock Plan)
whereby employees, at their option, can purchase shares of Cytel common stock
through payroll deductions at the lower of 85% of the fair market value on the
plan offering date or 85% of the fair market value of the common stock at the
purchase date. The aggregate number of shares that may be issued under the Stock
Plan is set at 107,142. As of December 31, 1998, 76,671 shares of common stock
have been purchased under the Plan.

STOCK PLANS

In November 1989, Cytel adopted a Stock Plan (the Plan), under which options may
be granted to employees, directors, consultants or advisors of Cytel. The Plan
provides for the grant of both incentive stock options and nonstatutory stock
options. The exercise price of an incentive stock option is not less than the
fair market value of the common stock on the date of grant. The exercise price
of nonstatutory options is not less than 85% of the fair market value of the
common stock on the date of grant. No options granted under the Plan have a term
in excess of ten years from the date of grant. Shares and options issued under
the Plan vest over varying periods of one to six years. For certain options
granted prior to Cytel's initial public offering, Cytel recognized deferred
compensation expense for the excess of the deemed value for accounting purposes
of the common stock issuable upon exercise of such options over the aggregate
exercise price of such options. This deferred compensation expense was amortized
ratably over the vesting period of each option.

In June 1994, Cytel adopted the 1994 Non-Employee Directors' Stock Option Plan
(the Directors' Plan). On January 1 of each year beginning January 1, 1995, each
Non-Employee Director who has been a Non-Employee Director for at least three
months shall be granted an option to purchase 714 shares of common stock of
Cytel. In addition, each person who becomes a Non-Employee Director of Cytel
after the adoption of the Directors' plan shall be granted an option to purchase
3,571 shares of common stock of Cytel. The exercise price of



                                      F-17
<PAGE>   63

                                Cytel Corporation

                   Notes to Consolidated Financial Statements

                                December 31, 1998


6. STOCKHOLDERS' EQUITY (CONTINUED)

options issued under the Directors' Plan shall be equal to 100% of the fair
market value of the common stock on the date of grant. Options issued under the
Directors' Plan vest over four and five years. No options issued under the
Directors' Plan have a term in excess of ten years from the date of grant. An
aggregate of 1,064,263 shares of common stock have been reserved for issuance
under both plans.

STOCK OPTION REPRICING

In June 1998, the stockholders approved an Option Exchange Program for certain
options under the 1989 Plan. These options vest over a six year period in
accordance with a schedule developed by management, in conjunction with the
State of Wisconsin Investment Board, a major stockholder of Cytel. On the date
of approval, all current employees were eligible to participate; however options
granted to outside directors and consultants to the Company were excluded from
the exchange. There were 546,962 options eligible for participation, of which
303,145 options were repriced. The effective exchange price was $10.7188.
Eligible employees who elected to participate forfeited a total of 42,879
shares. These shares were permanently canceled and not returned to the 1989 Plan
for future grants. The Option Exchange Program imposes restrictive vesting
provisions. If the holder exercises vested options before the sixth year, then
the remaining unvested options vest at 0% until the end of the sixth year, at
which time all remaining shares will be fully vested.

The following table summarizes stock option activity for the three years ended
December 31, 1998:

<TABLE>
<CAPTION>
                                                                         WEIGHTED
                                                       SHARES          AVERAGE PRICE
                                                      --------         -------------
<S>                                                   <C>              <C>

Balance at December 31, 1995                           417,288            $26.60
   Granted                                             235,378             40.18
   Exercised                                           (40,128)            15.47
   Cancelled                                           (23,758)            29.47
                                                      --------
Balance at December 31, 1996                           588,780             32.55
   Granted                                             133,788             19.95
   Exercised                                            (1,931)             2.10
   Cancelled                                          (180,044)            27.79
                                                      --------
Balance at December 31, 1997                           540,593             30.94
   Granted                                             437,671             10.82
   Exercised                                            (1,997)             1.50
   Cancelled                                          (418,009)            32.84
                                                      --------
Balance at December 31, 1998                           558,258            $13.88
                                                      ========
</TABLE>



                                      F-18
<PAGE>   64

                                Cytel Corporation

                   Notes to Consolidated Financial Statements

                                December 31, 1998


6. STOCKHOLDERS' EQUITY (CONTINUED)

As of December 31, 1998, 275,514 shares are available for future issuance under
these option plans. Following is a summary of the options outstanding as of
December 31, 1998:

<TABLE>
<CAPTION>
                                                  WEIGHTED                                                  WEIGHTED AVERAGE
                                                  AVERAGE                                                       EXERCISE 
                                                  REMAINING       WEIGHTED AVERAGE                              PRICE OF
                                                  LIFE IN            EXERCISE                OPTIONS             OPTIONS 
RANGE OF EXERCISE PRICES  OPTIONS OUTSTANDING      YEARS               PRICE                EXERCISABLE        EXERCISABLE
------------------------  -------------------     ---------       ----------------         -------------    ----------------
<S>                       <C>                     <C>             <C>                      <C>              <C>
$1.40  - $10.72                 30,335              7.20               $7.53                   14,696             $5.85
$10.72 - $10.72                303,357              9.45               10.72                   70,047             10.72
$10.94 - $18.82                149,267              8.35               12.48                   30,541             16.44
$20.13 - $84.00                 75,299              6.10               31.94                   59,974             33.17
                              --------                                                        -------
                               558,258              8.58              $13.88                  175,258            $18.99
                              ========                                                        =======
</TABLE>


Adjusted pro forma information regarding net income or loss is required by SFAS
123, and has been determined as if Cytel had accounted for its employee stock
options under the fair value method of that Statement. The fair value for these
options was estimated at the date of grant using the "Black-Scholes" method for
option pricing with the following weighted average assumptions for 1998, 1997
and 1996: risk-free interest rates of 6%; dividend yield of 0; and a weighted
average expected life for all options of six years. The volatility factor
assumptions of the expected market price Cytel's common stock were 105%, 105%
and 94% for 1998, 1997 and 1996, respectively.


For purposes of adjusted pro forma disclosures, the estimated fair value of the
option is amortized to expense over the option's vesting period. Cytel's
adjusted pro forma information is as follows:

<TABLE>
<CAPTION>
                                      1998               1997                 1996
                                  ------------       ------------       --------------
<S>                               <C>                <C>                <C>            
Pro forma  net loss               $(23,895,000)      $(17,273,000)      $  (14,316,000)
Pro forma net loss per share      $      (4.98)      $      (4.69)      $        (4.03)
</TABLE>

The weighted average fair value of options granted during 1998, 1997 and 1996
was $8.11, $14.49 and $31.78, respectively.



                                      F-19
<PAGE>   65


                                Cytel Corporation

             Notes to Consolidated Financial Statements (Continued)

                                December 31, 1998


6. STOCKHOLDERS' EQUITY (CONTINUED)


In March 1993, Cytel adopted a Stockholder Rights Plan. The Plan provides for
the distribution of a preferred stock purchase right (Rights) as a dividend for
each share of Cytel's common stock held as of the record date at the close of
business on April 8, 1993. Under certain conditions involving an acquisition by
any person or group of 15% or more of the common stock, the Rights permit the
holders (other than the 15% holder) to purchase one one-hundredth of a share of
Series A Preferred Stock at a price of $80 per one one-hundredth of a preferred
share per Right. Each one one-hundredth of a share of preferred stock has
rights, privileges and preferences which make its value approximately equal to
the value of a common share. In addition, in the event of certain business
combinations, the Rights permit the purchase of the common stock of an acquirer
at a 50% discount. Under certain conditions, the Rights may be redeemed by the
Board of Directors at a price of $.01 per Right. The Rights have no voting
privileges and are attached to and automatically trade with Cytel's common
stock. The Rights will expire on March 19, 2003.




                                      F-20
<PAGE>   66


                                Cytel Corporation

                   Notes to Consolidated Financial Statements

                                December 31, 1998


7. EQUIPMENT LOANS AND NOTES PAYABLE

In July 1998, Cytel entered into a $2.5 million secured term line of credit
agreement which requires monthly payments through December 2002. The carrying
value of the secured equipment and leasehold improvements under this agreement
at December 31, 1998 was $1,801,000. Accumulated depreciation at December 31,
1998 was $187,000. At December 31, 1998 the unused commitments totaling
$1,225,000 expired.

In August 1998, Epimmune entered into a $750,000 term credit facility for
capital equipment purchases and certain tenant improvements, which require
monthly payments beginning August 1999 through July 2002. The carrying value of
equipment advances under this agreement at December 31, 1998 was $239,000.
Accumulated depreciation at December 31, 1998 was $22,600. At December 31, 1998,
$511,000 is available for fixed asset acquisitions and will expire in August
1999.

Equipment loans and notes payable consist of the following:

<TABLE>
<CAPTION>
                                                                   DECEMBER 31
                                                           --------------------------
                                                              1998            1997
                                                           ----------      ----------
<S>                                                        <C>             <C>
Equipment loan payable in monthly installments of
    principal and interest of $20,600, due July 2002
    with a balloon payment of $182,000                     $  846,000              $-

Equipment loan payable in monthly installments of
    principal and interest of $3,500, due September
    2002 with a balloon payment of $31,000                    147,000              --

Equipment loan payable in monthly installments of
    principal and interest of $4,800, due December
    2002 with a balloon payment of $42,000                    209,000              --

Equipment loan payable in monthly installments of
    principal and interest of $7,600 beginning August
    1999, due July 2002                                       240,000              --

Unsecured note payable in monthly installments of
    principal and 10% imputed interest of $24,900,
    due June 2001                                             657,000              --

Bank loan payable in quarterly installments of
    principal of $93,800, loan paid off in September
    1998                                                           --       1,031,000

Equipment loan payable in monthly installments of
    principal and interest of $8,000, loan paid off
    in May 1998                                                    --          40,000
                                                           ----------      ----------

                                                           $2,099,000      $1,071,000
                                                           ==========      ==========
</TABLE>



                                      F-21
<PAGE>   67

                                Cytel Corporation

                   Notes to Consolidated Financial Statements

                                December 31, 1998


7. EQUIPMENT LOANS AND NOTES PAYABLE (CONTINUED)

Future annual payments on equipment loans and notes payable are as follows at
December 31, 1998:

<TABLE>
<S>                                                              <C>     
            1999                                                 $  493,000

            2000                                                    593,000

            2001                                                    505,000

            2002                                                    508,000

         Thereafter                                                       -
                                                                 ----------
                                                                 $2,099,000
                                                                 ==========
</TABLE>


In February 1999, Cytel sold some of the assets, which were collateralized by
the term line, to Nextran. Portions of the unpaid notes related to the sold
assets were assumed by Nextran as partial consideration for the transaction as
more thoroughly disclosed in Note 11.



                                      F-22
<PAGE>   68

                                Cytel Corporation

                   Notes to Consolidated Financial Statements

                                December 31, 1998


8. COMMITMENTS

The Company leases its offices, research and manufacturing facilities under
operating leases which expire at various dates through March 2009. Under these
operating leases, the Company pays taxes, insurance and maintenance expenses
related to the premises. Epimmune's facility lease requires a letter of credit
of $472,000 to secure the performance of the Company's lease obligation and is
reflected as restricted cash. Included in deposits and other assets is $113,000
and $303,000 deposited under these agreements at December 31, 1998 and 1997,
respectively.

Rent expense for 1998, 1997 and 1996 was $1,772,000, $1,783,000 and $1,842,000,
respectively.

Future minimum lease payments under operating leases at December 31, 1998 are as
follows:

<TABLE>
<CAPTION>
                                                                          TOTAL
                                                                         OPERATING
YEAR                                  CYTEL           EPIMMUNE             LEASES
----------                         -----------      -----------         ------------
<S>                                <C>              <C>                 <C>

1999                               $1,200,000       $  366,000           $1,566,000
2000                                  756,000          495,000            1,251,000
2001                                  378,000          507,000              885,000
2002                                  309,000          519,000              828,000
2003                                        -          531,000              531,000
Thereafter                                  -        3,059,000            3,059,000
                                   ----------       ----------           ----------
Total minimum lease payments        $2,643,00       $5,477,000           $8,120,000
                                   ==========       ==========           ==========
</TABLE>



                                      F-23
<PAGE>   69

                                Cytel Corporation

                   Notes to Consolidated Financial Statements

                                December 31, 1998

9. REVENUES UNDER COLLABORATIVE RESEARCH AND DEVELOPMENT AGREEMENTS

Elan Corporation, plc.

In July 1998, Cytel entered into an exclusive sublicense and option agreement
with Elan International Services Ltd. (Elan), a subsidiary of Elan Corporation
plc, granting Elan rights to a patent involving use of antibodies that bind
VLA-4 integrin for the treatment of inflammatory conditions. In connection with
this agreement, which included the grant of an exclusive sublicense, Elan made a
$4.0 million equity investment in Cytel, based on the fair value of the stock,
of which $2.6 million was allocated to the purchase price of 285,714 shares of
the Company's common stock and $1.4 million was allocated to the rights granted
under the exclusive sublicense and option agreement. Elan will make additional
payments upon achievement of certain milestones as well as royalty payments on
sales. In addition, Elan has an option to enter into a nonexclusive sublicense
for patent rights to other VLA-4 blocking compounds.

G.D. Searle & Co.

In September 1997 as part of a letter of intent, Searle purchased 317,460 shares
of Cytel common stock for $5.0 million for an exclusive right to negotiate a
definitive agreement. Cytel then invested $6.5 million in cash and transferred
$1.5 million in other assets to capitalize Epimmune.

In February 1998, Epimmune entered into a collaborative research and development
agreement with Searle to develop immune-stimulating products for the treatment
of cancer. Under the terms of the agreement, Epimmune has granted Searle
exclusive worldwide rights to its epitope and PADRE technologies in the cancer
field, excluding rights previously granted to Takara Shuzo Co., Ltd. Biomedical
Group (Takara) for the ex vivo treatment of cancer in Japan. As part of the
February 1998 agreement, Searle purchased 1,032,149 shares of Epimmune's Series
B convertible preferred stock for $6.1 million and 659,898 shares of Cytel's
Series B convertible preferred stock for $3.9 million. Cytel simultaneously
purchased 659,898 shares of Epimmune's Series B-1 convertible preferred stock
for $3.9 million. Searle has the right to convert the Cytel Series B convertible
preferred stock into Cytel common stock after three years, or to exchange the
Cytel Series B convertible preferred stock for Epimmune Series B-1 convertible
preferred stock owned by Cytel at any time. In addition to the $15 million
investment made to date, Searle will make milestone payments to Epimmune upon
achievement of certain preclinical and clinical milestones, and will pay
royalties on product sales. Searle has the option to deliver shares of the Cytel
convertible preferred stock in lieu of up to 50% of certain milestone payments.
In addition, Searle has rights of first refusal with respect to newly-issued
securities of Cytel, enabling Searle to maintain its percentage ownership in
Cytel. As of March 29, 1999, Cytel owned 74.7%, Epimmune employees owned 13.6%,
and Searle owned 11.7%. of the outstanding capital stock of Epimmune.



                                      F-24
<PAGE>   70


                                Cytel Corporation

                   Notes to Consolidated Financial Statements

                                December 31, 1998



9. REVENUES UNDER COLLABORATIVE RESEARCH AND DEVELOPMENT AGREEMENTS (CONTINUED)

Glycomed Incorporated

In February 1998, Cytel entered into a nonexclusive licensing agreement with
Glycomed Incorporated (Glycomed), a wholly-owned subsidiary of Ligand
Pharmaceuticals Incorporated, under which Cytel received rights to a family of
Glycomed patents relating to certain carbohydrate compounds for the treatment of
acute inflammation, including Cytel's most advanced product, Cylexin. Cytel paid
a license fee of $900,000 consisting of 84,475 shares of Cytel's common stock at
$10.65 per share. Glycomed would be entitled to receive milestone payments upon
the first New Drug Application and the first FDA approval of each licensed
product. These payments may also be made in Cytel stock, at Cytel's option.
Glycomed would also be entitled to receive royalties on worldwide net sales of a
licensed or sublicensed product. However, Cytel has terminated its therapeutic
anti-inflammatory business with respect to which milestones and royalties were
to be paid.

Baxter Healthcare Corporation

In September 1996, Cytel entered into a collaborative agreement with Baxter
Healthcare Corporation's Nextran unit (Nextran) to develop a carbohydrate
product for use in xenotransplantation. Under the agreement, Cytel was to
manufacture and sell a carbohydrate which Nextran would incorporate into a
xenotransplantation product. Nextran made an up-front payment and purchased
shares of the Cytel's common stock for the right to enter into an exclusive
supply agreement. In January 1997, Cytel achieved a milestone with delivery of
the initial batch of a bioactive carbohydrate to Nextran. As a result, Nextran
made the first milestone payment. In December 1997, Nextran paid an option fee
and purchased additional shares of the Company's common stock for the right to
extend and expand the original agreement. In October 1998, Nextran made a
payment upon exercise of an option to enter into a second exclusive supply
agreement with Cytel. As disclosed in Note 11, in February 1999, Cytel entered
into a new license agreement that supersedes Cytel's existing manufacturing
supply agreements with Nextran.

Abbott Laboratories

In December 1995, Cytel entered into a collaborative agreement with Abbott
Laboratories (Abbott) to develop manufacturing processes for the production of
certain carbohydrates for use in nutritional products. Abbott paid a $2 million
nonrefundable fee in January 1996 for an option to obtain a worldwide license
for limited applications under Cytel's patents and know-how in the area of
carbohydrate synthesis. In December 1996, Abbott made the first milestone
payment to Cytel in the amount of $2 million. An additional option fee of
$250,000 was earned in August 1997 and paid in two equal installments in
September 1997 and January 1998.

Abbott's option to license certain of Cytel's technology under its collaboration
with Cytel expired and the collaboration terminated as of July 31, 1998.



                                      F-25
<PAGE>   71


                                Cytel Corporation

             Notes to Consolidated Financial Statements (Continued)

                                December 31, 1998



9. REVENUES UNDER COLLABORATIVE RESEARCH AND DEVELOPMENT AGREEMENTS (CONTINUED)

Takara Shuzo Co., Ltd

Under two agreements with Takara Shuzo Co., Ltd. (Takara), which were assigned
to Epimmune in October 1997, Epimmune's technology is being applied to fungal
disease targets and ex-vivo cellular therapy for the treatment of cancer. Under
the anti-fungal collaboration initiated in June 1994, Takara obtained rights to
any anti-fungal products resulting from the collaboration for commercialization
in Japan. Epimmune has the right to develop products in North America, and the
companies share rights in the rest of the world. Research in the anti-fungal
field, using Epimmune technology is now being conducted independently by Takara
in Japan. Under the ex-vivo cellular therapy collaboration initiated in October
1994, Takara obtained rights to Epimmune's technology relevant to the
development of ex vivo cellular therapies for the treatment of cancer in Japan.
Takara will make payments upon achievement of certain clinical milestones and
pay royalties to Epimmune on sales from products resulting from the
collaboration under both agreements.

10. INCOME TAXES

Significant components of the Company's deferred tax assets as of December 31,
1998 and 1997 are shown below. At December 31, 1998, a valuation allowance of
$54,291,000 of which $6,448,000 is related to 1998, has been recognized to
offset the deferred tax assets as realization of such assets is uncertain.

<TABLE>
<CAPTION>
                                                     1998               1997
                                                 ------------       ------------
<S>                                              <C>                <C>         
 Deferred tax liabilities:
    Patents expensed for tax                     $  2,586,000       $  2,146,000
                                                 ------------       ------------
 Total deferred tax liabilities                     2,586,000          2,146,000
Deferred tax assets:
   Capitalized research expenses                    3,376,000          4,207,000
   Net operating loss carryforwards                44,849,000         35,641,000
   Research and development credits                 8,574,000          7,211,000
   Other, net                                          78,000          2,930,000
                                                 ------------       ------------
Total deferred tax assets                          56,877,000         49,989,000
Valuation allowance for deferred tax assets       (54,291,000)       (47,843,000)
                                                 ------------       ------------
Net deferred tax assets                          $         --       $         --
                                                 ============       ============
</TABLE>



                                      F-26
<PAGE>   72

                                Cytel Corporation

                   Notes to Consolidated Financial Statements

                                December 31, 1998


10. INCOME TAXES (CONTINUED)

At December 31, 1998, the Company has federal and California net operating loss
carryforwards of approximately $120,164,000 and $46,521,000, respectively. The
difference between the federal and California tax loss carryforwards is
primarily attributable to the capitalization of research and development
expenses for California tax purposes and the fifty percent limitation on
California loss carryforwards prior to 1999. The federal tax loss carryforwards
will begin expiring in 2002, unless previously utilized. The California tax loss
carryforwards will continue to expire in 1999. The Company also has federal and
California research and development tax credit carryforwards of $6,523,000 and
$3,155,000, respectively, which will begin expiring in 2002 unless previously
utilized.

Pursuant to Internal Revenue Code Sections 382 and 383, the annual use of the
Company's net operating loss and credit carryforwards will be limited because of
greater than 50% cumulative changes in ownership which occurred during 1989 and
1994. However, the Company believes that these limitations will not have a
material impact on the financial statements.


11. SUBSEQUENT EVENTS

Results of Cylexin clinical trial

On March 29, 1999, Cytel announced the results from its Cylexin clinical trials.
The results of these trials indicated that Cylexin, Cytel's lead therapeutic
compound, showed no benefit over placebo in the clinical trial. Accordingly,
Cytel has made the decision to terminate its therapeutic anti-inflammatory
business, and Cytel recorded a charge of $3.4 million as of December 31, 1998,
representing the book value of its cell adhesion patent portfolio. This charge
was recorded in accordance with SFAS 121, after Cytel determined that its
intangible assets were permanently impaired. Cytel has not recorded a charge for
intangible assets related to the Glytec carbohydrate synthesis and manufacturing
business, which were licensed or sold to third parties in February and March
1999 because the sales resulted in a gain of $3.3 million. Cytel analyzed its
remaining fixed assets for impairment under SFAS 121, but determined no
impairment existed due to proposals to purchase the assets that indicated
impairment did not exist.

Additionally, in February and March of 1999, Cytel completed sales of its Glytec
carbohydrate synthesis and manufacturing business, including the sale of fixed
assets and license of intellectual property, and assignment of certain
liabilities and personnel relating to this business. In the future, the Company
will focus all resources on Epimmune, a majority-owned subsidiary of Cytel.
Epimmune is developing novel vaccines that stimulate the body's immune system to
treat and prevent infectious diseases and cancer.



                                      F-27
<PAGE>   73


                                Cytel Corporation

             Notes to Consolidated Financial Statements (Continued)

                                December 31, 1998


11. SUBSEQUENT EVENTS (CONTINUED)


Cytel plans to use the proceeds from the disposition of the Glytec carbohydrate
synthesis and manufacturing business, together with its existing cash resources,
to meet its financial obligations, including corporate restructuring and
termination costs of the therapeutic anti-inflammatory business. There can be no
assurance, however, that Cytel's available cash will be sufficient to satisfy
all of its financial obligations. Cytel will record a restructuring charge to
operations of approximately $3.7 million in early 1999 to record the expenses
relating to the corporate restructuring and discontinuing its therapeutic
anti-inflammatory business, and will record gains on the sales of the fixed and
intangible assets of approximately $3.3 million.



                                      F-28