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                                 UNITED STATES
                      SECURITIES AND EXCHANGE COMMISSION
                            WASHINGTON, D.C. 20549
 
                             ---------------------
 
                                   FORM 10-K
 
                                  (Mark One)
 
 [X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
                                  Act of 1934
                  For the fiscal year ended December 31, 1996
 
    [_] Transition Report Pursuant to Section 13 or 15(d) of the Securities
                             Exchange Act of 1934
                  For the Transition Period from     to
 
                        Commission file number 0-28386
 
                            CELL THERAPEUTICS, INC.
            (Exact name of registrant as specified in its charter)
 
              WASHINGTON                           91-1533912
      (State of Incorporation)                  (I.R.S. Employer
                                                Identification No.)
                      201 ELLIOTT AVENUE WEST, SUITE 400
                           SEATTLE, WASHINGTON 98119
                   (Address of principal executive offices)
 
      Registrant's telephone number, including area code: (206) 282-7100
 
                             ---------------------
 
       Securities registered pursuant to Section 12(b) of the Act: None
 
          Securities registered pursuant to Section 12(g) of the Act:
 
                          Common Stock, no par value
                        Preferred Stock Purchase Rights
                             ---------------------
                              (titles of classes)
 
  Indicate by check mark whether the registrant (1) has filed all reports
required by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
                               Yes  X    No
 
  Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of the registrant's knowledge, in the definitive proxy statement
incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K. [_]
 
  On March 27, 1997, Cell Therapeutics, Inc. had 13,028,433 outstanding shares
of Common Stock. Of those, 7,675,371 shares of Common Stock were held by
nonaffiliates. The aggregate market value of such Common Stock held by
nonaffiliates, based on the closing price of such shares on the Nasdaq
National Market on March 27, 1996, was approximately 76,753,710. Shares of
Common Stock held by each executive officer and director and by each person
known to the Company who beneficially owns more than 5% of the outstanding
Common Stock have been excluded in that such persons may under certain
circumstances be deemed to be affiliates. This determination of executive
officer or affiliate status is not necessarily a conclusive determination for
other purposes.
 
                   Documents Incorporated by Reference: None
 
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  This Report contains forward-looking statements which involve risks and
uncertainties. When used in this Report, the words "believes," "anticipates,"
"expects" and similar expressions are intended to identify such forward-
looking statements. The Company's actual results may differ significantly from
the results discussed in the forward-looking statements. Factors that might
cause such a difference include, but are not limited to, those discussed in
"Item 1--Business--Risk Factors" and "Item 7--Management's Discussion and
Analysis of Financial Condition and Results of Operations." Readers are
cautioned not to place undue reliance on these forward-looking statements,
which speak only as of the date hereof. The Company undertakes no obligation
to publicly release the results of any revisions to these forward-looking
statements which may be made to reflect events or circumstances after the date
hereof or to reflect the occurrence of unanticipated events.
 

ITEM 1. BUSINESS
 
GENERAL
 
  Cell Therapeutics, Inc. ("cti" or the "Company") focuses on the discovery,
development and commercialization of small molecule drugs for the treatment of
cancer and inflammatory and immune diseases. The Company is conducting Phase
III clinical trials for its lead product candidate, Lisofylline, which is
being developed to prevent or reduce treatment-related toxicities,
specifically serious and fatal infections, mucositis and treatment-related
mortality, among cancer patients receiving high dose radiation and/or
chemotherapy. In November 1996 cti entered into a Collaboration and License
Agreement with Johnson & Johnson for the joint development and
commercialization of Lisofylline. The Company is focusing its oncology
development efforts on a portfolio of drugs that it believes will address the
three principal causes of cancer treatment failure: (i) Lisofylline--a
supportive care agent being investigated to prevent or reduce the incidence of
serious and fatal infections, mucositis (damage to the epithelial cells lining
the mouth, stomach and intestinal tract) and treatment-related mortality among
cancer patients receiving high dose radiation and/or chemotherapy, (ii) CT-
2584--a novel anti-cancer drug under investigation for the treatment of
patients with multidrug resistant tumors and (iii) tumor sensitizing agents
being investigated to enhance sensitivity to radiation among tumors that have
deleted or mutated tumor suppression genes. The Company believes that, in
addition to its oncology applications, Lisofylline may be effective as an
agent to prevent or reduce the incidence and severity of acute lung injury
("ALI") and mortality among patients requiring mechanical ventilation for
respiratory failure following pneumonia, multiple traumatic injuries, or
sepsis. The Company has expended approximately $60.9 million from its
inception to December 31, 1996 on research and development activities to build
a unique drug discovery platform based on its proprietary technology in
phospholipid chemistry.
 
  Cell Therapeutics, Inc. was incorporated in Washington in September 1991.
The Company has not received any revenue from the sale of products to date and
does not expect to receive revenues from the sale of products for at least the
next several years. The Company's executive offices are located at 201 Elliott
Avenue West, Seattle, Washington 98119, and its telephone number is (206) 282-
7100.
 
RISK FACTORS
 
  Dependence on Single Drug Candidate. The Company's lead drug candidate is
Lisofylline. A Phase II clinical trial of Lisofylline in cancer patients
undergoing high dose radiation and/or chemotherapy followed by bone marrow
transplantation ("BMT") was completed in the first quarter of 1996, and the
Company initiated a pivotal Phase III trial of Lisofylline for BMT in the
third quarter of 1996. The Company is also conducting ongoing Phase II and
Phase III trials of Lisofylline among patients with newly diagnosed acute
myelogenous leukemia ("AML") undergoing high dose induction chemotherapy.
There can be no assurance that such Phase III trials will be successfully
completed, that further clinical studies will not be needed, or that any such
clinical trials will lead to FDA approval. Furthermore, there can be no
assurance that the Company will be successful in its efforts to develop
Lisofylline for other indications, including mucositis and inflammatory
disease. The remainder of the Company's drug candidates are still in research
and development, preclinical trials or early stage clinical trials. Any
additional product candidates will require significant research, development,
preclinical and clinical testing, regulatory approval and commitments of
resources prior to commercialization. The Company is, therefore, dependent on
the successful completion of its Phase III trials and filing for and obtaining
regulatory approval of Lisofylline to generate revenues while it continues the
research, development and regulatory approval
 
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processes for its other drug candidates. Although the Company is currently
seeking to develop other drug candidates and to expand the number of drug
candidates it has under development, there can be no assurance that it will be
successful in such development or expansion. If Lisofylline does not
successfully complete clinical testing and meet applicable regulatory
requirements, or is not successfully manufactured or marketed, the Company may
not have the financial resources to continue research and development of other
product candidates. See "--Risk Factors--No Assurance of FDA Approval;
Comprehensive Government Regulation," "--Products under Development" and "--
Collaborations."
 
  Technological Changes and Uncertainty. The Company currently relies
exclusively upon its lipid-based small molecule technology for the discovery,
development and commercialization of drugs for the treatment of cancer and
inflammatory and immune diseases. To date, the Company's resources have been
dedicated primarily to the research and development of potential
pharmaceutical products that the Company believes regulate the production
and/or degradation of phospholipids such as phosphatidic acids ("PAs") or
oxidized lipids such as hydroperoxyoctadecadienoic acids ("HPODEs"). The
physiology of cancer, inflammatory and immune disease is complex, and the role
of PAs and HPODEs, and the stress-activated pathways ("SAPs") which they
appear to activate, is not fully known. Although preclinical and clinical data
to date suggest that the species of PAs and HPODEs targeted by the Company's
products under development play an important role in the cellular inflammatory
and injurious response to cell-damaging stimuli such as radiation,
chemotherapy and oxidative injury, there can be no assurance that the
Company's therapeutic approaches are correct or that its drug candidates will
be proven safe or effective. The Company believes that the elevation and
production of PAs and HPODEs and the activation of SAPs do not appear to be
primarily utilized for normal cellular processes, and that the Company's drug
candidates will not substantially interfere with normal cellular processes at
therapeutically-relevant levels. There can be no assurance that the PAs or
HPODEs or the SAPs believed to be targeted by the Company's drug candidates do
not serve a currently unidentified beneficial purpose which might be adversely
affected by the mechanism of action of the Company's drug candidates. No
assurance can be given that unforeseen problems will not develop with the
Company's technologies or applications, or that commercially feasible products
will ultimately be developed by cti. There can be no assurance that research
and discoveries by others will not render some or all of cti's programs or
products noncompetitive or obsolete or that the Company will be able to keep
pace with technological developments or other market factors. Technological
changes or medical advancements could diminish or eliminate the commercial
viability of the Company's focus on cell membrane lipids in regulating
cellular processes. The failure to commercialize such products would have a
material adverse effect on the Company.
 
  No Assurance of Successful Product Development; Uncertainties Related to
Clinical Trials. The Company has no products commercially available for sale
and does not expect to have any products commercially available for sale for
at least the next several years, if ever. The time frame for achievement of
market success for any potential product is long and uncertain. The Company's
lead product candidates, Lisofylline and CT-2584, are currently in clinical
trials for certain indications. However, the results obtained to date in
preclinical and clinical studies of Lisofylline and in preclinical studies and
preliminary clinical trials of CT-2584 are not necessarily indicative of
results that will be obtained during future clinical testing. A number of
companies in the pharmaceutical industry, including biotechnology companies,
have suffered significant setbacks in advanced clinical trials, even after
reporting promising results in earlier trials. In addition, data obtained from
clinical trials are susceptible to varying interpretations. For example, in
February 1996 the Company entered into an agreement with Schering AG
("Schering") for the development and commercialization of Lisofylline and CT-
2584. This agreement was contingent upon Schering finding the clinical trial
results and related data from the Company's Phase II BMT trial acceptable. In
April 1996, Schering informed the Company that it did not wish to activate the
agreement based on, among other factors, (i) its view that one of the
endpoints of the Phase II BMT trial, white blood cell recovery, was not met
and (ii) its view that the trial data regarding mortality rate and incidence
of serious and fatal infection were difficult to interpret and that, as a
result, Schering could not determine that the data was meaningful. See "--
Products under Development--Oncology" and Note 11 of Notes to Consolidated
Financial Statements appearing at Item 8 of this Report. There can be no
assurance that the Company and its collaborators will agree on the
interpretation of the Company's future clinical trial results or that the
Company's clinical trials
 
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will demonstrate sufficient terms of safety and efficacy necessary to obtain
the requisite regulatory clearance or will result in marketable products.
 
  The Company's research and development programs for products other than
Lisofylline and CT-2584 are at an early stage of development. Preclinical in
vitro and animal studies are not necessarily indicative of results that may be
obtained during human clinical testing. Many potential therapeutic products
indicate positive in vitro results which are not subsequently reproduced in
humans. Any additional product candidates will require significant research,
development, preclinical and clinical testing, regulatory approval and
commitments of resources prior to commercialization. There can be no assurance
that the Company's research will lead to the discovery of additional product
candidates or that Lisofylline, CT-2584 or any other products will be
successfully developed, prove to be safe and efficacious in clinical trials,
meet applicable regulatory standards, be capable of being produced in
commercial quantities at acceptable costs or be successfully or profitably
marketed. There can be no assurance as to the extent to which any products
developed by cti will be able to penetrate the potential market for a
particular therapy or indication or gain market acceptance among health care
providers, third-party payors or patients.
 
  The rate of completion of the Company's clinical trials is dependent upon,
among other factors, the rate of patient enrollment. Patient enrollment is a
function of many factors, including the size of the patient population, the
nature of the protocol, the proximity of patients to clinical sites and the
eligibility criteria for the study. Delays in planned patient enrollment may
result in increased costs or in delays or termination of clinical trials,
which could have a material adverse effect on the Company's business,
financial condition and results of operations. There can be no assurance that
the Company will be able to submit a new drug application as scheduled if
clinical trials are completed, or that any such application will be reviewed
and cleared by the FDA in a timely manner, or at all.
 
  There can be no assurance that unacceptable toxicities or side effects will
not occur at any dose level at any time in the course of toxicology studies or
clinical trials of the Company's potential products. The appearance of any
such unacceptable toxicities or side effects in toxicology studies or clinical
trials could cause the Company or regulatory authorities to interrupt, limit,
delay or abort the development of any of the Company's potential products and
could ultimately prevent their clearance by the FDA or foreign regulatory
authorities for any or all targeted indications. Even after being cleared by
the FDA or foreign regulatory authorities, a product may later be shown to be
unsafe or to not have its purported effect, thereby preventing widespread use
or requiring withdrawal from the market. There can be no assurance that any
potential products under development by the Company will be safe or effective
when administered to patients.
 
  History and Continuation of Losses; Early Stage of Development. The Company
commenced operations on February 1, 1992, and has not received any revenue
from the sale of products to date, nor does it expect to receive revenues from
the sale of products for at least the next several years. The Company has
incurred net losses since inception and had an accumulated deficit of
approximately $74.1 million as of December 31, 1996. These losses are
primarily attributable to research and development efforts, including
preclinical studies and clinical trials.
 
  To date, the Company's operations have been funded primarily through the
sale of equity securities, which has raised aggregate net proceeds of
approximately $133.9 million, including estimated net proceeds of $27.1
million from the Company's initial public offering which closed on March 26,
1997 and estimated net proceeds of $3.0 million from the sale of 300,000
shares of Common Stock to Johnson & Johnson concurrent with the the closing of
the initial public offering. The Company expects that its revenue sources for
at least the next several years will consist primarily of future expense
reimbursements and milestone payments under its collaboration agreements with
Johnson & Johnson and with an affiliate of BioChem Pharma, Inc. ("BioChem
Pharma"), and of interest income.
 
  The Company expects to continue to incur significant additional operating
losses over the next several years as its research, development and clinical
trial efforts expand. The Company is in the development stage and its
operations are subject to all of the risks inherent in the establishment of a
new business enterprise. The likelihood of the success of cti must be
considered in light of the problems, expenses and delays frequently
encountered in connection with the development of pharmaceutical products, the
utilization of unproven technology and the competitive environment in which
cti operates. The Company is working on a number of costly long-term
 
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development projects which involve experimental and unproven technology and
may ultimately prove unsuccessful. There can be no assurance that cti will
have sufficient funds or be able to successfully complete its research and
development, obtain regulatory approval for, or manufacture or market any
products in the future. In addition, since cti does not currently have any
marketable products, it expects to incur substantial operating losses for a
number of years. The amount of net losses and the time required by the Company
to reach profitability are highly uncertain. There can be no assurance that
the Company will be able to develop additional revenue sources or that its
operations will ever become profitable. See "Item 7.--Management's Discussion
and Analysis of Financial Condition and Results of Operations."
 
  Need for Substantial Additional Funds. The Company will require substantial
additional funds to conduct its existing and planned preclinical and clinical
trials, to establish manufacturing and marketing capabilities for any products
it may develop, and to continue research and development activities. The
Company expects that its existing capital resources and the interest earned
thereon, combined with anticipated funding from Johnson & Johnson under the
Collaboration Agreement, will enable the Company to maintain its current and
planned operations at least through the end of 1998. Furthermore, the Company
will need to raise substantial additional capital to fund its operations
beyond such time. See "--Risk Factors--Reliance on Relationship with Johnson &
Johnson," "--Collaborations" and "Item 7.--Management's Discussion and
Analysis of Financial Condition and Results of Operations."
 
  The Company's future capital requirements will depend on, and could increase
as a result of, many factors, including the continuation of the Company's
collaboration with Johnson & Johnson; continued scientific progress in its
research and development programs; the magnitude of such programs; the
progress of preclinical and clinical testing; the time and costs involved in
obtaining regulatory approvals; the costs involved in preparing, filing,
prosecuting, maintaining, enforcing and defending patent claims; competing
technological and market developments; changes in collaborative relationships;
the terms of any additional collaborative arrangements that the Company may
enter into; the ability of the Company to establish research, development and
commercialization arrangements pertaining to products other than those covered
by existing collaborative arrangements; the cost of establishing manufacturing
facilities; the cost of commercialization activities and the demand for the
Company's products if and when approved.
 
  The Company intends to raise additional funds through additional equity or
debt financings, research and development financings, collaborative
relationships, or otherwise. Because of these long-term capital requirements,
cti may seek to access the public or private equity markets from time to time,
even if it does not have an immediate need for additional capital at that
time. There can be no assurance that any such additional funding will be
available to cti, or, if available, that it will be on acceptable terms. If
additional funds are raised by issuing equity securities, further dilution to
shareholders may result. If adequate funds are not available, cti may be
required to delay, reduce the scope of, or eliminate one or more of its
research, development and clinical activities. The Company may also be
required to seek to obtain funds through arrangements with collaborative
partners or others that may require cti to relinquish rights to certain of its
technologies, product candidates or products that the Company would otherwise
seek to develop or commercialize itself. See "Item 7.--Management's Discussion
and Analysis of Financial Condition and Results of Operations--Liquidity and
Capital Resources."
 
  Reliance on Relationship with Johnson & Johnson. The Company is dependent on
the future payments from Johnson & Johnson to continue the development and
commercialization of Lisofylline as presently planned. Under the terms of the
Collaboration and License Agreement (the "Collaboration Agreement") between
Johnson & Johnson and the Company, Johnson & Johnson has committed to fund 60
percent of cti's budgeted development expenses incurred in connection with
obtaining regulatory approval for Lisofylline in the United States. Johnson &
Johnson will be responsible for obtaining regulatory approval for Lisofylline
outside of the United States and Canada at its own expense. Although cti and
Johnson & Johnson will co-promote Lisofylline in the United States, Johnson &
Johnson will have primary responsibility for commercializing Lisofylline.
There can be no assurance that Johnson & Johnson will be able to establish
effective sales and distribution capabilities
 
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or will be successful in gaining market acceptance for Lisofylline or that
Johnson & Johnson will devote sufficient resources to the commercialization of
products under the Collaboration Agreement.
 
  Although Johnson & Johnson has committed to fund up to $12.0 million of
cti's budgeted development expenses for each of the calendar years 1997 and
1998, Johnson & Johnson may terminate the Collaboration Agreement at any time
based upon material safety or tolerability issues related to Lisofylline upon
30 days' notice, and for any reason after November 8, 1997, subject to a six
month notice period. Johnson & Johnson would have no further obligation to
fund cti's development expenses related to Lisofylline following such
termination. However, the financial and other obligations of Johnson & Johnson
(aside from Johnson & Johnson's obligation to make additional payments to, and
equity investments in, cti if certain development milestones are achieved)
would continue during such six month notice period. If Johnson & Johnson were
to terminate its participation in the Collaboration Agreement, the Company
would not be able to continue the development of Lisofylline as presently
planned, and the Company's financial condition would be materially and
adversely affected. If adequate funds were not then available from other
sources, the Company would be required to delay, reduce the scope of, or
eliminate one or more of its research, development and clinical activities or
seek to obtain funds through arrangements with collaborative partners or
others on terms which may be less favorable to cti than the Collaboration
Agreement. See "--Risk Factors--Need for Substantial Additional Funds" and "--
Collaborations."
 
  No Assurance of FDA Approval; Comprehensive Government
Regulation. Regulatory approval to market human therapeutics must be obtained
from the FDA and comparable health authorities in foreign countries. This
process requires lengthy and detailed laboratory and clinical testing and
other costly and time-consuming procedures, which must establish that such
therapeutics are safe and efficacious. Obtaining regulatory approval to market
drugs typically takes one or more years after the completion of clinical
trials and the filing of a New Drug Application ("NDA"), with no assurance
that such approval will ever be obtained. The time involved for regulatory
review varies substantially based upon the type, complexity and novelty of the
drug. In addition, delays or rejections may be encountered based upon existing
and changing policies of regulatory authorities for drug approval during the
period of drug development and regulatory review of each submitted NDA. The
results obtained in preclinical and early clinical studies are not necessarily
indicative of results that will be obtained during future clinical testing.
There can be no assurance that the results obtained by the Company to date
will continue as testing and trials progress or that the Company's products
will ever be approved for commercial sale by the FDA or other regulatory
authorities.
 
  In addition to the substantial time commitment required, the regulatory
process, which includes preclinical testing and clinical trials of each
compound to establish its safety and efficacy, requires the expenditure of
substantial resources. Preclinical studies must be conducted in conformity
with the FDA's current Good Laboratory Practices ("GLP"). Clinical trials must
meet requirements for institutional review board oversight and informed
consent, as well as FDA prior review and acceptance of Investigational New
Drug applications ("IND"), continued FDA oversight, and current Good Clinical
Practices ("GCP"). The Company's experience in conducting clinical trials is
limited. Data obtained from preclinical studies and clinical trials are
susceptible to varying interpretations which could delay, limit or prevent
regulatory approval. Furthermore, studies conducted with alternative designs
or alternative patient populations could produce results which vary from those
obtained by the Company. There can be no assurance that the Company's data or
its interpretation of its data will be accepted by governmental regulators,
the medical community or the Company's collaborators. See "--Risk Factors--No
Assurance of Successful Product Development; Uncertainties Related to Clinical
Trials."
 
  Government regulation also affects the manufacture and marketing of
pharmaceutical drug products. Any future FDA or other governmental approval of
drug products developed by cti may entail significant limitations on the
indicated uses for which such products may be marketed. Approved drug products
will be subject to additional testing and surveillance programs required by
the regulatory agencies. In addition, product approvals may be withdrawn or
limited for noncompliance with regulatory standards or the occurrence of
unforeseen problems following initial marketing. Failure to comply with
applicable regulatory requirements can result in, among other things, fines,
suspensions of approvals, seizures or recalls of products, operating
restrictions or criminal proceedings. In the event that cti were to
manufacture therapeutic products, cti would be required to
 
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adhere to applicable standards for current Good Manufacturing Practices
("GMP") prescribed by the FDA, engage in extensive record keeping and
reporting, and submit its manufacturing facilities to periodic inspections by
state and federal agencies, including the FDA, and comparable agencies in
other countries.
 
  The effect of government regulation may be to considerably delay or prevent
the marketing of any product that cti may develop and/or to impose costly
procedures upon cti's activities, the result of which may be to furnish an
advantage to its competitors. There can be no assurance that regulatory
approval for any products developed by cti will be granted on a timely basis
or at all. Any such delay in obtaining or failure to obtain such approvals
would adversely affect cti's ability to market the proposed products and earn
product revenue. The Company is unable to predict the extent and impact of
regulation resulting from future federal, state or local legislation or
administrative actions, or whether such government regulation may have a
material adverse effect on cti. See "--Government Regulation."
 
  Outside the United States, the Company's ability to market a product is
contingent upon receiving marketing authorizations from the appropriate
regulatory authorities. The requirements governing the conduct of clinical
trials, marketing authorization, pricing and reimbursement vary widely from
country to country. At present, foreign marketing authorizations are applied
for at a national level, although within the European Union ("EU") certain
registration procedures are available to companies wishing to market a product
in more than one EU member state. This foreign regulatory approval process
includes all of the risks associated with FDA approval set forth above. See
"--Government Regulation."
 
  Ability to Protect Intellectual Property. The Company's success will depend
in part on its ability to obtain patent protection for its products and
technologies in the United States and other countries, effectively preserve
its trade secrets, enforce its rights against third parties which may infringe
on its technology and operate without infringing on the proprietary rights of
third parties. The patent positions of biotechnology and pharmaceutical
companies can be highly uncertain and involve complex legal and factual
questions. The Company intends to file applications as appropriate for patents
covering both its products and processes. There can be no assurance that any
patents will issue from any present or future applications or, if patents do
issue, that such patents will be issued on a timely basis or that claims
allowed on issued patents will be sufficient to protect the Company's
technology. In addition, there can be no assurance that the patents issued to
cti will not be challenged, invalidated or circumvented or that the rights
granted thereunder will provide proprietary protection or commercial advantage
to the Company. With respect to such issued U.S. patents or any patents that
may issue in the future, there can be no assurance that they will effectively
protect the technology involved, foreclose the development of competitive
products by others or otherwise be commercially valuable.
 
  The commercial success of the Company will also depend in part on the
Company's neither infringing the patents or proprietary rights of third
parties nor breaching any technological licenses which relate to the Company's
technologies and potential products. In general, the development of
therapeutic products is intensely competitive and many pharmaceutical
companies, biotechnology companies, universities and research institutions
have filed and will continue to file patent applications and receive patents
in this field. If patents are issued to other entities that contain
competitive or conflicting claims with respect to technology pursued by cti
and such claims are ultimately determined to be valid, no assurance can be
given that cti will be able to obtain licenses to these patents at a
reasonable cost or develop or obtain alternative technology or compounds. In
such case, the Company could be precluded from using technology that is the
subject matter of such patents, which could have a material adverse effect on
the Company. In order to enforce any patents issued to the Company or
determine the scope and validity of other parties' proprietary rights, the
Company may have to engage in litigation, which would result in substantial
cost to, and diversion of efforts by, the Company. In addition, if the Company
elects or is required to participate in interference proceedings declared by
the U.S. Patent and Trademark Office, substantial cost to the Company could
result. There can be no assurance that third parties will not assert
infringement claims in the future with respect to the Company's current or
future products or that any such claims will not require the Company to enter
into license arrangements or result in litigation, regardless of the merits of
such claims. No assurance can be given that any necessary licenses can be
obtained on commercially reasonable terms, or at all. Should litigation with
respect to any such claims commence, such
 
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litigation could be extremely expensive and time consuming and could have a
material adverse effect on the Company's business, financial condition and
results of operations, regardless of the outcome of such litigation.
 
  The Company is aware of a patent belonging to third parties that could be
interpreted to compromise the Company's freedom to sell Lisofylline in the
United States for certain non-oncology applications. The Company believes,
upon the advice of its patent counsel, that any such interpretation is
relevant only in connection with the Company's use of Lisofylline in
preventing lung injury following traumatic injury or sepsis; and, irrespective
of such interpretation, that the Company's planned manufacture, sale or use of
Lisofylline as described in this Form 10-K does not infringe any valid claim
of such third party patent. If such third party patent rights were interpreted
to limit the use of Lisofylline, the Company may be required to obtain a
license from such parties. There can be no assurance that any such license
would be available to the Company upon reasonably acceptable terms, if at all.
If the Company were so required to obtain a license from such parties, and if
the Company were unable to obtain such a license on reasonably acceptable
terms, the Company would be materially and adversely affected. The Company
could also face significant costs associated with any litigation relating to
such patent.
 
  In order to protect its proprietary technology and processes, cti also
relies on confidentiality and material transfer agreements with its corporate
partners, employees, consultants, outside scientific collaborators and
sponsored researchers, and other advisors. There can be no assurance that
these agreements will not be breached, that the Company will have adequate
remedies for breach or that the Company's trade secrets will not otherwise
become known or independently discovered by competitors. See "--Patents and
Proprietary Rights."
 
  Substantial Competition. The Company faces substantial competition from a
variety of sources, both direct and indirect. The Company faces direct
competition from many companies focusing on areas such as cell signal
transduction, surface receptor technology, transcription factors and gene
therapies. There are many companies, both public and private, including well-
known pharmaceutical companies, chemical companies and specialized
biotechnology companies, engaged more generally in developing synthetic
pharmaceutical and biotechnological products for the same therapeutic
applications as those which are the subject of the Company's research and
development efforts. In some instances, such products have already entered
clinical trials or received approval from the FDA. In addition, many of these
competitors have significantly greater experience than cti in undertaking
preclinical testing and clinical trials of new pharmaceutical products and
obtaining FDA and other regulatory approvals. The Company also competes with
companies that have substantially greater capital resources and research and
development, manufacturing, marketing and sales capabilities. Moreover,
certain academic institutions, governmental agencies and other public and
private research organizations are conducting research in areas in which the
Company is working. These institutions are becoming increasingly aware of the
commercial value of their findings and are becoming more active in seeking
patent protection and licensing arrangements to collect royalties for the use
of technology that they have developed. These institutions may also market
competitive commercial products on their own or through joint ventures and
compete with the Company in recruiting highly qualified scientific personnel.
Other companies may succeed in developing products that are more effective or
less costly than any that may be developed by cti and may also prove to be
more successful than cti at marketing such products. Competition may increase
further as a result of the potential advances in the commercial applicability
of genetic engineering technologies and organic chemistry. There can be no
assurance that the Company's competitors will not develop more effective or
more affordable products or achieve earlier patent protection or product
commercialization than cti. See "--Competition."
 
  Reliance on Third Party Manufacturers; Manufacture of Products in Commercial
Quantities. The manufacturing of sufficient quantities of new drugs is a time
consuming, complex and unpredictable process. The Company currently has no
internal facilities for the manufacture of any of its products for clinical or
commercial production. The Company currently relies on third parties to
manufacture compounds for preclinical testing and clinical trials. The Company
has recently entered into a manufacture and supply agreement with ChiRex, Ltd.
("ChiRex") for the manufacture and supply of Lisofylline bulk drug and
corresponding intermediate compounds for the Company's requirements for
ongoing and future clinical trials and commercial requirements during product
launch and commercialization. Under the terms of the Collaboration Agreement
with Johnson & Johnson, the Company will be responsible for the manufacture of
Lisofylline for development and commercialization purposes
 
                                       7

<PAGE>
 
until November 8, 1999. Thereafter, Johnson & Johnson will assume
responsibility for the manufacture of Lisofylline. However, Johnson & Johnson
may elect to assume responsibility for the manufacture of Lisofylline at any
time prior to such date. Lisofylline has never been manufactured on a
commercial scale, and no assurance can be given that the Company, together
with Johnson & Johnson will be able to make the transition to commercial
production. The Company may need to develop additional manufacturing
resources, or may seek to enter into collaborative arrangements with other
parties which have established manufacturing capabilities or may elect to have
other third parties such as ChiRex manufacture its products on a contract
basis. All manufacturing facilities must comply with applicable regulations of
the FDA. The Company has established a quality control and quality assurance
program, including a set of standard operating procedures and specifications,
designed to ensure that the Company's products are manufactured in accordance
with current GMP and other applicable domestic and foreign regulations.
However, the Company is dependent upon Johnson & Johnson and contract
manufacturers including ChiRex to comply with such procedures and regulations.
There can be no assurance that Johnson & Johnson or these contract
manufacturers will meet the Company's requirements for quality, quantity or
timeliness. See "--Manufacturing."
 
  Absence of Sales and Marketing Organization. The Company has no experience
in marketing, sales or distribution. To directly market any of its potential
products, the Company must obtain access to marketing and sales forces with
technical expertise and with supporting distribution capability. To this end,
the Company has entered into a collaboration with Johnson & Johnson which
permits cti to co-promote Lisofylline with Johnson & Johnson in the United
States while providing that Johnson & Johnson will have primary responsibility
for commercializing Lisofylline. See "Business--Collaborations." If the
Company develops additional products with commercial potential outside of the
Johnson & Johnson collaboration, cti may need to develop marketing and
additional sales resources, may seek to enter into collaborative arrangements
with other parties which have established marketing and sales capabilities or
may choose to pursue the commercialization of such products on its own. There
can be no assurance that the Company, Johnson & Johnson or, to the extent the
Company enters into any commercialization arrangements with any other third
parties, such other third parties, will establish adequate sales and
distribution capabilities or be successful in gaining market acceptance for
the Company's products.
 
  The successful commercialization of the Company's products in certain
markets will be dependent, among other things, on the establishment of
commercial arrangements with others in such markets. Such arrangements could
include the granting of marketing or other rights to third parties in exchange
for royalties, milestone development payments or other payments. There can be
no assurance that any such additional arrangements will be established. If the
Company is not able to establish such arrangements, it would encounter delays
in introducing its products into certain markets. While the Company believes
that parties to any such arrangements will have an economic motivation to
succeed in performing their contractual responsibilities, the amount and
timing of resources they devote to these activities will not be within the
Company's control. There can be no assurance that the Company will enter into
any such arrangements on acceptable terms or that any such parties will
perform their obligations as expected or that any revenue will be derived from
such arrangements. See "--Marketing."
 
  Management of Growth. The Company's success will depend in part on its
ability to expand its operations as the Company begins to commercialize its
potential drug products. Such growth is expected to place a significant strain
on the Company's managerial, operational and financial resources. The
Company's ability to manage growth effectively will require it to continue to
implement and improve its operational and financial systems and to expand,
train and manage its employee base. These demands are expected to require the
addition of new management personnel and the development of additional
expertise by existing management personnel. There can be no assurance that the
Company will be able to effectively manage the expansion of its operations,
that its systems, procedures or controls will be adequate to support the
Company's operations or that Company management will be able to exploit
opportunities for the Company's products or proprietary technology. There can
be no assurance that the Company will be successful in adding technical
personnel as needed to meet the staffing requirements of the Company's
collaboration with Johnson & Johnson or any additional collaborative
relationships into which the Company may enter. An inability to manage growth,
if any, could have a material adverse effect on the Company's business,
results of operations, financial condition and cash flow.
 
                                       8

<PAGE>
 
  Attraction and Retention of Key Employees and Consultants. The Company is
highly dependent on the principal members of its scientific and management
staff, the loss of whose services might impede the achievement of research and
development objectives. Recruiting and retaining qualified scientific
personnel to perform research and development work are critical to cti's
success. Although cti believes it will be successful in attracting and
retaining skilled and experienced scientific and technical personnel, there
can be no assurance that cti will be able to attract and retain such personnel
on acceptable terms. In addition, if cti reaches the point where its
activities require additional expertise in clinical testing, in obtaining
regulatory approvals, and in production and marketing, there will be increased
demands on cti's resources and infrastructure. The inability to obtain
additional qualified personnel could materially and adversely affect the
prospects for cti's success. There is intense competition for qualified
scientists and managerial personnel from numerous pharmaceutical and
biotechnology companies, as well as academia, government organizations,
research institutions and other entities. There can be no assurance that cti
will be able to attract and retain the qualified personnel necessary for the
development of its business. Loss of the services of, or the failure to
recruit, key managerial and scientific and technical personnel could have a
material adverse effect on cti's research and product development programs. In
addition, cti relies on consultants and advisors, including its scientific and
clinical advisors, to assist the Company in formulating its research and
development strategy. All of cti's consultants and advisors are employed by
employers other than the Company, or are self-employed, and have commitments
to or consulting or advisory contracts with other entities that may limit
their availability to the Company. See "--Human Resources."
 
  Product Liability; Insurance. The Company's business exposes it to potential
product liability risks which are inherent in the testing, manufacturing and
marketing of human pharmaceutical products. Although the Company is insured
against such risks up to a $20 million annual aggregate limit in connection
with human clinical trials, there can be no assurance that the Company's
present clinical trials liability insurance coverage is adequate or that the
Company will be able to maintain such insurance on acceptable terms. The
Company has no products commercially available for sale and has not procured
product liability insurance covering claims in connection with commercially
marketed products. There can be no assurance that the Company will be able to
obtain comparable insurance on commercially reasonable terms if and when it
commences the commercial marketing of any products or that such insurance will
provide adequate coverage against potential liabilities. A successful product
liability claim in excess of the Company's insurance coverage could have a
material adverse effect on the Company and may prevent the Company from
obtaining adequate product liability insurance in the future on commercially
reasonable terms.
 
  Uncertainty of Pharmaceutical Pricing and Reimbursement. Sales of cti's
proposed products will be dependent in part on the availability and extent of
reimbursement for the cost of such products and related treatments from third-
party health care payors, such as government and private insurance plans.
Significant uncertainty exists as to the reimbursement status of newly
approved health care products. Government and other third-party payors are
increasingly attempting to contain health care costs by limiting both coverage
and the level of reimbursement for new medical products and services and by
refusing, in some cases, to provide any coverage of uses of approved products
for disease indications other than those for which the FDA has granted
marketing approval. If cti succeeds in bringing any of its proposed products
to the market, there can be no assurance that any such products will be
considered cost-effective or that third-party reimbursement will be available
or will be sufficient to enable cti to sell its proposed products on a
competitive basis and to maintain price levels sufficient to realize an
appropriate return on its investment in product development. If adequate
coverage and reimbursement levels are not provided by government and other
third-party payors, the market acceptance of cti's products would be adversely
affected. In addition, legislation and regulations affecting the pricing of
pharmaceuticals may change in ways adverse to cti before or after any of the
Company's proposed products are approved for marketing. While cti cannot
predict whether any such legislative or regulatory proposals will be adopted,
the adoption of such proposals could have a material adverse effect on cti's
business, financial condition and prospects.
 
  Use of Hazardous Materials. The Company's research and development involves
the controlled use of hazardous materials, chemicals and various 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
 
                                       9

<PAGE>
 
eliminated. In the event of such accident, the Company could be held liable
for any damages that result and any such liability could exceed the resources
of the Company.
 
  Concentration of Ownership. Directors and officers of cti, and their
affiliates, beneficially own in the aggregate 2,171,461 shares of the
Company's Common Stock (including shares of Common Stock subject to options or
warrants exercisable or convertible within 60 days of March 28, 1997)
representing approximately 16.39% of the voting power of the Company's
outstanding securities. Such concentration of ownership may have the effect of
delaying, deferring or preventing a change in control of the Company. See
"Item 14-Security Ownership of Certain Beneficial Owners and Management."
 
  Volatility of Stock Price. Future trading prices of the Common Stock will
depend on many factors, including, among other things, the Company's operating
results and the market for similar securities. The market prices for
securities of pharmaceutical and biotechnology companies have 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. It is likely that the market price of the Common Stock will be
highly volatile. Factors such as announcements of technological innovations or
new commercial products by the Company, its collaborative partners or the
Company's present or potential competitors; announcements by the Company or
others of results of preclinical testing and clinical trials; developments or
disputes concerning patent or other proprietary rights; developments in the
Company's relationships with Johnson & Johnson or future collaborative
partners; acquisitions; litigation; changes in third-party reimbursement
policies; adverse legislation; regulatory decisions; releases of reports by
security analysts; public concern regarding the safety, efficacy or other
implications of the drugs sought to be developed by the Company, or of
biotechnology in general; economic and other external factors; as well as
period-to-period fluctuations in the Company's operating results and general
market conditions, may have a significant impact on the future price of the
Common Stock.
 
  Shares Eligible for Future Sale; Registration Rights; Possible Adverse
Effect on Future Market Price. Sales of a substantial number of shares of
Common Stock in the public market could adversely affect the market price of
the Common Stock. Taking into consideration certain amendments to Rule 144
under the Securities Act, as amended (the "Securities Act"), recently adopted
by the Securities and Exchange Commission and the effect of certain "lock-up"
agreements entered into by all officers, Directors and certain other
shareholders of the Company with the managing underwriters of the Company's
initial public offering, 3,116,224 shares which have been held by non-
affiliates for more than two years are eligible for immediate sale in the
public market without restriction pursuant to Rule 144(k) under the Securities
Act and an additional 15,244 shares will be eligible for sale subject to the
provisions of Rules 144 and 701 under the Securities Act. The officers,
Directors and certain other shareholders of the Company who beneficially own
an aggregate of approximately 7,888,918 shares of Common Stock have agreed,
pursuant to certain "lock-up" agreements, that they will not, without the
prior written consent of UBS Securities LLC, offer, sell or otherwise dispose
of any shares of Common Stock, options or warrants to acquire shares of Common
Stock or securities exchangeable for or convertible into shares of Common
Stock owned by them for a period of 180 days after March 26, 1997. At the end
of such 180-day period, approximately 2,693,444 shares of Common Stock will be
eligible for immediate sale in the public market without restriction under
Rule 144(k) or subject to Rules 144 and 701 upon the expiration of such lock-
up agreements. The remaining shares of Common Stock will have been held for
less than one year upon the expiration of such lock-up agreements and will
become eligible for sale under Rule 144 at various dates thereafter as the
holding period provisions of Rule 144 are satisfied. In addition, holders of
stock options and warrants exercisable for an aggregate of 1,101,991 shares of
Common Stock have entered into 180-day lock-up agreements. The Company intends
to file one or more registration statements under the Securities Act enabling
certain option holders to sell shares for which options are exercisable upon
the expiration of the lock-up agreements. The Company is obligated to register
approximately 5,653,076 shares of outstanding Common Stock and warrants to
purchase 77,907 shares of Common Stock for sale to the public beginning 180
days after March 26, 1997.
 
  Anti-Takeover Provisions; Possible Issuance of Preferred Stock; Rights
Plan. The Company's Restated Articles of Incorporation and Bylaws contain
provisions that may make it more difficult for a third party to acquire, or
may discourage acquisition bids for, cti. These provisions could limit the
price that certain investors might be
 
                                      10

<PAGE>
 
willing to pay in the future for shares of Common Stock. In addition, shares
of the Company's preferred stock may be issued in the future without further
shareholder approval and upon such terms and conditions, and having such
rights, privileges and preferences, as the Board of Directors may determine.
The rights of the holders of Common Stock will be subject to, and may be
adversely affected by, the rights of any holders of preferred stock that may
be issued in the future. The issuance of preferred stock, while providing
desirable flexibility in connection with possible acquisitions and other
corporate purposes, could have the effect of making it more difficult for a
third party to acquire, or of discouraging a third party from acquiring, a
majority of the outstanding voting stock of cti. The Company has no present
plans to issue any shares of preferred stock. In addition, the Company has
adopted a Rights Agreement that, along with certain provisions of the
Company's Restated Articles of Incorporation, have the effect of discouraging
certain transactions involving a change of control of the Company.
 
SCIENTIFIC OVERVIEW
 
  Cell communication occurs through a complex process that commences when
"first messengers" outside the cell, such as hormones, cytokines and growth
factors, recognize and bind to cellular receptors, some of which are embedded
in the cell membrane. The first messenger initiates a series of biochemical
events within the cell, known as signal transduction, which result in cellular
responses. In the 1970s scientists discovered that, in response to
extracellular binding of first messengers, certain molecules, including cell
membrane lipids, are chemically altered to form "second messengers" which
participate in transducing chemical information from the cell membrane to the
cell nucleus. Certain signal transduction pathways are essential for normal
day-to-day cellular processes, and are often referred to as "housekeeping
pathways" or "physiologic pathways." These housekeeping pathways are involved
in the normal growth and replenishment of cells in the body, such as blood
cells and the cells lining the intestinal tract. In contrast, there are also
signal transduction pathways, termed "stress-activated pathways" or "SAPs,"
which are part of the cellular response to injury following exposure to cell-
damaging stimuli such as radiation, chemotherapy or oxidative injury and which
are also activated in many disease states.
 
  The Company believes that such cell-damaging stimuli cause a number of their
toxic effects by altering the chemical composition of certain cell membrane
lipids and phospholipids, resulting in the production of biologically reactive
phospholipids termed phosphatidic acids ("PAs") and oxidized lipids termed
hydroperoxyoctadecadienoic acids ("HPODEs"). These phospholipids and oxidized
lipids in turn activate stress-related signaling pathways within the cell
which carry the cell-damaging message to the cell nucleus, resulting in the
activation of transcription factors. The activation of these transcription
factors may in turn lead to the (i) production of inflammatory cytokines and
the resulting activation of inflammatory and immune responses, (ii) production
of cytokines which inhibit the growth and renewal of the stem cells in the
bone marrow and of the cells lining the intestinal tract and (iii) promotion
of cell membrane damage leading to cell death.
 
  PA elevation, appearance of HPODEs and activation of SAPs are associated
with many disease states and do not appear to be primarily utilized for normal
cellular processes. The Company believes that therapeutics which regulate the
production and/or degradation of phospholipids or oxidized lipids such as PAs
and HPODEs and which regulate the activation of SAPs may offer greater
specificity and safety profiles for the treatment of oncologic, inflammatory
and immune diseases than pharmaceuticals that modulate the housekeeping
pathways necessary for normal day-to-day cellular function.
 
                                      11

<PAGE>
 
PRODUCTS UNDER DEVELOPMENT
 
  The following table summarizes the potential therapeutic indications,
current development status and current collaborators for the Company's
products under development:
 
 

<TABLE>
<CAPTION>
  DEVELOPMENT           POTENTIAL
    PROGRAM      THERAPEUTIC INDICATIONS         DEVELOPMENT   STATUS(1)      COLLABORATORS(2)
- -----------------------------------------------------------------------------------------------
  <C>          <S>                            <C>                             <C>
  ONCOLOGY
   Lisofylline Prevent or reduce infection,   Pivotal Phase III trial for BMT Johnson & Johnson
                mucositis and treatment-       ongoing                        BioChem Pharma
                related mortality following   Phase II trial for AML ongoing
                high dose radiation and/or    Pivotal Phase III trial for
                chemotherapy                   AML ongoing
   CT-2584     Anti-cancer agent targeting    Phase I trials ongoing          BioChem Pharma
                multidrug resistant tumors
   CT-2412     Tumor sensitizer               Research lead                   --
- -----------------------------------------------------------------------------------------------
  INFLAMMATION
   Lisofylline Prevent or reduce acute lung   Phase II trial completed        Johnson & Johnson
                injury and mortality among                                    BioChem Pharma
                patients requiring
                mechanical ventilation for
                respiratory failure
- -----------------------------------------------------------------------------------------------
  IMMUNOLOGY
   CT-3578     Treatment of acute organ       Research lead                   --
                transplant rejection
- -----------------------------------------------------------------------------------------------
</TABLE>

 (1) Research lead refers to a compound that exhibits pharmacological
     properties which are evaluated in vitro and in animal models prior to
     the commencement of the additional pharmacology and toxicology studies,
     formulation work and manufacturing scale-up required to submit an IND.
     See "--Government Regulation" for a description of the phases of human
     clinical trials.
 (2) See "--Collaborations" for a description of cti's collaboration
     agreements and commercial rights to such products.
 
 
ONCOLOGY
 
 Overview
 
  Cancer is the second leading cause of death in the United States, resulting
in over 550,000 deaths annually. The National Cancer Advisory Board reports
that more than eight million people in the United States have cancer, and
projects that cancer will surpass heart disease as the leading cause of death
in the United States by the end of the decade. Approximately 1.4 million new
cases of cancer are diagnosed each year in the United States. The most
commonly used methods for treating cancer patients include surgery, radiation
and drug chemotherapy. A cancer patient often receives a combination of these
treatment modalities depending upon the type and extent of the disease. At
some point in their disease treatment, 70 percent of all cancer patients will
receive radiation therapy and 50 percent of all newly diagnosed cancer
patients will receive chemotherapy. Despite their benefits for treating
cancer, there are significant limitations of, and complications associated
with, radiation and chemotherapy which result in a high rate of treatment
failure. For example, only ten percent of patients treated with chemotherapy
are cured. The principal causes of treatment failure include treatment-related
toxicities, multidrug resistance and tumor resistance to radiation.
 
  Treatment-Related Toxicities. Despite their benefits for treating cancer,
radiation and chemotherapy treatment result in toxicities that limit the use
of potentially more effective doses. These treatment-related toxicities are
directly responsible for placing patients at risk for serious and often life-
threatening infections and other undesirable side effects. Radiation and
chemotherapy are toxic to rapidly dividing cells, which include not
 
                                      12

<PAGE>
 
only cancer cells but also certain normal cells such as bone marrow cells,
hair follicle cells and the epithelial cells lining the mouth, stomach and
intestinal tract. The most common and problematic of the severe side effects
attributable to radiation and chemotherapy are neutropenia--bone marrow
suppression of infection-fighting white blood cells ("WBCs") and mucositis--
damage to the epithelial cells lining the mouth, stomach and intestinal tract.
Epithelial cells form an important barrier, preventing potentially lethal
bacterial, fungal and viral organisms which reside in the intestinal tract
from entering the sterile blood stream and organs. Damage from radiation or
chemotherapy to intestinal epithelial cells disrupts this important barrier,
allowing infectious pathogens to gain access to the systemic blood
circulation. When neutropenia and mucositis occur together, patients are at
high risk for serious and fatal infections. Patients often require supportive
care agents as an adjunct to the primary therapy in order to lessen the
toxicities associated with radiation and chemotherapy.
 
  Approximately 575,000 patients receive chemotherapy each year in the United
States, with more than 20 percent developing severe neutropenia and/or
mucositis. WBC growth factors such as Neupogen(R) (G-CSF), marketed by Amgen
Inc., target the fever and neutropenia (two surrogate markers that indicate
risk for developing infection) induced by radiation and chemotherapy, but in
most studies have failed to prevent serious or fatal infections, have had no
impact on survival, and have failed to treat other acute toxicities of cancer
treatment such as mucositis. Despite these limitations, Neupogen generated
worldwide sales in excess of $1 billion in 1996. There are currently no
supportive-care measures that adequately treat or prevent mucositis.
 
  Multidrug Resistance. Multidrug resistance to conventional chemotherapeutic
agents is a major impediment to the effective treatment of certain cancers.
Approximately 90 percent of all cancer patients undergoing chemotherapy (40
percent to 45 percent of all new cancer cases) express or will develop
multidrug resistance. Because most chemotherapeutic agents share a similar
mechanism of action, once a tumor develops resistance to a single therapeutic
agent, it becomes resistant to a broad range of chemotherapeutic drugs.
 
  Tumor Resistance to Radiation. Radiation therapy kills tumor cells by
generating highly reactive and toxic oxygen free radicals, resulting in damage
to cell replication machinery (e.g., DNA). Tumors are classified as being
sensitive (e.g., lymphomas) or resistant (e.g., colon or skin cancers) to
radiation therapy. Almost 50 percent of certain cancer cell types, such as
prostate and lung cancer, are resistant to radiation therapy at the time of
diagnosis. Mechanisms by which tumor cells develop resistance to radiation
include mutations or deletions in so-called tumor suppression genes (e.g.,
p53) that control cell replication, abnormal regulation of proteins which
inhibit programmed cell death, such as bcl-2, or mechanisms by which DNA is
repaired during cell replication. The p53 tumor suppression gene is mutated or
deleted in approximately 50 percent of newly diagnosed cancers and is a major
contributor to the failure of radiation therapy among such malignancies.
 
  The Company is focusing its oncology development efforts on a portfolio of
drugs that it believes will address the three principal causes of cancer
treatment failure. These include (i) Lisofylline--a supportive care agent
being investigated to prevent or reduce the incidence of serious and fatal
infections, mucositis and treatment-related mortality among patients receiving
high doses of radiation and/or chemotherapy, (ii) CT-2584--a novel anti-cancer
drug being investigated for the treatment of patients with multidrug resistant
tumors and (iii) tumor sensitizing agents including CT-2412--a research lead
with the potential ability to enhance sensitivity to radiation among tumors
that have deleted or mutated p53 tumor suppression genes, which the Company
believes will increase the effectiveness of radiation treatment on such
tumors.
 
 Lisofylline
 
  Lisofylline is a synthetic small molecule drug in Phase III clinical trials
among cancer patients receiving high dose radiation and/or chemotherapy.
Unlike blood cell growth factors or chemotherapy protecting agents,
Lisofylline is being developed to prevent or reduce the incidence of serious
and fatal infections, mucositis and treatment-related mortality. The Company
believes that the use of Lisofylline may permit the safer delivery of higher,
potentially more effective doses of radiation and chemotherapy. The Company is
collaborating with Johnson & Johnson to jointly develop and commercialize
Lisofylline. See "--Collaborations."
 
  The Company's development strategy for Lisofylline is to initially target
life threatening situations where Lisofylline might be used and where no
comparable treatment alternatives exist. The Company is conducting or
 
                                      13

<PAGE>
 
plans to conduct pivotal Phase III clinical trials of Lisofylline in patients
who require BMT after receiving ablative, or bone marrow destroying, doses of
chemotherapy, patients with newly diagnosed AML who receive standard high dose
induction chemotherapy and patients with solid tumors such as head and neck or
breast cancers who receive dose-intensive radiation and/or chemotherapy.
Common to each of these three categories of anti-cancer treatment (ablative,
induction and dose-intensive) is the occurrence of neutropenia and the
breakdown of the epithelial barrier cells lining the mouth, stomach and
intestinal tract, placing patients at a high risk of life threatening
infections, severe mucositis and mortality.
 
  For BMT and AML, the Company intends to pursue approval under FDA
initiatives intended to provide accelerated review and approval of therapies
intended to treat patients suffering from serious, life-threatening or
severely debilitating diseases and that provide a meaningful therapeutic
benefit to patients over existing treatments. The Company believes that this
strategy may shorten the time to market, accelerate product adoption by
oncologists and provide a platform for product line extensions in less urgent,
but clinically meaningful applications such as mucositis. However, there can
be no assurance that Lisofylline will be evaluated for regulatory approval on
such accelerated basis. See "--Government Regulation."
 
  In 1995 more than 20,000 patients in the United States were treated with
ablative doses of chemotherapy requiring BMT or peripheral blood stem cell
("PBSC") replacement. This type of chemotherapy regimen is one of the fastest
growing types of cancer treatments in the United States, with an estimated
annual growth rate of 15 to 20 percent. In 1995 in the United States
approximately 75,000 patients received induction-type chemotherapy regimens
for the treatment of leukemias, such as AML, and lymphomas, and almost 200,000
patients received dose-intensive chemotherapy for a variety of solid tumor
types.
 
  Clinical Trials--BMT. In the first quarter of 1996 the Company completed a
60 patient, multi-center, double blind placebo controlled Phase II trial which
investigated the effect of two different doses (2 mg/kg and 3 mg/kg) of
Lisofylline on the rate of blood cell recovery and the incidences of fever,
infection, toxicity and mortality in cancer patients undergoing high dose
radiation and/or chemotherapy followed by BMT. On an intent to treat analysis
at 100 days following BMT, this study demonstrated that administration of 3
mg/kg of Lisofylline resulted in a statistically significant reduction in
mortality (p = 0.022), the incidence of serious and fatal infections
(p = 0.005), and the duration of absolute neutropenia (p = 0.046) (defined as
the number of days following BMT with fewer than 100 neutrophils per
microliter of blood) when compared to placebo recipients or patients
randomized to receive 2 mg/kg of Lisofylline. In addition, there was a strong
trend toward a reduction in the overall incidence of mucositis (p = 0.08) and
in the incidence of severe mucositis (p = 0.104) among higher dose Lisofylline
recipients compared to placebo recipients or patients randomized to receive
the lower dose of Lisofylline. Certain endpoints of the trial regarding
neutrophil and platelet recovery, the duration of fever and transfusion
requirements were not met. No serious adverse side effects attributable to
Lisofylline were detected in this trial.
 
  The table below summarizes those results of the Phase II BMT trial of
Lisofylline in patients 100 days after receiving high dose radiation and/or
chemotherapy followed by BMT which the Company plans to more fully assess in
its Phase III clinical trials:
 

<TABLE>
<CAPTION>
                                                LISOFYLLINE
                                                 3MG/KG(1)  PLACEBO P VALUE(2)
                                                ----------- ------- ----------
      <S>                                       <C>         <C>     <C>
      Mortality rate...........................   11%       44%       0.022
      Incidence of serious and fatal infec-
       tions...................................   0%        39%       0.005
      Duration of absolute neutropenia (3).....   3 days    6 days    0.046
      Incidence of severe mucositis............   26%       44%       0.104
</TABLE>

- --------
  (1) Patients receiving a 2mg/kg dose of Lisofylline did not demonstrate
      statistically significant results when compared with placebo
      recipients.
  (2) A p value of less than or equal to 0.05 is considered statistically
      significant. A p value of less than or equal to 0.15 demonstrates a
      trend toward statistical significance.
  (3) Duration of absolute neutropenia is defined as the number of days
      following BMT with fewer than 100 neutrophils per microliter of blood.
 
 
                                      14

<PAGE>
 
  In the third quarter of 1996 the Company initiated a 106 patient, multi-
center, double blind placebo controlled pivotal Phase III trial for
Lisofylline in patients undergoing high dose radiation and/or chemotherapy
followed by BMT. This trial utilizes a 3 mg/kg dose of Lisofylline. The
primary endpoints of this study are neutropenia-related infection and
mortality. Based on the Company's discussions with the FDA, if the endpoints
of this study are met with statistical significance, the Company believes that
the results of this trial, together with the results of the completed Phase II
BMT trial and the safety data from the ongoing Phase II AML trial, would be
adequate to provide a basis for an NDA for Lisofylline for BMT indications. In
the first quarter of 1997, the Company commenced an 80 patient Phase III trial
which will examine the effect of a 5 mg/kg dose of Lisofylline on patients
with cancer receiving BMT from unrelated donors. In addition to being at high
risk for serious and fatal infections, these patients have a high incidence of
severe mucositis and cancer treatment-related deaths. This study will
determine the effect of higher doses of Lisofylline on infection and mucositis
and provide supportive dosing and efficacy data for mucositis applications of
Lisofylline. If effective, the Company believes that the use of Lisofylline
may increase the number of patients who are eligible to receive BMT from
unrelated donors. See "--Risk Factors--No Assurance of Successful Product
Development; Uncertainties Related to Clinical Trials."
 
  Clinical Trials--AML. The Company has ongoing a 75 patient, single center,
double blind placebo controlled Phase II trial of Lisofylline (3mg/kg) among
patients with newly diagnosed AML undergoing standard high dose induction
chemotherapy. This trial, which is being conducted in the United States at the
M.D. Anderson Cancer Center, will examine the effects of Lisofylline on the
incidence of infection and mortality, both of which are serious side effects
of induction chemotherapy in AML. Sixty-six patients have been enrolled to
date.
 
  In the fourth quarter of 1996 the Company initiated an 80 patient, multi-
center, double blind placebo controlled pivotal Phase III trial of Lisofylline
among patients with newly-diagnosed AML undergoing standard high dose
induction chemotherapy. This trial will examine the effect of a 3mg/kg dose of
Lisofylline on the incidence of infection and mortality among such patients.
The Company believes that if the Phase II AML trial demonstrates that
Lisofylline reduces infection and mortality with statistical significance, the
results of the Phase II AML trial, together with the results of the completed
Phase II BMT trial and, if positive, the ongoing Phase III BMT trial, may be
adequate to provide a basis for a supplemental NDA for Lisofylline for AML
indications.
 
  Clinical Trials--Mucositis. The Company intends to commence in the second
half of 1997 a 100 patient, multi-center, double blind placebo controlled
Phase II/III trial comparing a 3mg/kg dose of Lisofylline administered four
times daily to a 6mg/kg dose Lisofylline administered two times daily and to
placebo among patients with solid tumors receiving dose-intensive radiation
and/or chemotherapy at risk for developing severe mucositis and infection.
 
  Mechanism of Action. Following exposure to radiation, chemotherapy or
oxidative injury, oxygen free radicals (a highly reactive form of oxygen) are
generated. These oxygen free radicals are "soaked up" both in the blood stream
and in cell membranes by a pool of lipids termed "oxidizable lipids" to
produce highly reactive oxidized lipids such as HPODEs. These oxidized lipids
have been shown to have immediate effects on cell membranes, resulting in
membrane perturbation or disruption which may lead to cell damage or cell
death among the barrier cells lining the intestine or respiratory tract. As
such, HPODEs may contribute to the early breakdown in barrier function
observed following radiation, chemotherapy or oxidative injury. In addition to
the direct effects that HPODEs may have on cell membranes, they may also lead
to the activation of a number of SAPs within the cell.
 
  While the biomolecular target for Lisofylline is presently unknown, its
therapeutic activity appears to be due to the result of Lisofylline's effect
on oxidizable lipids, including those in the cell membrane, and on the
activation of SAPs. Lisofylline decreases the pool of oxidizable lipids, while
increasing neutral, less oxidizable lipid pools, and decreases the production
of HPODEs and other oxidized lipids in a dose dependent manner following
radiation or chemotherapy. In doing so, Lisofylline appears to inhibit the
early, immediate effects of HPODEs on cell membranes and appears to prevent
the activation of SAPs and the ensuing cellular inflammatory and injurious
response.
 
 
                                      15

<PAGE>
 
  The Company believes that the effects of Lisofylline on oxidizable lipids
and on the activation of SAPs may represent a critical upstream point of
intervention in the initiation of the cellular stress response. By modulating
the production of such oxidized lipids and phospholipids and the activation of
SAPs, Lisofylline may be able to prevent the early and late damage to the
epithelial barrier cells lining the mouth, stomach and intestinal tract,
resulting in a reduction in infection, mucositis and mortality following high
dose anti-cancer treatment. Because epithelial barrier cells also line the
lung tissue in the respiratory tract, cells which are susceptible to oxidative
injury, the Company believes that Lisofylline may also be effective for
preventing or reducing ALI in patients requiring mechanical ventilation for
respiratory failure. See "--Inflammatory Disease."
 
  The Company is utilizing its proprietary lipid technology as a platform to
investigate structure-function relationships with respect to the Lisofylline
chemical moiety. The Company is developing chemical analogs of Lisofylline,
such as CT-2408R, which has the potential to be administered orally.
 
 CT-2584
 
  CT-2584 is the Company's novel small molecule drug under investigation for
the treatment of patients with multidrug (e.g., chemotherapy) resistant
cancers, including sarcomas, prostate, colon, lung and breast cancer. The
Company believes that CT-2584 has a unique mechanism of action which may allow
the drug to be (i) toxic to cancers which have multidrug resistance to
conventional chemotherapeutic agents, (ii) more toxic to cancer cells than to
non-cancerous cells, (iii) not susceptible to multidrug resistance and (iv)
anti-angiogenic.
 
  The Company's development strategy for CT-2584 is to initially target
multidrug resistant cancers, such as sarcomas, for which first line treatments
are lacking or ineffective and where such applications may qualify for
accelerated regulatory approval. The Company believes that targeting
therapeutic applications of the drug where alternative treatments are lacking
or ineffective may also accelerate market acceptance. The Company intends to
pursue line extensions of CT-2584 to be used as a second line therapy for
cancers such as prostate, colon, lung and breast cancers which frequently
express or acquire multidrug resistance to conventional first line
chemotherapeutic agents, resulting in treatment failure. Because CT-2584's
mechanism for tumor cell killing appears to be unique, and because it does not
possess the toxicities of conventional anti-cancer agents, the Company
believes that CT-2584 may ultimately be used alongside conventional
chemotherapeutic agents as a first line therapy for a variety of cancer types.
 
  Preclinical and Clinical Trials. In preclinical testing, CT-2584
demonstrated toxicity to all tumor cell lines tested and to human tumor biopsy
samples. These cell lines and samples included sarcomas, prostate, brain,
colon, breast, lung and ovarian cancers, as well as certain leukemias and
lymphomas. Tumors that were multidrug resistant to high levels of conventional
chemotherapeutic agents were rendered more sensitive to those agents in the
presence of low concentrations of CT-2584. CT-2584 also significantly
inhibited cancer cell-induced new blood vessel formation (angiogenesis) at
drug levels below which cancer cell killing is observed.
 
  In November 1995 the Company initiated a Phase I trial, co-sponsored by the
Cancer Research Campaign, at the Christie Hospital in the United Kingdom among
patients with advanced cancers including colon cancer. In May 1996 the Company
initiated a parallel Phase I trial at the Memorial Sloan Kettering Cancer
Research Center in the United States for patients with advanced cancers
including prostate and ovarian cancer. As of February 1, 1997, more than 25
patients have been treated with CT-2584 at five different dose levels without
exhibiting the bone marrow or gastrointestinal toxicities observed with
conventional high dose anti-cancer treatment regimens. A maximum tolerated
dose level has not been achieved to date. The majority of patients enrolled in
this trial have tumor types which are known to express multidrug resistance.
As of February 1, 1997, seven patients with refractory cancers have
experienced disease stabilization or disease regression following more than
two cycles of CT-2584 therapy. Based on these preliminary results, the Company
anticipates starting disease-specific Phase II trials in the United States in
the second half of 1997.
 
  Mechanism of Action. CT-2584's unique mechanism of action of tumor cell
killing is believed to result from the effects it has on tumor cell
phospholipids such as PA. Unlike normal growing cells, such as bone
 
                                      16

<PAGE>
 
marrow cells, tumor cells overproduce PAs through the activation of an enzyme
called phosphatidylcholine phospholipase-D ("PC-PLD"). CT-2584 appears to
overactivate tumor cell PC-PLD, and this enzyme may be its biochemical target
in effecting tumor cell killing. Because of its unique mechanism of action,
CT-2584 appears to inactivate or bypass multidrug resistance mechanisms and
does not appear to be susceptible to multidrug resistance. Company scientists
have cloned PC-PLD, and the Company intends to establish high throughput
assays based on PC-PLD and its other proprietary technologies to discover more
potent or selective analogs of CT-2584.
 
 Tumor Sensitizing Agents
 
  The Company has recently focused a drug discovery effort on the development
of agents which would enhance the effectiveness of radiation. The Company
believes that its drug discovery and core technology platform may provide a
novel approach to the development of tumor sensitizing agents. The Company is
investigating the role of cell membrane lipids and phospholipids and their
contribution to the mechanisms by which tumors express or develop resistance
to radiation. The Company has identified compounds, including CT-2412, which
have the potential ability to enhance sensitivity to radiation in certain
resistant cancers, including those which have deleted or mutated p53 tumor
suppression genes.
 
INFLAMMATORY DISEASE
 
  Acute lung injury ("ALI") may be caused by or associated with many diseases
or conditions, but is most frequently observed following mechanical
ventilation for pneumonia, multiple traumatic injuries and sepsis. More than
one million patients are at risk each year in the United States for developing
ALI. ALI, when severe, leads to a condition termed Acute Respiratory Distress
Syndrome ("ARDS"). ALI can be fatal in a substantial percentage of the
patients who develop ARDS. There are no specific therapies to prevent or treat
the estimated 150,000 new cases of ARDS diagnosed each year. ALI results from
oxidative injury to the epithelial barrier cells which line the respiratory
tract following exposure to high levels of oxygen in connection with
mechanical ventilation and/or following resuscitation with blood transfusions
after multiple traumatic injury. In each setting, oxidative injury to the
epithelial cell membranes lining the lung causes a breakdown in the normal
barrier function, leading to the inability to provide adequate oxygen to the
blood stream and organs and resulting in multiorgan failure ("MOF") and death.
 
  In addition to its potential oncology applications, Lisofylline is also
under investigation by cti as an agent to prevent or reduce the incidence and
severity of ALI and mortality among patients requiring mechanical ventilation
for respiratory failure following pneumonia, multiple traumatic injuries or
sepsis. The mechanisms underlying the toxicity to gastrointestinal barrier
cells observed in the oncology setting may also operate to cause the toxicity
to respiratory barrier cells observed in the critical care setting. The
Company's development strategy for Lisofylline in critical-care applications
is to target patient populations at high risk for developing ALI, where early
intervention is feasible and clinically meaningful endpoints can be assessed
after relatively short (14-28 days) duration of drug treatment.
 
  Clinical Trials. The Company has completed a 13 patient, multi-center,
double blind placebo controlled Phase II feasibility study of Lisofylline in
patients suffering from septic shock randomized to receive a low dose
(1.5mg/kg) of Lisofylline or placebo. This study examined the safety and
pharmacokinetics of Lisofylline given to critically ill patients. Of the 12
patients evaluable for endpoint analysis, Lisofylline recipients experienced a
40 percent improvement from baseline in median MOF scores compared to placebo
recipients. All patients receiving Lisofylline survived to day 28 compared to
67 percent of placebo recipients.
 
  In January 1997 the National Heart, Lung and Blood Institute (the "NHLBI"),
through its ARDS Network, notified the Company that, after reviewing the
preclinical and clinical data to date, it had selected Lisofylline for
investigation in a multi-center, double blind placebo controlled Phase II/III
trial among patients experiencing ALI. The ARDS Network was established by the
NHLBI in cooperation with the FDA to accelerate the investigation and approval
of novel therapies for lung injury. This trial is expected to begin in the
second half of
 
                                      17

<PAGE>
 
1997. The trial will examine the effect of a 3mg/kg dose of Lisofylline on the
duration of mechanical ventilation and early mortality among patients who
develop ALI.
 
  Mechanism of Action. The Company believes that following exposure to high
levels of inspired oxygen by mechanical ventilation or following blood
transfusion resuscitation after multiple traumatic injury, the generation of
reactive oxygen free radicals converts oxidizable lipids to oxidized lipids
such as HPODEs. See "--Oncology-- Lisofylline--Mechanism of Action." These
HPODEs exert their damaging effects on cell membrane lipids and phospholipids
which may lead to the activation of SAPs, resulting in cellular inflammation
and injury. In addition, HPODEs may also cause an immediate disturbance in the
integrity of the cells lining the respiratory tract, allowing the undesired
movement of proteins and fluids into the lung air spaces, and decreasing the
ability of oxygen in the lung to cross into the bloodstream and reach the
tissues.
 
  In animal studies, Lisofylline prevented the occurrence of lung injury
and/or mortality following exposure to high levels of inspired oxygen,
resuscitation following blood loss and shock, and following severe systemic
bacterial infections. In clinical studies, Lisofylline decreased the pool of
oxidizable lipids and decreased HPODE generation and the activation of SAPs
and subsequent production of multiple inflammatory cytokines. The Company
believes that the effects of Lisofylline on such lipids and on the activation
of SAPs may represent a critical upstream point of intervention in the
initiation of the complex biochemical cascade that leads to cellular and
systemic inflammation, cell injury and cell death.
 
IMMUNE DISEASE
 
  The Company is investigating a class of novel compounds which inhibit the PA
regulating enzyme diacylglycerol kinase ("DAG Kinase"), and which have been
identified for potential use in the prevention of organ transplant rejection
and in the treatment of immune diseases. Early in vitro testing suggests that
one of these compounds, CT-3578, unlike currently used immunosuppressives
including cyclosporine A, leads to non-responsiveness of the immune system to
specific foreign antigens. The Company believes that such a compound could
induce tolerance to a specific foreign antigen and thus allow patients to
accept organ transplants from genetically different donors without the need
for long-term immunosuppressive therapy.
 
PROPRIETARY DRUG DISCOVERY TECHNOLOGY
 
  The Company's proprietary drug discovery technology consists of three
components: (i) technology for quantitative measuring of specific species of
lipids and phospholipids; (ii) cloning of critical lipid regulatory enzymes;
and (iii) using the cloned enzymes to validate targets and to develop high
throughput screens capable of analyzing large chemical libraries.
 
  The Company has developed proprietary technology that enables it to
determine the effects of a variety of physical and chemical stimuli (such as
radiation and chemotherapy), growth factors, cytokines and oncogene-induced
events on the production of oxidized lipids such as HPODEs, various species of
PAs and the enzymes which control their production and degradation. Standard
industry techniques for measuring lipid second messengers and structural lipid
membrane components are time consuming and often inadequate for measuring
lipids and phospholipids like HPODEs and PAs, which are produced in relatively
small quantities following stimulation and are degraded rapidly after their
production. Moreover, separation of specific species of oxidized lipids and
PAs is difficult. The Company possesses several proprietary lipid analytical
technologies which can identify different oxidized lipids and different
species of PA produced in response to a variety of stimuli in various cell
types. These technologies provide a qualitative and quantitative methodology
to examine the effects of cti compounds on a variety of such lipids and
phospholipids that are involved in normal and/or pathological functions in
certain cells.
 
  The Company believes that PAs have different functions within cells,
depending on how they are made and their biochemical species. In order to
further investigate the role of these phospholipids in cellular response
mechanisms and to provide a platform to develop novel targets for drug
development, Company scientists have
 
                                      18

<PAGE>
 
cloned several of the critical enzymes that produce or metabolize (degrade)
PAs. The following table lists the human enzymes cloned by the Company, their
biological effects and implied areas of indication:
 

<TABLE>
<CAPTION>
          CLONED ENZYME                 BIOLOGICAL EFFECT        DISEASE AREA
          -------------                 -----------------        ------------
 <C>                              <S>                            <C>
 PC-PLD (phosphatidylcholine-     Cancerous transformation,      Cancer
  phospholipase-D)                angiogenesis
 LPAAT (lyso-PA acyl transferase) Stress activated protein       Inflammation
                                  kinase ("SAPK") activation;
                                  TNFa, Interleukin-6 ("IL-6")
                                  release
 CDS (cytidyl diphosphate-        SAPK activation; TNFa, IL-6    Inflammation
  diacylgycerol synthase)         release
</TABLE>

 
  An additional PA regulating enzyme, diacylglycerol kinase ("DAG-Kinase"),
has been identified as a target enzyme for modifying the immune response and
is inhibited by cti's lead immunosuppressive compound, CT-3578.
 
  Through application of genetic, molecular and biochemical techniques, the
Company may be able to determine the relationship between the PA species
controlled by these enzymes and abnormal cellular functions which are thought
to be related to disease processes. The Company believes that PA modulating
enzymes, when coupled with high throughput screens and combinatorial diversity
libraries, may provide it with unique therapeutic targets for drug development
for oncological, inflammatory and immune diseases.
 
  The Company has also developed certain proprietary technologies that permit
the qualitative and quantitative analysis of a variety of complex lipids for
their content of oxidizable and oxidized lipid components such as HPODEs. The
Company believes that such technologies may be utilized in conjunction with
its chemical libraries and novel cloned enzymes to elucidate the relationship
of such complex oxidized lipids to conditions such as cancer, inflammatory and
immune disease. From these studies, the Company intends to identify additional
novel targets for future drug development.
 
COLLABORATIONS
 
 Johnson & Johnson
 
  In November 1996 the Company entered into a Collaboration and License
Agreement (the "Collaboration Agreement") with Ortho Biotech, Inc. and The
R.W. Johnson Pharmaceutical Research Institute (a division of Ortho
Pharmaceutical Corporation), each of which are wholly-owned subsidiaries of
Johnson & Johnson (collectively, "Johnson & Johnson"), for the joint
development and commercialization of Lisofylline. Upon execution of the
Collaboration Agreement, Johnson & Johnson paid to cti a $5.0 million license
fee. Under the Collaboration Agreement, cti is responsible for the development
of Lisofylline in the United States, and Johnson & Johnson has committed to
fund 60 percent of cti's budgeted development expenses incurred in connection
with obtaining regulatory approval for Lisofylline in the United States. For
each of 1997 and 1998 Johnson & Johnson has agreed, subject to certain
termination rights, to fund up to $12.0 million of cti's budgeted development
expenses per year. Any development expenses in excess of such currently
budgeted agreed upon amounts will be funded solely by cti unless otherwise
mutually agreed. Johnson & Johnson will be responsible for obtaining
regulatory approval for Lisofylline for markets outside of the United States
and Canada at its own expense.
 
  The Company and Johnson & Johnson will co-promote Lisofylline in the United
States, and each will share equally in any resulting operating profits and
losses. Although cti and Johnson & Johnson will co-promote Lisofylline in the
United States, Johnson & Johnson will have primary responsibility for
commercializing Lisofylline. See "--Marketing." Johnson & Johnson has the
exclusive right to develop and market Lisofylline, at its own expense, for
markets other than the United States and Canada, subject to specified royalty
payments to cti. Johnson & Johnson will make additional payments to, and
equity investments in, cti if certain milestones are achieved in the
development and commercialization of Lisofylline.
 
                                      19

<PAGE>
 
  The collaboration with Johnson & Johnson initially covers the development of
Lisofylline to prevent or reduce the toxic side effects among cancer patients
receiving high dose radiation and/or chemotherapy followed by BMT (the "BMT
Indication") through December 31, 1998. The collaboration also covers the
development of Lisofylline for the treatment of patients with AML undergoing
high dose chemotherapy (the "AML Indication") through June 30, 1997. Johnson &
Johnson has an option to continue to participate in the development of
Lisofylline for the AML Indication following the completion of cti's ongoing
Phase II AML trial. Johnson & Johnson also has certain options to expand the
collaboration to include the development of Lisofylline for any other
indication for which Lisofylline is being developed by cti. In the event that
Johnson & Johnson exercises any such option, it would be required to fund 60
percent of cti's budgeted development expenses incurred in connection with the
development of Lisofylline for such indication, including expenses incurred
prior to the exercise of such option, and would also be required to pay
additional license fees and milestone payments to cti. Thereafter, any
development expenses in excess of the then agreed upon budgeted amounts for
any such additional indication would be funded solely by Johnson & Johnson
unless otherwise mutually agreed. If Johnson & Johnson does not exercise such
option with respect to any such indication, cti would be free to develop
Lisofylline for such indication either on its own or in collaboration with
third parties. Johnson & Johnson also has the option to sponsor research at
cti with respect to discovering compounds structurally related to Lisofylline.
 
  The Company is dependent on the future payments from Johnson & Johnson to
continue the development and commercialization of Lisofylline as presently
planned. Johnson & Johnson may terminate the Collaboration Agreement at any
time and for any reason after November 8, 1997, subject to a six month notice
period. Johnson & Johnson would have no further obligation to fund cti's
development expenses related to Lisofylline following such termination.
However, the financial and other obligations of Johnson & Johnson (aside from
Johnson & Johnson's obligation to make additional payments to, and equity
investments in, cti if certain development milestones are achieved) would
continue during such six month notice period. In addition, Johnson & Johnson
has the right to terminate the Collaboration Agreement at any time based on
material safety or tolerability issues related to Lisofylline upon 30 days'
notice. In the event of a termination of the Collaboration Agreement by
Johnson & Johnson, cti would regain all development and commercialization
rights. Without Johnson & Johnson's continued collaborative support, cti would
not be able to continue the development of Lisofylline as presently planned,
and the Company's financial condition would be materially and adversely
affected. See "--Risk Factors--Reliance on Relationship with Johnson &
Johnson."
 
  In accordance with the terms of a Stock Purchase Agreement entered into
between the Company and Johnson & Johnson Development Corporation ("JJDC"), a
wholly-owned subsidiary of Johnson & Johnson, in connection with the
Collaboration Agreement, JJDC purchased shares of cti's Series B Convertible
Preferred Stock for an aggregate purchase price of $5.0 million. Johnson &
Johnson also purchased an additional 300,000 shares of Common Stock on March
26, 1997 concurrent with the closing of the Company's initial public offering
for an aggregate purchase price of $3.0 million. Pursuant to the Stock
Purchase Agreement, cti is entitled to require JJDC to purchase additional
shares of Common Stock upon the achievement of certain milestones. See "Item
13.--Certain Relationships and Related Transactions."
 
 BioChem Pharma
 
  In March 1995 the Company entered into a collaboration agreement with
BioChem Pharma for the development and commercialization of Lisofylline and
CT-2584 in Canada. Under the collaboration agreement (the "BioChem
Collaboration Agreement"), BioChem Pharma will be responsible for obtaining
regulatory approval for Lisofylline and CT-2584 in Canada. Although BioChem
Pharma will have no obligation to conduct any research and development
activities, it will have the right to have cti perform clinical trials in
Canada at BioChem Pharma's expense. BioChem Pharma will have the exclusive
right to commercialize Lisofylline and CT-2584 in Canada, subject to the
payment of royalties to cti. The Company will also receive payments under the
BioChem Collaboration Agreement if certain milestones are achieved. BioChem
Pharma may terminate the BioChem Collaboration Agreement with respect to any
product at any time for any reason upon 30 days' notice.
 
                                      20

<PAGE>
 
In connection with the BioChem Collaboration Agreement, BioChem Pharma agreed
to purchase shares of Series A Convertible Preferred Stock in the Company's
1995 Private Placement for an aggregate purchase price of $2.5 million.
 
PATENTS AND PROPRIETARY RIGHTS
 
  The Company has dedicated significant resources to protect its intellectual
property. In the United States, the Company has 10 issued patents and 68
allowed or pending patent applications, including divisional patent
applications and continuations-in-part, covering a variety of new chemical
entities, pharmaceutical compositions, synthetic processes, methods of use,
discovery, research tools and diagnostics. Three of the Company's issued
patents cover the oncology and anti-inflammatory methods of use for
Lisofylline, and nine of the Company's allowed or pending patent applications
cover the pharmaceutical composition, commercial synthetic manufacturing
process and other methods of use for Lisofylline. One allowed patent
application covers the chemical compounds and pharmaceutical compositions of
CT-2584 and CT-3578. The Company intends to file additional patent
applications, when appropriate, with respect to improvements in its core
technology and to specific products and processes that it develops. Generally
it is cti's policy to file foreign counterparts in countries with significant
pharmaceutical markets and a patent granting and enforcement infrastructure.
The Company has filed 51 foreign national patent applications in 14 countries
and the European Patent Office, including 18 counterparts of certain of its
issued patents and allowed or pending U.S. patent applications for Lisofylline
and 13 counterparts of certain of its issued patents and allowed or pending
U.S. patent applications for CT-2584 and CT-3578. There can be no assurance
that any patents will issue from any present or future applications or, if
patents do issue, that such patents will be issued on a timely basis or that
claims allowed on issued patents will be sufficient to protect the Company's
technology. In addition, there can be no assurance that the patents issued to
cti will not be challenged, invalidated or circumvented or that the rights
granted thereunder will provide proprietary protection or commercial advantage
to the Company. With respect to such issued U.S. patents or any patents that
may issue in the future, there can be no assurance that they will effectively
protect the technology involved, foreclose the development of competitive
products by others or otherwise be commercially valuable.
 
  The commercial success of the Company will also depend in part on the
Company's neither infringing patents or proprietary rights of third parties
nor breaching any technology licenses which relate to the Company's
technologies and potential products. In general, the development of
therapeutic products is intensely competitive and many pharmaceutical
companies, biotechnology companies, universities and research institutions
have filed and will continue to file patent applications and receive patents
in this field. If patents are issued to other entities that contain
competitive or conflicting claims with respect to the technology and compounds
pursued by cti and such claims are ultimately determined to be valid, no
assurance can be given that cti would be able to obtain licenses to these
patents at a reasonable cost or develop or obtain alternative technology or
compounds.
 
  The Company is aware of a patent belonging to third parties that could be
interpreted to compromise the Company's freedom to sell Lisofylline in the
United States for certain non-oncology applications. The Company believes,
upon advice of its patent counsel, that any such interpretation is relevant
only in connection with the Company's use of Lisofylline in preventing lung
injury following traumatic injury or sepsis; and, irrespective of such
interpretation, that the Company's planned manufacture, sale or use of
Lisofylline as described in this Form 10-K does not infringe any valid claim
of such third party patent. If such third party patent rights were interpreted
to limit the use of Lisofylline, the Company may be required to obtain a
license from such parties. There can be no assurance that any such license
would be available to the Company upon reasonably acceptable terms, if at all.
The Company could also face significant costs associated with any litigation
relating to such patent. See "--Risk Factors--Ability to Protect Intellectual
Property."
 
  The Company has sought and intends to aggressively seek patent protection in
the United States, Europe and Japan to protect any products that it may
develop. The Company also intends to seek patent protection or rely upon trade
secrets to protect certain of its enabling technologies that will be used in
discovering and evaluating new drugs which could become marketable products.
However, there can be no assurance that such
 
                                      21

<PAGE>
 
steps will effectively protect the technology involved. To protect any such
trade secrets and other proprietary information, cti relies on confidentiality
and material transfer agreements with its corporate partners, employees,
consultants, outside scientific collaborators and sponsored researchers and
other advisors. There can be no assurance that these agreements will not be
breached, that the Company will have adequate remedies for breach or that the
Company's trade secrets will not otherwise become known or independently
discovered by competitors. The Company also has its employees, members of its
Scientific Advisory Board and Clinical Advisory Board, and its consultants
enter into agreements requiring disclosure to cti of ideas, developments,
discoveries or inventions conceived during employment or during consulting and
assignment to cti of proprietary rights to such matters related to the
business and technology of cti. The extent to which efforts by others will
result in patents and the effect on cti of the issuance of such patents is
unknown. Further, to enforce any patents issued to the Company or determine
the scope and validity of other parties' proprietary rights, the Company may
have to engage in litigation, which would result in substantial cost to, and
diversion of efforts by, the Company. There can be no assurance that the
Company's issued or licensed patents would be held valid. An adverse outcome
could subject the Company to significant liabilities to third parties, require
disputed rights to be licensed from third parties or require the Company to
cease or modify its use of such technology, any of which could have a material
adverse effect on the Company. If the Company elects or is required to
participate in interference proceedings declared by the U.S. Patent and
Trademark Office to determine priority of invention, substantial cost to the
Company could result even if the eventual outcome is favorable to the Company.
 
  There can be no assurance that others will not independently develop
substantially equivalent proprietary information or otherwise obtain access to
cti's know-how or that others will not be issued patents which may prevent the
sale of Company products or require licensing and the payment of significant
fees or royalties by cti for the pursuit of its business. Trade secrets and
other unpatented proprietary information of cti may be difficult to protect,
notwithstanding confidentiality agreements with cti's employees and
consultants. See "--Risk Factors--Ability to Protect Intellectual Property."
 
MANUFACTURING
 
  The Company currently does not have the internal facilities to manufacture
products under current Good Manufacturing Practices ("GMP") prescribed by the
FDA. The Company seeks to develop such capacity through manufacturing
relationships. The Company has qualified and selected manufacturers which it
believes comply with GMPs and other regulatory standards, and Lisofylline is
currently being manufactured by third party vendors on a fee for service
basis. In January 1997 the Company entered into a supply agreement with
ChiRex, Ltd. ("ChiRex"), a British manufacturer of pharmaceutical
intermediates and active ingredients, for the manufacture and supply of
Lisofylline and corresponding intermediate compounds. Under the terms of the
agreement, ChiRex will manufacture and supply Lisofylline bulk drug and a key
intermediate compound in sufficient quantities to meet the Company's
requirements for ongoing and future clinical trials and commercial
requirements during product launch and commercialization. ChiRex is obligated
to comply with all regulatory requirements and policies concerning GMPs for
all phases of production. The agreement will expire on December 31, 2001, but
may be terminated by cti upon 12 months written notice prior to such date.
 
  The Company believes it has developed a process for manufacturing
Lisofylline in its own laboratories and those of external manufacturers that
would enable its manufacture in commercial quantities. Under the terms of the
Collaboration Agreement with Johnson & Johnson, the Company will be
responsible for the manufacture of Lisofylline for development and
commercialization purposes until November 8, 1999. Thereafter, Johnson &
Johnson will assume responsibility for the manufacture of Lisofylline.
However, Johnson & Johnson may elect to assume responsibility for the
manufacture of Lisofylline at any time prior to such date. The Company
currently uses ChiRex for the manufacture of Lisofylline bulk drug and uses
three suppliers for clinical trial quantities of the finished drug product.
Following commercial launch of Lisofylline, the Company expects that it will
continue to use ChiRex to manufacture Lisofylline bulk drug and expects that
OMJ Pharmaceuticals, Inc., an affiliate of Johnson & Johnson, will be the
Company's primary supplier for the finished drug product pursuant to the
Collaboration Agreement.
 
 
                                      22

<PAGE>
 
  The Company has established a quality control and quality assurance program,
including a set of standard operating procedures and specifications, designed
to ensure that the Company's products are manufactured in accordance with GMPs
and other applicable domestic and foreign regulations. However, the Company is
and expects to continue to be dependent upon Johnson & Johnson and contract
manufacturers such as ChiRex to comply with such procedures and regulations.
There can be no assurance that Johnson & Johnson or these manufacturers will
meet the Company's requirements for quality, quantity or timeliness.
Lisofylline has never been manufactured on a commercial scale, and no
assurance can be given that the Company, together with Johnson & Johnson or
such other third party contract manufacturers, will be able to make the
transition to commercial production.
 
  If the Company develops other products with commercial potential outside of
the Johnson & Johnson collaboration, cti will need to develop additional
manufacturing resources, and may seek to enter into additional collaborative
arrangements with other parties which have established manufacturing
capabilities or may elect to have a third party such as ChiRex manufacture its
products on a contract basis. If cti is unable to enter into collaborative
relationships or to obtain or retain third party manufacturing on commercially
acceptable terms, it may be delayed in its ability to commercialize its
products or may not be able to commercialize its products as planned. The
Company will be dependent upon such collaborators or third parties to supply
it in a timely manner with products manufactured in compliance with GMPs or
similar standards imposed by foreign regulators. Collaborators and contract
manufacturers may violate GMPs, and the FDA has intensified its oversight of
drug manufacturers. There can be no assurance that the FDA would not take
action against a collaborator or a contract manufacturer who violates current
GMPs. Such actions may include requiring such collaborator or contract
manufacturer to cease manufacturing activities. See "--Risk Factors--Reliance
on Third Party Manufacturers; Manufacture of Products in Commercial
Quantities."
 
MARKETING
 
  The Company intends to develop its own sales and marketing infrastructure in
the United States to commercialize its portfolio of oncology products,
including the oncology products that the Company plans to co-promote with
Johnson & Johnson pursuant to the Collaboration Agreement and any other
oncology products that the Company may commercialize, either on its own or, to
the extent the Company enters into any commercialization arrangements, with
collaborators. With respect to the commercialization of its oncology products
outside the United States, and with respect to the worldwide commercialization
of its portfolio of products for inflammatory and immune disease, the
Company's strategy is to pursue commercialization arrangements with
collaborators, including Johnson & Johnson.
 
  The Company has no experience in marketing, sales or distribution. The
Company believes, however, that the United States oncology market is
accessible by a limited marketing staff due to the concentrated market of
prescribing physicians. Approximately 5,000 oncologists control the vast
majority of prescriptions for cancer therapeutics. Under the Collaboration
Agreement, Johnson & Johnson will have primary responsibility for
commercializing Lisofylline. To assist in commercializing Lisofylline for the
BMT Indication, cti will employ medical affairs and marketing personnel who
will work with Johnson & Johnson's sales force to provide various medical and
marketing support functions. In connection with the launch and
commercialization of Lisofylline for all other indications, cti will be
permitted to provide its own field sales force to co-promote Lisofylline under
the direction and control of Johnson & Johnson. See "--Collaborations."
 
  If the Company develops additional products with commercial potential
outside of the Johnson & Johnson collaboration, cti may need to develop
marketing and additional sales resources, and may seek to enter into
collaborative arrangements with third parties which have established marketing
and sales capabilities or may choose to pursue the commercialization of such
products on its own. There can be no assurance that the Company, Johnson &
Johnson or, to the extent the Company enters into any commercialization
arrangements with any other third partries, such other third parties, will
establish adequate sales and distribution capabilities or be successful in
gaining market acceptance for products. There can be no assurance that cti
will enter into any
 
                                      23

<PAGE>
 
such alliances or that the terms of any such alliances will be favorable to
cti. See "--Risk Factors--Absence of Sales and Marketing Organization."
 
COMPETITION
 
  Competition in the pharmaceutical and biotechnology industries is intense.
The Company faces competition from a variety of sources, both direct and
indirect. The Company believes there may be several pharmaceutical or
biotechnology companies that focus on cell membrane lipids in regulating
cellular processes. Many other companies compete indirectly with cti for the
same therapeutic indications but with different approaches by focusing, for
example, on signal transduction, cell receptor technology, transcription
factors and gene therapies. The Company also competes with other large
pharmaceutical companies that produce and market synthetic compounds and with
other specialized biotechnology firms in the United States, Japan, Europe and
elsewhere. Many of the Company's existing or potential competitors have
substantially greater financial, technical and human resources than the
Company and may be better equipped to develop, manufacture and market
products. Smaller companies may also prove to be significant competitors,
particularly through collaborative arrangements with large pharmaceutical and
established biotechnology companies. Many of these competitors have
significant products that have been approved or are in development and operate
large, well funded research and development programs.
 
  The Company expects to encounter significant competition for the principal
pharmaceutical products it plans to develop. Companies that complete clinical
trials, obtain required regulatory approvals and commence commercial sales of
their products before their competitors may achieve a significant competitive
advantage. Accordingly, the relative speed with which the Company and Johnson
& Johnson or any future collaborators can develop products, complete
preclinical testing and clinical trials and approval processes, and supply
commercial quantities of the products to the market are expected to be
important competitive factors. A number of biotechnology and pharmaceutical
companies are developing new products for the treatment of the same diseases
being targeted by cti. In some instances, such products have already entered
late-stage clinical trials or received FDA approval.
 
  Significant levels of research in biotechnology, medicinal chemistry and
pharmacology occur in academic institutions, governmental agencies and other
public and private research institutions. These entities have become
increasingly active in seeking patent protection and licensing revenues for
their research results. They also compete with cti in recruiting and retaining
skilled scientific talent.
 
  The Company believes that its ability to compete successfully will be based
on its ability to create and maintain scientifically advanced technology,
develop proprietary products, attract and retain scientific personnel, obtain
patent or other protection for its products, obtain required regulatory
approvals and manufacture and successfully market its products either alone or
through outside parties. Many of cti's competitors have substantially greater
financial, marketing and human resources than cti. The Company will continue
to seek licenses with respect to technology related to its field of interest
and may face competition with respect to such efforts. There can be no
assurance that the Company's competitors will not develop more effective or
more affordable products, or achieve earlier patent protection or product
commercialization than the Company. See "--Risk Factors--No Assurance of
Successful Product Development; Uncertainties Related to Clinical Trials," "--
Substantial Competition" and "--Ability to Protect Intellectual Property."
 
GOVERNMENT REGULATION
 
 Drug Approval Process
 
  Regulation by governmental authorities in the United States and other
countries is a significant factor in the development, production and marketing
of cti's proposed products. All of cti's products will require regulatory
approval by governmental agencies prior to commercialization. In particular,
human therapeutic products are subject to rigorous preclinical and clinical
testing and other approval procedures in the United States by the FDA
 
                                      24

<PAGE>
 
and similar health authorities in foreign countries. Various federal statutes
and regulations also govern or influence the testing, manufacturing, quality
control, safety, labeling, storage, record-keeping and marketing of such
products. The process of obtaining these approvals and the subsequent
compliance with appropriate federal and foreign statutes and regulations
require the expenditure of substantial resources. Any failure by cti or its
collaborators or licensees to obtain, or any delay in obtaining, regulatory
approval could adversely affect the marketing of any product that cti may hope
to develop and its ability to receive revenues therefrom. The Company has
neither applied for nor received regulatory approval to market any products.
 
  The steps required before a pharmaceutical agent may be marketed in the
United States include (i) preclinical laboratory, in vivo and formulation
studies, (ii) the submission to the FDA of an Investigational New Drug
application ("IND"), which must become effective before human clinical trials
may commence, (iii) adequate and well-controlled human clinical trials to
establish the safety and efficacy of the proposed drug in its intended
indication, (iv) the submission of a New Drug Application ("NDA") to the FDA,
and (v) the FDA approval of the NDA.
 
  In order to clinically test, produce and market products for diagnostic or
therapeutic use, a company must comply with mandatory procedures and safety
standards established by the FDA and comparable agencies in foreign countries.
Before beginning human clinical testing of a potential new drug, a company
must file an IND and receive clearance from the FDA. The IND is a summary of
the preclinical studies which were carried out to characterize the drug,
including toxicity and safety studies, as well as an in-depth discussion of
the human clinical studies which are being proposed. Approval of a local
institutional review board ("IRB") and informed consent of trial subjects is
also required.
 
  Human clinical trials are typically conducted in three sequential phases
which may overlap. Phase I involves the initial introduction of the drug into
healthy human subjects or patients where the product is tested for safety,
dosage tolerance, absorption, metabolism, distribution and excretion. Phase II
involves studies in a limited patient population to (i) identify possible
adverse effects and safety risks, (ii) determine the efficacy of the product
for specific, targeted indications, and (iii) determine dosage tolerance and
optimal dosage. When Phase II evaluation demonstrates that the product may be
effective and has an acceptable safety profile, Phase III trials are
undertaken to further evaluate dosage and clinical efficacy and to further
test for safety in an expanded patient population at multiple clinical study
sites. A pivotal Phase III trial is an adequate and well-controlled study
which provides the primary basis for determining whether there is "substantial
evidence" to support the claims of effectiveness for new drugs and forms the
basis for an NDA. The regulatory authority or the sponsor may suspend clinical
trials at any point in this process if either entity concludes that clinical
subjects are being exposed to an unacceptable health risk, that the study is
not being conducted in compliance with applicable regulatory requirements, or
for other reasons. See "--Risk Factors--No Assurance of Successful Product
Development; Uncertainties Related to Clinical Trials."
 
  The results of product development, preclinical studies and clinical studies
are submitted to the FDA as part of an NDA for approval of the marketing and
commercial shipment of the product. The FDA may deny approval of an NDA if
applicable regulatory criteria are not satisfied, or may require additional
data. Even if such data is submitted, the FDA may ultimately decide that the
NDA does not satisfy the criteria for approval. Once issued, a product
approval may be withdrawn if compliance with regulatory standards is not
maintained or if problems occur after the product reaches the market. In
addition, the FDA may require testing and surveillance programs to monitor the
effect of approved products which have been commercialized, and it has the
power to prevent or limit further marketing of a product based on the results
of these post-marketing programs.
 
  Satisfaction of these FDA requirements, or similar requirements by foreign
regulatory agencies, typically takes several years and the time needed to
satisfy them may vary substantially, based upon the type, complexity and
novelty of the drug product. The effect of government regulation may be to
delay or to prevent marketing of potential products for a considerable period
of time and to impose costly procedures upon the Company's activities. There
can be no assurance that the FDA or any other regulatory agency will grant
approval for any products being developed by the Company on a timely basis, or
at all. Success in preclinical or early stage
 
                                      25

<PAGE>
 
clinical trials does not assure success in later stage clinical trials. Data
obtained from preclinical and clinical activities are susceptible to varying
interpretations which could delay, limit or prevent regulatory approval. If
regulatory approval of a product is granted, such approval may impose
limitations on the indicated uses for which a product may be marketed.
Further, even if regulatory approval is obtained, later discovery of
previously unknown problems with a product may result in restrictions on the
product, including withdrawal of the product from the market. Delay in
obtaining or failure to obtain regulatory approvals would have a material
adverse affect on the Company's business. Marketing the Company's products
abroad will require similar regulatory approvals and is subject to similar
risks. In addition, the Company is unable to predict the extent of adverse
government regulations that might arise from future United States or foreign
governmental action. See "--Risk Factors--No Assurance of FDA Approval;
Comprehensive Government Regulation."
 
  The FDA has implemented accelerated review and approval procedures for
certain pharmaceutical agents that have been studied for their safety and
effectiveness in treating serious, life-threatening or severely debilitating
diseases, and that provide a meaningful therapeutic benefit to patients over
existing treatments. Products intended to remove a serious or life-threatening
toxicity of cancer treatment may potentially qualify for review under these
procedures. The Company believes that Lisofylline may qualify for this
accelerated review and approval process and designed its pivotal Phase III BMT
trial with the objective of securing accelerated approval. The FDA has granted
the Company priority review status for its planned NDA for Lisofylline for BMT
indications. However, significant uncertainty exists as to the extent to which
these will result in accelerated review and approval. Further, the FDA retains
considerable discretion in determining eligibility for accelerated review and
approval and is not bound by discussions that an applicant may have with FDA
staff. Accordingly, the FDA could employ such discretion to deny eligibility
of Lisofylline as a candidate for accelerated review or require additional
clinical trials or other information before approving Lisofylline. In
addition, the approval of a product under the accelerated approval procedures
is subject to various conditions, including the requirement to verify clinical
benefit in postmarketing studies and the authority on the part of the FDA to
withdraw approval under streamlined procedures if such studies do not verify
clinical benefit or under various other circumstances. The Company cannot
predict the ultimate impact, if any, of the accelerated approval process on
the timing or likelihood of FDA approval of Lisofylline or any of its other
potential products.
 
  Facilities and manufacturing procedures used for the manufacture of products
for clinical use or for sale must be operated in conformity with current GMP
regulations, the FDA regulations governing the production of pharmaceutical
products. The Company intends to operate its facilities or to arrange for the
manufacture of products at facilities which are operated, as required, in
accordance with GMPs where necessary; however, no assurance can be provided
that such manufacture will successfully comply with GMPs. In addition, the FDA
also regulates promotion, marketing and distribution of drug products, and
inspects drug manufacturers to evaluate compliance with regulatory
requirements. Among other things, the FDA evaluates truthfulness and accuracy
of materials submitted to it, or otherwise prepared by a drug manufacturer,
and may take legal or regulatory action against companies or their products if
such materials contain any untrue statement of a material fact.
 
  Before the Company's products can be marketed outside of the United States,
they are subject to regulatory approval similar to that required in the United
States, although the requirements governing the conduct of clinical trials,
product licensing, pricing and reimbursement vary widely from country to
country. No action can be taken to market any product in a country until an
appropriate application has been approved by the regulatory authorities in
that country. The current approval process varies from country to country, and
the time spent in gaining approval varies from that required for FDA approval.
In certain countries, the sales price of a product must also be approved. The
pricing review period often begins after market approval is granted. No
assurance can be given that, even if a product is approved by a regulatory
authority, satisfactory prices will be approved for such product.
 
  No assurance can be provided that the Company's INDs or NDAs will be
successfully reviewed by the FDA, or that similar applications will be
successfully reviewed by foreign regulatory authorities. Further, the FDA and
foreign authorities may at any time take legal or regulatory action against a
product or the Company if
 
                                      26

<PAGE>
 
it concludes that cti has not complied with applicable laws and regulations or
that earlier evaluations of a product's safety or effectiveness may not have
been adequate or appropriate. Such action may include, but is not limited to,
restrictions on manufacture and shipment of products, seizure of products,
injunctions and civil and criminal penalties. The FDA's policies may change
and additional government regulations may be promulgated which could prevent
or delay regulatory approval of the Company's potential products. Moreover,
increased attention to the containment of health care costs in the United
States and in foreign markets could result in new government regulations which
could have a material adverse effect on the Company's business. The Company is
unable to predict the likelihood of adverse governmental regulation which
might arise from future legislative or administrative action, either in the
United States or abroad.
 
 Third Party Reimbursement and Health Care Reform
 
  The commercial success of the Company's products under development will be
substantially dependent upon the availability of government or private third-
party reimbursement for the use of such products. There can be no assurance
that Medicare, Medicaid, health maintenance organizations and other third-
party payors will authorize or otherwise budget such reimbursement. Such
governmental and third party payors are increasingly challenging the prices
charged for medical products and services. If the Company succeeds in bringing
one or more products to market, there can be no assurance that such products
will be viewed as cost-effective or that reimbursement will be available to
consumers or will be sufficient to allow the Company's products to be marketed
on a competitive basis. Furthermore, federal and state regulations govern or
influence the reimbursement to health care providers of fees and capital
equipment costs in connection with medical treatment of certain patients. In
response to concerns about the rising costs of advanced medical technologies,
the current administration of the federal government has publicly stated its
desire to reform health care, including the possibility of price controls and
revised reimbursement policies. There can be no assurance that actions taken
by the administration, if any, with regard to health care reform will not have
a material adverse effect on the Company. If any actions are taken by the
administration, such actions could adversely affect the prospects for future
sales of the Company's products. Further, to the extent that these or other
proposals or reforms have a material adverse effect on the Company's ability
to secure funding for its development or on the business, financial condition
and profitability of other companies that are prospective collaborators for
certain of the Company's product candidates, the Company's ability to develop
or commercialize its product candidates may be adversely affected. See "--Risk
Factors--Uncertainty of Pharmaceutical Pricing and Reimbursement."
 
  Given recent government initiatives directed at lowering the total cost of
health care throughout the United States, it is likely that the United States
Congress and state legislatures will continue to focus on health care reform
and the cost of prescription pharmaceuticals and on the reform of the Medicare
and Medicaid systems. The Company cannot predict the likelihood of passage of
federal and state legislation related to health care reform or lowering
pharmaceutical costs. In certain foreign markets pricing of prescription
pharmaceuticals is already subject to government control. Continued
significant changes in the nation's health care system could have a material
adverse effect on the Company's business.
 
 Environmental Regulation
 
  In connection with its research and development activities and its
manufacturing materials and products, the Company is subject to federal, state
and local laws, rules, regulations and policies governing the use, generation,
manufacture, storage, air emission, effluent discharge, handling and disposal
of certain materials, biological specimens, and wastes. Although the Company
believes that it has complied with these laws, regulations and policies in all
material respects and has not been required to take any significant action to
correct any noncompliance, there can be no assurance that the Company will not
be required to incur significant costs to comply with environmental and health
and safety regulations in the future. The Company's research and development
involves the controlled use of hazardous materials, including but not limited
to certain hazardous chemicals and radioactive materials. 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
 
                                      27

<PAGE>
 
accidental contamination or injury from these materials cannot be eliminated.
In the event of such an accident, the Company could be held liable for any
damages that result and any such liability could exceed the resources of the
Company. See "--Risk Factors--Use of Hazardous Materials."
 
HUMAN RESOURCES
 
  As of February 28, 1997 cti employed 118 individuals full-time (including 40
holding doctoral or other advanced degrees). In recruiting additional staff
members, cti expects to receive continued input from its consultants and
members of its Scientific Advisory Board and Clinical Advisory Board.
 
  The Company's policy is to have each employee and consultant enter into an
agreement which contains provisions prohibiting the disclosure of confidential
information to anyone outside cti and requires disclosure to cti of ideas,
developments, discoveries or inventions conceived during employment and
assignment to cti of proprietary rights to such matters related to the
business and technology of cti. The extent to which this policy will
effectively protect cti's proprietary technology and trade secrets is unknown.
See "--Patents and Proprietary Rights."
 
SCIENTIFIC ADVISORY BOARD
 
  The Company has a Scientific Advisory Board and plans to make arrangements
from time to time with other scientists to work with cti's management and the
Scientific Advisory Board. The Scientific Advisory Board is chaired by Dr.
Michael R. Hanley. Scientific Advisory Board members are expected to meet as a
board with management and key scientific employees of cti on a semi-annual
basis and in smaller groups or individually from time to time on an informal
basis. The Scientific Advisory Board members assist cti in identifying
scientific and product development opportunities, reviewing with management
the progress of cti's specific projects, and recruiting and evaluating cti's
scientific staff. Members of cti's Scientific Advisory Board are leaders in
the fields of immunology, cell and molecular biology, and synthetic and
medicinal chemistry.
 
  Current Members of cti's Scientific Advisory Board include:
 
  Michael R. Hanley, Ph.D. is the Chairman of cti's Scientific Advisory Board.
He is a Professor, Department of Biological Chemistry, at the University of
California, Davis School of Medicine. He is a noted authority in cell
communication processes and proto-oncogenes, as well as an expert in
phosopholipid signaling mechanisms in the central nervous system focusing on
regulation of neurotransmitter receptors. Dr. Hanley has authored over 80
manuscripts and has served as an editorial member for several journals,
including Molecular and Cellular Neurobiology and Nature.
 
  Irwin M. Arias, M.D. is a Professor and Chairman of the Department of
Physiology at Tufts University School of Medicine. He is a noted authority in
the physiology of multidrug resistance proteins. He is the recipient of
numerous awards and honors.
 
  Bruce Beutler, M.D. is an Associate Professor of Medicine at the University
of Texas Southwestern Medical Center and an Associate Investigator at the
Howard Hughes Medical Institute. He is internationally recognized for his work
on Tumor Necrosis Factor ("TNF") and has authored over 95 manuscripts, reviews
and books on TNF, its characterization, signaling, mechanisms of action and
activity in a variety of preclinical and clinical settings. Dr. Beutler serves
as the President of the International Congress on TNF and Related Cytokines
and Consulting editor for Journal of Clinical Investigation.
 
  Edward A. Dennis, Ph.D. is the Vice Chair of Medical Biochemistry at the
University of California, San Diego. He is a noted authority on
phospholipases, cell signaling, and phospholipid metabolism. Dr. Dennis serves
on the Scientific Advisory Board and Management Committee of, and chairs the
Management Executive Board of, the Keystone Symposia. He sits on the Editorial
Board of the Journal of Cellular Biochemistry and on the
 
                                      28

<PAGE>
 
Publications Committee of the American Society for Biochemistry and Molecular
Biology. He has authored over 185 manuscripts.
 
  Edwin Krebs, M.D. is a Professor Emeritus, Department of Pharmacology and
Biochemistry, at the University of Washington in Seattle and a Senior
Investigator Emeritus at the Howard Hughes Medical Institute. He is a
recognized authority on the mechanisms of action of second messengers,
including protein kinases and phosphorylation reactions. He is the recipient
of numerous awards and honors and has authored 297 manuscripts. In 1992, Dr.
Krebs was awarded the Nobel Prize in Physiology of Medicine for his work on
second messenger pathways.
 
  Wouter H. Moolenaar, Ph.D. is the Head of the Division of Cellular
Biochemistry at the Netherlands Cancer Institute. He is an expert in
phospholipid signal transduction, focusing on their role in responses to
growth factors and in cell differentiation. He has authored over 60
manuscripts and several chapters pertaining to the role of phosphatidic acid
in cell signaling.
 
  Klaus Resch, M.D. is a noted authority in membrane phospholipid
biochemistry, their role in immune system activation and inflammation. He is a
Professor and the Head of the Institute for Molecular Pharmacology of the
Hanover Medical School, Medizinische Hochschule Hannover, and a former Vice
President of the German Society for Pharmacology and Toxicology. He has
authored over 250 scientific publications.
 
  The Company has entered into consulting agreements with each member of the
Scientific Advisory Board. These agreements generally have a three-year term
and may be terminated by either party upon 30 days' written notice. These
agreements generally restrict the consultant from competing with cti during
the term of the agreement. These agreements contain provisions prohibiting the
disclosure of confidential information to anyone outside of cti and require
disclosure to cti of ideas, developments, discoveries or inventions conceived
during consulting and assignment to cti of proprietary rights to such matters
related to the business and technology of cti. Each consultant is required to
serve on cti's Scientific Advisory Board and provide such other consulting
services as cti may reasonably request. Each Scientific Advisory Board member
is paid an annual fee and is granted an option to purchase Common Stock.
Although cti expects to receive guidance from the members of its SAB, all of
such members are employed on a full-time basis by others and, accordingly, are
not likely to devote more than a small portion of their time to cti.
 
CLINICAL ADVISORY BOARD
 
  The Company has a Clinical Advisory Board which meets with cti's management
and the Scientific Advisory Board not less than three times per year and in
smaller groups or individually from time to time on an informal basis. The
Clinical Advisory Board members assist cti in determining its clinical
regulatory strategy, interpreting clinical trial data and identifying optimal
indications for its products. Members of cti's Clinical Advisory Board are
leaders in the fields of hematology, oncology, immunology, cell and molecular
biology, critical care and medicinal chemistry.
 
  Current members of cti's Clinical Advisory Board include:
 
  E. Donnall Thomas, M.D. is the Chairman of cti's Clinical Advisory Board. He
is the former Associate Director of Clinical Research and presently a
Professor Emeritus at the FHCRC. Dr. Thomas was a founding Member of the
FHCRC. His research has spanned a wide array of fields from radiation biology
to developmental immunology, and from cancer causing genes to gene transfer
therapies. For his pioneering work in BMT, Dr. Thomas was awarded the Nobel
Prize for Medicine in 1990. His work demonstrated the feasibility and clinical
effectiveness of marrow transplant therapy, and he has contributed to the
training of a significant majority of the physicians now performing BMTs
worldwide. Among the other honors awarded to Dr. Thomas in recognition of his
medical research are the American Cancer Society Award for Distinguished
Service in Basic Research and the Kettering Prize of the General Motors Cancer
Research Foundation. He is a member of the U.S. National Academy of Sciences.
 
                                      29

<PAGE>
 
  Karen H. Antman, M.D. is the Chief of the Division of Medical Oncology,
College of Physicians & Surgeons of Columbia University. Dr. Antman is an
expert in emerging treatment strategies for solid tumors, notably breast
cancer and sarcomas. From 1994 to 1995 she served as President of the American
Society of Clinical Oncology (ASCO). Since 1993 Dr. Antman has served on the
Sarcoma Committee of the Southwest Oncology Group, and has been its
chairperson since 1995. From 1993 to 1994 she was program committee chair of
the American Association for Cancer Research (AACR). She is on the editorial
board of several prestigious journals, including Associate Editor of The New
England Journal of Medicine. She has authored over 100 manuscripts and
textbooks.
 
  Frederick Appelbaum, M.D. is the Director of Clinical Research and Senior
Vice President of the FHCRC. He is a recognized authority in the treatment of
patients with leukemia and lymphoma. He serves on several editorial boards and
national committees, including the FDA Advisory Committee on Biologics; is
Chairman of the Southwest Oncology Group Leukemia Committee; and serves on the
Board of Directors of the American Society for Blood and Marrow
Transplantation. He has authored more than 450 manuscripts.
 
  H. Franklin Bunn, M.D. is the Director of the Hematology Division of the
Brigham and Women's Hospital and Professor of Medicine at Harvard Medical
School. His research interest focuses on blood cell production and regulation.
He is the recipient of numerous awards and honors and is Chairman of the
Advisory Committee of the American Society of Hematology.
 
  O. Michael Colvin, M.D. is the Director of the Duke Comprehensive Cancer
Center at Duke University Medical Center. Dr. Colvin is an expert in
therapeutic drug modeling and rational drug design. His work led to the
discovery of several chemotherapeutic agents. He was previously Chief of the
Division of Pharmacology and Experimental Therapeutics at The Johns Hopkins
Oncology Center. He has authored over 100 manuscripts.
 
  Milo Gibaldi, Ph.D. is the Gibaldi Endowed Professor of Pharmaceutics of the
School of Pharmacy at the University of Washington, with past faculty
appointments at Columbia University and the State University of New York at
Buffalo. His expertise in drug metabolism has led to consultantships with such
pharmaceutical firms as Hoffman-LaRoche, Ciba-Geigy and Glaxo. Dr. Gibaldi has
also served on the U.S. Food and Drug Administration's Panel on Generic Drugs.
His research has focused on gastrointestinal absorption of drugs and the
development of stable formulations for therapeutic compounds.
 
  William P. Peters, M.D., Ph.D. is a Director of the Meyer L. Prentis
Comprehensive Cancer Center of Metropolitan Detroit and the President and
Chief Executive Officer of the Karmanos Cancer Institute. He is a recognized
leader in the use of dose-intensive chemotherapy regimens with peripheral
blood stem cell support as a cost-effective approach to the treatment of
cancer. He has published extensively and is the recipient of many honors and
awards, among them the American Cancer Society Clinical Fellowship Award and
the R. Wayne Rundles Award for Excellence in Cancer Research.
 
  Thomas A. Raffin, M.D. is the Chief of the Division of Pulmonary and
Critical Care Medicine of the Stanford University Medical Center. He is a
recognized authority on mechanisms of ALI, MOF and Systemic Inflammatory
Response Syndrome ("SIRS") among critically ill patients. He serves on
numerous editorial boards and societies, including the Editorial Board of
Chest and Critical Care Medicine, the American Thoracic Society and the
Society of Critical Care Medicine. He has authored more than 175 manuscripts
and 60 chapters.
 
  Merle A. Sande, M.D. is a Professor and the Chairman of the Department of
Medicine at the University of Utah, School of Internal Medicine. He is a noted
authority in infectious disease and serves on the editorial boards of several
journals, including Journal of Infectious Disease and Infection and Immunity.
He is a member of the AIDS Task Force and is the Chairman of the AIDS
Subcommittee of the Infectious Disease Society of America.
 
  Thomas E. Starzl, M.D., Ph.D. is the Director of the Transplantation
Institute of the University of Pittsburgh. He is a noted expert in the field
of immunology and solid organ transplantation. He is the recipient of numerous
 
                                      30

<PAGE>
 
awards and was founding President of several prestigious societies, including
the American Society of Transplant Surgeons. He has authored approximately
1,400 manuscripts and more than 160 book chapters.
 
  The Company has entered into consulting agreements with each member of the
Clinical Advisory Board. These agreements generally have a three-year term and
may be terminated by either party upon 30 days' written notice. These
agreements generally restrict the consultant from competing with cti during
the term of the agreement. These agreements contain provisions prohibiting the
disclosure of confidential information to anyone outside of cti and require
disclosure to cti of ideas, developments, discoveries or inventions conceived
during consulting and assignment to cti of proprietary rights to such matters
related to the business and technology of cti. Each consultant is required to
serve on cti's Clinical Advisory Board and provide such other consulting
services as cti may reasonably request. Each Clinical Advisory Board Member is
paid an annual fee and is granted an option to purchase Common Stock. Although
cti expects to receive guidance from the members of its CAB, all of such
members are employed on a full-time basis by others and, accordingly, are not
likely to devote more than a small portion of their time to cti.
 

I
TEM 2. PROPERTIES
 
  The Company leases approximately 65,000 square feet of space at 201 Elliott
Avenue West in Seattle, Washington for its executive office, laboratory and
administrative operations. The lease expires January 31, 2003, with two
consecutive five-year renewal options at the then prevailing market rent. The
Company's existing and planned facilities are believed to be adequate to meet
its present requirements, and the Company currently believes that suitable
additional space will be available to it, when needed, on commercially
reasonable terms. See "Item 1.--Business--Manufacturing."
 

ITEM 3. LEGAL PROCEEDINGS
 
  The Company is not a party to any material legal proceedings.
 

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
 
  Not applicable.
 
                                      31

<PAGE>
 

                                    PART II
 

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
 
  In March 1997 the Company completed an initial public offering of its common
stock at an offering price of $10.00 per share. The Company's common stock has
been traded on the Nasdaq National Market under the symbol "CTIC" since March
21, 1997. Prior to such date, the Company's common stock was not traded on an
established public trading market. At March 27, 1997, the Company had 686
shareholders of record and 13,028,433 outstanding shares of Common Stock.
 
  The Company has not declared or paid any cash dividends on its capital stock
since its inception. The Company currently intends to retain all of its cash
and any future earnings to finance the growth and development of its business
and therefore does not anticipate paying any cash dividends in the foreseeable
future. Any future determination to pay cash dividends will be at the
discretion of the Board of Directors and will be dependent upon the Company's
financial condition, results of operations, capital requirements and such
other factors as the Board of Directors deems relevant.
 
                                      32

<PAGE>
 

ITEM 6. SELECTED FINANCIAL DATA
 
  The selected financial data set forth below with respect to the Company's
consolidated statements of operations for each of the three years in the
period ended December 31, 1996 and for the period from September 4, 1991 (date
of incorporation) to December 31, 1996, and with respect to the consolidated
balance sheets at December 31, 1995 and 1996, are derived from the audited
consolidated financial statements of the Company included elsewhere in this
Report, and is qualified by reference to such financial statements and the
notes related thereto. The consolidated balance sheets data at December 31,
1992, 1993 and 1994 and the consolidated statements of operations data for the
years ended December 31, 1992 and 1993 are derived from audited financial
statements of the Company not included in this Report. The data set forth
below should be read in conjunction with "Item 7.--Management's Discussion and
Analysis of Financial Condition and Results of Operations" and the
Consolidated Financial Statements and Notes thereto appearing at Item 8 of
this Report.
 

<TABLE>
<CAPTION>
                                                                               PERIOD FROM
                                                                              SEPTEMBER 4,
                                                                              1991 (DATE OF
                                   YEARS ENDED DECEMBER 31,                  INCORPORATION)
                         --------------------------------------------------  TO DECEMBER 31,
                          1992      1993      1994       1995       1996          1996
                         -------  --------  ---------  ---------  ---------  ---------------
                                       (in thousands, except per share data)
<S>                      <C>      <C>       <C>        <C>        <C>        <C>             <C>
CONSOLIDATED STATEMENTS
 OF OPERATIONS DATA:
Revenues:
  Collaboration
   agreements........... $   --   $    --   $     --   $     100  $   9,121     $  9,221
Operating expenses:
  Research and
   development..........   3,926    11,862     14,368     14,606     16,109       60,871
  General and
   administrative.......   1,661     4,052      5,283      6,144      7,602       24,743
                         -------  --------  ---------  ---------  ---------     --------
    Total operating
     expenses...........   5,587    15,914     19,651     20,750     23,711       85,614
                         -------  --------  ---------  ---------  ---------     --------
Loss from operations....  (5,587)  (15,914)   (19,651)   (20,650)   (14,590)     (76,393)
Other income (expense):
  Investment income.....     292       723        616      1,167      1,174        3,974
  Interest expense......     (29)     (137)      (464)      (509)      (512)      (1,653)
                         -------  --------  ---------  ---------  ---------     --------
Net loss................ $(5,324) $(15,328) $ (19,499) $ (19,992) $ (13,928)    $(74,072)
                         =======  ========  =========  =========  =========     ========
Net loss per share......                    $   (4.13) $   (4.19) $   (2.82)
                                            =========  =========  =========
Shares used in computa-
 tion of net loss per
 share..................                    4,716,399  4,771,247  4,939,388
                                            =========  =========  =========
Pro forma net loss per
 share (1)..............                                          $   (1.69)
                                                                  =========
Shares used in computa-
 tion of pro forma net
 loss per share.........                                              8,228
</TABLE>

 

<TABLE>
<CAPTION>
                                             DECEMBER 31,
                              -----------------------------------------------
                                1992      1993     1994      1995      1996
                              --------  --------  -------  --------  --------
                                            (in thousands)
<S>                           <C>       <C>       <C>      <C>       <C>
CONSOLIDATED BALANCE SHEETS
 DATA:
Cash, cash equivalents and
 securities available-for-
 sale........................ $ 28,648  $ 27,452  $ 9,131  $ 21,906  $ 30,987
Working capital..............   27,563    23,387    4,094    18,342    26,300
Total assets.................   33,422    35,230   17,278    28,048    37,002
Long-term obligations, less
 current portion.............      319     3,635    2,620     2,606     2,005
Deficit accumulated during
 development stage...........   (5,324)  (20,652) (40,151)  (60,119)  (74,083)
Total shareholders' equity...   31,851    28,848   10,051    21,858    30,054
</TABLE>

 
- --------
(1) See Note 1 of Notes to Consolidated Financial Statements for information
    concerning the computation of pro forma net loss per share.
 
                                      33

<PAGE>
 

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
 
OVERVIEW
 
  Since commencement of operations in 1992, the Company has been engaged in
research and development activities, including conducting preclinical studies
and clinical trials, and recruiting its scientific and management personnel,
establishing laboratory facilities and raising capital. The Company has not
received any revenue from the sale of products to date and does not expect to
receive revenues from the sale of products for at least the next several
years.
 
  In the fourth quarter of 1995 the Company began to receive revenue under a
collaboration agreement with BioChem Pharma, and in the fourth quarter of 1996
the Company began to receive revenue under the Collaboration Agreement with
Johnson & Johnson. The Company expects that its revenue sources for at least
the next several years will consist primarily of future expense reimbursements
and milestone payments under its collaboration agreements with Johnson &
Johnson and BioChem Pharma, and of interest income. The timing and amounts of
such revenues will likely fluctuate. The Company will be required to conduct
significant research, development and clinical activities during the next
several years to fulfill its obligations under the Collaboration Agreement
with Johnson & Johnson. There can be no assurance that Johnson & Johnson will
not terminate the Collaboration Agreement in accordance with its terms. See
"Item 1.--Business--Collaborations."
 
  As of December 31, 1996 the Company had incurred aggregate net losses of
approximately $74.1 million since its inception. The Company expects to
continue to incur significant additional operating losses over the next
several years as its research, development and clinical trial efforts expand.
Operating losses may fluctuate from quarter to quarter as a result of
differences in the timing of expenses incurred and revenues recognized. To
date, the Company's operations have been funded primarily from the sale of
equity securities, which have raised aggregate net proceeds of approximately
$133.1 million.
 
  On March 26, 1997 the Company completed an initial public offering of 3
million shares of its common stock at an offering price of $10.00 per share,
resulting in estimated net proceeds of $27.1 million. Concurrent with the
closing of the Offering, the Company sold 300,000 shares of Common Stock to
Johnson & Johnson at a price of $10.00 per share, resulting in estimated net
proceeds of $3.0 million.
 
RESULTS OF OPERATIONS
 
 Years Ended December 31, 1996 and 1995
 
  During the year ended December 31, 1996 the Company recorded a $5.0 million
license fee and $871,000 in development cost reimbursement from Johnson &
Johnson in connection with the Collaboration Agreement and a $250,000
milestone payment from BioChem Pharma in connection with a collaboration
agreement. The Company also received a $3.0 million signing fee from Schering
AG in connection with a collaboration agreement which was terminated by
Schering AG in April 1996. See "Item 1.--Business--Risk Factors--No Assurance
of Successful Product Development; Uncertainties Related to Clinical Trials"
and Note 11 of Notes to Consolidated Financial Statements. During the year
ended December 31, 1995, the Company received a milestone payment of $100,000
under the collaboration agreement with BioChem Pharma. See "Item 1.--
Business--Collaborations."
 
  Research and development expenses increased to approximately $16.1 million
for the year ended December 31, 1996 from approximately $14.6 million for the
year ended December 31, 1995. This increase was primarily due to expanded
manufacturing, preclinical and clinical-related development activities with
respect to Lisofylline, which increase was partially offset by costs of
approximately $1.2 million incurred in connection with the purchase of all the
intellectual property of Lipomed Corporation in October 1995, which was
accounted for as in-process research and development expense. The Company
expects that research and development expenses will increase significantly in
future years as the Company expands its research and development programs and
undertakes additional clinical trials, including research, development and
clinical activities undertaken pursuant to the Collaboration Agreement with
Johnson & Johnson.
 
 
                                      34

<PAGE>
 
  General and administrative expenses increased to approximately $7.6 million
for the year ended December 31, 1996 from approximately $6.1 million for the
year ended December 31, 1995. This increase was primarily due to transaction
costs associated with the collaboration agreement with Schering AG, which was
terminated by Schering AG in April 1996, transaction costs associated with the
Collaboration Agreement with Johnson & Johnson, offering costs associated with
the Company's withdrawn registration statement in 1996, and operating expenses
associated with supporting the Company's increased research, development and
clinical activities. General and administrative expenses are expected to
increase to support the Company's expected increase in research, development
and clinical trial efforts.
 
  Investment income principally comprises interest income from investment of
the Company's cash reserves. Interest expense results primarily from the
financing of laboratory and other equipment. Investment income was
approximately $1.2 million for each of the years ended December 31, 1996 and
1995, as average cash balances and interest earned thereon was little changed
between years. Interest expense was approximately $500,000 for both the year
ended December 31, 1996 and 1995.
 
 Years Ended December 31, 1995 and 1994
 
  Revenue from the BioChem Pharma collaboration totalled $100,000 in 1995, all
of which was received in the third quarter of 1995. The Company did not have
any operating revenue during 1994.
 
  Research and development expenses increased to approximately $14.6 million
in 1995 from approximately $14.4 million in 1994. This increase was primarily
due to costs of approximately $1.2 million incurred in connection with the
purchase of all the intellectual property of Lipomed Corporation in October
1995, which was accounted for as in-process research and development expense,
partially offset by a reduction in manufacturing costs associated with
Lisofylline.
 
  General and administrative expenses increased to approximately $6.1 million
in 1995 from approximately $5.3 million in 1994. This increase was primarily
due to operating expenses associated with supporting the Company's increased
research, development and clinical activities, including business development,
marketing studies and recruitment of additional personnel.
 
  Investment income net of interest expense increased to approximately
$658,000 in 1995 from approximately $152,000 in 1994. This increase was
associated with interest earnings on a higher average balance of cash reserves
resulting from a private placement of equity securities in 1995.
 
LIQUIDITY AND CAPITAL RESOURCES
 
  The Company has financed its operations since inception primarily through
the sale of equity securities. As of December 31, 1996 the Company had raised
aggregate net proceeds of approximately $103.0 million from such financing
activities, including $30.5 million and $16.9 million from the sale of Series
A Convertible Preferred Stock in 1995 and 1996, respectively, $5.0 million
from the sale of Series B Convertible Preferred Stock to Johnson & Johnson in
1996, $49.3 million from the sale of Common Stock in 1992 and 1993, $850,000
from a bridge loan which was subsequently converted to equity, and
approximately $400,000 from the exercise of stock options and warrants. The
Company expensed approximately $320,000 in deferred offering costs related to
its withdrawn initial public offering in 1996. As of December 31, 1996 the
Company has recorded approximately $360,000 of deferred offering costs related
to its currently planned offering. In addition, the Company financed the
purchase of approximately $11.3 million of property and equipment through
financing agreements, of which approximately $2.8 million remained outstanding
as of December 31, 1996.
 
  On March 26, 1997 the Company completed an initial public offering (the
"Offering") of 3 million shares of its common stock at an offering price of
$10.00 per share, resulting in estimated net proceeds of $27.1 million.
Concurrent with the closing of the Offering, the Company sold 300,000 shares
of Common Stock to Johnson & Johnson (the "Johnson & Johnson Stock Purchase")
at a price of $10.00 per share, resulting in estimated net proceeds of $3.0
million. The Company intends to use the substantial majority of the net
proceeds of the
 
                                      35

<PAGE>
 
Offering and the Johnson & Johnson Stock Purchase to fund its research and
development activities with respect to the Company's Lisofylline and CT-2584
programs, including preclinical testing, clinical trials and process
development activities, and to fund other research and development activities.
The amounts actually expended for research and development activities and the
timing of such expenditures will depend upon numerous factors, including the
progress of the Company's research and development programs, the results of
preclinical and clinical trials, the timing of regulatory submissions and
approvals, if any, technological advances, determinations as to the commercial
potential of the Company's compounds, and the status and timing of competitive
products. The amount of expenditures will also depend upon the continued
participation of Johnson & Johnson in the Collaboration Agreement, the timing
and availability of alternative methods of financing the Company's research
and development activities and preclinical and clinical trials, and the
establishment of collaborative agreements with other companies. In addition,
the Company's research and development expenditures will vary as product
development activities and preclinical and clinical trials, and the
establishment of collaborative agreements with other companies. In addition,
the Company's research and development expenditures will vary as product
development programs are added, expanded or discontinued. A variety of other
factors, some of which are beyond the Company's control, could also affect the
application of the proceeds.
 
  The balance of the net proceeds of the Offering and the Johnson & Johnson
Stock Purchase is expected to be used to improve facilities, to purchase
capital equipment and for general corporate purposes. The Company has not
identified precisely the amount it plans to spend on these specific programs
or the timing of such expenditures. Pending such uses, the Company intends to
invest the net proceeds from the Offering and the Johnson & Johnson Stock
Purchase in U.S. government obligations and other highly rated liquid debt
instruments. The Company may also from time to time consider the acquisition
of other companies, technologies or products that complement the business of
the Company, although no agreements or understandings are in effect with
respect to any such transactions at this time. See "Item 1.--Business--Risk
Factors--Need for Substantial Additional Funds."
 
  The Company's principal sources of liquidity are its cash balances, cash
equivalents and securities available-for-sale, which totaled approximately
$31.0 million as of December 31, 1996. The Company invests in U.S. government
obligations and other highly rated liquid debt instruments.
 
  The Company expects that its capital requirements will increase as the
Company expands its research and development programs and undertakes
additional clinical trials. In connection with such expansion, the Company
expects to incur substantial expenditures for hiring additional management,
scientific and administrative personnel, for planned expansion of its
facilities, and for the purchase or lease of additional equipment. See "Item
1.--Business--Risk Factors--Management of Growth."
 
  The Company does not expect to generate a positive cash flow from operations
for several years due to substantial additional research and development
costs, including costs related to drug discovery, preclinical testing,
clinical trials, manufacturing costs and operating expenses associated with
supporting such activities. The Company expects that its existing capital
resources and the interest earned thereon, combined with anticipated funding
from Johnson & Johnson under the Collaboration Agreement, will enable the
Company to maintain its current and planned operations at least through the
end of 1998. In the event that Johnson & Johnson were to terminate its
participation in the Collaboration Agreement prior to such date, cti expects
that it would eliminate certain presently planned development activities.
Furthermore, the Company will need to raise substantial additional capital to
fund its operations beyond such time. The Company's future capital
requirements will depend on, and could increase as a result of, many factors,
including the continuation of the Company's collaboration with Johnson &
Johnson; continued scientific progress in its research and development
programs; the magnitude of such programs; the progress of preclinical testing
and clinical trials; the time and costs involved in obtaining regulatory
approvals; the costs involved in preparing, filing, prosecuting, maintaining,
enforcing and defending patent claims; competing technological and market
developments; changes in collaborative relationships; the terms of any
additional collaborative arrangements that the Company may enter into; the
ability of the Company to establish research, development and
commercialization arrangements pertaining to products other than those covered
by existing collaborative arrangements; the cost of establishing manufacturing
facilities; the cost of commercialization activities and the demand for the
Company's products if and when approved.
 
                                      36

<PAGE>
 
  The Company intends to raise additional funds through additional equity or
debt financings, research and development financings, collaborative
relationships or otherwise. Because of these long-term capital requirements,
the Company may seek to access the public or private equity markets from time
to time, even if it does not have an immediate need for additional capital at
that time. There can be no assurance that additional financing will be
available to the Company, or, if available, that it will be on acceptable
terms. If additional funds are raised by issuing equity securities, further
dilution to shareholders may result. If adequate funds are not available, the
Company may be required to delay, reduce the scope of, or eliminate one or
more of its research, development and clinical activities. The Company may
also be required to seek to 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 otherwise seek to develop or commercialize itself. See "Item
1.--Business--Risk Factors--History and Continuation of Losses; Early Stage of
Development," "--Need for Substantial Additional Funds" and "--Reliance on
Relationship with Johnson & Johnson."
 
  As of December 31, 1996 the Company had available for Federal income tax
purposes net operating loss carryforwards of approximately $70 million and
research and development credit carryforwards of approximately $1.8 million.
These carryforwards begin to expire in 2007. The Company's ability to utilize
its net operating loss and research and development credit carryforwards is
subject to an annual limitation in future periods pursuant to the "change in
ownership" rules under Section 382 of the Internal Revenue Code of 1986. See
Note 10 of Notes to Consolidated Financial Statements.
 
                                      37

<PAGE>
 

I
TEM 8. CONSOLIDATED FINANCIAL STATEMENTS
 
                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
 

<TABLE>
<CAPTION>
                                                                            PAGE
                                                                            ----
<S>                                                                         <C>
Report of Ernst & Young LLP, Independent Auditors..........................  39
Consolidated Balance Sheets................................................  40
Consolidated Statements of Operations......................................  41
Consolidated Statements of Shareholders' Equity............................  42
Consolidated Statements of Cash Flows......................................  45
Notes to Consolidated Financial Statements.................................  46
</TABLE>

 
                                       38

<PAGE>
 

               REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS
 
The Board of Directors and Shareholders
Cell Therapeutics, Inc.
 
  We have audited the accompanying consolidated balance sheets of Cell
Therapeutics, Inc. (a development stage company) as of December 31, 1996 and
1995, and the related consolidated statements of operations, shareholders'
equity, and cash flows for each of the three years in the period ended
December 31, 1996 and for the period from September 4, 1991 (date of
incorporation) to December 31, 1996. These financial statements are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.
 
  We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
 
  In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Cell Therapeutics, Inc. (a
development stage company) at December 31, 1996 and 1995, and the results of
its operations and its cash flows for each of the three years in the period
ended December 31, 1996 and for the period from September 4, 1991 (date of
incorporation) to December 31, 1996, in conformity with generally accepted
accounting principles.
 
Seattle, Washington
January 24, 1997, except for paragraphs 2 through 4 of Note 12, as to which
 the date is March 26, 1997
 
 
                                          Ernst & Young LLP
 
 
                                      39

<PAGE>
 
                            CELL THERAPEUTICS, INC.
                         (A DEVELOPMENT STAGE COMPANY)
 
                          CONSOLIDATED BALANCE SHEETS
 

<TABLE>
<CAPTION>
                                                          DECEMBER 31,
                                                    --------------------------
                                                        1996          1995
                                                    ------------  ------------
<S>                                                 <C>           <C>
ASSETS
Current assets:
  Cash and cash equivalents........................ $  5,483,515  $  6,931,592
  Securities available-for-sale....................   25,503,049    14,974,430
  Prepaid expenses and other current assets........      256,892        20,080
                                                    ------------  ------------
Total current assets...............................   31,243,456    21,926,102
Property and equipment, net........................    5,117,936     5,713,227
Notes receivable from officers, less current por-
 tion..............................................      172,698       221,722
Other assets.......................................      467,603       187,244
                                                    ------------  ------------
Total assets....................................... $ 37,001,693  $ 28,048,295
                                                    ============  ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
  Accounts payable................................. $    651,130  $  1,057,428
  Accrued expenses.................................    3,065,297     1,412,424
  Current portion of long-term obligations.........    1,226,971     1,114,520
                                                    ------------  ------------
Total current liabilities..........................    4,943,398     3,584,372
Long-term obligations, less current portion........    2,004,575     2,605,698
Commitments                                                  --            --
Shareholders' equity:
  Preferred Stock:
    Authorized shares--10,000,000:
     Series A Convertible Preferred Stock, no par
      value:
      Designated shares--146,193.272 and 150,000 at
       December 31, 1996 and 1995, respectively

      Issued and outstanding shares--146,193.272
       and 95,447.004 at December 31, 1996 and
       1995, respectively (liquidation preference
       $335 per share aggregating $48,974,746 at
       December 31, 1996)..........................   47,366,204    30,496,204
     Series B Convertible Preferred Stock, no par
      value:
      Designated shares--14,925.373
      Issued and outstanding shares--14,925.373 at
       December 31, 1996 (liquidation preference
       $335 per share aggregating $5,000,000 at
       December 31, 1996)..........................    4,960,000           --
     Series C Preferred Stock, no par value:
      Designated shares--100,000
      No shares issued and outstanding (liquidation
       preference $1,000 per share)................          --            --
  Common Stock, no par value:
    Authorized shares--100,000,000
    Issued and outstanding shares--4,943,472 and
     4,933,410 at December 31, 1996 and 1995,
     respectively .................................   51,810,160    51,481,481
  Deficit accumulated during development stage.....  (74,082,644)  (60,119,460)
                                                    ------------  ------------
Total shareholders' equity.........................   30,053,720    21,858,225
                                                    ------------  ------------
Total liabilities and shareholders' equity......... $ 37,001,693  $ 28,048,295
                                                    ============  ============
</TABLE>

 
                            See accompanying notes.
 
                                       40

<PAGE>
 
                            CELL THERAPEUTICS, INC.
                         (A DEVELOPMENT STAGE COMPANY)
 
                     CONSOLIDATED STATEMENTS OF OPERATIONS
 

<TABLE>
<CAPTION>
                                                                     PERIOD FROM
                                                                    SEPTEMBER 4,
                                                                    1991 (DATE OF
                                YEAR ENDED DECEMBER 31,            INCORPORATION)
                         ----------------------------------------  TO DECEMBER 31,
                             1996          1995          1994           1996
                         ------------  ------------  ------------  ---------------
<S>                      <C>           <C>           <C>           <C>
Revenues:
  Collaboration
   agreements........... $  9,120,806  $    100,000  $        --    $  9,220,806
Operating expenses:
  Research and
   development..........   16,108,821    14,605,947    14,368,089     60,870,651
  General and
   administrative.......    7,601,796     6,144,650     5,283,263     24,743,279
                         ------------  ------------  ------------   ------------
                           23,710,617    20,750,597    19,651,352     85,613,930
                         ------------  ------------  ------------   ------------
Loss from operations....  (14,589,811)  (20,650,597)  (19,651,352)   (76,393,124)
Other income (expense):
  Investment income.....    1,174,219     1,167,369       616,223      3,973,759
  Interest expense......     (512,597)     (509,247)     (464,154)    (1,652,462)
                         ------------  ------------  ------------   ------------
Net loss................ $(13,928,189) $(19,992,475) $(19,499,283)  $(74,071,827)
                         ============  ============  ============   ============
Net loss per share...... $      (2.82) $      (4.19) $      (4.13)
                         ============  ============  ============
Shares used in computa-
 tion of net loss per
 share..................    4,939,388     4,771,247     4,716,399
                         ============  ============  ============
Pro forma (unaudited):
  Net loss per share.... $      (1.69)
                         ============
  Shares used in
   computation of net
   loss per share.......    8,277,888
</TABLE>

 
 
                            See accompanying notes.
 
                                       41

<PAGE>
 
                            CELL THERAPEUTICS, INC.
                         (A DEVELOPMENT STAGE COMPANY)
 
                CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
 

<TABLE>
<CAPTION>
                                                        PREFERRED STOCK         DEFICIT       DEFERRED
                                                  --------------------------- ACCUMULATED   COMPENSATION
                               COMMON STOCK         SERIES A      SERIES B      DURING     AND TECHNOLOGY
                           ---------------------  ------------- ------------- DEVELOPMENT    LICENSING
                            SHARES      AMOUNT    SHARES AMOUNT SHARES AMOUNT    STAGE         COSTS         TOTAL
                           ---------  ----------  ------ ------ ------ ------ -----------  -------------- -----------
<S>                        <C>        <C>         <C>    <C>    <C>    <C>    <C>          <C>            <C>
December 1991 issuance of
 common stock to founders
 at $0.04179 per share
 (including 182,143
 shares contributed by
 founders for
 compensation and
 technology).............  1,914,313  $   87,612   --     $--    --     $--   $       --        $(7,612)  $    80,000
 April 1992 proceeds
  received from issuance
  of shares at $11.20 per
  share and 57,143
  warrants at $0.07 each
  to the chairman of the
  Board of Directors.....    178,572   2,004,000   --      --    --      --           --            --      2,004,000
 Net proceeds from the
  issuance of common
  stock in August through
  December 1992 via
  private placement
  equity offering at
  $17.50 per share, net
  of offering costs of
  $3,467,352.............  2,225,139  35,083,440   --      --    --      --           --            --     35,083,440
 Net loss for the year
  ended December 31,
  1992...................        --          --    --      --    --      --    (5,323,737)          --     (5,323,737)
 Fair value of stock
  contributed by founders
  for compensation and
  technology.............        --          --    --      --    --      --           --          7,612         7,612
                           ---------  ----------   ---    ----   ---    ----  -----------    ----------   -----------
Balance at December 31,
 1992....................  4,318,024  37,175,052   --      --    --      --    (5,323,737)          --     31,851,315
 August 1993 Repurchase
  of common stock at
  $0.04179 per share and
  July 1993 cancellation
  of 1,072 shares........    (61,415)     (2,522)  --      --    --      --           --            --         (2,522)
 Net proceeds from the
  issuance of common
  stock and warrants in
  October and November
  1993 via private
  placement equity
  offering at $31.50 per
  unit, net of offering
  costs of $1,486,383....    438,540  12,326,885   --      --    --      --           --            --     12,326,885
 Net loss for the year
  ended December 31,
  1993...................        --          --    --      --    --      --   (15,328,143)          --    (15,328,143)
                           ---------  ----------   ---    ----   ---    ----  -----------    ----------   -----------
Balance at December 31,
 1993....................  4,695,149  49,499,415   --      --    --      --   (20,651,880)          --     28,847,535
</TABLE>

 
                                       42

<PAGE>
 
                            CELL THERAPEUTICS, INC.
                         (A DEVELOPMENT STAGE COMPANY)
 
          CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY--(CONTINUED)

<TABLE>
<CAPTION>
                                                     PREFERRED STOCK             DEFICIT       DEFERRED
                                           ----------------------------------- ACCUMULATED   COMPENSATION
                          COMMON STOCK           SERIES A          SERIES B      DURING     AND TECHNOLOGY
                      -------------------- --------------------- ------------- DEVELOPMENT    LICENSING
                       SHARES     AMOUNT     SHARES     AMOUNT   SHARES AMOUNT    STAGE         COSTS         TOTAL
                      --------- ---------- ---------- ---------- ------ ------ -----------  -------------- ------------
<S>                   <C>       <C>        <C>        <C>        <C>    <C>    <C>          <C>            <C>
 Net proceeds from
  the issuance of
  common stock and
  warrants in
  February 1994 via
  private placement
  equity offering at
  $31.50 per unit,
  net of offering
  costs of $85,823...    25,001    701,677        --         --   --     --            --        --             701,677
 Proceeds from stock
  options exercised
  in July 1994 at
  $17.50 per share...        79      1,375        --         --   --     --            --        --               1,375
 Net loss for the
  year ended December
  31, 1994...........       --         --         --         --   --     --    (19,499,283)      --         (19,499,283)
                      --------- ---------- ---------- ----------  ---    ---   -----------       ---       ------------
Balance at December
 31, 1994............ 4,720,229 50,202,467        --         --   --     --    (40,151,163)      --          10,051,304
 Net proceeds from
  the issuance of
  Series A
  convertible
  preferred stock in
  March through June
  1995 via private
  placement equity
  offering at $335.00
  per share, net of
  offering costs of
  $1,478,541.........       --         --  95,447.004 30,496,204  --     --            --        --          30,496,204
 Exchange of warrants
  for common stock in
  September 1995
  valued at $11.725
  per share..........   104,418        --         --         --   --     --            --        --                 --
 Issuance of common
  stock for purchased
  research and
  development in
  October 1995 at
  $11.725 per share..    98,574  1,155,750        --         --   --     --            --        --           1,155,750
 Proceeds from
  issuance of stock
  and stock options
  exercised in
  February through
  December 1995 at
  $11.725 and $17.50
  per share..........    10,189    123,264        --         --   --     --            --        --             123,264
 Net loss for the
  year ended December
  31, 1995...........       --         --         --         --   --     --    (19,992,475)      --         (19,992,475)
 Unrealized gains on
  securities
  available-for-
  sale...............       --         --         --         --   --     --         24,178       --              24,178
                      --------- ---------- ---------- ----------  ---    ---   -----------       ---       ------------
Balance at December
 31, 1995............ 4,933,410 51,481,481 95,447.004 30,496,204  --     --    (60,119,460)      --          21,858,225
 Net proceeds from
  the issuance of
  Series A
  convertible
  preferred stock in
  September and
  October 1996 via
  private placement
  equity offering at
  $335.00 per share,
  net of offering
  costs of $130,000..       --         --  50,746.268 16,870,000  --     --            --        --          16,870,000
</TABLE>

 
                                       43

<PAGE>
 
                            CELL THERAPEUTICS, INC.
                         (A DEVELOPMENT STAGE COMPANY)
 
          CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY--(CONTINUED)

<TABLE>
<CAPTION>
                                                       PREFERRED STOCK                  DEFICIT        DEFERRED
                                        --------------------------------------------- ACCUMULATED    COMPENSATION
                      COMMON STOCK             SERIES A               SERIES B           DURING     AND TECHNOLOGY
                  --------------------- ----------------------- --------------------- DEVELOPMENT     LICENSING
                   SHARES     AMOUNT      SHARES      AMOUNT      SHARES     AMOUNT      STAGE          COSTS         TOTAL
                  --------- ----------- ----------- ----------- ---------- ---------- ------------  -------------- -----------
<S>               <C>       <C>         <C>         <C>         <C>        <C>        <C>           <C>            <C>
 Net proceeds
  from the
  issuance of
  Series B
  convertible
  preferred stock
  in November
  1996 via
  private
  placement
  equity offering
  at $335.00 per
  share, net of
  offering costs
  of $40,000.....       --          --          --          --  14,925.373  4,960,000          --          --        4,960,000
 Exchange of
  warrants for
  common stock in
  February 1996
  valued at
  $11.725 per
  share..........       151         --          --          --         --         --           --          --              --
 Proceeds from
  stock options
  exercised in
  January through
  November 1996
  at $11.725 per
  share..........     1,974      23,121         --          --         --         --           --          --           23,121
 Proceeds from
  common stock
  warrants
  exercised in
  May 1996 at
  $38.50 per
  share..........     7,937     305,558         --          --         --         --           --          --          305,558
 Net loss for the
  year ended
  December 31,
  1996...........       --          --          --          --         --         --   (13,928,189)        --      (13,928,189)
 Unrealized
  losses on
  securities
  available-for-
  sale...........       --          --          --          --         --         --       (34,995)        --          (34,995)
                  --------- ----------- ----------- ----------- ---------- ---------- ------------     -------     -----------
Balance at
 December 31,
 1996............ 4,943,472 $51,810,160 146,193.272 $47,366,204 14,925.373 $4,960,000 $(74,082,644)       $--      $30,053,720
                  ========= =========== =========== =========== ========== ========== ============     =======     ===========
</TABLE>

 
                            See accompanying notes.
 
                                       44

<PAGE>
 
                            CELL THERAPEUTICS, INC.
                         (A DEVELOPMENT STAGE COMPANY)
 
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
 

<TABLE>
<CAPTION>
                                                                      PERIOD FROM
                                                                     SEPTEMBER 4,
                                                                     1991 (DATE OF
                                 YEAR ENDED DECEMBER 31,            INCORPORATION)
                          ----------------------------------------  TO DECEMBER 31,
                              1996          1995          1994           1996
                          ------------  ------------  ------------  ---------------
<S>                       <C>           <C>           <C>           <C>
OPERATING ACTIVITIES
Net loss................  $(13,928,189) $(19,992,475) $(19,499,283)  $(74,071,827)
Adjustments to reconcile
 net loss to net cash
 used in operating
 activities:
 Depreciation and amor-
  tization..............     1,658,475     1,718,765     1,617,438      6,461,261
 Noncash research and
  development expense...           --      1,155,750           --       1,155,750
 Noncash interest ex-
  pense.................           --            --            --          25,918
 Noncash rent expense...        54,216        33,396        33,396        494,288
 Investment premium am-
  ortization............       111,315        22,500       119,110        522,061
 Changes in assets and
  liabilities:
 Prepaid expenses.......      (236,812)       (2,789)      166,123       (256,892)
 Notes receivable from

  officers..............       (46,200)      (10,700)      (11,022)      (267,922)
 Other assets...........      (201,679)        9,208      (143,476)      (483,604)
 Accounts payable.......      (406,298)      329,525       330,197        651,130
 Accrued expenses.......     1,652,873      (245,376)      906,428      3,065,297
                          ------------  ------------  ------------   ------------
Total adjustments.......     2,585,890     3,010,279     3,018,194     11,367,287
                          ------------  ------------  ------------   ------------
Net cash used in operat-
 ing activities.........   (11,342,299)  (16,982,196)  (16,481,089)   (62,704,540)
INVESTING ACTIVITIES
Purchases of securities
 available-for-sale.....   (27,113,929)  (13,165,743)   (7,555,482)   (76,026,027)
Proceeds from sales of
 securities available-
 for-sale...............           --      3,856,167    11,034,146     14,890,313
Proceeds from maturities
 of securities avail-
 able-for-sale..........    16,439,000     1,059,296     2,048,016     35,099,787
Purchase of property and
 equipment..............    (1,046,640)     (204,424)   (1,654,517)   (11,334,936)
Dispositions of property
 and equipment..........           --         36,476       114,993        151,469
                          ------------  ------------  ------------   ------------
Net cash provided by
 (used in) investing ac-
 tivities...............   (11,721,569)   (8,418,228)    3,987,156    (37,219,394)
FINANCING ACTIVITIES
Sales of common stock to
 founders...............           --            --            --          80,000
Proceeds from borrowings
 from shareholder.......           --            --            --         850,000
Sale of Series A Pre-
 ferred Stock via pri-
 vate placement, net of
 offering costs.........    16,870,000    30,496,204           --      47,366,204
Sale of Series B Pre-
 ferred Stock via pri-
 vate placement, net of
 offering costs.........     4,960,000           --            --       4,960,000
Sale of common stock via
 private placements, net
 of offering costs......           --         67,000       701,677     49,307,084
Repurchase of common
 stock..................           --            --            --          (2,522)
Proceeds from common
 stock options exer-
 cised..................        23,121        56,264         1,375         80,760
Proceeds from common
 stock warrants exer-
 cised..................       305,558           --            --         305,558
Repayment of long-term
 obligations............    (1,159,188)   (2,954,434)   (3,940,830)    (8,471,269)
Change in deferred of-
 fering costs...........           --        458,726      (458,726)           --
Proceeds from the issu-
 ance of long-term obli-
 gations................       616,300     1,800,000     3,515,334     10,931,634
                          ------------  ------------  ------------   ------------
Net cash provided by
 (used in) financing ac-
 tivities...............    21,615,791    29,923,760      (181,170)   105,407,449
                          ------------  ------------  ------------   ------------
Net increase (decrease)
 in cash and cash equiv-
 alents.................    (1,448,077)    4,523,336   (12,675,103)     5,483,515
Cash and cash equiva-
 lents at beginning of
 period.................     6,931,592     2,408,256    15,083,359            --
                          ------------  ------------  ------------   ------------
Cash and cash equiva-
 lents at end of peri-
 od.....................  $  5,483,515  $  6,931,592  $  2,408,256   $  5,483,515
                          ============  ============  ============   ============
SUPPLEMENTAL SCHEDULE OF
 NONCASH INVESTING AND
 FINANCING ACTIVITIES
Acquisition of equipment
 pursuant to capital
 lease obligations......  $     85,532  $        --   $        --    $    362,425
                          ============  ============  ============   ============
Conversion of convert-
 ible debt and related
 accrued interest into
 common stock...........  $        --   $        --   $        --    $    875,918
                          ============  ============  ============   ============
SUPPLEMENTAL DISCLOSURE
 OF CASH FLOW
 INFORMATION
Cash paid during the pe-
 riod for interest......  $    514,534  $    529,847  $    476,845   $  1,626,025
                          ============  ============  ============   ============
</TABLE>

 
                            See accompanying notes.
 
                                       45

<PAGE>
 
                            CELL THERAPEUTICS, INC.
                         (A DEVELOPMENT STAGE COMPANY)
 
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
                               DECEMBER 31, 1996
 
 1.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
 Description of Business
 
  Cell Therapeutics, Inc. (the "Company") focuses on the discovery,
development, and commercialization of small molecule drugs for the treatment
of cancer and inflammatory and immune diseases. The Company's principal
business strategy is to focus its development activities on therapeutic areas
that represent large market opportunities which are not adequately served by
existing therapies. The Company incorporated on September 4, 1991, but did not
commence operations until February 1992.
 
  The Company operates in a highly regulated and competitive environment. The
manufacturing and marketing of pharmaceutical products require approval from
and are subject to ongoing oversight by the Food and Drug Administration in
the United States and by comparable agencies in other countries. Obtaining
approval for a new therapeutic product is never certain and may take several
years and involve expenditure of substantial resources. Competition in
researching, developing, and marketing pharmaceutical products is intense. Any
of the technologies covering the Company's existing products under development
could become obsolete or diminished in value by discoveries and developments
of other organizations.
 
 Principles of Consolidation
 
  The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiary. All intercompany transactions and balances
are eliminated in consolidation.
 
 Cash and Cash Equivalents
 
  The Company considers all highly liquid debt instruments with maturities of
three months or less at the time acquired to be cash equivalents. Cash
equivalents represent short-term investments consisting of investment-grade
corporate and government obligations, carried at cost, which approximates
market value.
 
 Securities Available-for-Sale
 
  Management determines the appropriate classification of debt securities at
the time of purchase. Management currently classifies its investment portfolio
as available-for-sale and carries the securities at fair value based on quoted
market prices with unrealized gains and losses included within the deficit
accumulated during development stage. The amortized cost of debt securities in
this category is adjusted for amortization of premiums and accretion of
discounts to maturity. Such amortization and accretion are included in
investment income. Realized gains and losses and declines in value judged to
be other than temporary on available-for-sale securities are included in
investment income. The cost of securities sold is based on the specific
identification method. Interest on securities classified as available-for-sale
is included in investment income.
 
 Management of Credit Risk
 
  The Company is subject to concentration of credit risk from its cash
investments. Under the Company's investment guidelines, credit risk is managed
by diversification of the investment portfolio and by the purchase of
investment-grade securities.
 
 Collaboration Agreement Receivables and Revenues
 
  Collaboration agreement receivables represent amounts earned, but not yet
collected, under collaboration and license agreements. Collaboration agreement
revenues are recognized as the earnings process is completed, based on the
provisions of each agreement.
 
                                      46

<PAGE>
 
                            CELL THERAPEUTICS, INC.
                         (A DEVELOPMENT STAGE COMPANY)
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 1.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
 
 Property and Equipment
 
  Property and equipment, including assets pledged as security in financing
agreements, are carried at cost, less accumulated depreciation and
amortization. Leasehold improvements are amortized over the lesser of the
useful life or the term of the applicable lease using the straight-line
method. Depreciation commences at the time assets are placed in service and is
computed using the straight-line method over the estimated useful lives of the
assets (three to five years).
 
 Deferred Offering Costs
 
  The Company records legal and other issuance costs related to its offerings
of stock as deferred offering costs until the offerings are completed and the
costs are netted against gross proceeds.
 
 Stock-Based Compensation
 
  The Company has elected to follow Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees," and related interpretations in
accounting for its employee stock options. Generally, stock compensation, if
any, is measured as the difference between the exercise price of a stock
option and the fair market value of the Company's stock at the date of grant,
which is then amortized over the related vesting period. The value of stock
options granted to consultants is recorded as an expense and amortized over
the lives of the respective contracts.
 
 Net Loss Per Share
 
  Net loss per share is computed using the weighted average number of shares
of common stock outstanding. Common stock equivalents from preferred stock,
stock options, and warrants are excluded from the computation as their effect
is antidilutive.
 
 
 Pro Forma Net Loss Per Share
 
  Unaudited pro forma net loss per share is computed based on the weighted
average number of shares of common stock outstanding plus the number of common
shares issuable upon conversion of all outstanding shares of Series A and
Series B Convertible Preferred Stock upon the closing of the Company's initial
public offering discussed in Note 12.
 
 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 amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
 
 Reclassifications
 
  Certain prior year items have been reclassified to conform to the current
year presentation.
 
                                      47

<PAGE>
 
                            CELL THERAPEUTICS, INC.
                         (A DEVELOPMENT STAGE COMPANY)
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 2.  SECURITIES AVAILABLE-FOR-SALE
 
  Securities available-for-sale consist of the following as of December 31:
 

<TABLE>
<CAPTION>
                                                    1996
                                ---------------------------------------------
                                              GROSS      GROSS
                                 AMORTIZED  UNREALIZED UNREALIZED
                                   COST       GAINS      LOSSES   FAIR VALUE
                                ----------- ---------- ---------- -----------
   <S>                          <C>         <C>        <C>        <C>
   U.S. Government obliga-
    tions...................... $   920,704  $ 1,214    $    --   $   921,918
   Corporate obligations.......  24,593,162   25,577     (37,608)  24,581,131
                                -----------  -------    --------  -----------
                                $25,513,866  $26,791    $(37,608) $25,503,049
                                ===========  =======    ========  ===========
</TABLE>

 

<TABLE>
<CAPTION>
                                                    1995
                                ---------------------------------------------
                                              GROSS      GROSS
                                 AMORTIZED  UNREALIZED UNREALIZED
                                   COST       GAINS      LOSSES   FAIR VALUE
                                ----------- ---------- ---------- -----------
   <S>                          <C>         <C>        <C>        <C>
   U.S. Government obliga-
    tions...................... $ 2,026,138  $   272    $   --    $ 2,026,410
   Corporate obligations.......  12,924,114   29,639     (5,733)   12,948,020
                                -----------  -------    -------   -----------
                                $14,950,252  $29,911    $(5,733)  $14,974,430
                                ===========  =======    =======   ===========
</TABLE>

 
  As of December 31, 1996 and 1995, the securities available-for-sale had
contractual maturities of less than one year. Expected maturities will differ
from contractual maturities because issuers of the securities may have the
right to prepay obligations without prepayment penalties.
 
 3.  PROPERTY AND EQUIPMENT
 
  Property and equipment are composed of the following as of December 31:
 

<TABLE>
<CAPTION>
                                                           1996        1995
                                                        ----------- -----------
   <S>                                                  <C>         <C>
   Leasehold improvements.............................. $ 4,296,136 $ 4,288,000
   Lab equipment.......................................   3,642,378   3,468,103
   Furniture and office equipment......................   3,441,253   2,577,024
                                                        ----------- -----------
                                                         11,379,767  10,333,127
   Less accumulated depreciation and amortization......   6,261,831   4,619,900
                                                        ----------- -----------
                                                        $ 5,117,936 $ 5,713,227
                                                        =========== ===========
</TABLE>

 
  As of December 31, 1996 and 1995, furniture and office equipment included
$362,425, and $276,893 respectively, of equipment acquired under capitalized
leases. Accumulated depreciation related to this equipment totaled $217,179
and $147,545 at December 31, 1996 and 1995, respectively. Annual maturities of
the capital lease obligations for 1997 and 1998, respectively, approximate
$96,000 and $35,000.
 
 4.  EQUITY OFFERINGS
 
  In 1992, the Company completed its first private placement equity offering.
Total gross proceeds amounted to $38,550,792, representing 2,225,139 shares of
the Company's common stock, including the required conversion of amounts
advanced (principal and interest of $850,000 and $25,918, respectively) from a
principal shareholder aggregating 50,053 shares.
 
  In 1993, the Company concluded a second round of equity financing through a
private offering of common stock and warrants at $31.50 per unit. Each unit
consisted of one share of common stock and a warrant to purchase one-half
share of common stock. The warrants had an exercise price of $38.50 per share
and expired in 1996. Total
 
                                      48

<PAGE>
 
                            CELL THERAPEUTICS, INC.
                         (A DEVELOPMENT STAGE COMPANY)
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 4.  EQUITY OFFERINGS (CONTINUED)
 
gross proceeds of the second round of equity financing amounted to
$13,813,268, representing 438,540 shares of common stock and warrants to
purchase 219,258 shares of common stock, including 21,256 shares of common
stock and warrants to purchase 10,627 shares of common stock sold to the sales
agents and their affiliates (including an affiliated sales agent, whose chief
executive officer was a principal shareholder of the Company).
 
  Offering costs related to the first and second offerings included $2,052,268
and $228,982, respectively, paid to the affiliated sales agent. In connection
with the offerings, the sales agents received warrants to purchase 215,769
shares of common stock at $17.50 per share, expiring in 1997 (including
warrants to purchase 167,800 shares of common stock issued to the affiliated
sales agent) and warrants to purchase 42,423 shares of common stock at $31.50
per share, expiring in 1998 (including warrants to purchase 7,538 shares of
common stock issued to the affiliated sales agent).
 
  In 1994, the Company sold additional units of common stock and warrants
under terms equivalent to those of the second round of equity financing. The
Company received gross proceeds of $787,500, representing 25,001 shares of
common stock and warrants to purchase 12,500 shares of common stock at $38.50
per share, which expired in 1996. Offering costs included $28,613 paid to the
affiliated sales agent. In addition, the sales agents received warrants to
purchase 2,500 shares of common stock at $31.50 per share, expiring in 1999
(including warrants to purchase 1,071 shares of common stock issued to the
affiliated sales agent).
 
  In 1995, the Company concluded a third round of equity financing through a
private offering of Series A Convertible Preferred Stock at $335 per share.
Total gross proceeds of the offering amounted to $31,974,745, representing
95,447.004 shares of Series A Convertible Preferred Stock. In 1996, the
Company concluded a fourth round of equity financing through a private
offering of Series A Convertible Preferred Stock at $335 per share. Total
gross proceeds of the offering amounted to $17,000,000, representing
50,746.268 shares of Series A Convertible Preferred Stock. Holders of Series A
Convertible Preferred Stock have preferential rights to noncumulative
dividends ($33.50 per share per annum) when and if declared by the Board of
Directors, and a liquidation preference of $335 per share. The Series A
Convertible Preferred Stock has the right to vote with the common stock on an
as-converted basis and, voting as a separate class, is entitled to elect one
director. As of December 31, 1996, the Company had reserved 4,341,704 shares
of common stock for issuance upon the conversion of the Series A Convertible
Preferred Stock. Each share of Series A Convertible Preferred Stock
automatically converted into 29.6986 shares of common stock at an adjusted
conversion price of $11.28 per share upon the closing of the Company's initial
public offering on March 26, 1997. See Note 12. The shares of common stock
issuable upon conversion of the Series A Convertible Preferred Stock have
certain registration rights.
 
  In 1996, the Company sold 14,925.373 shares of Series B Convertible
Preferred Stock to Johnson & Johnson Development Corporation at $335 per share
in a private placement. Total gross proceeds of the sale amounted to
$5,000,000. The Series B Convertible Preferred Stock has the same rights,
preferences and conversion features as the Series A Convertible Preferred
Stock, but is subordinate to it with respect to payment of dividends and
liquidation preference. The shares of common stock issuable upon conversion of
the Series B Convertible Preferred Stock have certain registration rights. The
Series B Convertible Preferred Stock has the right to vote with the common
stock on an as-converted basis. As of December 31, 1996, the Company had
reserved 443,262 shares of common stock for issuance upon conversion of the
Series B Convertible Preferred Stock. Each share of Series B Convertible
Preferred Stock automatically converted into 29.6986 shares of common stock at
an as adjusted conversion price of $11.28 per share upon the closing of the
Company's initial public offering on March 26, 1997. See Notes 11 and 12.
 
  In November 1996, the Board of Directors approved a shareholder rights plan
whereby a Right attaches to each share of common stock. Upon the occurrence of
certain acquisition related events, each Right entitles the
 
                                      49

<PAGE>
 
                            CELL THERAPEUTICS, INC.
                         (A DEVELOPMENT STAGE COMPANY)
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 4.  EQUITY OFFERINGS (CONTINUED)
 
holder of each outstanding share of common stock to purchase one one-
thousandth of a share (a "Unit") of Series C Preferred Stock at $175 per Unit,
subject to adjustment. Upon exercise, each holder of a Right will have the
right to receive value equal to two times the exercise price of the Right. A
total of 100,000 shares of Series C Preferred Stock are reserved for issuance
upon exercise of the Rights.
 
 5.  CONSULTING AND EMPLOYMENT AGREEMENTS
 
 Directors, Officers, and Employees
 
  The Company has employment agreements with its President and Chief Executive
Officer and one other founding officer. The agreements expire in 1999 and
1998, respectively, and provide for annual base salaries (approximately
$692,000 in the aggregate as of December 31, 1996), minimum annual and cost-
of-living increases, and discretionary incentive bonus awards.
 
  In December 1993, the Board of Directors authorized a loan of $200,000 to
the Company's President and Chief Executive Officer. The loan accrues interest
at 5.35%. On each of December 17, 1997, 1998, and 1999, the Company shall
forgive one-third of the principal amount of the loan together with accrued
interest. The portion of this loan which is to be forgiven in 1997 is included
in other current assets. Forgiveness of amounts remaining due under the loan
will be forfeited upon certain termination-related circumstances and will be
accelerated upon certain events, including a change in ownership of the
Company, or upon the Company's attaining a minimum public market
capitalization. The loan is secured by 5,715 shares of common stock.
 
  In 1992, the Company granted its then chairman warrants to purchase 57,143
shares of common stock at $17.50 per share.
 
  In 1994, the Company authorized a non-interest bearing loan of up to
$150,000 to its Executive Vice President, Product Development in connection
with relocation. In 1995 and 1996, $145,000 was advanced under the terms of
the loan, of which $40,000 and $57,000 was forgiven and treated as
compensation expense in 1995 and 1996, respectively.
 
  In 1996, the Company advanced a $35,000 non-interest bearing loan to its
Executive Vice President, Marketing and Business Development in connection
with his relocation. The Company shall forgive one-half of the loan on each of
April 8, 1997 and 1998. The portion of this loan to be forgiven in 1997 is
included in other current assets.
 
  The Company has also entered into severance agreements with certain of its
officers having terms of one or two years.
 
  In addition to the employment and severance agreements with the corporate
officers discussed above, the Company has entered into employment agreements
with certain employees, whose employment agreement terms generally range from
three to four years. The employment agreements can be terminated with cause,
as defined in the agreements, upon 30 days' notice.
 
 Advisory Boards
 
  The Company has entered into consulting agreements with the members of its
Scientific and Clinical Advisory Boards ("Advisory Boards") providing for
aggregate annual fees of approximately $108,000, the issuance of 22,860 shares
of common stock (a component of the 296,429 pool shares discussed in Note 8)
and options to purchase 88,571 shares of common stock at $11.725 to $17.50 per
share, all of which vest ratably over two to three years from the date of
appointment. The consulting agreements with members of the Advisory Boards are
cancelable upon 30 days' notice.
 
                                      50

<PAGE>
 
                            CELL THERAPEUTICS, INC.
                         (A DEVELOPMENT STAGE COMPANY)
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
 6.  CONTRACTUAL ARRANGEMENTS AND COMMITMENTS
 
 Licensed Technology
 
  In March 1992, the Company entered into agreements with the Fred Hutchinson
Cancer Research Center ("FHCRC") under the terms of which the Company has
received worldwide licenses and options to technology, or technology claimed,
for five U.S. patent applications. The Company paid initial license fees
totalling $100,000 and issued 76,572 shares of common stock valued at $3,200
to the FHCRC for such technology. The initial license fee and value of the
stock granted to the FHCRC were expensed as in-process research and
development. The Company is obligated to pay royalties on revenues resulting
from future sales of products employing the technology and on revenues
received from sublicenses for the technology, with minimum annual royalties of
$50,000 prior to, and $100,000 after, the first commercial sale of such
products. The agreements are for a term equal to the later of 15 years or the
expiration of the last issued patent included within the licensed technology,
unless terminated earlier for certain specified events, including the failure
of the Company to take reasonable efforts to engage in research and
development with respect to the licensed technology.
 
 Facilities Lease
 
  The Company has executed noncancelable operating leases for office and
laboratory space that generally expire the first quarter of 2003, with two
five-year renewal options at the then-current market rates. The lessor
provided $450,000 for leasehold improvements and rent concessions, which is
being amortized over the initial lease term. Rent expense amounted to
$995,866, $993,471, and $977,778 for the years ended December 31, 1996, 1995,
and 1994, respectively.
 
  Future minimum annual rental payments under the leases approximate the
following for the years ended December 31:
 

<TABLE>
             <S>                            <C>
             1997.......................... $1,014,000
             1998..........................  1,133,000
             1999..........................  1,143,000
             2000..........................  1,143,000
             2001..........................  1,143,000
             Thereafter....................  1,239,000
                                            ----------
                                            $6,815,000
                                            ==========
</TABLE>

 
 7.  LONG-TERM OBLIGATIONS
 
  Long-term obligations consisted of the following at December 31:

<TABLE>
<CAPTION>
                                                            1996       1995
                                                         ---------- ----------
   <S>                                                   <C>        <C>
   Master financing agreements:
     Due December 1998, monthly payments of $55,827,
      including interest at 14.7%....................... $1,154,281 $1,616,295
     Due December 1998, monthly payments of $45,820,
      including interest at 17.6%.......................    921,289  1,274,342
     Due December 1996, monthly payments of $21,944,
      including interest at 17.6%.......................        --     239,847
     Due August 1999, monthly payments of $20,523,
      including
      interest at 16.1%.................................    531,336        --
   Capital lease obligations............................    130,352    149,667
   Deferred rent........................................    494,288    440,067
                                                         ---------- ----------
                                                          3,231,546  3,720,218
   Less current portion.................................  1,226,971  1,114,520
                                                         ---------- ----------
                                                         $2,004,575 $2,605,698
                                                         ========== ==========
</TABLE>

 
                                      51

<PAGE>
 
                            CELL THERAPEUTICS, INC.
                         (A DEVELOPMENT STAGE COMPANY)
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 7.  LONG-TERM OBLIGATIONS (CONTINUED)
 
  In December 1994, the Company entered into a master financing agreement with
a financing company, whereby the Company borrowed $2,015,334 in exchange for
granting the lessor a security interest in approximately the same net book
value of specific fixed assets and warrants to purchase 12,432 shares of
common stock at $12.8975 per share.
 
  In July 1995, the Company entered into master financing agreements with
another finance company, whereby the Company borrowed $1,450,000 over 42
months and $350,000 over 18 months. In June 1996, the Company borrowed an
additional $616,300 over 38 months from this finance company. For each
borrowing, the Company granted the lessor a security interest in approximately
the same net book value of specified fixed assets.
 
  Annual maturities of the master financing agreements for 1997 through 1999,
respectively, approximate $1,128,000, $1,323,000, and $155,000.
 
 8.  CAPITAL STOCK
 
  In connection with the formation of the Company, certain shareholders
contributed 296,429 shares of common stock to a pool to be issued to the
FHCRC, the Scientific Advisory Board ("SAB"), and key employees. (Refer to
Notes 5 and 6 with regards to the stock issued to the SAB and the FHCRC.) From
this pool, 76,572, 22,860, 49,282, and 114,286 shares were distributed to the
FHCRC, SAB, key employees and its former chairman of the Board of Directors,
respectively. As of December 31, 1992, 33,429 undistributed shares reverted
back to the contributing shareholders. The shares issued to key employees were
subject to forfeiture and cancellation in the event such individuals'
employment agreements were terminated. The restrictions on the stock expired
in 1996.
 
  In August 1993, the Company repurchased 60,343 shares of common stock at
$0.04179 per share from one of its founders pursuant to a stock repurchase
agreement.
 
 Common Stock Reserved
 
  A summary of common stock reserved for issuance is as follows as of December
31:
 

<TABLE>
<CAPTION>
                                                               1996      1995
                                                             --------- ---------
        <S>                                                  <C>       <C>
        Series A Preferred Stock...........................  4,341,704 2,727,023
        Stock Options......................................  1,330,009   824,840
        Series B Preferred Stock...........................    443,262        --
        Employee Stock Purchase Plan.......................    285,714        --
        Warrants...........................................     77,907   119,050
                                                             --------- ---------
                                                             6,478,596 3,670,913
                                                             ========= =========
</TABLE>

 
 9.  STOCK OPTIONS AND WARRANTS
 
 Stock Options
 
  In 1994, shareholders approved the 1994 Equity Incentive Plan (the "1994
Plan") in replacement of the 1992 Stock Option Plan (the "1992 Plan"). The
1994 Plan provides for (a) the grant of incentive stock options (with terms
not to exceed ten years), nonstatutory stock options and stock appreciation
rights, (b) the award of stock bonuses, (c) the sale of stock, and (d) any
other equity-based or equity-related awards which the Plan Administrator
determines to be consistent with the purpose of the 1994 Plan and the
interests of the Company.
 
                                      52

<PAGE>
 
                            CELL THERAPEUTICS, INC.
                         (A DEVELOPMENT STAGE COMPANY)
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 9.  STOCK OPTIONS AND WARRANTS (CONTINUED)
 
Option-vesting schedules are specified by the Plan Administrator. The number
of shares available for future grant under the 1994 Plan is the number of
shares of common stock available for issuance under the 1992 Plan at the time
of approval of the 1994 Plan (177,993), plus such shares for which options
previously granted under the 1992 Plan may expire, terminate, or be canceled.
The 1994 Plan also provides for the automatic grant of nonstatutory options to
nonemployee directors.
 
  In May 1995 and April 1996, shareholders approved share increases of 246,887
and 507,143, respectively, in the number of shares reserved for issuance under
the 1994 Plan. As of December 31, 1996, the Company had reserved 1,330,009
shares of common stock for issuance under the 1992 and 1994 Plans, of which
488,336 were exercisable at an average price of $11.85 per share, and 121,401
were available for future grant.
 
  In April 1995, the Board of Directors approved the repricing of outstanding
options to $11.725 per share by exchanging such outstanding options for a
fewer number of options pursuant to a Black-Scholes formula. Subsequently,
options for 434,664 shares, with prices of $17.50 and $31.50 per share, were
exchanged for 377,121 options with a price of $11.725 per share. All other
terms and conditions of the options remained unchanged. These amounts have
been included as granted and canceled options in the summary activity table as
shown below. The pro forma net loss under SFAS 123 noted below includes
$143,707 and $672,884 in 1996 and 1995, respectively, related to this option
repricing.
 
  A summary of the activity related to the 1992 and 1994 Plans follows:

<TABLE>
<CAPTION>
                                                        SHARES       AVERAGE
                                                         UNDER    EXERCISE PRICE
                                                        OPTION      PER SHARE
                                                       ---------  --------------
   <S>                                                 <C>        <C>
   Balance December 31, 1993, unexercised.............   404,692     $20.37
     Granted..........................................    61,970      31.50
     Canceled.........................................   (10,923)     23.14
     Exercised........................................       (79)     17.50
                                                       ---------
   Balance December 31, 1994, unexercised.............   455,660      21.84
     Granted..........................................   815,086      11.725
     Canceled.........................................  (504,499)     21.42
     Exercised........................................    (4,653)     12.11
                                                       ---------
   Balance December 31, 1995, unexercised.............   761,594      11.81
     Granted..........................................   505,923      11.725
     Canceled.........................................   (56,935)     11.83
     Exercised........................................    (1,974)     11.725
                                                       ---------
   Balance December 31, 1996, unexercised............. 1,208,608      11.78
                                                       =========
</TABLE>

  The weighted average fair value of options granted during 1996 was $2.34.
 
  Exercise prices for options outstanding at December 31, 1996 range from
$11.725 to $17.50 per share, with an average remaining maximum term of
approximately 8.5 years.
 
  In 1996, the Company adopted the accounting provisions of Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" (SFAS 123). SFAS 123 encourages, but does not require, entities
to adopt the fair value of accounting for their stock-based compensation
plans. Under this method, compensation cost for stock-based compensation plans
is measured at the grant date based on the fair value of the award and is
recognized over the vesting period. Fair value is determined using minimum
value option pricing models that take into account (1) the stock price at the
grant date, (2) the exercise price, (3) a four-year expected
 
                                      53

<PAGE>
 
                            CELL THERAPEUTICS, INC.
                         (A DEVELOPMENT STAGE COMPANY)
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
life of the options, (4) no expected dividends, and (5) risk free interest
rates ranging from 5.4% to 7.8%, and 5.2% to 6.2%, during 1996 and 1995,
respectively, over the expected life of the options. In accordance with the
provisions of SFAS 123, the Company applies Accounting Principles Board
Opinion No. 25 and related interpretations in accounting for its stock option
plans and, accordingly, does not recognize compensation cost for options
granted with exercise prices equal to or greater than fair value. Although not
reflective of the effects of reported net income in future years until the
rules of SFAS 123 are applied to all outstanding non vested options, if the
Company elected to recognize compensation cost based on the fair value of the
options granted at grant date as prescribed by SFAS 123, net loss and pro
forma net loss per share would have been increased as follows for the years
ended December 31:
 

<TABLE>
<CAPTION>
                                        1996                        1995
                              --------------------------  --------------------------
                              AS REPORTED    PRO FORMA    AS REPORTED    PRO FORMA
                              ------------  ------------  ------------  ------------
     <S>                      <C>           <C>           <C>           <C>
     Net loss................ $(13,928,189) $(14,536,137) $(19,992,475) $(20,812,869)
     Historical net loss per
      share.................. $      (2.82) $      (2.94) $      (4.19) $      (4.36)
</TABLE>

 
  Historical net loss per share is computed as described in Note 1.
 
  In December 1996, the Board of Directors approved the grant of an aggregate
of 114,280 ten year fully vested nonstatutory options to non employee
directors at an exercise price of $11.725 per share, subject to approval by
shareholders at the 1997 Annual Meeting of Shareholders. These options will be
recorded as granted upon shareholder approval. The Company will record
compensation expense on the date of shareholder approval for the amount by
which fair market value at that date exceeds the exercise price.
 
 Warrants
 
  During 1995, the Company offered to exchange shares of common stock for
outstanding warrants to purchase common stock, issuing 104,569 shares of
common stock in exchange for warrants to purchase 443,353 shares of common
stock. During 1996, the Company concluded its offer to exchange shares of
common stock for outstanding warrants of common stock, issuing 151 shares of
common stock in exchange for warrants to purchase 377 shares of common stock.
 
  A summary of the warrants to purchase common stock which remain outstanding
(and for which common stock is reserved for issuance) is as follows as of
December 31, 1996:
 

<TABLE>
<CAPTION>
            SHARES OF
             COMMON                 PRICE PER SHARE OF
              STOCK                    COMMON STOCK                            EXPIRATION
            ---------               ------------------                         ----------
            <S>                     <C>                                        <C>
             68,901                       $17.50                                  1997
              7,935                        31.50                                  1998
              1,071                        31.50                                  1999
             ------
             77,907
             ======
</TABLE>

 
 Employee Stock Purchase Plan
 
  In April 1996 the shareholders approved the adoption of the 1996 Employee
Stock Purchase Plan (the "Purchase Plan"). A maximum of 285,714 shares of the
Company's common stock will be reserved for purchase under the Purchase Plan,
under which eligible employees may purchase a limited number of shares of the
Company's common stock at 85% of fair market value. As of December 31, 1996,
no shares of the Company's common stock have been purchased under the Purchase
Plan.
 
                                      54

<PAGE>
 
                            CELL THERAPEUTICS, INC.
                         (A DEVELOPMENT STAGE COMPANY)
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
10.  INCOME TAXES
 
  The Company follows Statement of Financial Accounting Standards No. 109,
"Accounting for Income Taxes," which requires an asset and liability approach
for financial accounting and reporting for income taxes. The standard requires
that deferred tax liabilities and assets be adjusted currently for effects of
changes in tax laws or rates.
 
  As of December 31, 1996, the Company had net operating tax loss
carryforwards of approximately $70 million and research and development credit
carryforwards of approximately $1.8 million. The carryforwards begin to expire
in the year 2007. Due to prior rounds of equity financing (see Note 4) and the
Company's proposed initial public offering of common stock (see Note 12), the
Company has incurred and will incur "ownership changes" pursuant to applicable
regulations in effect under the Internal Revenue Code of 1986, as amended.
Accordingly, the Company's use of losses incurred through the date of these
ownership changes will be limited during the carryforward period. The Company
estimates that use of the loss carryforwards would be limited to approximately
$8 million per year. To the extent that any single year loss is not utilized
to the full amount of the limitation, such unused loss is carried over to
subsequent years until the earlier of its utilization or the expiration of the
relevant carryforward period.
 
  Deferred income taxes reflect the net tax effects of temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. The Company has
recognized a valuation allowance equal to the deferred tax assets due to the
uncertainty of realizing the benefits of the assets. The Company's valuation
allowance increased $4,785,000, $6,928,000 and $7,332,000 during 1996, 1995
and 1994, respectively. Significant components of the Company's deferred tax
liabilities and assets as of December 31 are as follows:
 

<TABLE>
<CAPTION>
                                                           1996        1995
                                                        ----------- -----------
   <S>                                                  <C>         <C>
   Deferred tax assets:
     Net operating loss carryforwards.................  $23,914,000 $19,535,000
     Research and development tax credit
      carryforwards...................................    1,752,000   1,667,000
     Accruals on financial statements in excess of tax
      returns.........................................      444,000     301,000
     Depreciation in financial statements in excess of
      tax returns.....................................      327,000     149,000
                                                        ----------- -----------
   Net deferred tax assets............................  $26,437,000 $21,652,000
                                                        =========== ===========
   Valuation allowance for deferred tax assets........  $26,437,000 $21,652,000
                                                        =========== ===========
</TABLE>

 
11.  SIGNIFICANT AGREEMENTS
 
  On March 7, 1995, the Company and BioChem Therapeutic Inc. ("BioChem"), a
wholly owned subsidiary of BioChem Pharma, Inc., signed collaboration and
supply agreements (the "BioChem Collaboration Agreement" and the "BioChem
Supply Agreement", respectively). The BioChem Collaboration Agreement grants
an exclusive license to enable BioChem to seek Canadian regulatory approval
for, and to use and sell, the Company's Lisofylline and/or CT-2584 compounds
(and compositions thereof) (collectively, the "CTI Compounds") in Canada.
 
  Under the BioChem Collaboration Agreement, BioChem purchased 7,462.687
shares of Series A Convertible Preferred Stock for $2,500,000 in the Company's
third private equity offering. See Note 4. In addition, the Company is
entitled to receive payments for each of the CTI Compounds upon the
satisfaction of specified product development milestones and royalties on all
sales, if any. The BioChem Collaboration Agreement terminates upon the
expiration of the last to expire patents covering the CTI Compounds or, absent
a patent, upon the tenth anniversary of the first commercial sale of such CTI
Compound. The Company recorded milestone payments of $250,000 and $100,000
under the BioChem Collaboration Agreement in 1996 and 1995, respectively.
 
                                      55

<PAGE>
 
                            CELL THERAPEUTICS, INC.
                         (A DEVELOPMENT STAGE COMPANY)
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
11. SIGNIFICANT AGREEMENTS (CONTINUED)
 
  Under the BioChem Supply Agreement, the Company is to supply to BioChem the
CTI Compounds at a percentage mark-up above cost. The BioChem Supply Agreement
terminates 20 years from the date of termination of the BioChem Collaboration
Agreement with respect to each of the CTI Compounds.
 
  In October 1995, the Company purchased all of the intellectual property of
Lipomed Corporation ("Lipomed") from its shareholders and expensed the
purchase price as in-process research and development expense. The purchase
price was $1,155,750 consisting of 98,574 shares of common stock. The
agreement also provides for a possible future payment to Lipomed of $100,000
upon the occurrence of certain events.
 
  In February 1996, the Company entered into an agreement with Schering AG
("Schering") pursuant to which, among other things, the Company and Schering
would collaborate in the funding, research, development and commercialization
of Lisofylline and CT-2584 on the terms and conditions specified therein. Upon
execution of the agreement, Schering paid the Company a $3,000,000
nonrefundable signing fee. The remainder of the agreement was contingent upon
Schering finding the clinical trial results and related data from the
Company's Phase II bone marrow transplantation ("BMT") trial acceptable within
thirty days after its receipt. The Company furnished Schering with this data
in late February 1996. On April 2, 1996, after a mutual extension of the
thirty-day review period, Schering informed the Company that it did not wish
to activate the agreement based on, among other factors, (i) its view that one
of the endpoints of the Phase II BMT trial, white blood cell recovery, was not
met and (ii) its view that the trial data regarding mortality rate and
incidence of serious and fatal infection were difficult to interpret and that,
as a result, Schering could not determine that the data was meaningful.
 
  In November 1996, the Company entered into a collaboration and license
agreement with Ortho Biotech Inc. and the R.W. Johnson Pharmaceutical Research
Institute (a division of Ortho Pharmaceutical Corporation) each of which are
wholly-owned subsidiaries of Johnson & Johnson (collectively, "Johnson &
Johnson") for the joint development and commercialization of Lisofylline. Upon
execution of the collaboration agreement, Johnson & Johnson paid to the
Company a $5,000,000 nonrefundable license fee. In addition, Johnson & Johnson
Development Corporation ("JJDC"), a wholly-owned subsidiary of Johnson &
Johnson, purchased 14,925.373 shares of the Company's newly issued Series B
Convertible Preferred Stock at $335 per share for an aggregate purchase price
of $5,000,000. See Note 4.
 
  Under the collaboration agreement, the Company will be responsible for
development of Lisofylline in the United States. The Company will also be
responsible for the manufacture of Lisofylline for development and
commercialization purposes until November 1999, and Johnson & Johnson will be
responsible for the manufacture of Lisofylline thereafter, unless Johnson &
Johnson elects to assume such responsibility prior to such date. Johnson &
Johnson has agreed to fund 60% of the Company's budgeted development expenses
incurred in connection with obtaining regulatory approval for Lisofylline in
the United States. For each of 1997 and 1998 Johnson & Johnson has agreed,
subject to certain termination rights, to fund up to $12,000,000 of the
Company's budgeted development expenses per year. Any development expenses in
excess of such currently budgeted agreed upon amounts will be funded solely by
the Company unless otherwise mutually agreed. Johnson & Johnson will be
responsible for obtaining regulatory approval for Lisofylline for markets
outside of the United States and Canada at its own expense. The Company
recorded $870,806 of collaboration agreement revenues related to the
reimbursement of development expenses by Johnson & Johnson in 1996.
 
  The Company and Johnson & Johnson will co-promote Lisofylline in the United
States and each will share equally in any resulting operating profits and
losses. Although the Company and Johnson & Johnson will co-promote Lisofylline
in the United States, Johnson & Johnson will have primary responsibility for
commercializing Lisofylline.
 
                                      56

<PAGE>
 
                            CELL THERAPEUTICS, INC.
                         (A DEVELOPMENT STAGE COMPANY)
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
11. SIGNIFICANT AGREEMENTS (CONTINUED)
 
Johnson & Johnson will have the exclusive right to develop and market
Lisofylline, at its own expense, for markets outside of the United States and
Canada, subject to specified royalty payments to the Company. The Company will
receive additional equity, license, milestone and similar payments under the
agreement if certain milestones are achieved in the development and
commercialization of Lisofylline.
 
  The collaboration with Johnson & Johnson initially covers the development of
Lisofylline to prevent or reduce the toxic side effects among cancer patients
receiving high dose radiation and/or chemotherapy followed by BMT (the "BMT
Indication") through December 31, 1998. The collaboration also covers the
development of Lisofylline for the treatment of patients with acute
myelogeneous leukemia ("AML") undergoing high dose chemotherapy (the "AML
Indication") through June 30, 1997. Johnson & Johnson has an option to
continue to participate in the development of Lisofylline for the AML
Indication following the completion of the Company's ongoing Phase II AML
trial. Johnson & Johnson also has certain options to expand the collaboration
to include the development of Lisofylline for any other indication for which
Lisofylline is being developed by the Company. In the event that Johnson &
Johnson exercises any such option, it would be required to fund 60% of the
Company's budgeted development expenses incurred in connection with the
development of Lisofylline for such indication, including expenses incurred
prior to the exercise of such option, and would also be required to pay
additional license fees and milestone payments to the Company. Thereafter, any
development expenses in excess of the then agreed-upon budgeted amounts for
any such additional indication would be funded solely by Johnson & Johnson
unless otherwise mutually agreed. If Johnson & Johnson does not exercise such
option with respect to any such indication, the Company would be free to
develop Lisofylline for such indication either on its own or in collaboration
with third parties. Johnson & Johnson also has the option to sponsor research
at the Company with respect to discovering compounds structurally related to
Lisofylline.
 
  In connection with the execution of the collaboration agreement, JJDC, a
wholly-owned subsidiary of Johnson & Johnson, has granted to the Company an
option (the "Johnson & Johnson Option") to sell to JJDC a number of shares of
common stock equal to not more than ten percent of the number of shares of
common stock sold by the Company at the initial closing of its currently
proposed initial public offering, at a price per share equal to the initial
public offering price in such proposed offering. See Note 12.
 
12. SUBSEQUENT EVENTS
 
 Supply Agreement
 
  In January 1997, the Company entered into a supply agreement with ChiRex,
Ltd. ("ChiRex"), a British manufacturer of pharmaceutical intermediates and
active ingredients, for the manufacture and supply of Lisofylline and
corresponding intermediate compounds. Under the terms of the agreement, ChiRex
will manufacture and supply Lisofylline bulk drug product and a key
intermediate compound in sufficient quantities to meet the Company's
requirements for ongoing and future clinical trials and commercial
requirements during launch and commercialization. The agreement will expire on
December 31, 2001, but may be terminated by the Company upon 12 months'
written notice prior to such date.
 
 Initial Public Offering and Related Events
 
  On March 26, 1997 the Company completed an initial public offering (the
"Offering") of 3 million shares of its common stock at an offering price of
$10.00 per share, resulting in estimated net proceeds of $27.1 million.
Concurrent with the closing of the Offering, the Company sold 300,000 shares
of Common Stock to Johnson & Johnson at a price of $10.00 per share, resulting
in estimated net proceeds of $3.0 million.
 
                                      57

<PAGE>
 
                            CELL THERAPEUTICS, INC.
                         (A DEVELOPMENT STAGE COMPANY)
 
            NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
 
12. SUBSEQUENT EVENTS (CONTINUED)
 
  In connection with the Offering, on March 3, 1997 the Company's shareholders
approved a reverse stock split of the outstanding shares of common stock on
the basis of one new share of common stock for every three and one-half
outstanding shares of common stock. The reverse stock split became effective
when an amendment to the Company's Restated Articles of Incorporation was
filed with the Secretary of State of the State of Washington on March 14,
1997. All outstanding common and common equivalent shares and per-share
amounts in the accompanying financial statements and related notes to
financial statements have been retroactively adjusted to give effect to the
reverse stock split.
 
  In addition, upon the closing of Offering, all of the outstanding shares of
Series A Convertible Preferred Stock automatically converted into 4,341,704
shares of common stock and all of the outstanding shares of Series B
Convertible Preferred Stock automatically converted into 443,262 shares of
common stock (in each case after giving effect to certain anti-dilution
adjustments of the conversion price as a result of the closing of the Offering
at an initial public offering price below $11.725 per share). Unaudited pro
forma Series A and Series B Convertible Preferred Stock, Series C Preferred
Stock, Common Stock, and Total Shareholders' Equity at December 31, 1996, as
adjusted for the conversion of the Series A and Series B Convertible Preferred
Stock, are $0, $0, $0, $104,136,364, and $30,053,720, respectively, with no
shares of Preferred Stock outstanding, and 9,728,438 shares of Common Stock
outstanding.
 
                                      58

<PAGE>
 

I
TEM 9. CHANGES IN DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE.
 
  None.
 

                                   PART III
 

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
 
  The following table sets forth certain information with respect to the
Directors and executive officers of cti as of January 31, 1997:
 

<TABLE>
<CAPTION>
 NAME                               AGE POSITION
 ----                               --- --------
 <C>                                <C> <S>
 Max E. Link, Ph.D.(1).............  56 Chairman of the Board of Directors
 James A. Bianco, M.D.(1)..........  40 President, Chief Executive Officer and
                                         Director
 Jack W. Singer, M.D...............  54 Executive Vice President, Research
                                         Program Chairman and Director
 Louis A. Bianco...................  44 Executive Vice President, Finance and
                                         Administration
 Maurice J. Schwarz, Ph.D..........  57 Executive Vice President, Product
                                         Development
 Robert A. Lewis, M.D. ............  51 Executive Vice President, Chief
                                         Scientific Officer
 Susan O. Moore....................  48 Executive Vice President, Human
                                         Resource Development
 Jack M. Anthony...................  50 Executive Vice President, Marketing and
                                         Business Development
 Dalton W. Weekley.................  54 Managing Director, Project Planning and
                                         Controls
 Jack L. Bowman(2).................  64 Director
 Jeremy L. Curnock Cook(1)(2)......  47 Director
 Wilfred E. Jaeger, M.D.(2)(3).....  41 Director
 David W. Martin, Jr., M.D.........  56 Director
 Terrence M. Morris(2)(3)..........  49 Director
 Phillip M. Nudelman, Ph.D.(1)(3)..  61 Director
</TABLE>

- --------
(1)Member of the Executive Committee.
(2)Member of the Compensation Committee.
(3)Member of the Audit Committee.
 
  Dr. Link joined the Board of Directors in July 1995 as its Vice Chairman and
has served as Chairman of the Board of Directors since January 1996. In
addition, Dr. Link has held a number of executive positions with
pharmaceutical and healthcare companies. Most recently, he served as Chief
Executive Officer of Corange, Limited ("Corange"), from May 1993 until June
1994. Prior to joining Corange, Dr. Link served in a number of positions
within Sandoz Pharma Ltd., including Chief Executive Officer from 1990 until
April 1992, and Chairman from April 1992 until May 1993. Dr. Link currently
serves on the boards of directors of Alexion Pharmaceuticals, Inc., Human
Genome Sciences, Inc., Procept, Inc. and Protein Design Labs, Inc. Dr. Link
received his Ph.D. in Economics from the University of St. Gallen.
 
  Dr. Bianco is the principal founder of cti and has been cti's President and
Chief Executive Officer since February 1992 and a Director of cti since the
Company's inception in September 1991. Prior to joining cti, Dr. Bianco was an
Assistant Professor of Medicine at the University of Washington, Seattle, and
an Assistant Member in the clinical research division of the Fred Hutchinson
Cancer Research Center ("FHCRC"), the world's largest bone marrow transplant
center. From 1990 to 1992, Dr. Bianco was the director of the Bone Marrow
Transplant Program at the Veterans Administration Medical Center in Seattle.
Dr. Bianco received his B.S. degree in Biology and Physics from New York
University and his M.D. from Mount Sinai School of Medicine.
 
  Dr. Singer is a founder and Director of cti and currently serves as cti's
Executive Vice President, Research Program Chairman. Dr. Singer has been a
Director of cti since the Company's inception in September 1991. From April
1992 to July 1995, Dr. Singer was cti's Executive Vice President, Research and
Development. Prior
 
                                      59

<PAGE>
 
to joining cti, Dr. Singer was Professor of Medicine at the University of
Washington and full Member of the FHCRC. From 1975 to 1992, he was the Chief
of Medical Oncology at the Veterans Administration Medical Center in Seattle.
In addition, from 1978 to 1992, he served as director for the National
Transplant Board for the Veterans Administration. Dr. Singer has authored
approximately 220 scientific publications in the areas of cell biology,
hematopoiesis and BMT. Prior to joining cti, he headed the Growth Factor
Research Program at the FHCRC. Dr. Singer received his B.A. degree in
Mathematics from Columbia College and his M.D. from State University of New
York, Downstate Medical College. His clinical training was performed at the
University of Chicago and at the University of Washington.
 
  Mr. Bianco is a founder of cti and has been cti's Executive Vice President,
Finance and Administration since February 1, 1992, and a Director of cti from
the Company's inception in September 1991 to April 1992 and from April 1993 to
April 1995. From January 1989 through January 1992, Mr. Bianco was a Vice
President at Deutsche Bank Capital Corporation in charge of risk management.
Mr. Bianco is a Certified Public Accountant and received his M.B.A. from New
York University.
 
  Dr. Schwarz has been cti's Executive Vice President, Product Development
since May 1994. Dr. Schwarz held a variety of product development positions at
Ciba-Geigy for 26 years prior to joining cti, most recently as Vice President
of Pharmaceutical and Analytical Development and Chairman of the Development
Operations Board at Ciba-Geigy Pharmaceuticals Division. Dr. Schwarz received
his B.A. and Ph.D. degrees in chemistry from the University of Oregon.
 
  Dr. Lewis has been cti's Executive Vice President, Chief Scientific Officer
since April 1996. From September 1994 to May 1995, Dr. Lewis was Senior Vice
President and Director, Preclinical Research and Development at Syntex-Roche
("Syntex"). From February 1992 to September 1994, he was President, Discovery
Research at Syntex. From February 1986 to February 1992, he held various
Senior and Executive Vice Presidential offices at Syntex. While at Syntex, he
held associate professorships at Stanford University and at the University of
California, San Francisco, where he also held an adjunct professorship from
1992 to 1994. Prior to joining Syntex, Dr. Lewis was an Associate Professor of
Medicine at Harvard Medical School. Dr. Lewis received his M.D. from the
University of Rochester and B.S. degree in chemistry from Yale University.
 
  Ms. Moore has been cti's Executive Vice President, Human Resource
Development since July 1995. From March 1993 to July 1995, Ms. Moore was cti's
Vice President of Human Resources. Prior to joining cti, Ms. Moore was self-
employed as a compensation consultant. From 1991 to December 1992, Ms. Moore
was the Director of Human Resources of ICOS Corporation, a biotechnology
company.
 
  Mr. Anthony has been cti's Executive Vice President, Marketing and Business
Development since January 1997. From April 1996 to January 1997, Mr. Anthony
was cti's Vice President of Marketing and Business Development. Prior to
joining cti, Mr. Anthony was Vice President of Marketing and Business
Development at Inhale Therapeutic Systems, a drug delivery company, from
October 1994 to April 1996. From August 1989 to October 1994, he was Vice
President of Marketing and Business Development of Applied Immune Sciences
(AIS), a cell and gene therapy concern. From 1973 to 1989, Mr. Anthony held
various executive management positions at Baxter Healthcare Corporation,
lastly as Vice President, Blood Therapy Group.
 
  Mr. Weekley has been cti's Managing Director, Project Planning and Controls
since July 1995. From April 1994 to July 1995, Mr. Weekley was cti's Director
of Planning Support Services. Prior to joining cti, he was an Executive
Director/Senior Consultant of Milestone Computing, Inc., a management
consulting firm.
 
  Mr. Bowman has been a Director of cti since April 1995. From 1987 until
January 1994, Mr. Bowman was a company group chairman at Johnson & Johnson,
having primary responsibility for a group of companies in the diagnostic,
blood glucose monitoring and pharmaceutical businesses. From 1980 to 1987, Mr.
Bowman held various positions at American Cyanamid Company, most recently as
Executive Vice President. Mr. Bowman was a member of the Board of Trustees of
The Johns Hopkins University and serves on the Board of Directors of NeoRx
Corporation, CytRx Corporation, PharmaGenics, Inc. and Cellegy
Pharmaceuticals, Inc.
 
 
                                      60

<PAGE>
 
  Mr. Curnock Cook has been a Director of cti since March 1995. Mr. Curnock
Cook has been a director of the Bioscience Unit of Rothschild Asset Management
Limited since 1987. He is a director of several British companies, including
The International Biotechnology Trust, plc, Biocompatibles International, plc,
Therexsys, Ltd. and Vanguard Medica Group, plc. He also serves on the Boards
of Directors of Creative Biomolecules, Inc., Targeted Genetics, Corp., Sugen
Inc. and Ribozyme Pharmaceuticals, Inc. in the United States.
 
  Dr. Jaeger has been a Director of cti since September 1992. Dr. Jaeger is a
founding general partner of Three Arch Partners, a venture capital firm which
focuses on health care investments. Prior to joining Three Arch Partners in
1993, he was a partner at Schroder Venture Advisers (presently named Collinson
Howe Venture Partners) and The Phoenix Partners. Dr. Jaeger received his M.D.
from the University of British Columbia in Vancouver, B.C., Canada, in 1981.
He practiced medicine for six years before earning an M.B.A. from Stanford
University. Dr. Jaeger is also a director of Intensiva Healthcare Corporation
and several privately held companies.
 
  Dr. Martin has been a Director of cti since July 1995. From April 1995 to
November 1996, Dr. Martin was President and a director, and from January 1996
to November 1996 he was also Chief Executive Officer, of Lynx Therapeutics,
Inc. From January 1994 to April 1995, he was President of Chiron Therapeutics
and a Senior Vice President of Chiron Corporation. From 1991 through 1993, he
was an Executive Vice President of the DuPont Merck Pharmaceutical Company.
From 1982 to 1990, Dr. Martin held various positions at Genentech, Inc., most
recently as Senior Vice President Research and Development. He is currently a
director of Varian Associates, Inc.
 
  Mr. Morris has been a Director of cti since July 1995. He is the Chief
Executive Officer of T. Morris & Company (d/b/a Morningside Ventures), which
advises Kummell Investments Limited, an international investment concern based
in Hong Kong, on its private venture capital portfolio. Mr. Morris has served
as Chief Executive Officer of Morningside Ventures since 1991. His previous
positions include product line manager at Baxter Healthcare Corporation and
strategy consultant with the Boston Consulting Group. Mr. Morris is a director
of several privately held companies.
 
  Dr. Nudelman has been a Director of cti since March 1994. Since 1990 Dr.
Nudelman has been the President and Chief Executive Officer of Group Health
Cooperative of Puget Sound, a health maintenance organization. Dr. Nudelman
received his B.S. degree in Microbiology, Zoology and Pharmacy from the
University of Washington, and holds an M.B.A. and a Ph.D. in Health Systems
Management from Pacific Western University. Dr. Nudelman is a member of the
American Hospital Association House of Delegates, Regional Policy Board, and
chairs the Governing Counsel for Health Care Systems. Dr. Nudelman serves on
the Boards of Directors of Advanced Technology Laboratories, Inc., SpaceLabs
Medical, Inc., Cytran Ltd. and Intensiva Healthcare Corporation.
 
  The Board of Directors of cti is divided into three approximately equal
classes of Directors serving staggered three-year terms and until their
successors are elected and qualified. As a result, approximately one-third of
the total number of Directors will be elected every year. The current terms of
Drs. Bianco, Singer and Jaeger expire in 1997; the current terms of Dr.
Nudelman and Mr. Bowman expire in 1998; the current term of Mr. Curnock Cook
expires in 1998 or, if earlier, the first annual meeting following the
conversion of the Series A Convertible Preferred Stock in accordance with its
terms; and the current terms of Drs. Link and Martin and Mr. Morris expire in
1999. Executive officers of cti serve at the discretion of the Board of
Directors. Under cti's Bylaws, the number of Directors constituting the entire
Board of Directors may be decreased or increased by majority action of either
the Board of Directors or the shareholders, but no decrease in the number of
Directors may have the effect of shortening the term of any incumbent
Director. Currently, the Board of Directors has fixed the number of Directors
at nine. James A. Bianco and Louis A. Bianco are brothers. Mr. Curnock Cook
was elected as a Director by the holders of the Series A Convertible Preferred
Stock, who are entitled to vote as a separate class to elect one Director to
the Board of Directors. See "Item 13.--Certain Relationships and Related
Transactions."
 
 
                                      61

<PAGE>
 
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
 
  Section 16(a) of the Securities Exchange Act of 1934, as amended, requires
the Company's officers and Directors, and persons who own more than ten
percent of a registered class of the Company's equity securities, to file with
the Securities and Exchange Commission (the "SEC") reports of ownership and
changes in ownership of common stock and other equity securities of the
Company. Officers, Directors and greater than ten percent shareholders are
required by SEC regulations to furnish the Company with copies of all Section
16(a) forms they file. The Company does prepare Section 16(a) forms on behalf
of its officers and Directors based on the information provided by them.
 
  Based solely on review of this information, or written representations from
reporting persons that no other reports were required, the Company believes
that, during the 1996 fiscal year, all Section 16(a) filing requirements
applicable to its officer, Directors and greater than ten percent beneficial
owners were complied with, other than one late Form 3 that was filed after
Jack M. Anthony became a Section 16(a) reporting person.
 

ITEM 11. EXECUTIVE COMPENSATION
 
  The following table sets forth all compensation paid for the years ended
December 31, 1995 and 1996 to the Company's Chief Executive Officer and the
four other most highly compensated executive officers who were serving as
executive officers at December 31, 1996 (collectively, the "Named Executive
Officers"):
 
                          SUMMARY COMPENSATION TABLE

<TABLE>
<CAPTION>
                                                                             LONG-TERM
                                                                            COMPENSATION
                                                ANNUAL COMPENSATION          AWARDS(1)
                                         ---------------------------------- ------------
                                                                  OTHER      SECURITIES      ALL
                                                                 ANNUAL      UNDERLYING     OTHER
NAME AND                                                         COMPEN-      OPTIONS/     COMPEN-
PRINCIPAL POSITION               YEAR    SALARY ($) BONUS ($) SATION ($)(2)   SARS (#)    SATION ($)
- ------------------               ----    ---------- --------- ------------- ------------  ----------  ---
<S>                              <C>     <C>        <C>       <C>           <C>           <C>         <C>
James A. Bianco, M.D............ 1996     358,032    27,475         --         85,714       72,223(4)
President and Chief              1995     315,984       --          --        137,955(3)     7,402(5)
 Executive Officer
Jack W. Singer, M.D. ........... 1996     248,976       --          --         28,571       10,524(5)
Executive Vice President,        1995     248,976       --          --         20,957(3)     9,762(5)
 Research Program Chairman
Louis A. Bianco................. 1996     263,088    10,000         --         21,428       55,367(4)
Executive Vice President,        1995     232,195       --          --         55,098(3)     6,772(5)
 Finance and Administration
Maurice J. Schwarz, Ph.D........ 1996     187,500    12,936         --         28,571       65,619(6)
Executive Vice President,        1995     187,500       --        8,200(6)     28,571(3)    45,802(6)
 Product Development
Robert A. Lewis, M.D............ 1996(7)  181,512       --        6,964(7)     67,142       26,144(7)
Executive Vice President,
 Chief Scientific Officer
</TABLE>

- --------
(1) The Company did not make any long-term incentive plan payments to any of
    the Named Executive Officers in 1995 and 1996.
(2) Other annual compensation in the form of perquisites and other personal
    benefits has been omitted where the aggregate amount of such perquisites
    and other personal benefits constituted the lesser of $50,000 or 10% of
    the total annual salary and bonus for the Named Executive Officer for the
    applicable year.
(3) In April 1995, the Board of Directors approved the repricing of
    outstanding options to $11.725 per share by exchanging such outstanding
    options for a fewer number of options pursuant to a Black-Scholes formula.
    All other terms and conditions of the options remained unchanged. Grants
    for the year ended December 31, 1995 include options which were initially
    granted in prior years and have been repriced and exchanged for a fewer
    number of options in 1995 as follows: Dr. Bianco, 64,285 options were
    repriced and exchanged for 57,857 options; Dr. Singer, 14,285 options were
    repriced and exchanged for 12,857 options; Mr. Bianco, 42,857 options were
    repriced and exchanged for 36,428 options; and Dr. Schwarz, 21,428 options
    were repriced and exchanged for 17,142 options.
(4) All other compensation represents payment of unused sick leave for Dr.
    Bianco and Mr. Bianco accrued during 1992, 1993 and 1994, pursuant to the
    terms of their employment agreements then in effect, aggregating $64,526
    and $47,415, respectively, and reimbursement for long-term disability
    insurance premiums of $7,697 and $7,952, respectively.
 
                                      62

<PAGE>
 
(5) Represents reimbursement for long-term disability insurance premiums.
(6) All other compensation includes the amount of loan principal and interest
    forgiven in 1995 and 1996 of $42,210 and $60,789, respectively, in
    connection with Dr. Schwarz's relocation to the Seattle area and $3,592
    and $4,830 of relocation expenses which were reimbursed in 1995 and 1996,
    respectively. Other annual compensation represents amounts reimbursed for
    the payment of income taxes on the reimbursement of Dr. Schwarz's
    relocation expenses in 1994. See "--Employment Agreements."
(7) Includes compensation for employment beginning on April 1, 1996, the date
    on which Dr. Lewis joined the Company as Executive Vice President, Chief
    Scientific Officer. All other compensation represents reimbursement of
    relocation expenses. Other annual compensation represents amounts
    reimbursed for the payment of income taxes on the reimbursement of Dr.
    Lewis' relocation expenses.
 
  The following table sets forth for each of the Named Executive Officers the
number of options granted during the year ended December 31, 1996 and the
potential realizable value of such grants:
 
                      OPTIONS GRANTED IN LAST FISCAL YEAR

<TABLE>
<CAPTION>
                                      INDIVIDUAL GRANTS
                         --------------------------------------------
                                                                      POTENTIAL REALIZABLE
                                                                        VALUE AT ASSUMED
                                     % OF TOTAL                           ANNUAL RATES
                          NUMBER OF   OPTIONS                            OF STOCK PRICE
                         SECURITIES  GRANTED TO                         APPRECIATION FOR
                         UNDERLYING  EMPLOYEES   EXERCISE                OPTION TERM(3)
                           OPTIONS   IN FISCAL    PRICE    EXPIRATION ---------------------
NAME                     GRANTED (1)  YEAR (%)  ($/SH) (2)    DATE     5% ($)     10% ($)
- ----                     ----------- ---------- ---------- ---------- --------- -----------
<S>                      <C>         <C>        <C>        <C>        <C>       <C>
James A. Bianco, M.D....   85,714       18.1%    $11.725    11/19/06  $ 632,141 $ 1,601,995
Jack W. Singer, M.D.....   28,571        6.0%     11.725    11/07/06    210,711     533,992
Louis A. Bianco.........   21,428        4.5%     11.725    11/07/06    158,032     400,489
Maurice J. Schwarz,
 Ph.D...................   28,571        6.0%     11.725    11/07/06    210,711     533,992
Robert A. Lewis, M.D....    2,857          *      11.725    03/29/06     21,070      53,397
                           42,857        9.0%     11.725    04/01/06    316,070     800,997
                           21,428        4.5%     11.725    11/07/06    158,032     400,489
</TABLE>

- --------
 * Less than one percent.
(1) Options were granted under the 1994 Equity Incentive Plan (the "1994
    Plan").
(2) Stock options were granted at an exercise price equal to 100% of the
    estimated fair value of the Common Stock, as determined by the Board of
    Directors on the date of grant.
(3) Potential realizable value is based on the assumption that the Common
    Stock appreciates at the annual rates shown (compounded annually) from the
    date of grant until the expiration of the option term. These assumed rates
    of appreciation are mandated by the rules of the Securities and Exchange
    Commission and do not represent the Company's estimate or projection of
    the future Common Stock price. There can be no assurance that any of the
    values reflected in this table will be achieved.
 
  The following table sets forth for each of the Named Executive Officers, the
fiscal year-end number and value of unexercised options. No options were
exercised by any of the Named Executive Officers during 1996.
 
 AGGREGATED OPTION EXERCISES IN LATEST FISCAL YEAR AND FISCAL YEAR-END OPTION
                                    VALUES
 

<TABLE>
<CAPTION>
                           NUMBER OF SECURITIES      VALUE OF UNEXERCISED
                                UNDERLYING           IN-THE-MONEY OPTIONS
                          UNEXERCISED OPTIONS AT      AT FISCAL YEAR-END
                            FISCAL YEAR-END (#)           1996 ($)(1)
                         ------------------------- -------------------------
NAME                     EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- ----                     ----------- ------------- ----------- -------------
<S>                      <C>         <C>           <C>         <C>
James A. Bianco, M.D....   85,574       138,095        $ 0          $ 0
Jack W. Singer, M.D.....   16,195        33,333          0            0
Louis A. Bianco.........   43,669        32,857          0            0
Maurice J. Schwarz,
 Ph.D...................   15,238        41,904          0            0
Robert A. Lewis, M.D....    2,857        64,285          0            0
</TABLE>

- --------
(1) Based on the estimated fair value of the underlying securities at December
    31, 1996, the fiscal year end, no options were "in-the-money."
 
 
                                      63

<PAGE>
 
COMPENSATION OF DIRECTORS
 
  Directors who are also employees of the Company are not paid an annual
retainer nor compensated for serving on the Board. Non-employee Directors are
paid $2,000 per meeting of the Board or committees, up to a maximum of $10,000
per Director each calendar year. All Directors are reimbursed for their
expenses incurred in attending Board meetings. In addition, each non-employee
Director is entitled to certain automatic option grants under the 1994 Plan.
See "--Stock Option Plans."
 
  In December 1996, the Board approved the grant to each non-employee Director
of a 10-year, fully-vested nonstatutory stock option to purchase 14,285 shares
of Common Stock, other than Dr. Link, who was granted a 10-year, fully-vested
nonstatutory stock option to purchase 28,570 shares of Common Stock. Such
option grants will not be effective until approved by the shareholders at the
1997 Annual Meeting of Shareholders. The exercise price of such options is
$11.725. The Board also formally eliminated a $10,000 annual cash retainer for
non-employee Directors which had been previous company policy. See Note 9 of
Notes to Consolidated Financial Statements appearing at Item 8 of this Report.
 
EMPLOYMENT AGREEMENTS
 
  Dr. Bianco, President and Chief Executive Officer, entered into an
employment agreement with cti, effective December 17, 1996 which agreement
will expire on December 31, 1999. The agreement provides that Dr. Bianco would
receive a base salary at an annual rate of $393,835 in 1997 or such greater
amount as the Board of Directors shall determine. The agreement provides that,
in the event that cti terminates Dr. Bianco's employment without cause or Dr.
Bianco terminates his employment for cause, cti shall at such time pay
Dr. Bianco an amount equal to twenty-four months' base salary, all of Dr.
Bianco's stock options in cti shall immediately become vested and cti shall
continue to provide certain benefits through the term of the agreement. The
agreement also provides for the forgiveness over the term of the agreement of
certain indebtedness of Dr. Bianco to cti. See "Item 13.--Certain
Relationships and Related Transactions." In addition, the agreement provides
that Dr. Bianco is entitled to four weeks of paid vacation per year and that
any unused vacation time shall be paid in cash upon the termination of Dr.
Bianco's employment for any reason or at such earlier time as required to
avoid forfeiture of accrued but unused vacation time. The employment agreement
restricts Dr. Bianco from competing with cti for the term of the agreement and
for two years after termination of his employment with cti, unless cti shall
have terminated Dr. Bianco's employment without cause or Dr. Bianco shall have
terminated his employment for cause. The agreement also provides that, in the
event a "Change in Ownership" (as defined in Dr. Bianco's employment contract)
occurs, then all stock options of Dr. Bianco shall immediately become vested.
 
  Mr. Bianco, Executive Vice President, Finance and Administration, entered
into a three-year employment agreement with cti, effective February 1, 1992,
which agreement was extended for an additional three-year period to expire on
January 31, 1998 by a letter agreement dated May 27, 1994. Effective January
1, 1997, cti's Board of Directors increased Mr. Bianco's annual base salary to
$298,080. His employment agreement provides that this base salary is subject
to annual increases in proportion to increases in the CPI, plus 10% of the
CPI-adjusted annual base salary, or such greater amount as the Board of
Directors shall determine. The agreement provides that, in the event that cti
terminates Mr. Bianco's employment without cause or Mr. Bianco terminates his
employment for cause, cti shall at such time pay Mr. Bianco an amount equal to
the total base salary otherwise payable through the expiration of the term of
the agreement or six months' base salary, whichever is greater, and shall
continue to provide certain benefits through the term of the agreement. The
agreement also provides that Mr. Bianco is entitled to four weeks of paid
vacation per year and that any unused vacation time and sick leave shall be
paid in cash upon the termination of Mr. Bianco's employment for any reason.
 
  Dr. Schwarz, Executive Vice President, Product Development, entered into a
two-year employment agreement with cti effective May 2, 1994, which is
renewable automatically for successive one-year terms subject to certain
termination provisions contained in the agreement. The agreement provides that
Dr. Schwarz initially would receive an annual base salary of $187,500, subject
to periodic increases based on performance. In
 
                                      64

<PAGE>
 
the event cti terminates Dr. Schwarz's employment without cause, cti shall pay
Dr. Schwarz such amounts owing for the remaining term of the agreement. The
agreement further provides that in connection with his relocation to the
Seattle area, Dr. Schwarz be reimbursed for capital loss on the sale of his
former residence in the form of a forgivable loan in an amount not to exceed
$150,000. The loan shall be forgiven in three annual installments, subject to
Dr. Schwarz's continued employment with cti, with any unforgiven portion
becoming immediately due and payable within three months of any termination of
Dr. Schwarz's employment.
 
  Dr. Lewis, Executive Vice President, Chief Scientific Officer, has a two-
year severance agreement with cti, effective April 1, 1996. The agreement
provides that, in the event that Dr. Lewis is terminated by cti without cause
or that Dr. Lewis terminates his employment for good reason, cti shall
continue to pay Dr. Lewis his monthly base salary and benefits through the
expiration of the term of the agreement. The inventions and proprietary
information agreement restricts Dr. Lewis from competing with cti for two
years after his termination of employment with cti.
 
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
 
  During the last completed fiscal year, the Compensation Committee consisted
of Dr. Jaeger and Messrs. Curnock Cook and Bowman. None of these individuals
was at any time during the last completed fiscal year, or at any other time,
an officer or employee of the Company. At the 1996 Annual Meeting of
Shareholders, Mr. Curnock Cook was elected as a Director by the holders of the
outstanding shares of Convertible Preferred Stock voting as a separate class.
In September 1996, The International Biotechnology Trust plc ("IBT"), which is
an affiliate of Mr. Curnock Cook and Rothschild Asset Management Limited,
purchased 14,925.373 shares of Series A Convertible Preferred Stock for an
aggregate purchase price of $5.0 million. In March 1997, Biotechnology
Investments Limited, which is an affiliate of IBT and Rothschild, purchased
250,000 shares of Common Stock in the Company's initial public offering for an
aggregate purchase price of $2.5 million. See "Item 13.--Certain Relationships
and Related Transactions."
 
STOCK OPTION PLANS
 
  In January 1994 the Board of Directors adopted, and in February 1994 the
shareholders of the Company approved, the Company's 1994 Equity Incentive Plan
(the "1994 Plan"). A total of 582,685 shares of Common Stock were initially
reserved for issuance under the 1994 Plan and a predecessor plan, the
Company's 1992 Stock Option Plan (the "1992 Plan"). In May 1995 and April 1996
the shareholders of the Company approved the adoption of amendments to the
1994 Plan to increase the aggregate number of shares authorized for issuance
thereunder by 246,887 shares and 507,143 shares, respectively, bringing the
total number of shares reserved under the 1994 Plan to 1,336,715 shares of
Common Stock. As of December 31, 1996, 6,706 options have been exercised, 10-
year options to purchase 1,208,608 shares were granted and outstanding, and
options to purchase 121,401 shares of Common Stock remained available for
future grants under the 1994 Plan.
 
  The 1994 Plan provides for (i) the grant of incentive stock options
("ISOs"), nonstatutory stock options ("NSOs") and stock appreciation rights
("SARs"), (ii) the award of stock bonuses (iii) the sale of stock, and (iv)
any other equity-based or equity-related awards which the plan administrator
determines to be consistent with the purpose of the 1994 Plan and the
interests of the Company to employees (including officers) and independent
consultants. The 1994 Plan also provides for the automatic grant of NSOs to
non-employee Directors pursuant to the formula described below. The 1994 Plan
supersedes the 1992 Plan, pursuant to which the Board of Directors was
authorized to issue ISOs and NSOs upon terms and conditions similar to the
1994 Plan. Options granted under the 1992 Plan remain valid under the terms of
the 1992 Plan. The number of shares available for future grants under the 1994
Plan will be increased by the number of shares for which options granted under
the 1992 Plan expire, terminate or are canceled.
 
 
                                      65

<PAGE>
 
  The 1994 Plan is administered by the Compensation Committee of the Board of
Directors (the "Committee"). The Committee determines the persons to whom
awards will be made, the exercise or purchase price of each award, the number
of shares to be covered by each option, the term of each option, the times at
which each award may be exercised, and whether each option granted under the
1994 Plan is an ISO or a NSO. The exercise price of ISOs and NSOs granted by
the Committee must be at least 100% of the fair market value of the underlying
shares on the date of the grant, except that the exercise price of ISOs
granted to an optionee holding more than 10% of the combined voting power of
all classes of the Company's stock ("10% Shareholders") must be at least 110%
of the fair market value of the underlying shares on the date of the grant.
The Committee sets the vesting schedule for and the term of options granted
under the 1994 Plan, subject to the limitations that (i) options granted to
Directors and officers of the Company may not be exercised within six months
after the grant thereof, (ii) the term of ISOs may not exceed 10 years and
(iii) the term of ISOs granted to 10% Shareholders may not exceed five years.
The Committee may also advance the lapse of any waiting period, accelerate any
exercise date, waive or modify any restriction with respect to an award or
give an employee an election to surrender an existing award in exchange for
the grant of a new award.
 
  Options granted under the 1994 Plan are nontransferable. In the event of the
death or other termination of an optionee's employment with the Company, the
1994 Plan provides that the optionee's options may be exercised for a period
of three months to one year thereafter. The 1994 Plan also provides that upon
any termination of employment, the Committee may extend the exercise period
for any period up to the expiration date of the option and may increase the
portion of the option that is exercisable.
 
  The purchase price for shares of Common Stock purchased on exercise of
options granted under the 1994 Plan must be paid in cash, including cash that
may be the proceeds of a loan from the Company or, with the consent of the
Committee, in whole or in part in shares of Common Stock of the Company. With
the consent of the Committee, an optionee may request the Company to apply the
shares to be received on exercise of a portion of an option to satisfy the
exercise price for additional portions of the option.
 
  Under the 1994 Plan, each non-employee Director is automatically granted a
10-year, fully vested nonstatutory stock option to purchase 2,857 shares of
Common Stock upon his or her election to the Board of Directors for the first
time. In addition, each non-employee Director is automatically granted a 10-
year, fully vested nonstatutory stock option to purchase 1,904 shares of
Common Stock on each anniversary of his or her immediately preceding election
to the Board of Directors. The exercise price of such options is 100% of the
fair market value of the shares of Common Stock on the date of grant.
 
  The Committee may grant SARs either alone or in connection with a stock
option. An SAR entitles the holder to payment from the Company of an amount
equal to the excess, on the date of exercise, of the fair market value of one
share over its fair market value on the date of grant (or, if granted in
connection with an option, the exercise price per share under the option to
which the SAR relates), multiplied by the number of shares covered by the
portion of the SAR or option that is surrendered. The Committee may also award
stock bonuses or issue shares for consideration subject to such terms,
conditions and restrictions as the Committee may determine, including
restrictions concerning transferability and forfeiture of the shares awarded.
No cash consideration will be paid in connection with SARs and stock bonuses
other than tax withholding amounts. Where shares are issued for consideration,
such consideration may not be less than 75% of the fair market value of the
shares on the date of issuance.
 
  The 1994 Plan provides for automatic acceleration of the vesting of options
and SARs granted under the 1994 Plan if a merger, consolidation,
reorganization, plan of exchange or liquidation results in the Company's
shareholders receiving cash, stock or other property in exchange for their
shares, except as specified below. Option holders will have the right during
the 30-day period immediately prior to any such event to exercise their
options or SARs without any limitation on exercisability. The 1994 Plan
requires the purchase of options and SARs granted to officers or Directors
following the expiration of the required six-month holding period. The 1994
Plan provides that, if the Company's shareholders receive stock of another
corporation in exchange for shares of the Company in any merger,
consolidation, reorganization or plan of exchange, all options granted
 
                                      66

<PAGE>
 
under the 1994 Plan will be converted into options to purchase shares of the
stock of the other corporation and all SARs will be converted into SARs
measured by the stock of the other corporation. The 1994 Plan also allows the
Committee to accelerate the vesting of the options and SARs granted under the
1994 Plan and to grant the option holders a 30 day period prior to such event
to exercise their options or SARs, as provided above.
 
  The 1994 Plan also allows the Committee to accelerate the vesting of all
options and SARs granted thereunder (including options and SARs granted to
officers and Directors in the six months prior to such event) upon the
occurrence of a "Change in Control." A "Change in Control" is defined as (a)
the acquisition, directly or indirectly, by any individual, entity or group of
beneficial ownership of securities representing 50.1% or more of either the
then outstanding shares of Common Stock or the combined voting power in the
election of Directors of then outstanding voting securities of the Company,
(b) individuals who, as of the effective date of the 1994 Plan, constitute the
Board of Directors (the "Incumbent Board") (including any individual whose
subsequent election or nomination was approved by a vote of at least a
majority of the Directors then comprising the Incumbent Board) cease for any
reason to constitute at least a majority of the Board of Directors or (c)
approval by the shareholders of the Company of certain reorganizations,
mergers or consolidations, or of certain liquidations, dissolutions or
dispositions of all or substantially all of the assets of the Company.
 
  The Committee may make awards under the 1994 Plan that have terms and
conditions that vary from those specified in the 1994 Plan when such awards
are granted in substitution for, or in connection with the assumption of,
existing awards made by another corporation and assumed or otherwise agreed to
be provided for by the Company in connection with a corporate merger or other
similar transaction to which the Company or an affiliated company is a party.
The Committee may also specify the terms and provisions of other equity-based
or equity-related awards not described in the 1994 Plan which the Committee
determines to be consistent with the purpose of the 1994 and the interests of
the Company.
 
  The 1994 Plan may be amended by the Board of Directors at any time and will
terminate on January 1, 2004 unless terminated earlier by the Board of
Directors. No options may be granted after the termination of the 1994 Plan.
However, options granted under the 1994 Plan will remain valid under the 1994
Plan until their respective expiration dates.
 
  As of December 31, 1996, the 10-year options to purchase 1,208,608 shares of
Common Stock which are outstanding pursuant to the 1992 Plan and the 1994 Plan
were granted to 144 employees (excluding executive officers), consultants and
Directors, and generally vest in equal annual installments on the first three
or four anniversaries of the date of grant. In April 1995 the Board of
Directors approved the repricing of outstanding options to $11.725 per share
by offering to exchange such outstanding options for a fewer number of options
pursuant to a Black-Scholes formula. Subsequently, options for 434,664 shares,
with initial exercise prices of $17.50 and $31.50 per share, were exchanged
for 377,121 options with a price of $11.725 per share. All other terms and
conditions of the options remained unchanged.
 
EMPLOYEE STOCK PURCHASE PLAN
 
  In March 1996 the Board of Directors adopted, and in April 1996 the
shareholders of the Company approved, the Company's 1996 Employee Stock
Purchase Plan (the "Purchase Plan"). The Purchase Plan is intended to
encourage ownership of the Company's Common Stock by employees of the Company
and to provide additional incentive for the employees to promote the success
of the business of the Company. A maximum of 285,714 shares of Common Stock
have been reserved for purchase under the Purchase Plan. As of December 31,
1996, no options to purchase shares of Common Stock have been granted and no
shares of Common Stock have been purchased under the Purchase Plan.
 
  Employees of the Company or any of its subsidiaries who customarily work
more than twenty hours per week and more than five months per calendar year,
and who have been employed by the Company or any of its subsidiaries for at
least one year may participate in the Purchase Plan. The Purchase Plan is
administered by the Compensation Committee of the Board of Directors (the
"Committee"). The Purchase Plan provides for the
 
                                      67

<PAGE>
 
automatic grant of options to purchase shares of Common Stock ("Options"). The
Options are granted on the first day of an offering period, which lasts
approximately six months. Payroll deductions are accumulated in an account for
each participant, based on the amounts specified by the participant in an
enrollment form. At the end of the offering period, the participant's account
balance is used to purchase shares of Common Stock pursuant to the Option. The
purchase price of shares of Common Stock under an Option will equal 85% of the
average of the fair market value of the shares at the beginning and at the end
of the offering period. Options may not be assigned or transferred. No
participant may purchase shares having a fair market value exceeding $25,000
in any calendar year. A participant may withdraw from an offering period at
any time without affecting his or her eligibility to participate in future
offering periods.
 
  There are no tax consequences to either the participant or the Company when
the Option is issued. When shares are issued upon the exercise of the Option,
there are no tax consequences to the participant (except to the extent any
excess in the fair market value of the Common Stock over the exercise price
constitutes a tax preference item which requires payment of the alternative
minimum tax) or the Company. A participant's Option will terminate and his or
her accumulated account balance will be returned if such participant ceases to
be employed by the Company.
 
  If a participant disposes of shares purchased under the Purchase Plan at
least two years after the first day of the applicable offering period and at
least one year after the date of purchase, the participants will recognize
ordinary income in the year of disposition equal to the amount of the
discount. The amount of ordinary income recognized by a participant will be
added to the participant's basis in the shares. Any additional gain recognized
upon the disposition will be long-term capital gain. The Company will not
generally be entitled to a deduction if the participant complies with these
holding periods.
 
  If a participant disposes of shares purchased under the Purchase Plan within
two years from the first day of the applicable offering period or within one
year from the date of purchase (a "disqualifying disposition"), the
participant will recognize ordinary income in the year of such disposition
equal to the amount by which the fair market value of the shares on the date
the shares were purchased exceeded the purchase price. The amount of ordinary
income will be added to the participant's basis in the shares, and any
additional gain or resulting loss recognized on the disposition of the shares
will be a capital gain or loss. The Company will be entitled to a deduction in
the year of the disqualifying disposition equal to the amount of ordinary
income recognized by the participant as a result of the disposition.
 
  The Purchase Plan provides that in the event of a "Change in Control," the
Committee will either provide for the immediate exercise of the Options to the
extent of accumulated payroll balances or provide for a successor to adopt the
Purchase Plan. For purposes of the Purchase Plan, events constituting a
"Change in Control" are (i) the direct or indirect sale or exchange by the
shareholders of the Company of all or substantially all of the shares of
Common Stock of the Company where the shareholders of the Company before the
sale or exchange do not retain, directly or indirectly, at least a majority of
the beneficial interest in the voting stock of the Company, (ii) a merger in
which the shareholders of the Company before such merger do not retain,
directly or indirectly, at least a majority of the beneficial interest in the
voting stock of the Company or (iii) the sale, exchange or transfer of all or
substantially all of the Company's assets. The Board of Directors may
terminate or amend the Purchase Plan at any time. No termination of or
amendment to the Purchase Plan may materially adversely affect the rights of a
participant in the Purchase Plan without such participant's consent.
 
  In the event any change is made to the stock issuable under the Purchase
Plan by reason of any stock split, stock dividend, combination of shares or
recapitalization, appropriate adjustment will be made to the share reserve of
the Purchase Plan and the number of shares that a participant may purchase
with respect to an Option.
 
                                      68

<PAGE>
 

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
 
  The following table sets forth certain information regarding beneficial
ownership of Common Stock, as of March 28, 1997 by (i) each shareholder known
by the Company to be the beneficial owner of more than 5% of its outstanding
shares of Common Stock, (ii) each of the Company's Directors and the Named
Executive Officers and (iii) all Directors and executive officers as a group:
 

<TABLE>
<CAPTION>
                                              NUMBER OF SHARES     PERCENTAGE
   NAME AND ADDRESS OF BENEFICIAL OWNER    BENEFICIALLY OWNED (1) OWNERSHIP (1)
   ------------------------------------    ---------------------- -------------
<S>                                        <C>                    <C>
The International Biotechnology Trust plc        1,358,156            10.42%
 (2) .....................................
 c/o Rothschild Asset Management Limited
 Five Arrows House
 St. Swithen's Lane
 London, England EC4N 8NR
Kummell Investments Limited (3)...........       1,287,456             9.88
 922 Europort
 Gibraltar
LGT Capital...............................       1,000,000             7.68
 50 California Street, 27th Floor
 San Francisco, CA 94104
Collinson Howe Venture Partners (4).......         948,800             7.28
 1055 Washington Boulevard
 Stamford, CT 06901
Biotechnology Investment Group, L.L.C.             815,755             6.26
 (5)......................................
 c/o Collinson Howe Venture Partners
 1055 Washington Boulevard
 Stamford, CT 06901
Johnson & Johnson Development Corporation          743,262             5.70
 .........................................
 One Johnson & Johnson Plaza
 New Brunswick, NJ 08933
The Phoenix Partners (6)..................         724,592             5.56
 1000 Second Avenue, Suite 3600
 Seattle, WA 98104
James A. Bianco, M.D.** (7)...............         359,232             2.74
Jack L. Bowman** (8)......................           6,666                *
Jeremy L. Curnock Cook** (9)..............       1,364,822            10.47
Wilfred E. Jaeger, M.D.** (10)............           6,476                *
Max E. Link, Ph.D.** (11).................          10,476                *
David W. Martin Jr., M.D.** (12)..........           4,762                *
Terrence M. Morris** (13).................           4,762                *
Phillip M. Nudelman, Ph.D.** (14).........           6,095                *
Jack W. Singer, M.D.** (15)...............         215,944             1.66
Louis A. Bianco (16)......................         146,179             1.12
Maurice J. Schwarz, Ph.D. (17)............          15,238                *
Robert A. Lewis, M.D. (18)................           2,857                *
All Directors and executive officers as a
 group
 (15 persons) (19)........................       2,171,461            16.39
</TABLE>

- --------
  * Less than 1%
  ** Denotes Director of the Company
 (1) Beneficial ownership is determined in accordance with the rules of the
     Securities and Exchange Commission and generally includes voting or
     investment power with respect to securities. Shares of Common Stock
     subject to options or warrants currently exercisable or convertible, or
     exercisable or convertible within 60 days of March 28, 1997, are deemed
     outstanding for computing the percentage of the person holding such
     option or warrant but are not deemed outstanding for computing the
     percentage of any other person. Except as indicated in the footnotes to
     this table and pursuant to applicable community property laws, the
     persons named in the table have sole voting and investment power with
     respect to all shares of Common Stock beneficially owned.
 
                                      69

<PAGE>
 
 (2) Consists of 1,108,156 shares of Common Stock beneficially owned by The
     International Biotechnology Trust plc, a company formed under the laws of
     England ("IBT") managed by Rothschild Asset Management Limited
     ("Rothschild") and 250,000 shares of Common Stock beneficially owned by
     Biotechnology Investments Limited ("BIL"). Rothschild has or shares
     voting and investment power with respect to the shares held by IBT and
     may be deemed to be the beneficial owner of such shares. Rothschild, as
     advisor to BIL and to Rothschild Asset Management (C.I.) Limited
     ("Rothschild CI"), which is the manager of BIL, has or shares voting and
     investment power with respect to the shares held by BIL and may be deemed
     to be the beneficial owner of such shares. Mr. Curnock Cook is a director
     of IBT and Rothschild, and may be deemed to be the beneficial owner of
     any shares beneficially owned by each of IBT, Rothschild and BIL.
     Mr. Curnock Cook disclaims beneficial ownership of shares beneficially
     owned by IBT, Rothschild and BIL except to the extent of his
     proportionate interest therein. See footnote (9) below.
 (3) Mr. Morris is the Chief Executive Officer of Morningside Ventures, which
     advises Kummell Investments Limited ("Kummell") on its private venture
     capital portfolio. Mr. Morris does not have or share voting or investment
     power with respect to the shares held by Kummell. See footnote (13)
     below.
 (4) Collinson Howe Venture Partners ("CHVP") is a venture capital investment
     management firm which is the managing member of Biotechnology Investment
     Group, L.L.C., a Delaware limited liability company ("BIG"), and is the
     investment advisor to Schroder Ventures Limited Partnership ("SVLP"),
     Schroder Ventures U.S. Trust ("SVUST") and Schroders Incorporated ("SI").
     As such, CHVP has or shares voting and investment power with respect to
     the shares held by BIG, SVLP, SVUST and SI and may be deemed to be the
     beneficial owner of such shares. The shares listed above consist of (i)
     815,755 shares of Common Stock held by BIG, 66,991 shares of Common Stock
     held by SVLP, 16,748 shares of Common Stock held by SVUST and 36,449
     shares of Common Stock held by SI, and (ii) an additional 8,229, 2,057
     and 2,571 shares of Common Stock issuable upon exercise of options
     beneficially owned by SVLP, SVUST and SI, respectively, pursuant to an
     agreement with Dr. Jaeger. See footnotes (5) and (10) below.
 (5) BIG is a limited liability company which was created to acquire, hold,
     protect, manage and dispose of equity, debt and derivative securities of
     biotechnology and other companies. 771,429 of the shares of Common Stock
     held by BIG were acquired in January 1995 from The Edward Blech Trust
     ("EBT"). The sole beneficiary of EBT is the minor child of David Blech, a
     founder, former director and shareholder of the Company. The present
     members of BIG are (i) the managing member, CHVP, an investment
     management firm of which Jeffrey J. Collinson is President, sole director
     and majority shareholder, (ii) EBT, and (iii) Wilmington Trust Company
     ("WTC"), as voting trustee under a voting trust agreement (the "Voting
     Trust Agreement") among WTC, BIG and BIO Holdings L.L.C. ("Holdings").
     The managing member of BIG is CHVP. The members of BIG share voting and
     investment power with respect to all shares held of record by BIG. All of
     the shares held of record by BIG have been pledged as collateral to
     Citibank, N.A. ("Citibank") to secure indebtedness owed to such bank.
     Each of Citibank and Holdings has the right pursuant to the Voting Trust
     Agreement to direct certain actions of WTC as a member of BIG. WTC, as
     the member holding a majority interest in Holdings, has the right to
     direct the actions of Holdings under the Voting Trust Agreement.
     Citibank, pursuant to a separate voting trust agreement among WTC, David
     Blech and Holdings, has the right to direct the actions of WTC as a
     member of Holdings with respect to the rights of Holdings under the
     Voting Trust Agreement. By virtue of their status as members of BIG, each
     of CHVP and EBT may be deemed to be the beneficial owner of all shares
     held of record by BIG. By virtue of his status as the majority owner and
     controlling person of CHVP, Jeffrey J. Collinson may also be deemed the
     beneficial owner of all shares held of record by BIG. Each of CHVP, EBT
     and Mr. Collinson disclaims beneficial ownership of shares held by BIG
     except to the extent of such person's proportionate interest therein.
 (6) Consists of 190,133 shares of Common Stock held by The Phoenix Partners
     II Limited Partnership Liquidating Trust ("PPII"), 234,459 shares of
     Common Stock held by The Phoenix Partners III Limited Partnership
     ("PPIII"), and 300,000 shares of Common Stock held by The Phoenix
     Partners IV Limited Partnership ("PPIV"). Stuart C. Johnston is the
     Managing General Partner of The Phoenix Management Partners II, which is
     the General Partner of PPII, the Managing General Partner of The Phoenix
     Management Partners III, which is the General Partner of PPIII, and the
     Managing Member of The Phoenix Management IV LLC, which is the General
     Partner of PPIV. As such, Mr. Johnston has voting and investment power
     with respect to the shares held by PPII, PPIII and PPIV, and may be
     deemed to be the beneficial owner of such shares. Mr. Johnston disclaims
     beneficial ownership of shares held by PPII, PPIII and PPIV, except to
     the extent of his proportionate partnership interest therein.
 (7) Includes 85,574 shares issuable upon exercise of options that are
     currently exercisable or exercisable within 60 days of March 28, 1997.
     Does not include 138,095 shares issuable upon exercise of options not yet
     vested. 52,381 of such options vest in equal installments on December 5,
     1997 and 1998, and 85,714 of such options vest in equal installments on
     November 19, 1997, 1998 and 1999.
 (8) Consists of 6,666 shares issuable upon exercise of options that are
     currently exercisable or exercisable within 60 days of March 28, 1997.
     Does not include 3,809 shares issuable upon exercise of options not yet
     vested. Such options vest in equal installments on May 22, 1997 and 1998.
 (9) Includes 1,108,156 shares of Common Stock beneficially owned by IBT and
     250,000 shares beneficially owned by BIL. IBT is managed by Rothschild
     and Rothschild has or shares voting and investment power with respect to
     the shares held by IBT and may be deemed to be the beneficial owner of
     such shares. BIL is managed by Rothschild CI, each of which are advised
     by Rothschild, and Rothschild has or shares voting and investment power
     with respect to the shares held by BIL and may be deemed to be the
     beneficial owner of such shares. Mr. Curnock Cook is a director of IBT
     and Rothschild and may be deemed to be the beneficial owner of any shares
     beneficially owned by each of IBT, Rothschild and BIL. Mr. Curnock Cook
     disclaims beneficial ownership of shares beneficially owned by IBT,
     Rothschild and BIL except to the extent of his proportionate interest
     therein. Also includes an immediately exercisable option to purchase
     6,666 shares of Common Stock. See footnote (2) above and "Item 13.--
     Certain Relationships and Related Transactions."
(10) Consists of 6,476 shares issuable upon exercise of options that are
     currently exercisable or exercisable within 60 days of March 28, 1997.
     Does not include 12,857 shares issuable upon exercise of options
     beneficially owned by affiliates of CHVP
 
                                      70

<PAGE>
 
   pursuant to an agreement with Dr. Jaeger. Dr. Jaeger, a director of the
   Company, is a former partner at CHVP. Dr. Jaeger disclaims beneficial
   ownership of shares of Common Stock beneficially owned by affiliates of
   CHVP. See footnote (4) above.
(11) Includes an immediately exercisable option to purchase 1,904 shares of
     Common Stock.
(12) Consists of an immediately exercisable option to purchase 4,762 shares of
     Common Stock.
(13) Consists of an immediately exercisable option to purchase 4,762 shares of
     Common Stock. Mr. Morris is the Chief Executive Officer of Morningside
     Ventures, which advises Kummell on its private venture capital portfolio.
     Mr. Morris does not have or share voting or investment power with respect
     to the shares held by Kummell. See footnote (3) above.
(14) Consists of 6,095 shares issuable upon exercise of options that are
     currently exercisable or exercisable within 60 days of March 28, 1997.
     Does not include 3,809 shares issuable upon exercise of options not yet
     vested. Such options vest in equal installments on May 22, 1997 and 1998.
(15) Includes 16,195 shares issuable upon exercise of options that are
     currently exercisable or exercisable within 60 days of March 28, 1997.
     Does not include 33,333 shares issuable upon exercise of options not yet
     vested. 4,762 of such options vest in equal installments on December 5,
     1997 and 1998, and 28,571 of such options vest in equal installments on
     November 7, 1997, 1998 and 1999.
(16) Includes 43,669 shares issuable upon exercise of options that are
     currently exercisable or exercisable within 60 days of March 28, 1997.
     Does not include 32,857 shares issuable upon exercise of options not yet
     vested. 11,429 of such options vest in equal installments on December 5,
     1997 and 1998, and 21,428 of such options vest in equal installments on
     November 7, 1997, 1998 and 1999.
(17) Consists of 15,238 shares issuable upon exercise of options that are
     currently exercisable or exercisable within 60 days of March 28, 1997.
     Does not include 41,904 shares issuable upon exercise of options not yet
     vested. 5,714 of such options vest on June 1, 1997, 7,619 of such options
     vest in equal installments on December 5, 1997 and 1998, and 28,571 of
     such options vest in equal installments on November 7, 1997, 1998 and
     1999.
(18) Consists of an immediately exercisable option to purchase 2,857 shares of
     Common Stock. Does not include 64,285 shares issuable upon exercise of
     options not yet vested. 28,585 of such options vest on April 1, 1998,
     14,271 of such options vest on April 1, 1999, and 21,429 of such options
     vest in equal installments on November 7, 1997, 1998, and 1999.
(19) Includes an aggregate of 222,466 shares of Common Stock issuable upon
     exercise of options that are currently exercisable or exercisable within
     60 days of March 28, 1997. See footnotes (7) through (18). Excludes, with
     respect to each of Mr. Bowman, Mr. Curnock Cook, Dr. Jaeger, Dr. Martin,
     Mr. Morris and Dr. Nudelman, 14,285 shares of Common Stock, and with
     respect to Dr. Link, 28,570 shares of Common Stock, which will become
     issuable upon exercise of outstanding options following the approval of
     such option grants by the Company's shareholders at the 1997 Annual
     Meeting of Shareholders. See Note 9 of Notes to Consolidated Financial
     Statements.
 

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
 
  In December 1993 cti loaned Dr. Bianco $200,000 at 5.35% annual interest.
The promissory note originally provided for a single payment of principal and
interest on the earlier of July 1, 1997 or the third anniversary of the
effective date of the initial underwritten public offering of cti's Common
Stock. In December 1996 Dr. Bianco entered into an employment agreement with
the Company which amended the note to provide for the forgiveness of one-third
of the loan on each anniversary of the agreement. The unpaid portion of the
loan will accelerate and become due and payable in the event that cti
terminates Dr. Bianco's employment for cause or Dr. Bianco terminates his
employment without cause. The unpaid portion of the loan will be forgiven in
the event that cti terminates Dr. Bianco's employment without cause, Dr.
Bianco terminates his employment for cause, dies or becomes disabled, a
"Change in Ownership" (as defined in Dr. Bianco's employment agreement) occurs
or cti's public market capitalization equals or exceeds $500 million. See
"Item 11.--Executive Compensation--Employment Agreements." The loan is secured
by a pledge of 5,715 shares of Common Stock owned by Dr. Bianco.
 
  At the 1996 Annual Meeting of Shareholders, Mr. Curnock Cook was elected as
a Director by the holders of the outstanding shares of Series A Convertible
Preferred Stock voting as a separate class. In September 1996, The
International Biotechnology Trust plc ("IBT"), which is an affiliate of Mr.
Curncock Cook and Rothschild Asset Management Limited ("Rothschild"),
purchased 14,925.373 shares of Series A Convertible Preferred Stock for an
aggregate purchase price of $5.0 million. In March 1997, Biotechnology
Investments Limited, which is an affiliate of IBT and Rothschild, purchased
250,000 shares of Common Stock in the Company's initial public offering for an
aggregate purchase price of $2.5 million. See "Item 12--Security Ownership of
Certain Beneficial Owners and Management."
 
  In September 1996 Kummell Investments Limited ("Kummell") purchased
14,925.373 shares of Series A Convertible Preferred Stock for an aggregate
purchase price of $5.0 million. In connection with this transaction, the
Company agreed that (i) it will take all necessary action to nominate a
designee of Kummell at the 1999 Annual
 
                                      71

<PAGE>
 
Meeting of Stockholders to serve as a Director until the 2002 Annual Meeting
of Stockholders, and (ii) if prior to the 1999 Annual Meeting of Stockholders
Mr. Morris, as a designee of Kummell, shall cease to be a Director, it will
take all necessary action to nominate a designee of Kummell as a Director to
fill the vacancy created by Mr. Morris' termination. Mr. Morris is the Chief
Executive Officer of Morningside Ventures, which advises Kummell on its
private venture capital portfolio. Such agreement terminated upon the closing
of the Company's initial public offering on March 26, 1997.
 
  In November 1996 Johnson & Johnson Development Corporation ("JJDC"), a
wholly-owned subsidiary of Johnson & Johnson, purchased 14,925.373 shares of
Series B Convertible Preferred Stock, for an aggregate purchase price of $5.0
million, pursuant to a Stock Purchase Agreement entered into between cti and
JJDC in connection with the execution of the Collaboration Agreement. Johnson
& Johnson also purchased an additional 300,000 shares of Common Stock on March
26, 1997 concurrent with the closing of the Company's initial public offering
for an aggregate purchase price of $3.0 million. Pursuant to the Stock
Purchase Agreement, cti is entitled to require JJDC to purchase additional
shares of Common Stock upon the achievement of certain milestones. See "Item
1.--Business--Collaborations."
 
                                      72

<PAGE>
 

                                    PART IV
 

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
 
 (a)Financial Statements and Financial Statement Schedules
 
  (i)Financial Statements
 

    Report of Ernst & Young LLP, Independent Auditors
 
    Consolidated Balance Sheets
 
    Consolidated Statements of Operations
 
    Consolidated Statements of Shareholders' Equity
 
    Consolidated Statements of Cash Flows
 

    Notes to Consolidated Financial Statements
 
  (ii)Financial Statement Schedules
 
    None.
 
    All schedules have been omitted since they are either not required, are
  not applicable, or the required information is shown in the financial
  statements or related notes.
 
 (b)Reports on Form 8-K.
 
    Form 8-K filed on October 21, 1996 -- Item 5.--Other Events (reporting
  the closing of an unregistered offering)
 
 (c)Exhibits
 

<TABLE>
<CAPTION>
 EXHIBIT
 NUMBER                                DESCRIPTION
 -------                               -----------
 <C>     <S>
  3.1(1) Registrant's Restated Articles of Incorporation
  3.2(1) Registrant's Articles of Amendment to Restated Articles of
          Incorporation Establishing a Series of Preferred Stock (Series A
          Convertible Preferred Stock)
  3.3(6) Registrant's Articles of Amendment to Restated Articles of
          Incorporation Reducing the Number of Authorized Shares of Series A
          Convertible Preferred Stock
  3.4(6) Registrant's Articles of Amendment to Restated Articles of
          Incorporation Establishing a Series of Preferred Stock (Series B
          Convertible Preferred Stock)
  3.5(6) Registrant's Articles of Amendment to Restated Articles of
          Incorporation Establishing a Series of Preferred Stock (Series C
          Preferred Stock)
  3.6(6) Registrant's Articles of Amendment to Restated Articles of
          Incorporation of Cell Therapeutics, Inc. Effecting a Reverse Stock
          Split.
  3.7(5) Registrant's Restated Bylaws
  4.1(3) Form of Rights Agreement dated as of November 11, 1996, between the
          Registrant and Harris Trust Company of California, which includes the
          Form of Rights Certificate as Exhibit A, the Summary of Rights to
          Purchase Preferred Stock as Exhibit B and the Form of Certificate of
          Designation of the Series C Preferred Stock as Exhibit C
 10.1(2) Lease Agreement between David A. Sabey and Sandra L. Sabey and the
          Registrant, dated March 27, 1992, as amended March 31, 1993 and
          October 13, 1993

 10.2(6) Third Amendment to Lease Agreement between David A. Sabey and Sandra
          L. Sabey and the Registrant, dated as of September 10, 1996.
 10.3(1) Assignment of Lease between Manlove Travel and the Registrant, dated
          April 23, 1993
 10.4(6) Letter Agreement between David A. Sabey, Sandra L. Sabey and the
          Registrant, dated as of September 6, 1996, amending the Assignment of
          Lease.
</TABLE>

 
 
                                      73

<PAGE>
 

<TABLE>
<CAPTION>
  EXHIBIT
  NUMBER                               DESCRIPTION
 ---------                             -----------
 <C>       <S>
 10.5(6)   Employment Agreement between the Registrant and James A. Bianco,
            dated as of December 17, 1996
 10.6(2)   Employment Agreement between the Registrant and Louis A. Bianco,
            dated as of February 1, 1992, as amended May 27, 1994
 10.7(1)   Employment Agreement between the Registrant and Maurice J. Schwarz,
            dated May 2, 1994
 10.8(1)   Severance Agreement between the Registrant and Robert A. Lewis,
            dated April 1, 1996
 10.9(6)   Form of Strategic Management Team Severance Agreement.
 10.10(1)  Promissory Note between James A. Bianco, M.D. and the Registrant,
            dated December 23, 1993
 10.11(1)  Stock Pledge Agreement between James A. Bianco, M.D. and the
            Registrant, dated December 23, 1993
 10.12(1)  1994 Equity Incentive Plan, as amended
 10.13(1)  1992 Stock Option Plan, as amended
 10.14(1)  1996 Employee Stock Purchase Plan
 10.15(1)  Form of Sales Agent Warrant for the 1992 Private Placement
 10.16(1)  Warrant, dated November 25, 1992, between the Registrant and David
            H. Smith, M.D.
 10.17(1)  Registration Agreement between the Registrant and the other parties
            included therein, dated as of November 23, 1993
 10.18(1)  Form of Sales Agent Warrant for the 1993 Private Placement
 10.19(1)  Subscription Agreement between the Registrant and the other parties
            included therein, dated as of March 21, 1995
 10.20(1)  Registration Rights Agreement between the Registrant and the other
            parties included therein, dated as of March 21, 1995
 10.21(5)  Registration Rights Agreement between the Company and the other
            parties included therein, dated as of September 17, 1996, as
            amended by Amendment No. 1 thereto dated as of October 11, 1996.
 10.22(5)  Letter Agreement between the Company and Kummell Investments
            Limited, dated September 17, 1996.
 10.23+(2) Collaboration Agreement by and between BioChem Therapeutic Inc. and
            the Registrant, dated March 7, 1995, as amended November 30, 1995
            and December 6, 1995
 10.24+(2) Supply Agreement by and between BioChem Therapeutic Inc. and the
            Registrant, dated March 7, 1995
 10.25+(6) Supply Agreement by and between ChiRex, Ltd. and the Registrant,
            dated January 21, 1997
 10.26+(6) Collaboration and License Agreement, dated as of November 8, 1996,
            by and between the Registrant and Ortho Biotech Inc. and The R.W.
            Johnson Pharmaceutical Research Institute, a division of Ortho
            Pharmaceutical Corporation
 10.27(6)  Stock Purchase Agreement, dated as of November 8, 1996, by and
            between the Registrant and Johnson & Johnson Development
            Corporation
 10.28(1)  Master Lease Agreement, dated as of December 28, 1994 between the
            Registrant and Aberlyn Capital Management Limited Partnership
 10.29(1)  Common Stock Purchase Warrant, dated December 28, 1994 between the
            Registrant and Aberlyn Capital Management Limited Partnership
 10.30(1)  Loan and Security Agreement, dated as of May 30, 1995, between the
            Registrant and Financing for Science International, Inc.
 10.31(4)  Loan and Security Agreement, dated as of June 28, 1996, between the
            Registrant and Financing for Science International, Inc.
</TABLE>

 
 
                                       74

<PAGE>
 

<TABLE>
<CAPTION>
 EXHIBIT
  NUMBER                               DESCRIPTION
 --------                              -----------
 <C>      <S>
 10.32(1) Asset Purchase Agreement, dated of October 17, 1995, between Lipomed
           Corporation, its Stockholders and the Registrant, as amended
 10.33(2) Form of Scientific Advisory Board Consulting Agreement
 10.34(2) Form of Clinical Advisory Board Consulting Agreement
 11.1     Computation of net loss and pro forma net loss per share
 22.1     Subsidiaries of the Registrant
 27.1     Financial Data Schedule
</TABLE>

- --------
 +Confidential treatment requested.
(1) Incorporated by reference to exhibits to the Registrant's Registration
    Statement on Form S-1 (No. 33-4154).
(2) Incorporated by reference to exhibits to the Registrant's Registration
    Statement on Form 10.
(3) Incorporated by reference to exhibits to the Registrant's Registration
    Statement on Form 8-A.
(4) Incorporated by reference to exhibits to the Registrant's Quarterly Report
    on Form 10-Q for the quarter ended June 30, 1996.
(5) Incorporated by reference to exhibits to the Registrant's Quarterly Report
    on Form 10-Q for the quarter ended September 30, 1996.
(6) Incorporated by reference to the Registrant's Registration Statement on
    Form S-1 (No. 333-20855)
 
                                      75

<PAGE>
 

 
                                 SIGNATURES
 
  PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED
ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED, IN THE CITY OF
SEATTLE, STATE OF WASHINGTON, ON MARCH 31, 1997.
 
                                          Cell Therapeutics, Inc.
 
                                                 /s/ James A. Biano, M.D.
                                          By: _________________________________
                                              JAMES A. BIANCO, M.D. PRESIDENT
                                                AND CHIEF EXECUTIVE OFFICER
 
  PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS
REPORT HAS BEEN SIGNED BY THE FOLLOWING PERSONS IN THE CAPACITIES AND ON THE
DATES INDICATED.
 
              SIGNATURE                        TITLE                 DATE
 
       /s/ Max E. Link, Ph.D.          Chairman of the          March 31, 1997
- -------------------------------------   Board and Director
          MAX E. LINK, PH.D
 
      /s/ James A. Bianco, M.D.        President, Chief         March 31, 1997
- -------------------------------------   Executive Officer
        JAMES A. BIANCO, M.D.           and Director
                                        (Principal
                                        Executive Officer)
 
         /s/ Louis A. Bianco           Executive Vice           March 31, 1997
- -------------------------------------   President, Finance
           LOUIS A. BIANCO              and Administration
                                        (Principal
                                        Financial Officer
                                        and Principal
                                        Accounting Officer)
 
      /s/ Jack W. Singer, M.D.         Director                 March 31, 1997
- -------------------------------------
        JACK W. SINGER, M.D.
 
         /s/ Jack L. Bowman            Director                 March 31, 1997
- -------------------------------------
           JACK L. BOWMAN
 
     /s/ Jeremy L. Curnock Cook        Director                 March 31, 1997
- -------------------------------------
       JEREMY L. CURNOCK COOK
 
 
                                      76

<PAGE>
 
              SIGNATURE                         TITLE                DATE
 
     /s/ Wilfred E. Jaeger, M.D.        Director                March 31, 1997
- -------------------------------------
       WILFRED E. JAEGER, M.D.
 
   /s/ David W. Martin, Jr., M.D.       Director                March 31, 1997
- -------------------------------------
     DAVID W. MARTIN, JR., M.D.
 
       /s/ Terrence M. Morris           Director                March 31, 1997
- -------------------------------------
         TERRENCE M. MORRIS
 
                                        Director                March  , 1997
- -------------------------------------
     PHILLIP M. NUDELMAN, PH.D.
 
                                       77





<PAGE>
 
                                                                    EXHIBIT 11.1
 
                            CELL THERAPEUTICS, INC.
                         (A DEVELOPMENT STAGE COMPANY)
            COMPUTATION OF NET LOSS AND PRO FORMA NET LOSS PER SHARE
 

<TABLE>
<CAPTION>
                                             YEAR ENDED DECEMBER 31,
                                      ----------------------------------------
                                          1996          1995          1994
                                      ------------  ------------  ------------
<S>                                   <C>           <C>           <C>
Net loss............................. $(13,928,189) $(19,992,475) $(19,499,283)
                                      ============  ============  ============
Net loss per share
Shares used in calculating pro forma
 net loss per share:
  Weighted average common shares out-
   standing..........................    4,939,388     4,771,247     4,716,399
                                      ------------  ------------  ------------
   Total.............................    4,939,388     4,771,247     4,716,399
                                      ============  ============  ============
Net loss per share................... $      (2.82) $      (4.19) $      (4.13)
                                      ============  ============  ============
Net loss............................. $(13,928,189)
                                      ============
Pro forma net loss per share
Shares used in calculating pro forma
 net loss per share:
  Weighted average common shares out-
   standing..........................    4,939,388
  Weighted average common shares giv-
   ing effect to conversion of con-
   vertible preferred stock to common
   stock at the time of preferred
   stock issuance....................    3,288,500
                                      ------------
   Total.............................    8,227,888
                                      ============
Pro forma net loss per share......... $      (1.69)
                                      ============
</TABLE>






<PAGE>
 
                                                                    EXHIBIT 22.1
 
 
                    SUBSIDIARIES OF CELL THERAPEUTICS, INC.
 
CTI Technologies, Inc., A Nevada Corporation





<TABLE> <S> <C>


<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM DECEMBER 31,
1996 FORM 10-K AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
       
<S>                             <C>
<PERIOD-TYPE>                   12-MOS
<FISCAL-YEAR-END>                          DEC-31-1996
<PERIOD-START>                             JAN-01-1996
<PERIOD-END>                               DEC-31-1996
<CASH>                                       5,483,515
<SECURITIES>                                25,503,049
<RECEIVABLES>                                        0
<ALLOWANCES>                                         0
<INVENTORY>                                          0
<CURRENT-ASSETS>                            31,243,456
<PP&E>                                      11,379,767
<DEPRECIATION>                             (6,261,831)
<TOTAL-ASSETS>                              37,001,693
<CURRENT-LIABILITIES>                        4,943,398
<BONDS>                                      2,004,575
<PREFERRED-MANDATORY>                                0
<PREFERRED>                                 52,326,204
<COMMON>                                    51,810,160
<OTHER-SE>                                (74,082,644)
<TOTAL-LIABILITY-AND-EQUITY>                37,001,693
<SALES>                                              0
<TOTAL-REVENUES>                             9,120,806
<CGS>                                                0
<TOTAL-COSTS>                                        0
<OTHER-EXPENSES>                            23,710,617
<LOSS-PROVISION>                                     0
<INTEREST-EXPENSE>                             512,597
<INCOME-PRETAX>                           (13,928,189)
<INCOME-TAX>                                         0
<INCOME-CONTINUING>                       (13,928,189)
<DISCONTINUED>                                       0
<EXTRAORDINARY>                                      0
<CHANGES>                                            0
<NET-INCOME>                              (13,928,189)
<EPS-PRIMARY>                                   (1.69)
<EPS-DILUTED>                                   (1.69)
        

</TABLE>