CURIS INC - Annual Report: 2002 (Form 10-K)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark one)

For the fiscal year ended December 31, 2002

OR

Commission File Number 000-30347

CURIS, INC.

(Exact Name of Registrant as Specified in Its Charter)

61 Moulton Street

Cambridge, Massachusetts 02138

(Address of Principal Executive Offices, Including Zip Code)

617-503-6500

(Registrant’s Telephone Number, Including Area Code)

Securities registered pursuant to Section 12(b) of the Act:    

None

Securities registered pursuant to Section 12(g) of the Act:    

Common Stock, $0.01 par value per share

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes x    No ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    ¨

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Exchange Act Rule  12b-2).    Yes ¨    No x

As of June 28, 2002, the aggregate market value of the Common Stock held by non-affiliates of the Registrant was approximately $35,142,000 based on the closing sale price of $1.22 of the Registrant’s Common Stock on the NASDAQ National Market on such date.

As of February 28, 2003, 31,720,837 shares of the Registrant’s Common Stock were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

The Registrant’s definitive Proxy Statement for the Annual Meeting of Stockholders scheduled to be held on June 12, 2003, to be filed with the Commission not later than 120 days after the close of the Registrant’s fiscal year, has been incorporated by reference in whole or in part, into Part III Items 10, 11, 12 and 13 of this Annual Report on Form 10-K.

CURIS, INC.

TABLE OF CONTENTS

Form 10-K

FORWARD-LOOKING INFORMATION

This Annual Report on Form 10-K contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and Section 27A of the Securities Act of 1933, as amended. For this purpose, any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, the words “believes,” “anticipates,” “plans,” “expects,” “seeks” and similar expressions are intended to identify forward-looking statements. There are a number of important factors that could cause our actual results to differ materially from those projected or assumed in these forward looking statements, including the factors set forth under the caption “Risk Factors” within Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” All forward-looking statements and reasons why our results may differ included in this Annual Report are made as of the date hereof, and we disclaim any obligation to update these forward-looking statements or reasons why actual results might differ.

As used in this Annual Report, the terms “we,” “us,” “our,” the “Company” and “Curis” shall mean Curis, Inc.

Curis^™, Chondrogel^™, Vascuject^™ and Vascugel^™ are our trademarks. All other trademarks or trade names referred to in this Annual Report are the property of their respective owners.

PART I

ITEM 1.    BUSINESS

General

Curis, Inc. is a therapeutic drug development company. Our technology focus is on regulatory signaling pathways that control repair and regeneration of human tissue and organs. Our product development approach involves using proteins or small molecules to modulate these regulatory signaling pathways, for example, to increase the pathway signals when they are insufficient or to decrease them when they are excessive. We have successfully used this product development approach to produce several promising preclinical product candidates in the fields of kidney disease, neurological disorders, cancer and hair regrowth.

Our mission is to discover and develop novel therapeutic drugs to treat diseases and disorders for which there are no adequate therapies or for which a new drug would represent a significant advancement over the current therapy. We seek to develop new medicines to improve the overall state of human health while at the same time striving to give our shareholders a substantial return on their investment reflective of the risks associated with pharmaceutical drug development.

In the last quarter of 2002, we announced a significant corporate partnership with Ortho Biotech Products, L.P. (a subsidiary of Johnson & Johnson) and the monetization of our future revenue stream from Stryker Corporation. In addition, we entered into transactions with Amylin Pharmaceuticals, Inc., and ES Cell International Pte, Ltd.

In February of 2002, we completed a realignment of our research and development programs and a re-focusing of our resources on our proprietary signaling pathways, particularly the Bone Morphogenic Protein (BMP) and Hedgehog (Hh) families of product candidates. As part of the realignment, we terminated our cell therapy clinical programs, reduced our workforce by 46 people, incurred cash expenses of $3,490,000 and non-cash expenses of $5,337,000 and terminated a lease on a 50,000 square foot development and manufacturing facility.

In December 2002, we further reduced our workforce by 14 employees for the purpose of reducing our cash burn (see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Overview”).

We are organized as a Delaware Corporation, incorporated in 2000. Our principal executive office is located at 61 Moulton Street, Cambridge, Massachusetts, 02138. We maintain a website with the address www.curis.com. We are not including the information contained in our website as part of, or incorporating it by reference into, this annual report on Form 10-K. We make available free of charge through our website our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, and amendments to these reports, as soon as reasonably practicable after we electronically file these materials with, or otherwise furnish them to, the Securities and Exchange Commission.

SIGNALING PATHWAY TECHNOLOGY BACKGROUND

Through our research, we seek an understanding of the biological signaling pathways that the body uses to promote human tissue and organ repair and regeneration and seek to use that understanding to modulate and control those signaling pathways to promote therapeutic benefit.

Each cell in the human body is programmed during the embryonic stage of development to respond to a specific set of signals that regulate its behavior. Signaling pathways deliver messages to cells, which determine how a cell differentiates and also whether it replicates or dies.

The signaling pathways that orchestrate early stages of tissue and organ formation are often the same pathways used by the body in adulthood to maintain physiological balance and to repair and regenerate tissue.

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We have used our knowledge of these signaling pathways to build a diverse portfolio of preclinical product candidates in several important therapeutic areas including kidney disease, neurological disorders, cancer and hair regrowth (alopecia).

We have developed a significant intellectual property portfolio in several major signaling pathways, including the Hedgehog pathway and the Bone Morphogenetic Protein, or BMP, pathway. Both of these pathways are prominent regulators of specific tissue and organ formation during development and are used by the body in adulthood to repair and regulate human tissue.

PRODUCT DEVELOPMENT PROGRAMS

We are developing product candidates in several important medical fields where there is substantial therapeutic need that is either unmet or underserved. These product development initiatives (see chart below) either are being pursued using our internal resources or have been partnered with pharmaceutical or biotechnology firms that are able to dedicate additional resources and clinical development expertise. These product development initiatives derive primarily from our substantial intellectual property portfolio in key signaling pathways.

BMP Kidney Disease Program

Over the last several years, we have been developing BMP-7 as a therapeutic compound to halt the progression of chronic kidney failure and to prevent skeletal and blood vessel complications that are associated with chronic kidney disease. This work, which has been conducted in conjunction with academic and medical research laboratories, has demonstrated therapeutic efficacy in numerous animal models of kidney disease.

In November of 2002, we entered into a partnership with Ortho Biotech (a subsidiary of Johnson & Johnson) for the continued development of this kidney disease product candidate. Ortho Biotech is a pharmaceutical company with broad expertise in protein based therapeutic drug development and is an established presence in the kidney disease marketplace. The partnership with Ortho Biotech also targets the development of BMP-based products for the treatment of other medical disorders including stroke and traumatic brain injury. Ortho Biotech will assume all future costs and responsibility for BMP-based product development and we will receive clinical milestone payments and royalties on product sales, if clinical evaluations of any BMP-based products are successful.

Hedgehog Agonist Neurological Disorders Program

We believe that the Hedgehog pathway is essential for the formation of normal nerves in the peripheral nervous system as well as in the central nervous system. Our scientists and collaborators have shown that treatment with a Hedgehog protein accelerates the restoration of nerve function in animal models of nerve trauma and disease thus suggesting potential therapeutic utility in treating certain human neurological disorders, such as Parkinson’s disease, diabetic neuropathies, and others.

Recently, our scientists have developed a series of small molecule Hedgehog agonists that are capable of activating the Hedgehog pathway and fostering tissue repair. Many of these small molecule Hedgehog agonists

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are orally available and can cross the blood brain barrier, therefore making them attractive product development candidates. Currently, these small molecule Hedgehog agonists are being evaluated in animal models of Parkinson’s Disease, diabetic neuropathy, and other neurological disorders.

The Hedgehog Agonist Neurological Disorders Program is currently being conducted under our joint venture with Elan Corporation.

Hedgehog Antibody Cancer Program

We believe that one of the ways that the Hedgehog protein promotes restoration of tissue function, such as the restoration of nerve function in animal models described above, is by inducing the synthesis of multiple growth factors and angiogenic factors. The growth factors stimulate new tissue formation and the angiogenic factors stimulate new blood vessel growth to nourish the newly formed tissue.

Our scientists have recently discovered that certain cancers appear to be inappropriately expressing high concentrations of Hedgehog protein thereby creating local environments favorable to the rapid growth of cancerous tissue. By utilizing an antibody that blocks the action of Hedgehog protein, our scientists have been able to significantly slow and, in some cases, halt the growth of certain cancers (for example, pancreatic and colon cancers) in animal models of solid tumor growth.

We are currently evaluating other cancers to determine if they are also inappropriately expressing Hedgehog protein and therefore may be target cancers for Hedgehog antibody therapy. We are in discussions with several potential development partners for cancer applications of Hedgehog antibody therapy.

Hedgehog Small Molecule Antagonist Basal Cell Carcinoma Program

Basal Cell Carcinoma (BCC), the most common form of human cancer, is a cancer affecting the skin. Several years ago, it was discovered that almost all forms of BCC are caused by mutations in the Hedgehog receptor complexes, which in turn results in unregulated activation of the Hedgehog pathway. Although it is not typically life threatening, BCC can be significantly disfiguring due to the propensity for tumors to develop in sun accessible sites (such as the face and hands). Currently, treatment for BCC usually involves surgical excision.

Our scientists have discovered small molecule inhibitors of the Hedgehog pathway that in animal models of BCC cause regression of established tumors and prevent development of new tumors. We believe that a drug-based treatment for BCC could have a significant market advantage over current surgical treatment options. We have developed one of the small molecule Hedgehog inhibitors (CUR-61414) to the point of IND acceptance and are now seeking a partner with dermatological clinical expertise to complete the evaluation of human therapeutic safety and efficacy.

We believe that our small molecule Hedgehog antagonists may also have therapeutic potential in the treatment of types of cancer other than BCC. We are currently evaluating this therapeutic possibility for medulloblastoma (the most common malignant brain tumor in children) and other cancers.

Hedgehog Small Molecule Agonist Alopecia Program

Several years ago, our scientists showed that Hedgehog protein could stimulate rapid hair regrowth when implanted under the skin of an animal. More recently, other researchers have shown that the Hedgehog gene when delivered with a virus, can stimulate rapid hair regrowth in animals that had lost hair due to chemotherapy treatment. Our scientists have recently demonstrated that one of our small molecule Hedgehog agonists can induce hair regrowth in an animal model. We are currently evaluating the therapeutic potential of small molecule Hedgehog agonists to promote hair regrowth in other models of age-induced alopecia and chemotherapy-induced alopecia.

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Other Programs

PYY Peptide Obesity Program

PYY is a gut peptide that has been shown in animals and humans to suppress appetite and reduce food intake. Several years prior to these results, our scientists working in the field of diabetes filed patent applications on the potential utility of using PYY as a treatment for certain metabolic disorders, including obesity.

In December of 2002, we licensed our PYY patent applications to Amylin in exchange for an up-front fee, milestone payments upon the achievement of certain development objectives, and royalties on potential future product sales. Amylin has extensive development experience with other similar gut peptides. Amylin has exclusive responsibility for expenses related to further development of the PYY compound and has recently announced that it expects to file an IND on PYY for an obesity indication in 2003.

Stem Cells Diabetes Program

For several years, we have been evaluating the potential of using adult-derived stem cells as a therapy to treat diabetes. We successfully demonstrated the “rescue” of diabetic animals using proprietary methods which convert adult stem cells into insulin-producing cells. Recently, we have decided that this program would be best developed by partnering it with a company that specializes in stem cell based therapeutics. In December 2002, we assigned and licensed our patent rights related to the development of cellular therapeutics for the treatment of diabetes to ES Cell in exchange for an up-front fee and an equity position in ES Cell. ES Cell is a Singapore-based company that develops stem cells as therapeutic products for various human disorders. As part of the transaction, ES Cell will assume all responsibility and expense for future development and clinical testing of our diabetes stem-cell technologies.

STRATEGIC ALLIANCES AND LICENSE AGREEMENTS

Our strategy for development and commercialization of products depends upon successful strategic alliances with third parties. We look to strategic alliances as a means to provide us with the requisite capital, as well as the necessary preclinical and clinical development and manufacturing and marketing capabilities to commercialize product candidates produced by our discovery and preclinical programs. In evaluating possible strategic alliances, we consider the following criteria:

We may not be able to establish new strategic alliances necessary to develop and commercialize our product candidates and any future arrangements may not be on terms favorable to us. We cannot predict whether current or future strategic alliances will be successful.

We are currently seeking partners for our Hedgehog Antibody Cancer Program and our Hedgehog Small Molecule Antagonist Basal Cell Carcinoma Program. Our current strategic alliances are described below.

Ortho Biotech (a subsidiary of Johnson & Johnson)

We licensed our broad BMP technology portfolio to Ortho Biotech for all non-orthopaedic therapeutic applications in November of 2002 in exchange for a $3,500,000 up-front fee, a series of cash milestones if certain

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research objectives are achieved including a $30,000,000 milestone payment upon U.S. regulatory approval of a product for the treatment of kidney disease, and a royalty on potential future product sales. If the program progresses successfully through clinical development, we would receive additional milestone payments for the kidney disease related product candidate and milestone payments for the first neurology product candidate. We are unable to disclose additional financial terms of the strategic alliance based on the confidentiality obligation of our agreement with Ortho Biotech. Initial target indications include prevention of bone and blood vessel complications associated with chronic kidney disease and treatments to promote recovery following stroke and brain injury.

Elan Corporation, plc

We formed a joint venture, Curis Newco, Ltd., with affiliates of Elan in July of 2001 for the development of protein and small molecule modulators of the Hedgehog signaling pathway intended for the treatment of neurological disorders including Parkinson’s Disease and diabetic neuropathy. The arrangement with Elan covers the use of both Hedgehog protein and Hedgehog small molecule agonists. Upon formation of Curis Newco, Elan International Services, Ltd. (EIS), an affiliate of Elan, purchased $4,000,000 of our common stock at $7.32 per share. Additionally, Elan Pharma International, Ltd. (EPIL), another affiliate of Elan, agreed to loans, subject to EPIL’s continuing consent, to allow payment for our share of Curis Newco’s operating expenses. Each loan is being made under an $8,010,000 line of credit made available to us by EPIL and is evidenced by a convertible promissory note issued by us. We have funded our share of Curis Newco expenses through September 30, 2002 using the line of credit, which has an outstanding balance of $4,921,000 as of February 28, 2003. Under the terms of the joint venture arrangement, Elan is responsible for a portion of Curis Newco expenses. Future funding of the Curis Newco development program, both in terms of loans and direct reimbursement of expenses, is contingent upon various factors, including consent by EPIL to continued loans and consensus between the parties on future development plans.

Amylin Pharmaceuticals

In December of 2002, we licensed our PYY patent applications to Amylin Pharmaceuticals in exchange for an up-front fee, milestone payments if specified research objectives are achieved, and a royalty on potential future product sales. Amylin has sole responsibility for all further development of the PYY compound and has recently announced that it may file an IND on PYY for an obesity indication in 2003.

ES Cell International Pte Ltd.

In December of 2002, we assigned and licensed our patent rights related to the development of cellular therapeutics for the treatment of diabetes to ES Cell International Pte, Ltd. in exchange for an up-front fee and an equity position in ES Cell. As part of the overall transaction, ES Cell will assume all responsibility for future development and clinical testing of our diabetes stem-cell technologies, including funding all costs of six of our scientists through December 17, 2003.

Micromet AG

In 2001, we entered into three agreements with Micromet AG including (i) a purchase and sale agreement pursuant to which we assigned our single-chain-polypeptide technology to Micromet in exchange for certain consideration, (ii) a product development agreement and (iii) a target research and license agreement. Under these agreements, we are entitled to receive royalties on Micromet’s revenues, if any, arising out of the assigned technology, rights to jointly develop and commercialize future product discoveries, if any, arising out of the product development agreement, and access to other technologies. The product development agreement provides us with the right, but not the obligation, to jointly fund research to develop antibodies against up to four potential targets through the proof of principle stage. We will also have the right, but not the obligation, to jointly fund the development of two such antibody targets from the proof of principle stage through the completion of phase I clinical trials.

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Academic Collaborations

We have relationships with a number of academic institutions and investigators that are focused on areas of interest to us, including morphogenic proteins and tissue repair and regeneration in certain disease models. In these collaborations, we seek to expand our scientific knowledge concerning internal research programs as well as the activities and characteristics of various proteins and small molecules under development by our scientists. The academic collaborators are not our employees. As a result, we have limited control over their activities and limited amounts of their time are dedicated to our projects. From time to time, academic collaborators have relationships with other commercial entities, some of which may be competitors of ours. Although the precise nature of each relationship varies, the collaborators and their primary affiliated institutions generally sign agreements that provide for confidentiality of our proprietary technology and results of studies. We seek to obtain exclusive rights to license developments that may result from these studies, however, there is no guarantee that such licenses can be obtained or that any associated royalties will permit effective commercialization of such developments.

Competition

The product candidates that we are developing would compete with existing and new products being developed by others for treatment of the same indications. Competition in the development of human therapeutics is particularly intense and includes many large pharmaceutical and biopharmaceutical companies, as well as specialized biotechnology and medical device firms. Many of these companies have extensive financial, marketing and human resource capacities, which may result in significant competitive advantages. Others have extensive experience in undertaking clinical trials, in obtaining regulatory approval to market products and in manufacturing products on a large scale, which may enhance their competitive position. In addition to competing with pharmaceutical, biotechnology and medical device companies, the products we are developing would also compete with those being developed by academic and research institutions, government agencies and other public organizations. Any of these organizations may discover new therapies, seek patent protection or establish collaborative arrangements for products and technologies which are competitive with our products and technologies.

The technology underlying the development of human therapeutic products is expected to continue to undergo rapid and significant advancement and change. In the future, our technological and commercial success will be based on our ability to develop proprietary positions in key scientific areas and efficiently evaluate potential product opportunities.

The timing of a product’s introduction may be a major factor in determining eventual commercial success and profitability. Early entry may have important advantages in gaining product acceptance and market share. Accordingly, we believe the relative speed with which we or our collaborative partners can complete preclinical and clinical testing, obtain regulatory approvals, and supply commercial quantities of a product will have an important impact on our competitive position, both in the United States and abroad. Other companies may succeed in developing similar products that are introduced earlier, are more effective, or are produced and marketed more effectively. If research and development by others renders any of our products obsolete or noncompetitive, then our potential for success and profitability may be adversely affected.

Research in the field of signaling pathways is highly competitive. Competitors include, among others, Amgen, Inc., Chiron Corporation, Exelixis, Inc., Genentech, Inc., Geron Corporation, and Regeneron Corporation, as well as other private companies and major pharmaceutical companies. We also compete with universities and other research institutions, including those receiving federal government funding. Our competitors may discover, characterize and develop important inducing molecules or genes before we do, which could have a material adverse effect on any of our related research programs.

We rely on or will rely on our strategic partners for support in our disease research programs and for preclinical evaluation and clinical development of our potential products and manufacturing and marketing of

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any products. Some of our strategic partners are conducting multiple product development efforts within each disease area that is the subject of our strategic alliance with them. Our strategic alliance agreements may not restrict the strategic partner from pursuing competing internal development efforts. Any of our product candidates, therefore, may be subject to competition with a product candidate under development by a strategic partner.

Patents and Proprietary Rights

Our ability to commercialize products and compete effectively with other companies will depend, in part, on our ability to maintain proprietary rights to our products and technology. We currently own or have rights to approximately 153 issued and 139 pending patent applications in the United States and have foreign counterpart patent filings for most of these patents and patent applications. These patents and patent applications are directed to compositions of matter, methods of making and using these compositions, methods of repairing, replacing, augmenting and creating tissue for multiple applications, methods for drug screening and discovery, developmental biological processes, and patents relating to our proprietary technologies. The patent positions of pharmaceutical, biopharmaceutical, and biotechnology companies, including ours, are generally uncertain and involve complex legal and factual questions. Our pending patent applications may not result in issued patents and we may not successfully develop additional proprietary technologies or products that are patentable. Furthermore, our patents or those of our collaborative partners may not provide a basis for commercially viable products or provide us with any competitive advantages and may be challenged by third parties. The patents of others could have an adverse effect on our ability to conduct our business.

Our success will depend in part on our ability to obtain marketing exclusivity for our products for a period of time sufficient to establish a market position and achieve an adequate return on our investment in product development. We believe that protection of our products and technology under United States and international patent laws and other intellectual property laws is an important factor in securing such market exclusivity.

Although we pursue patent protection for our technology, significant legal issues remain as to the extent to which patent protection may be afforded in the field of biotechnology, in both the United States and foreign countries. Furthermore, the scope of protection has not yet been broadly tested. Therefore, we also rely upon trade secrets, know-how and continuing technological advancement to develop and maintain our competitive position. Disclosure of our know-how is generally protected under confidentiality agreements. We do not know, however, whether all of our confidentiality agreements will be honored. Moreover, third parties could develop equivalent technology independently, and disputes could also arise as to the ownership of technical information or wrongful disclosure of our trade secrets.

Our academic and research institution collaborators have certain rights to publish data and information regarding their discoveries to which we have rights. While we believe that the limitations on publication of data developed by our collaborators pursuant to our collaboration agreements will be sufficient to permit us to apply for patent protection in the areas in which we are interested in pursuing further research, there is considerable pressure on such institutions to publish discoveries in the genetics and genomics fields. Any such publication could affect our ability to obtain patent protection in the areas in which we may have an interest.

We are party to various license agreements that give us rights to commercialize various technologies and to use technologies in our research and development processes. The consideration payable in exchange for these licenses include up-front fees, issuances of shares of common stock, annual royalties, milestone payments and running royalties on net sales by us and our sub-licensees. The licensors may terminate these agreements if we fail to meet certain diligence requirements, fail to make payments or otherwise commit a material breach that is not cured after notice.

Others may have filed, and in the future are likely to file, patent applications covering molecules, genes or gene products that are similar or identical to our technologies or products. These third party patent applications

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may have priority over patent applications filed by us. Any legal action against us or our strategic partners claiming damages and seeking to enjoin commercial activities relating to the affected products and processes could, in addition to subjecting us to potential liability for damages, require us or our strategic alliance partners to obtain a license in order to continue to manufacture or market the affected products and processes. We or our strategic alliance partners may not prevail in any such action and any license required under any such patent may not be made available upon commercially acceptable terms, or at all. Litigation, which could result in substantial costs to us, may be necessary to enforce any patents issued or licensed to us or to determine the scope and validity of third party proprietary rights. Some of our competitors have, or are affiliated with companies having, substantially greater resources than we have, and such competitors may be able to sustain the costs of complex patent litigation to a greater degree and for longer periods of time than us.

Manufacturing

We have no experience or capabilities in large-scale commercial manufacturing of protein and small molecule products. We do not currently have any commercial manufacturing operations in-house and do not have a qualified cGMP commercial manufacturing facility for any of our products. We have no current plans to develop manufacturing capability and instead plan to rely on our corporate partners or subcontractors to manufacture products.

Sales and Marketing

We have no sales, marketing and distribution experience or infrastructure and we have no current plans to develop a sales, marketing and distribution capability. We plan to rely on our corporate partners for product sales, marketing and distribution.

Regulatory Matters

Regulation by governmental agencies in the United States and other countries is a significant factor in the clinical evaluation and licensing of our product candidates as well as in the development and research of new products. All of our product candidates currently under development will require regulatory approval by the FDA under the Food, Drug, and Cosmetic Act, as drugs or devices, or under the Public Health Service Act, as biologicals, before they can be marketed in the United States and by similar foreign governmental agencies before they can be marketed outside the United States. Regardless of the classifications assigned to our product candidates, all human diagnostic and therapeutic products are subject to rigorous testing to demonstrate their safety and efficacy. Generally, considerable time and expense are required to demonstrate safety and efficacy for use in humans of a new product candidate. This process includes the time and expense of designing acceptable clinical trials, enrolling patients, and clinically evaluating the safety and efficacy data resulting from the clinical trials. Moreover, even after extensive preclinical testing, unanticipated side effects can arise during clinical trials and in the course of related or unrelated research (within or outside our control) that can halt or substantially delay the regulatory process. Seeking and obtaining regulatory approval for a new therapeutic or diagnostic product candidate is likely to take several years and require the expenditure of substantial resources. We cannot predict whether any product candidate that enters preclinical or clinical development will be approved for sale by the FDA or any other regulatory authorities.

Products like ours developed through genetic engineering are relatively new, and therefore may become the subject of increased regulation, as genetically engineered products become more common. The federal government oversees certain recombinant DNA research activity through the National Institutes of Health (NIH) Guidelines for Research Involving Recombinant DNA Molecules, known as the NIH Guidelines. We believe that our activities comply with the NIH Guidelines. Discussions have been underway since 1996 between the NIH and the FDA regarding alternative models for regulation of recombinant DNA research and the products resulting from such research, and the appropriateness of any continued NIH role. It is not possible to predict the effect of such potential regulatory changes on our business or our potential competitors.

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Our ability to conduct preclinical research is also subject to new and evolving regulations governing the use of human and embryonic tissues for isolating new growth factors and genes which may be useful in identifying and developing new therapeutic product candidates. Our ability to conduct critical research on which our development activities are based could be restricted or delayed depending on the outcome of pending rulemaking proceedings governing the use of these tissues and the collection of related genetic information.

Pharmaceutical and Biological Products

We expect that certain of our product candidates will be regulated by the FDA or other regulatory authorities as pharmaceuticals or biologicals. In the United States, the regulatory approval process for pharmaceutical and biological products intended for therapeutic use in humans involves several phases. Similar requirements are imposed by the regulatory authorities in other major market countries.

Clinical testing to demonstrate safety and efficacy of a product candidate usually occurs in three phases:

After product approval, the FDA may request or require an additional phase (phase IV) of clinical studies to provide further information on safety and/or efficacy.

Employees

As of February 28, 2003, we had 64 full time employees, of whom 38 hold Ph.D. or other advanced degrees. 45 of these employees are currently involved in research and development. None of our employees is a party to a collective bargaining agreement, and we consider our relations with our employees to be good.

ITEM 2.    PROPERTIES

We have three facilities which are located at 25, 45 and 61 Moulton Street in Cambridge, Massachusetts and which consist of 1,526, 35,095 and 17,800 square feet, respectively. All of these facilities are leased until April 2007. We have sublet approximately 5,300 square feet at our 45 Moulton Street location for a period of 30 months beginning March 1, 2002. In addition, we have sublet 11,980 square feet at our 61 Moulton Street location for an initial term of 24 months beginning on August 15, 2002, with an option, at the subtenant’s discretion, to extend the term for an additional two years and eight months. We currently use all of our available space, other than that which we have subleased, to conduct our research and development initiatives and to manage the administrative aspects of our business. We believe that our facilities will be adequate through at least the end of 2003.

ITEM 3.    LEGAL PROCEEDINGS

Other than ordinary routine litigation incidental to our business, there are no material legal proceedings pending to which we are a party or of which our property is the subject. To our knowledge, no material legal proceeding is being contemplated by any third party or governmental authority.

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

We did not submit any matter to a vote of security holders during the fourth quarter of the fiscal year covered by this Annual Report.

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ITEM 4A.    EXECUTIVE OFFICERS OF THE COMPANY

Our executive officers are as follows:

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PART II

ITEM 5.     MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDERS

                   MATTERS

Our Common Stock was first traded on the NASDAQ National Market on August 1, 2000. Our trading symbol is CRIS. The following table sets forth, for the fiscal periods indicated, the high and low sales prices per share of our Common Stock as reported on the NASDAQ National Market:

There were 324 holders of record of our Common Stock as of February 28, 2003. The number of record holders may not be representative of the number of beneficial owners because many of the shares of our Common Stock are held by depositories, brokers or other nominees.

We have never declared or paid any cash dividends on our Common Stock. We currently intend to retain earnings, if any, to support our growth strategy and do not anticipate paying cash dividends in the foreseeable future. Payment of future dividends, if any, will be at the sole discretion of the Board of Directors after taking into account various factors, including our financial condition, operating results, capital requirements and any plans for expansion.

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ITEM 6.     SELECTED FINANCIAL DATA

The selected consolidated financial data set forth below have been derived from our consolidated financial statements. These historical results are not necessarily indicative of results to be expected for any future period. You should read the data set forth below in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Consolidated Financial Statements and related Notes included in this Report.

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ITEM 7.     MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

                   RESULTS OF OPERATIONS

You should read the following discussion and analysis in conjunction with “Selected Financial Data” and our financial statements and notes included elsewhere in this Report.

Overview

Curis is a therapeutic drug development company. Our technology focus is on regulatory signaling pathways that control repair and regeneration of human tissue and organs. Our product development approach involves using proteins or small molecules to modulate these regulatory signaling pathways, for example, to increase the pathway signals when they are insufficient or to decrease them when they excessive. We have successfully used this product development approach to produce several promising drug product candidates in the fields of kidney disease, neurological disorders, cancer and hair regrowth.

Our mission is to discover and develop novel therapeutic drugs to treat diseases and disorders for which there are no adequate therapies or for which a new drug would represent a significant advancement over the current therapy. We seek new medicines to improve the overall state of human health while at the same time striving to give our shareholders a return on their investment reflective of the risks associated with pharmaceutical drug development.

In February of 2002, we completed a realignment of our research and development programs and a re-focusing of our resources on our proprietary signaling pathways, particularly the Bone Morphogenic Protein (BMP) and Hedgehog (Hh) families of product candidates. As part of the realignment, we terminated our cell therapy clinical programs, reduced our workforce by 46 people, incurred cash expenses of $3,490,000 and non-cash expenses of $5,337,000 and terminated a lease on a 50,000 square foot development and manufacturing facility. In December 2002, we further reduced our workforce by 14 employees for the purpose of reducing our cash burn.

Since completing the realignment of our business in 2002, we are now seeking to maximize the potential returns on our remaining assets, particularly in regulatory signaling pathways. Because we are a small company with limited human and financial resources, we believe that the best way to advance many of our scientific programs is through the establishment of corporate collaborations with pharmaceutical or biotechnology companies that possess the financial resources and/or specific areas of expertise (i.e., clinical and regulatory development) to push product candidates toward commercialization. We have recently completed business transactions with Ortho Biotech, ES Cell, and Amylin relating to our BMP, diabetes cellular therapy and PYY peptide technologies, respectively. In 2001, we entered into collaborations with Elan and Micromet relating to the Hedgehog signaling pathway for neurological indications and our single chain antibody technologies, respectively. In the future, we plan to continue to seek corporate partners for certain technologies including our Hedgehog Antibody Cancer Program and our Hedgehog Small Molecule Antagonist Basal Cell Carcinoma Program, however, we may not be successful in our efforts to enter into new partnerships, and our existing partnerships may not successful. Even though we are seeking partners to help develop some of our technologies, we expect to select at least one program in 2003 that we will develop further on our own. Our selection of a program will be based on a number of factors including the time, expense and complexity of clinical trials that we estimate will be required for approval. We are considering whether the Hedgehog Small Molecule Agonist Alopecia Program may be a good program to develop further without a partner.

Strategic Alliances

To date, our research and development contract and license fee revenues have been generated from agreements with collaborative partners. Over the next few years, we anticipate deriving most of our revenues from existing collaboration and additional collaboration agreements which we may enter into in the future. We

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may not be able to find suitable partners willing to form collaborations on terms we consider acceptable, or at all. Failure to form such collaborations would adversely affect our future research and development contract revenues.

On October 1, 2002, we completed a transaction with Stryker, under the terms of which Stryker paid us $14,000,000 in cash in exchange for the termination of Stryker’s future BMP-7 (OP-1) royalty obligations. In addition to this cash payment of the estimated net present value of our potential BMP-7 (OP-1) royalty stream, this transaction allowed us to reduce future BMP-7 royalties that we would owe to Stryker for products sold in therapeutic indications other than orthopedics and dental, if any sales ever occur. We recorded the $14,000,000 cash payment as revenue during the fourth quarter of 2002. We will receive no future royalties or payments of any other kind from Stryker as a result of this transaction.

Since January of 2002, we have entered into three collaborations, including (i) a license agreement with Ortho Biotech involving our broad BMP portfolio for all non-orthopaedic therapeutic applications, (ii) a license agreement with Amylin for our PYY patent applications, and (iii) assignment and license agreements with ES Cell related to our patent rights for the development of cellular therapeutics for the treatment of diabetes. In addition, in an effort to increase our focus on signaling pathway technologies and to reduce our cash burn rate, we terminated a sponsored research agreement with Aegera Therapeutics, Inc. under which we were obligated to fund Aegera scientists at a rate of $600,000 per year. The Aegera collaboration was established in January 2001 and involved research in skin derived, adult stem cell technologies.

We were awarded $4,000,000 of government grants from the National Institute of Standards and Technology (NIST). These grants were to be received over the period ending on December 31, 2003. We discontinued our work on the programs covered by these NIST grants as part of our business realignment. As a result, on April 15, 2002, these awards were terminated.

Future operating results will depend largely on the magnitude of payments from our current and potential future corporate partners and the outcome of other product candidates currently in our research and development pipeline. We cannot be sure of either the timing and amount of these payments or the likelihood of successful outcomes for products currently in our pipeline. We have never been profitable and we expect to incur additional operating losses in the next several years. The results of our operations will vary significantly from year to year and quarter to quarter and depend on, among other factors, the timing of our entry into new collaborations and the timing of the receipt of payments from collaborators and the cost and outcome of clinical trials. We believe that our existing capital resources should enable us to maintain current and planned operations into the first quarter of 2005.

Critical Accounting Policies

In December of 2001, the Securities and Exchange Commission requested that all registrants list their most “critical accounting policies” in Management’s Discussion and Analysis of Financial Condition and Results of Operations. The SEC indicated that a “critical accounting policy” is one which is both important to the portrayal of our financial condition and results and requires management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. While our significant accounting policies are fully described in Note 4 to our consolidated financial statements, included elsewhere in this Annual Report on Form 10-K, we believe that the following accounting policies are critical:

Long-Lived Assets.    Long-lived assets consist of goodwill, a long-term note receivable from Micromet, equity securities held in certain of our strategic alliance partners, capitalized patent costs, and long-term deposits. We assess the impairment of identifiable intangibles and long-lived assets whenever events or changes in circumstances indicate that the carrying value may not be recoverable. If it were determined that the carrying value of intangible or long-lived assets might not be recoverable based upon the existence of one or more indicators of impairment, we would measure any impairment based on a projected cash flow method. As a result

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of the adoption of SFAS No. 142, effective January 1, 2002, we ceased amortization of goodwill. In lieu of amortization, we performed an initial assessment of impairment of our goodwill in the first quarter of 2002. This initial assessment involved comparing the fair value of the Company to the net assets of the Company. We determined our fair value based on quoted market prices adjusted to provide for a control premium. The fair value of the Company was in excess of the Company’s net assets and, therefore, we concluded that our goodwill was not impaired. SFAS No. 142 requires us to perform an impairment assessment annually or whenever events or changes in circumstances indicate that our goodwill may be impaired. We concluded that the decline in our market capitalization during the three-month period ended June 30, 2002 indicated that the carrying value of goodwill might be impaired. As a result, we conducted an impairment assessment as required under SFAS No. 142 by comparing our fair value to our net assets, including goodwill, as of June 30, 2002. Because the carrying value of our net assets exceeded our fair value at June 30, 2002, we determined that our goodwill had been impaired. To determine the amount of the impairment charge, we calculated our implied goodwill as the difference between our fair value and the fair value of our assets and liabilities. The fair value of our intangible assets, principally consisting of completed and in-process technology, was estimated using a discounted cash flow methodology. Based on this valuation, we determined that our implied goodwill was $8,982,000 and we recorded a non-cash charge of approximately $64,098,000 to write-down our existing goodwill. This charge is included in operating costs and expenses within our statements of operations for the year ended December 31, 2002.

The goodwill impairment analysis involves considerable judgment and the use of several estimates including: control premium, discount rates, projected cash flows of OP-1, and projected cash flows of our in-process research and development programs. The control premium used in determining our fair value was based on an analysis of control premiums involved in other biotechnology and medical products acquisitions. Most of our research and development programs will not be completed for several years, if ever, and therefore estimating the costs to complete these programs and the revenue to be derived through collaborations and commercialization of the products involves substantial judgment. The discount rates used to determine the net present value of these cash flows was based on a consideration of the risks associated with achieving these cash flow projections, including the risk of successfully completing our in-process technology. All of these estimates involve a significant amount of judgment by our management. Although the estimates used reflect management’s best estimates based upon all available evidence, the use of different estimates could have yielded different results in our transitional impairment assessment conducted as of January 1, 2002 and in our impairment assessment conducted in the second quarter of 2002. Had we used a significantly lower control premium in determining the fair value of the Company, our transitional impairment analysis could have indicated that goodwill was impaired at January 1, 2002. In addition, using different estimated cash flows or discount rates in determining our implied goodwill in the second quarter of 2002 could have resulted in a higher or lower goodwill impairment charge.

During the year ended December 31, 2002, we recorded impairment charges of property and equipment assets related to our business realignment of approximately $5,337,000. These charges relate to impairment on assets at our former manufacturing and development facility located at 21 Erie Street in Cambridge, Massachusetts. $4,761,000 of the total impairment charge relates to the write-off of tenant improvements made to the Erie Street facility since such improvements are affixed to the facility and therefore cannot be sold separately from the facility. The remaining charge of $576,000 was to write-down equipment to its estimated salvage value. The amount we received from the sale of these assets was not significantly different from the originally estimated fair value.

During the third quarter of the year ended December 31, 2000, we recorded an impairment charge of approximately $4,611,000 to reduce the carrying value of patents determined not to be beneficial or not expected to be utilized in future operations and which have no alternative future use.

Revenue recognition.    Our revenue recognition policy is critical because revenue is a key component of our results of operations. We follow the provisions of the Securities and Exchange Commission’s Staff Accounting Bulletin No. 101 (SAB No. 101), Revenue Recognition. In accordance with SAB No. 101, we recognize revenue

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related to research activities as they are performed, so long as there is persuasive evidence of an arrangement, the fee is fixed or determinable, and collection of the related receivable is probable.

Amounts received for license fees are deferred and recognized as services are performed over the performance period of the contract. Amounts received for milestones will be recognized upon achievement of the milestone as long as the milestone is deemed to be substantive and we have no other performance obligations. In the event that we have remaining performance obligations, the portion of the milestone payment equal to the lesser of the non-refundable cash received or the percentage of the services performed through that date multiplied by the total milestone payment would be recognized as revenue. The percentage of services performed is based on the ratio of the number of direct labor hours performed to date to total direct labor hours that we are obligated to perform under the related contract, as determined on a full-time equivalent basis. The remainder, if any, will be recognized proportionately as the remaining services are performed. For the year ended December 31, 2002, we recognized $245,000 of revenues relating to research and development services performed under our corporate collaboration agreements. We have not recognized any revenue under such agreements during the years ended December 31, 2001 and 2000. Royalty revenue is recognized upon the sale of the related products, provided the royalty amounts are fixed or determinable and collection of the related receivable is reasonably assured.

Amounts received prior to satisfying the above revenue recognition criteria are recorded as deferred revenue in the accompanying balance sheets. Amounts not expected to be recognized during the year ended December 31, 2003 are classified as long-term deferred revenue. As of December 31, 2002, we have recorded long-term deferred revenue of approximately $11,962,000 related to the Micromet (see Note 11(d) to our Consolidated Financial Statements) multiple element arrangement and short-term revenue of approximately $192,000 related to our collaboration with ES Cell (see Note 11(e) to our Consolidated Financial Statements).

Government grant revenues consist of grant awards from the Department of Health and Human Services and the NIST (see Note 10). Revenue is recognized under government grants as the services are provided and payment is assured under the terms of the grant.

We follow detailed guidelines in measuring revenue; however, certain judgments affect the application of our revenue policy. For example, we entered into purchase and sale, product development and target research agreements with Micromet, under which we recorded on our balance sheet short- and long-term deferred revenue based on our best estimate of when such revenue will be recognized. A portion of the consideration received from this transaction with Micromet was equity securities and a convertible note. The estimate of deferred revenue includes management’s assessment of the value attributable to the equity securities and realization of the convertible note. The up-front payments received from Micromet for the sale of technology will be recognized as revenue as services are performed over our estimated performance period under the product development agreement. To date, $183,000 has been recognized as revenue.

The above list is not intended to be a comprehensive list of all of our accounting policies. In many cases, the accounting treatment of a particular transaction is specifically dictated by generally accepted accounting principles, with no need for management’s judgment in their application. There are also areas in which management’s judgment in selecting any available alternative would not produce a materially different result. See our audited consolidated financial statements and notes thereto which begin on page F-1 which contain accounting policies and other disclosures required by generally accepted accounting policies.

Critical Accounting Estimates

The preparation of our consolidated financial statements in conformity with accounting principles generally accepted in the United States requires that we make estimates and assumptions that affect the reported amounts and disclosure of certain assets and liabilities at our balance sheet date. Such estimates include the collectibility of receivables, the carrying value of property and equipment and intangible assets and the value of certain

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liabilities. Actual results may differ from such estimates. Examples of some of our significant estimates are as follows:

Valuation of investments in privately-held companies.    We have investments in Aegera Therapeutics, Inc., Micromet and ES Cell of $167,000, $686,000 and $150,000, respectively. These investments are included in the “Deposits and other assets” category of our Consolidated Balance Sheets. At each balance sheet date, we review these investments to determine whether the fair value of these investments is less than the carrying value and, if so, whether we should write-down the investment. These companies are not publicly-traded and, therefore, determining the fair value of our investments in these companies involves significant judgment. We considered available information in estimating the fair value of these investments and, as of December 31, 2002, believe that the fair value of these investments is not less than their carrying value. However, if the financial condition or results of these companies declines significantly, the fair value of these investments would likely decline and, as a result, we may have to record an impairment charge to the extent such impairment is deemed other-than-temporary.

Collectibility of long-term note receivable.    As of December 31, 2002, we have a note receivable from Micromet totaling $4,663,000, including accrued interest of $398,000. This amount is presented as “Deposits and other assets” in our Consolidated Balance Sheets. Payment of this note is not due until the earlier of the closing of an initial public offering by Micromet or June 30, 2005. As of December 31, 2002, we believe this note is fully collectible and, therefore, we have not recorded a reserve against this balance. If Micromet’s financial condition declines, some or all of this note could become uncollectible and, as a result, we would have to record a reserve for some or all of the note.

Timing of Deferred Revenue Recognition.    The Company has recorded short-term deferred revenue of $192,000 and long-term deferred revenue of $11,962,000 as of December 31, 2002. Short-term deferred revenue consists of amounts not expected to be recognized as revenue during the year ended December 31, 2003. However, this estimate is based on the Company’s current operating plan as of December 31, 2002. If this operating plan should change during 2003, a different amount of deferred revenue may be recognized by the Company for the year ended December 31, 2003.

Results of Operations

On July 31, 2000, Creative BioMolecules, Inc., Ontogeny, Inc. and Reprogenesis, Inc. merged with and into Curis pursuant to an Agreement and Plan of Merger dated as of February 14, 2000. As a result of the merger, the consolidated statement of operations data for the year ended December 31, 2000 include the operating results of Creative for the seven months ended July 31, 2000 and our operating results, comprising the combined operations of Creative, Ontogeny and Reprogenesis, for the five months ended December 31, 2000. The consolidated statement of operations data for the years ended December 31, 2002 and 2001 include only our operating expenses for such periods. Accordingly, comparisons of operating expenses between the 2001 and the 2000 periods presented below may not prove to be meaningful. Additionally, in the year ended December 31, 2000, we and Creative incurred significant non-cash charges associated with the merger and cash expenses for merger related fees and expenses.

Years Ended December 31, 2002 and 2001

Revenues

Total revenues for the year ended December 31, 2002 were $18,391,000 as compared to $1,087,000 for the year ended December 31, 2001. The increase in revenues was primarily attributable to the consummation in 2002 of various corporate collaboration transactions. Research and development contract and government grant revenue decreased by $723,000, or 75%, to $245,000 for the year ended December 31, 2002 compared to a

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$968,000 for the year ended December 31, 2001. The research and development contract and government grant revenue for the year ended December 31, 2002 was derived entirely from revenue recognized under corporate collaborations. For the year ended December 31, 2001, this revenue was derived solely from government grants.

License fees and royalty revenue increased by $18,027,000, to $18,146,000 for the year ended December 31, 2002 as compared to $119,000 for the year ended December 31, 2001. The increase was primarily due to the recognition of revenue upon the completion of various transactions in 2002 including (i) $14,000,000 in revenue recognized under a transaction with Stryker, under which we sold our rights to future royalties from Stryker on sales of OP-1, (ii) $3,500,000 in revenue recognized from an up-front payment received by us in connection with the licensing of certain of our BMP technology to Ortho Biotech, a member of the Johnson & Johnson family of companies, and (iii) $258,000 recognized under other transactions completed in 2002. In addition, royalty revenue received in 2002 from Stryker on sales of OP-1 increased by $268,000 to $387,000 for the year ended December 31, 2002 as compared to $119,000 for the year ended December 31, 2001. As part of the Stryker transaction, we will receive no future royalties on sales by Stryker of OP-1.

Operating Expenses

Research and development expenses decreased 52% to $14,058,000 for the year ended December 31, 2002 from $29,072,000 for the year ended December 31, 2001. The decrease was primarily due to a reduction in ongoing operating costs as a result of the February 2002 realignment of our research and development programs and a re-focusing of our resources on our proprietary signaling pathways and stem cell technologies, including the Bone Morphogenic Protein and the Hedgehog family of product candidates. In addition, our allocation of research and development expenses to Curis Newco increased to $5,263,000 for the year ended December 31, 2002 from $1,774,000 for the year ended December 31, 2001. Our 80.1% share of these costs is included in “Equity in loss from joint venture” in our Consolidated Statement of Operations and Comprehensive Loss.

Research and development expenses for the year ended December 31, 2002 include the cost of employees involved in research and development of $4,528,000, outside services including medicinal chemistry, consulting and sponsored research collaborations of $3,059,000, occupancy and depreciation charges of $2,058,000, lab supplies of $1,514,000 and legal fees associated with our intellectual property of $1,996,000. Research and development expenses for the year ended December 31, 2002 are net of $5,263,000 in expenses that were charged by us to Curis Newco, however, 80.1% of these costs are included as part of “Equity in loss from joint venture” in our Consolidated Statement of Operations and Comprehensive Loss.

Research and development expenses for the year ended December 31, 2001 include the cost of employees involved in research and development of $8,337,000, outside services including clinical trials, medicinal chemistry, consulting and sponsored research collaborations of $8,532,000, occupancy and depreciation charges of $4,291,000, lab and clinical trial manufacturing supplies of $3,630,000 and legal fees associated with our intellectual property of $2,427,000. Research and development expenses for the year ended December 31, 2001 are net of $1,774,000 in expenses that were charged by us to Curis Newco. However, 80.1% of these costs are included as part of “Equity in loss from joint venture” in our Consolidated Statement of Operations and Comprehensive Loss.

General and administrative expenses decreased 22% to $8,160,000 for the year ended December 31, 2002 from $10,493,000 for the year ended December 31, 2001. The decrease was primarily due to a reduction in ongoing operating costs as a result of our business realignment.

General and administrative expenses for the year ended December 31, 2002 include the costs of employees of $3,689,000, occupancy and depreciation charges of $889,000, professional service fees and other outside services including legal costs and consultants of $1,548,000, and a charge to record a reserve for possible non-collection of notes receivable outstanding to two former officers of Creative of $686,000. This charge is based on the total book value of the notes receivable less the underlying value of our common stock that secures the notes

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receivable. The book value of these notes receivable was $1,338,000 and $1,292,000 as of December 31, 2002 and 2001, and is included as “Notes receivable” at the Stockholders’ Equity section of our Consolidated Balance Sheets. The reserve on the notes receivable was $1,194,000 and $508,000 as of December 31, 2002 and 2001, and is included as part of “Accrued Liabilities” in our Consolidated Balance Sheets.

General and administrative expenses for the year ended December 31, 2001 include the costs of employees of $3,978,000, occupancy and depreciation charges of $1,545,000, professional service fees and other outside services including legal costs and consultants of $2,617,000, and a charge to record a reserve for possible non-collection of notes receivable outstanding to two former officers of Creative of $508,000. This charge is based on the total book value of the outstanding obligation due from the former Creative officers less the underlying value of our common stock that secures the notes receivable. The book value of the notes receivable was $1,292,000 as of December 31, 2001, and is included as “Notes receivable” at the Stockholders’ Equity section of our Consolidated Balance Sheet. The reserve on the notes receivable was $508,000 as of December 31, 2001, and is included in “Accrued Liabilities” at our Consolidated Balance Sheet.

Stock-based compensation decreased by $8,198,000, or 79%, to $2,160,000 for the year ended December 31, 2002 from $10,358,000 for the year ended December 31, 2001. The decrease was primarily attributable to the stock-based compensation expense related to deferred compensation resulting from the merger that was amortized over the vesting period of the underlying options through August 1, 2001. Stock-based compensation related to these options was approximately $6,257,000 for the year ended December 31, 2001. In addition, there was a decrease in the amount of stock-based compensation expense related to our issuance on August 18, 2000 of stock options with exercise prices below fair market value. Because these options were issued with exercise prices below fair market value, we recorded deferred compensation and have been amortizing the deferred compensation over the four-year vesting period of the options. When an option holder’s employment with us is terminated, we treat any unvested portion of their options and related deferred compensation as charged to the additional paid-in capital accounts (not the stock-based compensation accounts). Accordingly, the departure of four officers and approximately 55 other employees as a result of the realignment of our business and a subsequent staff reduction in December 2002 has resulted in a decrease of stock-based compensation expense, since the remaining deferred compensation balance associated with each terminated employees’ August 18, 2000 stock options was immediately charged to additional paid-in capital instead of to stock-based compensation.

Amortization of intangible assets decreased by $22,864,000, or 98%, to $475,000 for the year ended December 31, 2002 from $23,339,000 for the year ended December 31, 2001. The decrease was primarily due to the adoption of SFAS 142, which required companies to stop amortizing goodwill and certain other intangible assets. We are currently amortizing only capitalized patent and technology costs. Amortization of goodwill totaling $23,114,000 was recorded for the year ended December 31, 2001.

Loss on property and equipment for the year ended December 31, 2002 of approximately $5,337,000 related to impairment on assets at our facility at 21 Erie Street in Cambridge, Massachusetts. Total carrying value of assets at the Erie Street facility before the impairment charge was approximately $5,652,000. The property and equipment assets at the Erie Street facility were used to support clinical programs that were suspended or terminated as part of the realignment and have been deemed to be unlikely to be used in our future operations. $4,761,000 of the impairment charge related to the write-off of tenant improvements made to the Erie Street facility since such improvements were affixed to the facility and therefore could not be sold separately from the facility. The remaining $576,000 of impairment charge represents our estimate of loss on disposition of the furniture and equipment assets held at the Erie Street facility. We do not expect to incur additional impairment on property and equipment related to the realignment in future periods.

Impairment of goodwill for the year ended December 31, 2002 was $64,098,000. In accordance with SFAS No. 142, we concluded that the decline in our market capitalization during the three-month period ended June 30, 2002 indicated that the carrying value of our goodwill may be impaired. Accordingly, we conducted an

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impairment review as required under SFAS No. 142 as of June 30, 2002 and determined that goodwill impairment had occurred as of June 30, 2002. Our value, as a single reporting unit, was calculated using quoted market prices adjusted to provide for a control premium. In calculating the impairment charge, the fair value of our intangible assets, principally consisting of completed and in-process technology, was estimated using a discounted cash flow methodology.

Realignment expenses of $3,490,000 were recorded for the year ended December 31, 2002. These charges relate to: (i) costs of approximately $1,139,000 associated with workforce reductions of 46 people, including 4 officers, (ii) costs of approximately $2,306,000 associated with the closing of clinical programs and decommissioning of a manufacturing and development facility and (iii) other costs of approximately $45,000. As of December 31, 2002, we have expended approximately all of the $3,490,000 in realignment expenses. We do not expect to incur additional expenses in future periods.

Equity in Loss from Joint Venture

Equity in loss from joint venture decreased by $9,142,000, or 68%, to $4,311,000 for the year ended December 31, 2002 from $13,453,000 for the year ended December 31, 2001. The equity in loss from joint venture relates to our joint venture with affiliates of Elan Corporation, plc. The decrease is primarily caused by our 80.1%, or $12,015,000, share of a $15,000,000 write-off of technology recorded by the joint venture in July 2001. This decrease was partially offset by an increase in our 80.1% share of ongoing operating expenses recorded by the joint venture for the year ended December 31, 2002 as compared to the year ended December 31, 2001. The increase in ongoing operating expenses for the year ended December 31, 2002 as compared to the year ended December 31, 2001 was primarily caused by the joint venture operating for twelve months in 2002 versus five months in 2001.

Other Income (Expenses)

For the year ended December 31, 2002, interest income was $1,067,000 as compared to $2,854,000 for the year ended December 31, 2001, a decrease of $1,787,000, or 63%. The decrease in interest income resulted from a lower available investment balance and lower average investment yields for the year ended December 31, 2002 as compared to the year ended December 31, 2001.

For the year ended December 31, 2002, other income was $1,262,000 as compared to $1,694,000 for the year ended December 31, 2001, a decrease of $432,000, or 26%. This decrease was principally due to a decrease in the amount of gain recognized on sales of Exelixis, Inc. common stock. We recognized gains of $601,000 and $1,466,000 for the years ended December 31, 2002 and 2001, respectively, related to sales of Exelixis, Inc. common stock. The decrease in the gain recognized on sales of Exelixis common stock was partially offset by an increase in the gain recognized on currency rate fluctuations on a EURO-denominated long-term note receivable issued to us by Micromet in connection with our strategic alliance. We recognized gains on currency rate fluctuations of $660,000 and $145,000, respectively, for the years ended December 31, 2002 and 2001.

For the year ended December 31, 2002, interest expense was $947,000 as compared to $784,000 for the year ended December 31, 2001, an increase of $163,000, or 21%. The increase in interest expense resulted partially from the increase in the amount that we owe to Elan Pharma International, Ltd., an affiliate of Elan, as part of our Curis Newco joint venture. Interest expense associated with the Curis Newco joint venture increased to $200,000 for the year ended December 31, 2002 from $1,000 for the year ended December 31, 2001. In addition, we incurred $193,000 for the year ended December 31, 2002 in non-cash interest expense related to a $2,000,000 convertible subordinated note payable issued to Becton Dickinson in June 2001. This represented a $121,000 increase over the $99,000 incurred for the year ended December 31, 2001. These increases were partially offset by a decrease in interest expense paid on capital leases in 2002 compared to 2001.

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Accretion on Series A Convertible Exchangeable Preferred Stock

Accretion on Series A Convertible Exchangeable Preferred Stock increased by $397,000, or 121%, to $723,000 for the year ended December 31, 2002 from $326,000 for the year ended December 31, 2001. This charge relates to the accretion of a mandatory dividend on shares of convertible exchangeable preferred stock issued to an affiliate of Elan. The amounts are included in the net loss applicable to common stockholders for years ended December 31, 2002 and 2001.

Net Loss Applicable to Common Stockholders

As a result of the foregoing, we incurred a net loss applicable to common stockholders of $83,038,000 for the year ended December 31, 2002 as compared to $82,190,000 for the year ended December 31, 2001.

Years Ended December 31, 2001 and 2000

Revenues

Total revenues for the year ended December 31, 2001 were $1,087,000 as compared to $1,024,000 for the year ended December 31, 2000. A majority of revenues for both years was derived from research and development contracts and government grants. Revenues recognized from these sources totaled $968,000 and $997,000 for the years ended December 31, 2001 and 2000, respectively.

License fees and royalties increased $93,000 to $119,000 for the year ended December 31, 2001 as compared to $26,000 for the year ended December 31, 2000. The increase in royalties was primarily due to an increase in royalty revenues received from Stryker arising out of sales of OP-1.

Operating Expenses

Research and development expenses increased 67% to $29,072,000 for the year ended December 31, 2001 from $17,424,000 for the year ended December 31, 2000. The increase was primarily attributable to the consummation of the merger of Creative, Ontogeny and Reprogenesis which occurred on July 31, 2000. Research and development expenses for the year ended December 31, 2001 include the costs incurred by the combined companies for the entire twelve-month period, whereas research and development expenses for the year ended December 31, 2000 include the costs incurred by only Creative for the seven-month period of January 1, 2000 to July 31, 2000 and the combined companies for the five-month period from August 1, 2000 to December 31, 2000. This general increase based on the timing of the merger was offset in part by severance payments made by Creative in the year ended December 31, 2000.

Research and development expenses for the year ended December 31, 2001 include the cost of employees involved in research and development of $8,337,000, outside services including clinical trials, medicinal chemistry, consulting and sponsored research collaborations of $8,532,000, occupancy and depreciation charges of $4,291,000, lab and clinical trial manufacturing supplies of $3,630,000 and legal fees associated with our intellectual property of $2,427,000. Research and development expenses for the year ended December 31, 2001 are net of $1,774,000 in expenses that were charged by us to Curis Newco. However, 80.1% of these costs are included as part of “Equity in loss from joint venture in our Consolidated Statement of Operations and Comprehensive Loss.”

Research and development expenses for the year ended December 31, 2000 include the cost of employees involved in research and development of $5,100,000, external lab services including clinical trials, medicinal chemistry, consulting and sponsored research collaborations of $3,200,000, and facility related costs of $1,300,000. In addition, research and development expenses for the year ended December 31, 2000 include severance payments to former officers of Creative totaling $656,000, and severance payments relating to the termination of seven other employees totaling $251,000.

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General and administrative expenses increased 12% to $10,493,000 for the year ended December 31, 2001 from $9,330,000 for the year ended December 31, 2000. The increase was primarily attributable to the consummation of the merger which occurred on July 31, 2000. General and administrative expenses for the year ended December 31, 2001 include the costs incurred by the combined companies for the entire twelve-month period. General and administrative expenses for the year ended December 31, 2000 include the costs incurred by only Creative for the seven-month period of January 1, 2000 to July 31, 2000 and the combined companies for the five-month period from August 1, 2000 to December 31, 2000. This general increase based on the timing of the merger was offset in part by severance payments made by Creative in the year ended December 31, 2000.

General and administrative expenses for the year ended December 31, 2001 include the costs of employees of $3,978,000, occupancy and depreciation charges of $1,545,000, professional service fees and other outside services including legal costs and consultants of $2,617,000, and a charge to record a reserve for possible non-collection of notes receivable outstanding to two former officers of Creative of $508,000. This charge is based on the total book value of the notes receivable less the underlying value of our common stock that secures the notes receivable. The book value of the notes receivable was $1,292,000 as of December 31, 2001, and is included as “Notes receivable” at the Stockholders’ Equity section of our Consolidated Balance Sheet. The reserve on the notes receivable was $508,000 as of December 31, 2001, and is included in “Accrued Liabilities” at our Consolidated Balance Sheet.

General and administrative expenses for the year ended December 31, 2000 include the costs of employees of $1,400,000, legal and professional fees of $875,000, and insurance expense of $600,000. In addition, general and administrative expenses for the year ended December 31, 2000 include severance paid to former officers of Creative of $1,048,000 and severance payments relating to the termination of approximately eight other employees totaling $122,000.

Stock-based compensation decreased by $6,270,000, or 38%, to $10,358,000 for the year ended December 31, 2001 from $16,628,000 for the year ended December 31, 2000. The decrease was partially due to two stock-based compensation charges arising out of the merger that were recorded in the year ended December 31, 2000 including (i) $3,538,000 that was related to the acceleration of certain stock options and the extension of the exercise period for options held by Creative’s executive officers, outside directors and employees, and (ii) compensation expense of $1,623,000 based on the fair value of 57,094 shares of restricted common stock granted to a former Reprogenesis executive officer that became fully vested upon the merger. In addition, our amortization expense related to deferred compensation resulting from the merger, which was amortized over the vesting period of the underlying options through August 1, 2001, decreased to $6,257,000 in the year ended December 31, 2001 from $9,563,000 in the year ended December 31, 2000. These decreases in stock-based compensation expenses related to the merger were partially offset by an increase in stock-based compensation expense related to our issuance on August 18, 2000 of options to purchase 3,473,006 shares of our common stock with an exercise price below fair market value. The resulting stock-based compensation, net of terminations, of $17,330,000 is being amortized over the four-year vesting period of the underlying stock options for options granted to employees and as earned for nonemployees in accordance with EITF 96-18. The total deferred compensation expense related to these options was $3,964,000 and $1,904,000 for the years ended December 31, 2001 and 2000, respectively.

Amortization of intangible assets increased by $8,888,000, or 62%, to $23,339,000 for the year ended December 31, 2001, compared to $14,451,000 for the year ended December 31, 2000. The increase was principally due to the amortization of goodwill increasing to $23,114,000 from $9,641,000 for the years ended December 31, 2001 and 2000, respectively. The increase in the amortization of goodwill in 2001 was partially offset by an impairment charge in the year ended December 31, 2000 of approximately $4,611,000 to reduce the carrying value of certain capitalized patents determined not to be beneficial or expected to be utilized in future operations and which have no alternative future use.

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Fixed asset disposition charges totaling $204,000 were incurred during the year ended December 31, 2000 for the net book value of equipment disposed of as a result of the merger. No such charges were incurred for the year ended December 31, 2001.

A charge of $294,800,000 was incurred on July 31, 2000 resulting from that portion of the purchase price of Ontogeny and Reprogenesis that was identified as in-process research and development. The purchase price of Ontogeny and Reprogenesis was allocated to the assets acquired, including IPR&D, based upon an independent appraisal, which used proven valuation tools and techniques.

Equity in Loss from Joint Venture

During the year ended December 31, 2001, we formed a joint venture with affiliates of Elan Pharmaceuticals, plc. In 2001, we incurred an equity in loss from joint venture of $13,453,000, which represented 80.1% of the total net loss incurred by the joint venture. We financed a majority of this loss with the issuance of 1,000 shares of Series A Convertible Exchangeable Preferred Stock, which were valued at $12,015,000, to Elan International Services, Ltd., an affiliate of Elan. Our portion of Curis Newco’s other operating expenses for the twelve-month period ended December 31, 2001 was $1,438,000.

Other Income (Expenses)

For the year ended December 31, 2001, interest income was $2,854,000 compared to $1,901,000 for the year ended December 31, 2000, an increase of $953,000, or 50%. The increase in interest income resulted partially from the consolidation into Curis of the investable cash and marketable security balances and income earned thereon from the three companies prior to the merger for an entire twelve-month period in the year ended December 31, 2001 versus only a five-month period in the year ended December 31, 2000. The increase in interest income is also partially attributed to our holding a higher average investable cash balance as a result of net proceeds from a private placement of approximately $43,348,000, offset in part by lower average investment yields in the year ended December 31, 2001 as compared to the year ended December 31, 2000.

For the year ended December 31, 2001, other income was $1,694,000 compared to $5,000 for the year ended December 31, 2000, an increase of $1,689,000. This increase was principally due to a $1,470,000 gain recognized on the sale of Exelixis, Inc. common stock for the year ended December 31, 2001.

For the year ended December 31, 2001, interest expense was $784,000 compared to $481,000 for the year ended December 31, 2000, an increase of $303,000, or 63%. The increase in interest expense resulted partially from the consolidation into Curis of the outstanding lease obligations from the three companies prior to the Merger for an entire twelve-month period in the year ended December 31, 2001 versus only a five-month period in the year ended December 31, 2000. In addition, we recognized $135,000 of interest expense related to a $5,000,000 debt facility, which was fully drawn down by December 31, 2001. Lastly, we incurred $99,000 in non-cash interest expense related to a $2,000,000 convertible subordinated note payable issued in 2001.

Accretion on Series A Convertible Exchangeable Preferred Stock

Accretion on Series A Convertible Exchangeable Preferred Stock of $326,000 was recorded for the year ended December 31, 2001. This charge relates to the accretion of a mandatory dividend on shares of convertible exchangeable preferred stock issued to an affiliate of Elan.

Net Loss Applicable to Common Stockholders

As a result of the foregoing, we incurred a net loss applicable to common stockholders of $82,190,000 for the year ended December 31, 2001 compared to $350,351,000 for the year ended December 31, 2000.

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Liquidity and Capital Resources

At December 31, 2002, our principal sources of liquidity consisted of cash, cash equivalents and marketable securities of $40,976,000, including restricted cash and cash equivalents of $4,403,000. We have financed our operations primarily through placements of equity securities, payments received under agreements with collaborative partners and government grants, amounts received under debt and capital lease agreements, manufacturing contracts and the sale of certain OP-1 manufacturing rights and facilities to Stryker.

Net cash used in operating activities was $6,917,000, $24,877,000, and $23,701,000 for the years ended December 31, 2002, 2001 and 2000, respectively. Net cash used in operating activities during the year ended December 31, 2002 was primarily the result of our net loss for the period of $82,315,000 partially offset by $74,384,000 in non-cash charges including impairment charges on our intangible and tangible assets, stock-based compensation, depreciation, amortization and non-cash interest income and expense. Our net loss was further offset by our equity in loss of joint venture of $4,311,000. We used approximately $3,297,000 of operating cash as a result of changes in certain of our asset and liabilities. Net cash used in operating activities during the year ended December 31, 2001 was primarily the result of our net loss for the period of $81,864,000 partially offset by $36,854,000 in non-cash charges including stock-based compensation, depreciation, amortization and non-cash interest income and expense. Our net loss was further offset by our equity in loss of joint venture of $13,453,000 and by an increase in operating cash of $6,582,000 as a result of changes in certain of our assets and liabilities. The most significant change in our assets and liabilities related to $8,000,000 recorded as deferred revenue on our balance sheet that related to cash consideration received in our collaboration with Micromet. Net cash used in operating activities for the year ended December 31, 2000 was primarily the result of our net loss for the period of $350,351,000 offset by $327,331,000 in non-cash charges including the write-offs of in-process research and development costs and certain patents deemed by us to be impaired, stock-based compensation and amortization of intangibles, depreciation, amortization and non-cash interest income and expense.

Net cash used in investing activities was $1,066,000 for the year ended December 31, 2002. Net cash provided by investing activities was $6,429,000 and $25,842,000 for the years ended December 31, 2001 and 2000, respectively. Cash used by investing activities in 2002 was primarily the result of the transfer of $4,403,000 to a restricted cash account under the terms of a debt agreement with Boston Private Bank & Trust Company offset in part by net proceeds from the sale of marketable securities totaling $2,785,000. Net cash provided by investing activities the year ended December 31, 2001 was primarily the result of net proceeds from the sale of marketable securities totaling $8,862,000, offset in part by net expenditures for leasehold improvements and equipment of $1,746,000. Cash provided by investing activities in 2000 was primarily the result of the receipt of $28,619,000 of cash and marketable securities from Ontogeny and Reprogenesis as part of the consummation of the merger, offset in part by cash expenditures for the purchase of marketable securities of $2,530,000.

Net cash used in financing activities was $3,374,000 for the year ended December 31, 2002. The cash used in financing activities for the year ended December 31, 2002 was primarily due to $2,549,000 in net repayments of obligations under capital lease and debt arrangements. In addition, we used $869,000 in cash to repurchase shares of our common stock during 2002. Financing activities generated approximately $5,116,000 of cash in the year ended December 31, 2001 resulting primarily from the sale of 546,448 shares of common stock at $7.32 for total net proceeds of $3,853,000, proceeds received from the issuance of a convertible subordinated note payable to Becton Dickinson of $2,000,000 and proceeds from the exercise of options and warrants totaling approximately $951,000. These amounts were partially offset by repayments on debt and capital lease arrangements by us of $1,603,000. Financing activities generated approximately $47,521,000 of cash in the year ended December 31, 2000 resulting primarily from the sale of 5,200,000 shares of common stock at $9.00 for total net proceeds of $43,348,000 and proceeds from the exercise of options and warrants totaling approximately $5,357,000.

On October 1, 2002, we completed a transaction with Stryker, under the terms of which we received $14,000,000 in cash in exchange for our termination of any future BMP-7 (OP-1) royalty obligations owed by

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Stryker. This transaction reduces future BMP-7 royalties that we would owe to Stryker for products sold in therapeutic indications other than orthopaedics and dental, if any sales ever occur. We recorded the $14,000,000 received as revenue during the fourth quarter of 2002. We will receive no future royalties or payments of any other kind from Stryker as a result of this transaction.

On June 14, 2002, we entered into a loan agreement with Boston Private Bank & Trust Company pursuant to which we borrowed approximately $4,695,000. We used the proceeds of this loan to pay off our existing credit facility with Fleet National Bank. Under the terms of the loan agreement, we will (i) pay interest monthly in arrears at a variable interest rate (3.75% at December 31, 2002), and (ii) repay principal in equal quarterly installments over a five-year term, beginning on September 1, 2002. This loan is fully collateralized with a money market account maintained by us at Boston Private Bank & Trust Company. The collateral is included in “Cash and cash equivalents—restricted” at our Consolidated Balance Sheet as of December 31, 2002. As of December 31, 2002, there was approximately $4,239,000, including approximately $14,000 in accrued interest, outstanding under the loan agreement.

On July 18, 2001, we and Elan International Services, Ltd., or EIS, formed Curis Newco, an entity that is committed to the research and development of molecules that stimulate the Hedgehog signaling pathway in the area of neurological disorders. As part of the joint venture arrangement, we entered into an $8,010,000 convertible promissory note agreement with Elan Pharma International Limited, or EPIL. This note agreement bears interest at 8% per annum through July 18, 2005 and 6% per annum thereafter, compounded and payable semi-annually. Our borrowings under this note agreement may only be used to meet our funding obligations for Curis Newco’s development program. As of December 31, 2002, there was approximately $4,860,000, including approximately $200,000 in capitalized interest, outstanding under the note agreement.

On June 29, 2001, we entered into a purchase and sale agreement with Micromet, a German biotechnology corporation, pursuant to which we assigned our single-chain-polypeptide technology to Micromet in exchange for $8,000,000 in cash received, 3,003 shares of Micromet common stock valued at approximately $686,000 and a convertible promissory note of EUR 4,068,348 (principal value of approximately $4,264,000 at December 31, 2002). During the first quarter of 2002, we entered into a target research and license agreement and a product development agreement with Micromet. These agreements will provide us with royalties on Micromet’s product revenues, if any, arising out of the assigned technology, rights to jointly develop and commercialize future product discoveries, if any, arising out of the product development agreement, and exclusive access by us to Micromet’s proprietary single cell analysis of gene expression technology in the field of stem cell research. The product development agreement provides us the right but not the obligation to jointly fund research to develop antibiotics against up to four potential targets through the proof of principle stage. We will also have the right, but not the obligation, to jointly fund the development of two such antibody targets from the proof of principle stage through the completion of phase I clinical trials. Lastly, we will be obligated to pay milestones to Micromet upon the attainment of certain development goals.

On June 26, 2001, we received $2,000,000 from Becton Dickinson under a convertible subordinated note payable in connection with the exercise by Becton Dickinson of an option to negotiate a collaboration agreement. The note is repayable at any time up to its maturity date of June 26, 2006 by us, at our discretion, in either cash or upon issuance to Becton Dickinson of shares of our common stock. The note bears interest at 7%.

We lease equipment under various capital lease arrangements. Monthly payments on leases outstanding as of December 31, 2002, range from $363 to $21,170 and maturities range from January 2003 to July 2004. The initial terms of the leases range from 36 months to 60 months and bear interest at rates ranging from 11.0% to 16.3%. As of December 31, 2002, approximately $1,291,000 was outstanding under these agreements and we were in compliance with all covenants under these agreements.

On October 5, 2000, we received our second $2,000,000 grant from NIST to support the development of a new class of biomaterials designed to enable surgical procedures that augment, repair or regenerate lost structural tissue or physiological function. The grant period is from January 1, 2001 to December 31, 2003. Previously,

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Reprogenesis had been awarded a $2,000,000 grant from NIST to support the development of our cardiovascular products, Vascugel^™ and Vascuject^™. The grant period for the NIST grant made to Reprogenesis is from November 1, 1999 to October 31, 2002. The programs covered by these two NIST awards were terminated as part of the realignment. Effective April 15, 2002, these awards were terminated and we will receive no future revenue under these awards.

As of December 31, 2002, we had future payments required under contractual obligations and other commitments approximately as follows:

We anticipate that existing capital resources should enable us to maintain current and planned operations into the first quarter of 2005. We expect to incur substantial additional research and development and other costs, including costs related to preclinical studies and clinical trials for the foreseeable future. Our ability to continue funding planned operations beyond the first quarter of 2005 is dependent upon the success of our collaborations with our collaborative partners, our ability to continue to reduce our cash burn rate, and our ability to raise additional funds through equity or debt financings, or from other sources of financing. Our ability to generate sufficient cash flows depends on a number of factors, including the ability to obtain regulatory approval to market and commercialize products to treat indications in major commercial markets. We are seeking additional collaborative arrangements and also expect to raise funds through one or more financing transactions, if conditions permit. Over the longer term, because of our significant long-term capital requirements, we intend to seek to raise funds through the sale of debt or equity securities when conditions are favorable, even if we do not have an immediate need for additional capital at such time. However, additional financing may not be available or, if available, it may not be available on favorable terms. In addition, the sale of additional debt or equity securities could result in dilution to our stockholders. If substantial additional funding is not available, our ability to fund research and development and other operations will be significantly affected and, accordingly, our business will be materially and adversely affected.

We have no off-balance sheet arrangements as of December 31, 2002.

New Accounting Pronouncements

In July 2002, the FASB issued SFAS 146, “Accounting for Costs Associated with Exit or Disposal Activities.” SFAS 146 requires that a liability for a cost associated with an exit or disposal activity be recognized

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at its fair market value when the liability is incurred, rather than at the date of an entity’s commitment to an exit plan. The provisions of SFAS 146 are effective for exit or disposal activities that are initiated after December 31, 2002. The adoption of SFAS 146 has not had a material effect on our financial statements.

In November 2002, the FASB issued FIN 45 “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others, an interpretation of FASB Statements No. 5, 57, and 107 and rescission of FASB Interpretation No. 34.” FIN 45 requires that a guarantor recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken by issuing the guarantee. The Interpretation also requires additional disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under certain guarantees it has issued. The accounting requirements for the initial recognition of guarantees are applicable on a prospective basis for guarantees issued or modified after December 31, 2002. The disclosure requirements are effective for all guarantees outstanding, regardless of when they were issued or modified, during the first quarter of fiscal 2003. The adoption of FIN 45 did not have a material effect on our consolidated financial statements.

In December 2002, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure.” SFAS 148 provides alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based employee compensation as originally provided by SFAS No. 123 “Accounting for Stock-Based Compensation.” Additionally, SFAS 148 amends the disclosure requirements of SFAS 123 to require prominent disclosure in both the annual and interim financial statements about the method of accounting for stock-based compensation and the effect of the method used on reported results. The transitional requirements of SFAS 148 will be effective for all financial statements for fiscal years ending after December 15, 2002. The disclosure requirements shall be effective for financial reports containing condensed financial statements for interim periods beginning after December 15, 2002. We expect to adopt the disclosure portion of this statement for the quarter ending March 31, 2003. The application of this standard will have no impact on our consolidated financial position or results of operations.

In January 2003, the FASB issued FIN 46, “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51.” The primary objective of the Interpretation is to provide guidance on the identification of, and financial reporting for, entities over which control is achieved through means other than voting rights. Such entities are known as variable-interest entities (VIEs). Although the FASB’s initial focus was on special-purpose entities (SPEs), the final guidance applies to a wide range of entities. FIN 46 applies to new entities that are created after the effective date, as well as applies to existing entities. The FIN is effective to preexisting entities as of the beginning of the first interim period beginning after June 15, 2003, and to any new entities beginning February 1, 2003. Once it goes into effect, FIN 46 will be the guidance that determines (1) whether consolidation is required under the “controlling financial interest” model of Accounting Research Bulletin No. 51 (ARB 51), Consolidated Financial Statements, or other existing authoritative guidance, or, alternatively, (2) whether the variable-interest model under FIN 46 should be used to account for existing and new entities. We are evaluating the impact of FIN 46 on our financial statements.

RISK FACTORS

Investing in our securities involves a high degree of risk. Before making an investment decision, you should carefully consider the following information about these risks as well as other information we include or incorporate by reference in this annual report filed on Form 10-K. The risks and uncertainties we have described are not the only ones facing us. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also affect our business operations. If any of the following risks actually occur, our business, financial condition or results of operations would likely suffer, and you could lose all or part of your investment.

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RISKS RELATED TO OUR BUSINESS, INDUSTRY, STRATEGY AND OPERATIONS

We sold our rights to future OP-1 royalties from Stryker in October 2002. We have not commercialized any other products to date. If we are not able to commercialize any other products, we will not be profitable.

On October 1, 2002, we sold our right to receive BMP-7 (OP-1) royalty revenues back to Stryker Corporation in exchange for $14,000,000 in cash. While this transaction provided us with capital to pursue our other product opportunities, it eliminated our only ongoing product (royalty) revenue stream.

All but one of our other product opportunities, described more fully in “Item 1. Business” section of this annual report filed on form 10-K, are in various stages of preclinical development. Only our program for BCC has had an IND accepted. An IND allows for human clinical trials to begin. Because our product opportunities have several years of development prior to reaching commercialization, there is a substantial risk that none of our current product opportunities will ever be commercialized. If none our product opportunities are commercialized, we would not recognize any revenue and we would not be profitable.

We are dependent on collaborative partners for the development and commercialization of many of our products. Any failure or delay by these partners in developing or commercializing our products could eliminate significant portions of our anticipated product pipeline.

The success of our strategy for development and commercialization of product candidates depends upon our ability to form productive collaborations and strategic alliances. Because we are a small company with limited human and financial resources, we believe that the best way to advance many of our scientific programs is through the establishment of corporate collaborations with pharmaceutical or biotechnology companies that possess the financial resources and/or specific areas of expertise (i.e., clinical and regulatory development) which we currently do not possess. We currently have strategic alliances with Ortho Biotech, Products, L.P. (a member of the Johnson & Johnson family of companies), ES Cell International Pte Ltd., Amylin Pharmaceuticals, Inc., Micromet AG, Elan Corporation plc, and others. If these strategic alliances are terminated or if none of the strategic alliances develop viable products, or if the products developed as a result of these alliances are not approved for commercial sale in the United States and/or other markets around the world, our expected royalty revenues would be diminished and our business would be materially and adversely affected. As an integral part of our ongoing research and development efforts, we periodically review opportunities to establish new collaborations, joint ventures and strategic alliances for the development and commercialization of products in our development pipeline. In the coming year, we intend to enter into additional strategic alliances. Even if we determine that it would be advantageous to establish a new collaboration, joint venture, or strategic alliance to exploit a product candidate in our development pipeline, we may not be able to establish such an arrangement on terms that we find acceptable, or at all. If we are unable to enter into new relationships to further our development efforts, we may be compelled to divert financing away from programs we consider promising.

By entering into strategic alliances to further our research program goals, we have relinquished a degree of control over the resources that our alliance partners dedicate to our research programs or the development schedule that they set in pursuit of our research goals and thereby may not be able to control the efforts that our alliance partners may devote to their respective programs with us. The timing and amount of any future royalty and clinical development milestone revenues with respect to product sales and product development under such collaborative arrangements will therefore depend on the level of commitment, timing and success of such collaborative partners’ efforts. Accordingly, we cannot predict the success of current or future strategic alliances.

We rely on our collaborative partners for support in our disease research programs and intend to rely on our strategic partners for certain preclinical evaluation and clinical development of our potential products and manufacturing and marketing of any products. Some of our strategic partners are conducting multiple product development efforts within each disease area that is the subject of our strategic alliance with them. Our strategic

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alliance agreements may not restrict a strategic partner from pursuing competing internal development efforts. Any of our product candidates, therefore, may be subject to competition with a potential product under development by a strategic partner.

Also, our partners may fail to perform their obligations under the strategic alliances or may be slow in performing their obligations. Our partners may terminate our strategic alliances under certain conditions. If any collaborative partner were to terminate or breach an agreement, or otherwise fail to complete its obligations in a timely manner, our anticipated revenue, if any, from the agreement and from the development and commercialization of our products under development which are the subject of the agreement could be severely limited. Furthermore, if any of our existing strategic alliances are terminated and we are not able to enter into alternative strategic alliances on acceptable terms, we may be required to undertake product development, manufacturing and commercialization and we may not have the funds or capability to do this, which could result in a discontinuation of such program.

We face substantial competition, which may result in our competitors discovering, developing or commercializing products before or more successfully than we do.

The product candidates currently in our development pipeline may face competition with existing and new products being developed by biotechnology, medical device and pharmaceutical companies, as well as universities and other research institutions. Many of our competitors have substantially greater capital resources, research and development staffs and facilities than we have. Efforts by other biotechnology, medical device and pharmaceutical companies could render our programs or products uneconomical or result in therapies superior to those that we develop. Furthermore, many of our competitors are more experienced in product development and commercialization, obtaining regulatory approvals and product manufacturing. As a result, they may develop competing products more rapidly and at a lower cost. These competitors may discover, develop and commercialize products which render the products that we or our collaborative partners are seeking to develop and commercialize non-competitive or obsolete.

Research in the fields of regulatory signaling pathways and functional genomics, which includes our work in oncology and renal disease, is highly competitive. Our primary competitors in the field of regulatory signaling pathways include Amgen, Inc., Chiron Corporation, Exelixis, Inc., Genentech, Inc. and Geron Corporation. Our primary competitors in the field of functional genomics include Axys Pharmaceuticals, Inc., Genome Therapeutics Corporation, Human Genome Sciences, Inc., Incyte Pharmaceuticals, Inc., Millennium Pharmaceuticals, Inc. and Myriad Genetics, Inc. We also compete with universities and other research institutions, including those receiving financial support from the federally-funded Human Genome Project. A number of entities are seeking to identify and patent randomly sequenced genes and gene fragments, typically without specific knowledge of the function that such genes or gene fragments perform. Our competitors may discover, characterize and develop important inducing molecules or genes in advance of us. We also face competition from these and other entities in gaining access to DNA samples used in our research and development projects. We expect competition to intensify in genomics research and regulatory signaling pathways as technical advances in the field are made and become more widely known.

Since our technologies have many potential applications and we have limited resources, our election to focus on a particular application may result in our failure to capitalize on other potentially profitable applications of our technologies.

We have limited financial and managerial resources. These limitations require us to focus on a select group of product candidates in specific therapeutic areas and to forego the exploration of other product opportunities. For example, a decision to concentrate on a particular indication within our neurology program may mean that we will not be able to allocate sufficient resources to fully exploit several different indications within our neurology program. While our technologies may permit us to work in both areas, resource commitments may require trade-offs resulting in delays in the development of certain programs or research areas, which may place

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us at a competitive disadvantage. Our decisions as to resource allocation may not lead to the development of viable commercial products and may divert resources away from other market opportunities which ultimately proved to be more profitable.

If any of our products ever receive regulatory approval for commercialization, the market may not be receptive to products we develop due to their use of new technologies or cost. Such a lack of reception would adversely affect expected revenues.

If any of our product opportunities ever receive regulatory approval, the commercial success of these products will depend upon their acceptance by patients, the medical community and third-party payors. Our future products, if any are successfully developed, may not gain commercial acceptance among physicians, patients and third-party payors, even if necessary marketing approvals have been obtained. We believe that recommendations and endorsements by physicians will be essential for market acceptance of our products. If we are not able to obtain a positive reception for our products, our expected revenues from sales of these products would be adversely affected.

Our growth could be limited if we are unable to attract and retain key personnel and consultants.

Our success depends on the ability to attract, train and retain qualified scientific and technical personnel to further our research and development efforts. The loss of services of one or more of our key employees or consultants could have a negative impact on our business and operating results. Competition for hiring personnel in the biotechnology industry is intense and locating candidates with the appropriate qualifications can be difficult. Although we expect to be able to attract and retain sufficient numbers of highly skilled employees for the foreseeable future, we may not be able to do so.

Any growth and expansion into areas and activities that may require additional human resources or expertise, such as regulatory affairs, compliance, manufacturing and marketing, would require us to hire new key personnel. The pool of personnel with the skills that we require is limited. Competition to hire from this limited pool is intense, and we may not be able to hire, train, retain or motivate such additional personnel.

If we fail to obtain an adequate level of reimbursement for our future products from third-party payors such as Medicare or insurance companies, there may be no commercially viable markets for our products.

The availability of reimbursement by governmental and other third-party payors for future products affects the market viability of any pharmaceutical product. These governmental and third-party payors persistently try to limit the costs of healthcare by exerting downward pressure on the prices for pharmaceutical products. The net effect of this downward pressure can be reduced availability of reimbursement by governmental and other third-party payors. In some foreign countries, particularly the countries of the European Union, the pricing of prescription pharmaceuticals is subject to governmental control. We or our partners may not be able to sell our products profitably if reimbursement is unavailable or limited in scope or amount.

In both the United States and some foreign jurisdictions, there have been a number of legislative and regulatory proposals to change the healthcare system. Further proposals are likely. The potential for adoption of some or all of these proposals affects or will affect our ability to raise capital, obtain additional collaborative partners and to market our products.

If we or our collaborative partners obtain marketing approval for our products, we expect to experience pricing pressure due to the trend toward managed health care, the increasing influence of health maintenance organizations and additional legislative proposals.

We could be exposed to significant risk from liability claims if we are unable to obtain insurance at acceptable costs or otherwise protect ourselves against potential product liability claims.

We may be subjected to product liability claims arising from the testing, manufacturing, marketing and sale of human health care products. Product liability claims, inherent in the process of researching and developing

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human health care products, could expose us to significant liabilities and prevent or interfere with the development or commercialization of our product candidates. Product liability claims would require us to spend significant time, money and other resources to defend such claims and could ultimately lead to our having to pay a significant damage award. Product liability insurance is expensive to procure for biopharmaceutical companies such as ours. Although we maintain product liability insurance coverage for the clinical trials of our products, it is possible that we will not be able to obtain additional product liability insurance on acceptable terms, if at all, and that our product liability insurance coverage will not prove to be adequate to protect us from all potential claims.

RISKS RELATING TO FINANCING

We have incurred substantial losses, we expect to continue to incur substantial losses and we may never achieve profitability.

We expect to incur substantial operating losses for the foreseeable future and we have no current sources of material ongoing revenue. It is uncertain when, if ever, we will develop significant sources of ongoing revenue or achieve profitability, even if we are able to develop and commercialize products.

We expect to spend significant capital to fund our research and development programs for the foreseeable future. As a result, we will need to generate significant revenues in order to achieve profitability. We cannot be certain whether or when this will occur because of the significant uncertainties that affect our business.

We may require additional financing, which may be difficult to obtain and may dilute your ownership interest in us.

We will require substantial funds to continue our research and development programs. Our future capital requirements will depend on many factors, including the following:

In 2003, we expect to seek additional funding through collaborative arrangements with strategic partners and may seek additional funding through public or private financings. The biotechnology market, however, is highly volatile and, depending on market conditions and the status of our development pipeline, additional funding may not be available to us on acceptable terms, if at all. If we fail to obtain such additional financing on a timely basis, our ability to continue all of our research, development, commercialization, manufacturing and marketing activities will be adversely affected.

If we raise additional funds by issuing equity securities, dilution to our stockholders will result. In addition, the terms of such a financing may adversely affect other rights of our stockholders. We also could elect to seek funds through arrangements with collaborative partners or others that may require us to relinquish rights to certain technologies, product candidates or products.

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RISKS RELATING TO CLINICAL AND REGULATORY MATTERS

We expect to rely heavily on third parties for the conduct of clinical trials of our product candidates. If these clinical trials are not successful, or if we are not able to obtain the necessary regulatory approvals, we will not be able to complete development and commercialization of our products.

In order to obtain regulatory approval for the commercial sale of our product candidates, we will be required to complete extensive preclinical studies as well as clinical trials in humans to demonstrate the safety and efficacy of our products. We have limited experience in conducting clinical trials and expect to rely primarily on contract research organizations and collaborative partners for their performance and management of clinical trials of our product candidates.

Clinical trials, if any, of our product candidates under development may not be successful. Furthermore, the timing and completion of clinical trials, if any, of our products, depend on, among other factors, the numbers of patients required for approval and the rate at which those patients are enrolled. Any increase in the required number of patients or decrease in recruitment rates may result in increased costs, program delays or both. Also, these products may not be effective in treating any of our targeted disorders or may prove to have undesirable or unintended side effects, toxicities or other characteristics that may prevent or limit their commercial use.

We could also experience delays in our preclinical trials of any of our product candidates, obtain unfavorable results in a development program, or fail to obtain regulatory approval for the commercialization of a product. Any of these events would adversely affect our ability to market a product candidate.

The development process necessary to obtain regulatory approval is lengthy, complex and expensive and we may not obtain necessary regulatory approvals.

In furtherance of our research programs, we and our collaborative partners are required periodically to obtain regulatory approval for our ongoing development activities and, in the future, our marketing and selling efforts. If we are unable to navigate the complexities of dealing with the several interested regulatory agencies, we may not receive the necessary approvals to conduct clinical trials of our product candidates or to market and sell our product candidates. In addition, regulatory agencies may not grant approvals on a timely basis or may revoke or significantly modify previously granted approvals. Delays in obtaining, or failure to obtain, necessary approvals could adversely affect our ability to market and sell our products and our ability to generate product revenue.

The process of obtaining FDA and other required regulatory approvals is lengthy and expensive. The time required for FDA and other approvals is uncertain and typically takes a number of years, depending on the complexity and novelty of the product. The process of obtaining FDA and other required regulatory approvals for many of our products is further complicated because some of these products use non-traditional or novel materials in non-traditional or novel ways, and the regulatory officials have little precedent to follow. We have only limited experience in filing and prosecuting applications for the conduct of clinical studies and for obtaining marketing approval. Any delay in obtaining or failure to obtain required clearance or approvals would reduce our ability to generate revenues from the affected product. We also plan to rely significantly on contract research organizations and collaborative partners as we build internal capabilities.

Our analysis of data obtained from preclinical activities is subject to confirmation and interpretation by regulatory authorities, which could delay, limit or prevent regulatory approval. Any regulatory approval to market a product may be subject to limitations on the indicated uses for which we may market the product. These limitations may restrict the size of the market for the product and affect reimbursement by third party payors.

We also are subject to numerous foreign regulatory requirements governing the design and conduct of the clinical trials and the manufacturing and marketing of our potential future products outside of the United States. The approval procedure varies among countries and the time required to obtain foreign approvals often differs

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from that required to obtain FDA approvals. Moreover, approval by the FDA does not ensure approval by regulatory authorities in other countries, and vice versa.

Even if we obtain marketing approval, our products will be subject to ongoing regulatory oversight which may affect our ability to successfully commercialize any products we may develop.

Even if we receive regulatory approval of a product candidate, the approval may be subject to limitations on the indicated uses for which the product is marketed or require costly post-marketing follow-up studies. After we obtain marketing approval for any product, the manufacturer and the manufacturing facilities for that product will be subject to continual review and periodic inspections by the FDA and other regulatory agencies. The subsequent discovery of previously unknown problems with the product, or with the manufacturer or facility, may result in restrictions on the product or manufacturer, including withdrawal of the product from the market.

If we fail to comply with applicable regulatory requirements, we may be subject to fines, suspension or withdrawal of regulatory approvals, product recalls, seizure of products, operating restrictions, and criminal prosecution.

We are subject to governmental regulations other than those imposed by the FDA. We may not be able to comply with these regulations, which could subject us to penalties and otherwise result in the limitation of our operations.

In addition to regulations imposed by the FDA, we are subject to regulation under the Occupational Safety and Health Act, the Environmental Protection Act, the Toxic Substances Control Act, the Research Conservation and Recovery Act, as well as regulations administered by the Nuclear Regulatory Commission, national restrictions on technology transfer, import, export and customs regulations and certain other local, state or federal regulation. From time to time, other federal agencies and congressional committees have indicated an interest in implementing further regulation of biotechnology applications. We are not able to predict whether any such regulations will be adopted or whether, if adopted, such regulations will apply to our business, or whether we would be able to comply with any applicable regulations.

Our research and development activities involve the controlled use of hazardous materials and chemicals. Although we believe that our safety procedures for handling and disposing of such materials comply with all applicable laws and regulations, we cannot completely eliminate the risk of accidental contamination or injury caused by these materials.

RISKS RELATING TO PRODUCT MANUFACTURING AND SALES

We will depend on third-party manufacturers to produce most, if not all, of our products under development, and if these third parties do not successfully manufacture our products our business will be harmed.

If we receive the necessary regulatory approvals for our products under development, we expect to rely upon third parties, including our collaborative partners, to produce materials required for commercial production. We may not be able to enter into commercial-scale manufacturing contracts on a timely or commercially reasonable basis, if at all. To the extent that we enter into manufacturing arrangements with third parties, we will be dependent upon these third parties to perform their obligations in a timely and effective manner. If third-party manufacturers with whom we contract fail to perform their obligations our competitive position and ability to generate revenue may be adversely affected in a number of ways, including;

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We have no sales and marketing experience and, as such, will depend significantly on third parties who may not successfully sell our products.

We have no sales, marketing and products distribution experience. We plan to rely solely on sales, marketing and distribution arrangements with third parties, including our collaborative partners. For example, as part of our agreement with Ortho Biotech, we have granted Ortho Biotech an exclusive right to distribute BMP kidney and neurological disorders products, if any are ever successfully developed. We may have to enter into additional marketing arrangements in the future and we may not be able to enter into these additional arrangements on terms which are favorable to us, if at all. In addition, we may have limited or no control over the sales, marketing and distribution activities of these third parties and sales through these third parties could be less profitable to us than direct sales. These third parties could sell competing products and may devote insufficient sales efforts to our products. Our future revenues will be materially dependent upon the success of the efforts of these third parties.

We may seek to independently market products that are not already subject to marketing agreements with other parties. If we determine to perform sales, marketing and distribution functions ourselves, we could face a number of additional risks, including:

RISKS RELATING TO INTELLECTUAL PROPERTY

We may not be able to obtain patent protection for our discoveries and our technologies may be found to infringe patent rights of third parties.

The patent positions of pharmaceutical and biotechnology companies, including ours, are generally uncertain and involve complex legal, scientific and factual questions.

The long-term success of our enterprise depends in significant part on our ability to:

Patents may not issue from any of the patent applications that we own or license. If patents do issue, the allowed claims may not be sufficiently broad to protect our technology from exploitation by our competitors. In addition, issued patents that we own or license may be challenged, invalidated or circumvented. Our patents also may not afford us protection against competitors with similar technology. Because patent applications in the United States are maintained in secrecy until patents issue, it is possible that third parties have filed or maintained patent applications for technology used by us or covered by our pending patent applications without our knowledge.

We may not have rights under patents which may cover one or more of our product candidates. In some cases, these patents may be owned or controlled by third-party competitors and may impair our ability to exploit our technology. As a result, we or our collaborative partners may be required to obtain licenses under third-party

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patents to develop and commercialize some of our product candidates. If we are unable to secure licenses to such patented technology on acceptable terms, we or our collaborative partners will not be able to develop and commercialize the affected product candidate or candidates.

If we are unable to keep our trade secrets confidential, our technology and information may be used by others to compete against us.

We also rely significantly upon unpatented proprietary technology, information, processes and know-how. We seek to protect this information through confidentiality agreements with our employees, consultants and other third-party contractors as well as through other security measures. These confidentiality agreements may be breached, and we may not have adequate remedies for any such breach. In addition, our trade secrets may otherwise become known or be independently developed by competitors.

We may become involved in expensive patent litigation or other intellectual property proceedings which could result in liability for damages or stop our development and commercialization efforts.

There have been substantial litigation and other proceedings regarding patent and other intellectual property rights in the pharmaceutical and biotechnology industries. We may become a party to patent litigation or other proceedings regarding intellectual property rights.

Situations which may give rise to patent litigation or other disputes over the use of our intellectual property include:

The costs associated with any patent litigation or other proceeding, even if resolved favorably, likely would be substantial. Some of our competitors may be able to sustain the cost of such litigation or other proceedings more effectively than we can because of their substantially greater financial resources. If a patent litigation or other intellectual property proceeding is resolved unfavorably, we or our collaborative partners may be enjoined from manufacturing or selling our products and services without a license from the other party and be held liable for significant damages. Moreover, we may not be able to obtain required licenses on commercially acceptable terms or any terms at all. In addition, we could be held liable for lost profits if we are found to have infringed a valid patent, or liable for treble damages if we are found to have willfully infringed a valid patent. Litigation results are highly unpredictable and we or our collaborative partners may not prevail in any patent litigation or other proceeding in which we may become involved.

Uncertainties resulting from the initiation and continuation of patent litigation or other proceedings could damage our ability to compete in the marketplace. Patent litigation and other proceedings may also absorb significant management time and expense.

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If we breach any of the agreements under which we license or have acquired intellectual property from others, we could lose intellectual property rights that are important to our business.

We are a party to intellectual property licenses and agreements that are important to our business and expect to enter into similar licenses and agreements in the future. These licenses and agreements impose various research, development, commercialization, sublicensing, royalty, indemnification, insurance and other obligations on us. If we fail to perform under these agreements or otherwise breach obligations thereunder, we could lose intellectual property rights that are important to our business.

If licensees or assignees of our intellectual property rights breach any of the agreements under which we have licensed or assigned our intellectual property to them, we could be deprived of important intellectual property rights and future revenue.

We are a party to intellectual property out-licenses, collaborations and agreements that are important to our business and expect to enter into similar agreements with third parties in the future. Under these agreements, we license or transfer intellectual property to third parties and impose various research, development, commercialization, sublicensing, royalty, indemnification, insurance, and other obligations on them. If a third party fails to comply with these requirements, we generally retain the right to terminate the agreement, and to bring a legal action in court or in arbitration. In the event of breach, we may need to enforce our rights under these agreements by resorting to arbitration or litigation. During the period of arbitration or litigation, we may be unable to effectively use, assign or license the relevant intellectual property rights and may be deprived of current or future revenues that are associated with such intellectual property.

RISKS RELATED TO OUR COMMON STOCK

Our common stock may be delisted from The NASDAQ National Market, which could reduce the liquidity of our common stock and adversely affect our ability to raise additional necessary capital.

On February 26, 2003, we received written notification from The NASDAQ National Market that for the last 30 consecutive trading days the minimum bid price of our common stock had closed below the minimum of $1.00 per share requirement to remain listed on The NASDAQ National Market. In order to continue trading on The NASDAQ National Market, we must comply with The NASDAQ National Market’s continued listing requirements, which require that we either maintain a minimum stockholders’ equity of $10.0 million and a minimum closing bid price of $1.00 per share or, if we fall below the minimum stockholder’s equity requirement, maintain a minimum closing bid price of $3.00 per share. At February 28, 2003, we were in compliance with the minimum stockholder’s equity requirement. According to NASDAQ National Market rules, we have 90 calendar days, or until May 27, 2003, to regain compliance with the minimum closing bid price requirement. If, at any time before May 27, 2003, the bid price of our common stock closes at $1.00 per share or more for a minimum of 10 consecutive trading days, we will be deemed to be back in compliance with respect to the minimum bid price requirements.

If we do not satisfy The NASDAQ National Market’s continued listing requirements by May 27, 2003, our common stock may be delisted from The NASDAQ National Market. The delisting of our common stock may result in the trading of the stock on the NASDAQ SmallCap Market or the OTC Bulletin Board. Consequently, a delisting of our common stock from The NASDAQ National Market may reduce the liquidity of our common stock and adversely affect our ability to raise additional necessary capital.

NASDAQ has proposed rule changes that would extend the 90 calendar day grace period, between notification of noncompliance and delisting, to 180 calendar days. NASDAQ has indicated that it has requested that the rules be effective upon filing for all issuers and applicable retroactively to issuers who have received deficiency letters but who have not been delisted. The proposed rule changes are currently being considered by the SEC and may not be approved.

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We expect that our stock price will fluctuate significantly.

Our common stock is listed on the NASDAQ National Market under the ticker symbol “CRIS.” The stock market, particularly in recent years, has experienced significant volatility particularly with respect to biopharmaceutical- and biotechnology-based company stocks. The volatility of biopharmaceutical- and biotechnology-based company stocks often does not relate to the operating performance of the companies represented by the stock. Factors that could cause such volatility in the market price of our common stock include:

If stockholders do not receive dividends, they must rely on stock appreciation for any return on their investment in us.

We have not declared or paid cash dividends on any of our capital stock. We currently intend to retain earnings, if any, for future growth and, therefore, do not anticipate paying cash dividends in the future. As a result, only appreciation of the price of the common stock will provide a return to investors.

We have anti-takeover defenses that could delay or prevent an acquisition and could adversely affect our stock price.

Provisions of our certificate of incorporation, our bylaws and Delaware law may have the effect of deterring unsolicited takeovers or delaying or preventing changes in control of our management, including transactions in which our stockholders might otherwise receive a premium for their shares over then current market prices. In addition, these provisions may limit the ability of stockholders to approve transactions that they may deem to be in their best interest. Our certificate of incorporation permits the board of directors to issue preferred stock without stockholder approval. In addition to delaying or preventing an acquisition, the issuance of a substantial number of preferred shares could adversely affect the price of the common stock.

Our certificate of incorporation provides for staggered terms to be served by the board of directors which makes it difficult for stockholders to change the composition of the board of directors in any one year. In addition, our bylaws restrict the ability of stockholders to call a special meeting of the stockholders. These provisions may have the effect of preventing or delaying changes in control of our management.

ITEM 7A.     QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We invest cash balances in excess of operating requirements in cash equivalents and short-term marketable securities, generally money market funds, insurance annuity contracts, corporate debt and government securities with an average maturity of less than one year. All marketable securities are considered available for sale. At December 31, 2002, the fair market value of these securities amounted to approximately $9,653,000 with net unrealized gains of approximately $120,000 included as a component of stockholders’ equity. Because of the

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quality of the investment portfolio and the short-term nature of the marketable securities, we do not believe that interest rate fluctuations would impair the principal amount of the securities. Our investments are investment grade securities and deposits are with investment grade financial institutions. We believe that the realization of losses due to changes in credit spreads is unlikely as we expect to hold our debt to maturity.

At December 31, 2002, we had approximately $1,291,000 outstanding under fixed rate debt and capital lease agreements which are not subject to fluctuations in interest rates and approximately $4,239,000 outstanding under a cash-secured term loan agreement with an adjustable rate equal to 3.75% as of December 31, 2002. In addition, we had approximately $2,212,000, including accrued interest of $212,000, outstanding under a convertible subordinated note payable to Becton Dickinson. Lastly, $4,860,000, including accrued interest of $200,000, was outstanding under a convertible promissory note payable to EPIL in connection with Curis Newco.

ITEM 8.     FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The financial statements are included beginning at F-1. See Index to the Financial Statements.

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

On April 26, 2002, we dismissed our independent auditors, Arthur Andersen LLP and engaged the services of PricewaterhouseCoopers LLP as our new independent auditors effective immediately. These actions followed our decision to seek proposals from independent accountants to audit our financial statements, and were approved by our Board of Directors upon the recommendation of the Audit Committee. PricewaterhouseCoopers has audited our financial statements for the fiscal year ending December 31, 2002 and performed all quarterly reviews for fiscal 2002.

During the two most recent fiscal years ended December 31, 2001, and the subsequent interim period through April 26, 2002, there were no disagreements between Arthur Andersen and us on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreements, if not resolved to Arthur Andersen’s satisfaction, would have caused Arthur Andersen to make reference to the subject matter of the disagreement in connection with its reports.

None of the reportable events described under Item 304(a) (1) (v) of Regulation S-K occurred within the two most recent fiscal years ended December 31, 2001 or within the interim period through April 26, 2002.

None of the audit reports of Arthur Andersen on our consolidated financial statements as of and for the fiscal years ended December 31, 2000 and December 31, 2001 contained an adverse opinion or a disclaimer of opinion nor was any such audit report qualified or modified as to uncertainty, audit scope or accounting principles.

During the two most recent fiscal years ended December 31, 2001, and the subsequent interim period through April 26, 2002, we did not consult with PricewaterhouseCoopers with respect to the application of accounting principles to a specified transaction, either completed or proposed or the type of audit opinion that might be rendered on our consolidated financial statements, or any other matters or events set forth in Item 304(a)(2)(i) and (ii) of Regulation S-K, except that PricewaterhouseCoopers was previously engaged by Ontogeny, Inc. as the principal auditors of Ontogeny’s financial statements. In connection therewith, PricewaterhouseCoopers provided us with an opinion regarding Ontogeny’s financial statements, which was included in our Registration Statement on Form S-4 filed in connection with the merger of Creative BioMolecules, Inc., Ontogeny and Reprogenesis, Inc. with and into Curis.

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PART III

ITEM 10.     DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

Information concerning directors that is required by this Item 10 is set forth in the proxy statement to be provided to stockholders in connection with our 2003 Annual Meeting of Stockholders (the “Proxy Statement”) under the headings “Directors and Nominees for Director” and “Section 16(a) Beneficial Ownership Reporting Compliance,” which information is incorporated herein by reference. The name, age, and position of each executive officer of the Company is set forth under the heading “Executive Officers of the Company” in Part I of this Annual Report on Form 10-K, which information is incorporated herein by reference.

ITEM 11.     EXECUTIVE COMPENSATION

Information required by this Item 11 is set forth in the Proxy Statement under the headings “Compensation of Executive Officers” and “Director Compensation,” which information is incorporated herein by reference. Information specified in Items 402(k) and 402(1) of Regulation S-K and set forth in the Proxy Statement is not incorporated by reference.

ITEM 12.     SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

Information required by this Item 12 is set forth in the Proxy Statement under the heading “Security Ownership of Certain Beneficial Owners and Management,” which information is incorporated herein by reference.

ITEM 13.     CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Information required by this Item 13 is set forth in the Proxy Statement under the headings “Compensation of Executive Officers Employment Agreements” and “Equity Compensation Plan Information,” which information is incorporated herein by reference.

ITEM 14.     DISCLOSURE CONTROLS AND PROCEDURES

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PART IV

ITEM 15.     EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

(a)    Documents Filed as a Part of this Form 10-K:

(b)    Current Reports on Form 8-K.

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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.

Date: March 14, 2003

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

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CERTIFICATIONS

I, Daniel R. Passeri, certify that:

Date: March 14, 2003

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I, Christopher U. Missling, certify that:

Date: March 14, 2003

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CURIS, INC. AND SUBSIDIARIES

Index

F-1

Report of Independent Public Accountants

To the Board of Directors and Stockholders of

Curis, Inc. and Subsidiary:

In our opinion, the accompanying consolidated balance sheet and the related consolidated statements of operations and comprehensive loss, of stockholders’ equity and of cash flows present fairly, in all material respects, the financial position of Curis, Inc. at December 31, 2002, and the results of operations and cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America. 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 audit. We conducted our audit of these statements in accordance with auditing standards generally accepted in the United States of America which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

The consolidated financial statements of Curis, Inc. and its subsidiaries as of December 31, 2001, and for each of the two years in the period ended December 31, 2001 were audited by other independent accountants who have ceased operations. Those independent accountants expressed an unqualified opinion on those financial statements in their report date February 14, 2002.

As discussed in Note 4(k) to the consolidated financial statements, the Company changed its method of accounting for goodwill in 2002.

/s/ PRICEWATERHOUSECOOPERS LLP

Boston, Massachusetts

February 4, 2003

F-2

Report of Independent Public Accountants

To the Board of Directors and Stockholders of

Curis, Inc. and Subsidiaries:

We have audited the accompanying consolidated balance sheets of Curis, Inc. (f.k.a. Creative BioMolecules, Inc.) and its subsidiaries as of December 31, 2001 and 2000, and the related consolidated statements of operations and comprehensive loss, stockholders’ equity and cash flows for the years then ended. These financial statements are the responsibility of Curis, Inc.’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States. 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 Curis, Inc. and its subsidiaries as of December 31, 2001 and 2000 and the results of their operations and their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States.

ARTHUR ANDERSEN LLP

Boston, Massachusetts

February 14, 2002

NOTE:  THIS IS A COPY OF THE AUDIT REPORT PREVIOUSLY ISSUED BY ARTHUR ANDERSEN LLP IN CONNECTION WITH CURIS, INC.’S FORM 10-K FILING FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001. THE INCLUSION OF THIS PREVIOUSLY ISSUED ARTHUR ANDERSEN LLP REPORT IS PURSUANT TO THE “TEMPORARY FINAL RULE AND FINAL RULE REQUIREMENTS FOR ARTHUR ANDERSEN LLP AUDITING CLIENTS,” ISSUED BY THE SECURITIES AND EXCHANGE COMMISSION IN MARCH 2002. NOTE THAT THE PREVIOUSLY ISSUED ARTHUR ANDERSEN LLP REPORT INCLUDES REFERENCES TO CERTAIN FISCAL YEARS WHICH ARE NOT REQUIRED TO BE PRESENTED IN THE ACCOMPANYING CONSOLIDATED FINANCIAL STATEMENTS AS OF AND FOR THE YEAR ENDED DECEMBER 31, 2002. THIS AUDIT REPORT HAS NOT BEEN REISSUED BY ARTHUR ANDERSEN LLP IN CONNECTION WITH THIS FILING ON FORM 10-K.

F-3

CURIS, INC. AND SUBSIDIARIES

Consolidated Balance Sheets