CURIS INC - Annual Report: 2003 (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, 2003

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) (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 x    No ¨

As of June 30, 2003, the aggregate market value of the common stock held by non-affiliates of the registrant was approximately $106,073,000 based on the closing sale price of the registrant’s common stock on The NASDAQ National Market on such date.

As of February 23, 2004, there were 41,359,136 shares of the registrant’s common stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Specified portions of the registrant’s proxy statement for the annual meeting of stockholders scheduled to be held on June 2, 2004, which are to be filed with the Commission not later than 120 days after the close of the Registrant’s fiscal year ended December 31, 2003 pursuant to Regulation 14A, have been incorporated by reference in Item 5 of Part II and Items 10-14 of Part III of this Annual Report on Form 10-K.

CURIS, INC.

TABLE OF CONTENTS

Form 10-K

PART I

This annual report on Form 10-K contains forward-looking statements that involve risks and uncertainties, as well as assumptions that, if they never materialize or prove incorrect, could cause the results of Curis to differ materially from those expressed or implied by such forward-looking statements. All statements other than statements of historical fact are statements that could be deemed forward-looking statements, including any projections of revenue, expenses, earnings or losses from operations, or other financial items; any statements of the plans, strategies and objectives of management for future operations; any statements concerning product research, development and commercialization timelines; any statements of expectation or belief; and any statements of assumptions underlying any of the foregoing. The risks, uncertainties and assumptions referred to above include risks that are described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Factors That May Affect Future Results” and elsewhere in this annual report and that are otherwise described from time to time in our Securities and Exchange Commission reports filed after this report.

The forward-looking statements included in this annual report represent our estimates as of the date of this annual report. We specifically disclaim any obligation to update these forward-looking statements in the future. These forward-looking statements should not be relied upon as representing our estimates or views as of any date subsequent to the date of this annual report.

ITEM 1.    BUSINESS

Our Company

We are a therapeutic drug development company principally focused on the discovery, development and future commercialization of products that modulate key regulatory signaling pathways controlling the repair and regeneration of human tissues and organs. Our product development approach involves using small molecules, proteins or antibodies 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 multiple compounds for several different disease indications. For example, we have developed several promising preclinical product candidates in the fields of kidney disease, cancer, neurological disorders, cardiovascular disease and hair growth regulation.

Regulatory signaling pathways, also referred to as signaling pathways, are prominent regulators of specific tissue and organ formation during prenatal development and are used by the body throughout life to repair and regulate human tissue. We are developing our product candidate programs around several major signaling pathways including the Hedgehog and Bone Morphogenetic Protein pathways. We have substantial intellectual property rights in these signaling pathways, which we believe will enable us to have a technological and competitive advantage in developing therapeutic products based upon these pathways. In addition, we intend to expand our technology offerings and associated intellectual property portfolio through in-licensing arrangements and the acquisition of complimentary technologies, including additional signaling pathways.

Our research programs are conducted both internally and through strategic alliances and collaborations. We currently have strategic collaborations with Ortho Biotech, Genentech and Wyeth. Our strategic alliances and collaborations generally provide for our research, development and commercialization programs to be funded by our collaborators and provide us with the opportunity to receive additional payments if specified milestones are achieved, as well as royalty payments upon the successful commercialization of any products based upon the collaboration. In some cases, we have retained development and commercialization rights in areas where we believe we can attain the greatest potential long-term value through the application of our own internal resources. We believe that our approach allows us to augment our development capabilities and capacities through collaborations with leading pharmaceuticals companies and also provides us with the opportunity to discover and develop products while reducing our internal product development costs and related risks.

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In the future, we plan to continue to seek corporate partners for the further development and commercialization of some of our technologies. Even though we are seeking partners to help develop some of our technologies, we expect to select at least one program that we will develop further on our own.

Regulatory Signaling Pathways Background

Regulatory signaling pathways are the means by which tissues and organs exchange instructional messages that regulate specific biological functions. Early in prenatal development, the instructional messages that direct the formation of tissues and organs are controlled by master pathways, including the Hedgehog and Bone Morphogenetic pathways, which act by initiating cascades of other pathways required for tissue formation and regulation. Later in life, the body uses these master pathways to repair damage and regenerate tissues. For example, in damaged nerve tissue, we have demonstrated in preclinical models that activation of the Hedgehog pathway promotes repair and regeneration of nerve function, in part, by inducing the activation of a cascade of secondary signaling pathways that promote the growth of new cells and blood vessels.

The ability to activate certain signaling pathways is of great interest to biotechnology and pharmaceutical companies as many diseases and disorders are now known to be associated with insufficient or damaged signaling pathways. For example, one of the most successful biotechnology-derived drugs is a formulation of a signaling protein called erythropoietin. Erythropoietin is made in the kidney and controls a pathway that instructs the bone marrow to make new red blood cells. In dialysis patients with end-stage kidney disease, in which their kidneys have mostly or completely stopped functioning, the kidneys are unable to make erythropoietin,. These patients therefore develop severe anemia, a critical medical condition caused by a lack of sufficient red blood cells. Administration of erythropoietin restores normal levels of red blood cells thus alleviating the patient’s anemia. The erythropoietin market for dialysis patients in the U.S. is estimated to be over $2 billion annually.

Our BMP-7 program, which is partnered with Ortho Biotech, is similar to erythropoietin in several respects. BMP-7 is also a signaling protein made in the kidney that regulates several important tissue repair and maintenance pathways. Dialysis patients develop several other serious complications in addition to severe anemia, including bone diseases and blood vessel calcification resulting in life-threatening cardiovascular complications. In preclinical models, administration of BMP-7 has been shown to prevent the bone and blood vessel complications that are associated with chronic kidney disease. Preclinical studies also suggest that BMP-7 may delay progression of kidney disease, delay the need for dialysis and stabilize kidney function for dialysis patients. If successfully developed, we estimate that the market size for BMP-7 in dialysis patients may approximate the market size for erythropoietin in dialysis patients.

There is also significant pharmaceutical interest in the inhibition of abnormally or inappropriately activated signaling pathways which have been implicated in certain cancers. For instance, Novartis Inc.’s Gleevec^® is a small molecule drug that inhibits a signaling pathway that is abnormally expressed in certain cancers. Gleevec^® is among the first signaling pathway inhibitors to be approved by the FDA and is Novartis’ second largest-selling drug with estimated annual worldwide sales of more than $1 billion.

Abnormal expression of the Hedgehog signaling pathway has been shown to be associated with certain cancers, including basal cell carcinoma, small cell lung cancer and pancreatic cancer. We have also developed small molecule Hedgehog pathway inhibitors and Hedgehog blocking antibodies. Our Hedgehog pathway inhibitors and antibodies, which are partnered with Genentech, have been demonstrated to slow or halt the growth of these cancers in preclinical models of tumor growth. Because the Hedgehog signaling pathway appears to control the expression of tissue growth factors and blood vessel growth factors, we believe that our pathway inhibitors may be applicable to a broad array of cancers.

We believe that our focus on developing drugs based primarily on the master signaling pathways will give us a competitive advantage over similar efforts by other biotechnology and pharmaceutical companies. Our approach has already enabled us to develop a diverse portfolio of preclinical product candidates in several

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important therapeutic areas including kidney disease, cancer, neurological disorders, cardiovascular disease and hair growth regulation.

Our Strategy

Our goal is to become the leading therapeutic drug development company focusing on regulatory signaling pathways. Our strategy to accomplish this goal includes the following:

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Product Development Programs

We are developing product candidates in several important medical fields where there is substantial unmet therapeutic need. These product development initiatives, described in the chart below, are being pursued using our internal resources or through partnering and licensing arrangements with pharmaceutical or biotechnology firms that are able to dedicate additional resources and clinical development expertise. These product development initiatives are derived primarily from our substantial intellectual property portfolio in key regulatory signaling pathways.

Most of our programs are in various stages of preclinical drug development. In the table below, the term early preclinical means we are seeking to obtain initial demonstrations of therapeutic efficacy in preclinical models of human disease, mid preclinical means we are seeking to obtain multiple demonstrations of efficacy in preclinical models of human disease, and late preclinical means we are seeking to obtain both multiple demonstrations of efficacy in preclinical models of human disease and relevant toxicology and safety data required for an investigational new drug application, or IND, filing with the FDA seeking to commence a phase I clinical trial to assess safety in humans.

BMP-7 Program

BMP-7 is a signaling protein that is synthesized in the kidney and has been implicated in the maintenance of the normal health of the kidney, the skeleton, and the vascular system. Prior to November 2002, we had been developing BMP-7 as a therapeutic compound to halt the progression of chronic kidney failure and to prevent skeletal and vascular complications that are associated with chronic kidney disease.

During 2003, several academic researchers published reports concluding that BMP-7 may be an effective therapy for chronic kidney disease. These reports, from the Beth Israel Deaconess Medical Center, the Harvard Medical School and the Washington University School of Medicine, have demonstrated the potential of using BMP-7 as a potential treatment to both halt the progression and reverse the effects of chronic progressive kidney disease. These reports are published in Nature Medicine 2003 July 9(7): 964-8 and The Journal of the American Society of Nephrology 2003 June 14(6): 1559-67.

These data suggest that BMP-7 may be similar in some respects to erythropoietin, believed to be one of the most successful biotechnology-derived drugs. Erythropoietin is a signaling protein that is made in the kidney. It is secreted into the blood system and controls the process that instructs bone marrow to make new red blood cells. In dialysis patients with end-stage kidney disease, in which their kidneys have mostly or completely stopped functioning, the kidneys are unable to make erythropoietin. These patients therefore develop severe anemia, a critical medical condition caused by a lack of sufficient red blood cells. Administration of erythropoietin restores normal levels of red blood cells thus alleviating the patient’s severe anemia. Dialysis patients develop several other serious complications in addition to severe anemia, including bone disease and severe blood vessel calcification resulting in life-threatening cardiovascular complications. The preclinical demonstration that BMP-7 prevents the bone and blood vessel complications that are associated with chronic

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kidney disease suggests that the market size for BMP-7 in dialysis patients may approximate the market size for erythropoietin in dialysis patients, which is currently estimated to be over $2 billion in the U.S.

In November 2002, we entered into an agreement with Ortho Biotech 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 has an established presence in the kidney disease marketplace. 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. Ortho Biotech has sole responsibility for deciding if and when human clinical trials of BMP-7 will begin.

Hedgehog Small Molecule and Antibody Antagonist Cancer Programs

The Hedgehog signaling pathway controls the development and growth of many kinds of tissues in the body by activating other secondary pathways that control the synthesis of 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.

Several years ago, our scientists and scientists at independent academic and medical research laboratories discovered that certain cancers, such as basal cell carcinoma, are expressing abnormally high concentrations of Hedgehog protein, thereby creating local environments favorable to the rapid growth of cancerous tissue. Furthermore, in 2003, several academic researchers published reports that also noted the link between abnormal expression of the Hedgehog signaling pathway and the malignant growth of other tumors, including small cell lung cancer and certain tumors of the gastrointestinal tract. These reports, from the Johns Hopkins University School of Medicine, University of California, San Francisco, Massachusetts General Hospital, and the Harvard Medical School were published in Nature 2003 October 23 425(6960): 846-51 and 851-6.

Our preclinical evidence indicates that inhibition of the Hedgehog pathway, in cells where it is being abnormally activated, results in the selective and specific death of the tumor cells while conferring no harm to adjacent normal cells. This selectivity contrasts with more traditional cancer treatments that often kill both cancer cells and normal cells. We believe that the ability to selectively kill cancer cells while leaving healthy cells intact represents the next generation of cancer treatments that are in development.

In June 2003, we established a collaboration with Genentech for the continued development of these anti-cancer drug candidates. Genentech is a pharmaceutical company with broad expertise in the development of cancer therapeutics. Except for the co-development option described below, Genentech will assume all future responsibility for the clinical development of the Hedgehog small molecule and antibody antagonists as cancer drugs for solid tumors. We will receive clinical milestone payments and royalties on product sales if clinical evaluations of any Hedgehog antagonist and antibody technology-based products are successful. We have retained a co-development option in the field of basal cell carcinoma, a type of skin cancer.

Hedgehog Small Molecule Agonist Neurological Disorders Programs

The Hedgehog signaling pathway is essential for the formation of normal nerves in the central and peripheral nervous systems. Our scientists and academic collaborators have shown that treatment with a Hedgehog protein accelerates the restoration of nerve function in models of nerve trauma and disease. This finding suggests that the Hedgehog pathway may have a potential therapeutic effect in treating certain human neurological disorders. During 2003, our scientists and several academic researchers presented reports concluding that activation of the Hedgehog pathway promotes improved recovery from stroke, Parkinson’s disease, and spinal cord injury. In addition to findings reported by us, reports were also made by researchers at the Université Victor Segalen in France, the University of Manchester in the United Kingdom, the Toronto Western Research Institute in Canada, the California Institute of Technology in Pasadena, California, and at Case

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Western Reserve University. The stroke data were presented by our scientists at the 2003 Society for Neuroscience conference, the Parkinson’s data were published in the FASEB Journal 2003 December 17(15): 2337-8, and the spinal cord injury data were presented at the 2003 meeting of the North American Spine Society.

Our scientists have developed a series of small molecule Hedgehog agonists that, in preclinical models, have shown to be capable of activating the Hedgehog pathway. Many of these small molecule Hedgehog agonists are orally available and can cross the blood brain barrier, a protective barrier formed by blood vessels and brain tissue that prevents most substances in the blood from entering brain tissue. Small molecules that cross this blood brain barrier can reach and treat damaged brain tissue, therefore making them attractive product development candidates.

We believe that the positive effects of the Hedgehog agonists in neuronal disease models are due to neuroprotection that is induced by activation of the Hedgehog signaling pathway. Neuroprotection is the prevention of the progressive death of cells in the brain caused by disease or injury. In addition, we also know that activation of the Hedgehog pathway results in an increased proliferation of brain stem cells. We are currently exploring the possibility that this may enable to develop drugs that can promote the replacement of brain cells lost as a result of injury or disease.

In January 2004, we entered into a collaboration agreement with Wyeth Pharmaceuticals to continue the development of these promising drug candidates for the treatment of neurological disorders and other potential indications. Wyeth is one of the world’s largest research-driven pharmaceutical companies with broad expertise in the development of drugs to treat neurological disorders and other diseases. Under the terms of the collaboration, Wyeth paid us an up-front license fee and is obligated to provide two years of research funding. In addition, if clinical evaluations of any Hedgehog agonist technology-based products are successful, Wyeth is obligated to pay us clinical milestone payments and royalties on product sales.

Wyeth has agreed to assume all future responsibility for clinical development of the Hedgehog small molecule and protein agonists as systemic treatments for neurological and other disorders. As part of the agreement, we have retained development and licensing options for certain therapeutic applications of Hedgehog agonist technologies, including those applications that qualify as orphan drug indications, topical applications for hair growth, local delivery applications for treatment of cardiovascular disease, and use of the technology with stem cells.

Hedgehog Agonist Cardiovascular Disease Program

In November 2003, researchers from the St. Elizabeth’s Medical Center in Boston, Massachusetts presented data at the annual Scientific Sessions of the American Heart Association demonstrating that localized activation of the Hedgehog signaling pathway, several hours after heart injury, can significantly improve heart function and reduce overall heart damage in a model of myocardial infarction, or heart attack.

Our scientists and our academics collaborators are currently conducting additional studies to evaluate the therapeutic potential of using locally-delivered Hedgehog agonists that activate the Hedgehog pathway to promote recovery from cardiovascular disease. Wyeth has a first right of negotiation to license our Hedgehog pathway technologies in the field of cardiovascular disease.

Hedgehog Small Molecule Agonist and Antagonist Hair Growth Regulation Program

Several years ago, our scientists and other researchers demonstrated that activation of the Hedgehog pathway can stimulate rapid hair re-growth in models of hair loss, including hair loss as a result of chemotherapy treatment. These latter results were published in the Journal of the National Cancer Institute 2001 Dec 19 93(24): 1858-64.

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More recently, our scientists have demonstrated that our small molecule Hedgehog agonists can induce hair re-growth in animal models. We are currently evaluating the therapeutic potential of small molecule Hedgehog agonists to promote hair re-growth in preclinical models of hair loss. We are also evaluating the potential of Hedgehog pathway antagonists to block hair growth.

PPY Peptide Obesity License

PYY is a gut peptide that has been shown to suppress appetite and reduce food intake in animals and humans. Several years ago, 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 2002, we licensed our PYY patent applications to Amylin Pharmaceuticals for in-vivo therapeutic uses in exchange for an up-front fee, milestone payments upon the achievement of specified development objectives, and royalties on potential future product sales. Amylin has extensive development experience with our similar gut peptides.

In December 2003, Amylin filed an investigational new drug application with the FDA on PYY for an obesity indication and has indicated that it expects to initiate clinical testing in the first quarter of 2004. Amylin has responsibility for all expenses related to further development of the PYY compound.

Strategic Alliances And License Agreements

Our strategy for development and commercialization of products depends upon successful strategic alliances with third parties. We use 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:

Since inception, substantially all of our revenue has been derived from our collaborations and other agreements with third parties.

Our current strategic alliances are described below.

Ortho Biotech, a subsidiary of Johnson & Johnson

In November 2002, we licensed our broad BMP technology portfolio to Ortho Biotech on an exclusive, worldwide royalty-bearing basis, for all non-orthopedic and non-dental therapeutic applications in exchange for a $3.5 million up-front fee, a series of cash milestones if specified clinical research objectives and regulatory approvals are achieved, including a $30 million 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 are entitled to receive additional milestone payments for the kidney disease related product candidate and milestone payments for the first neurology product candidate. Initial target indications include the systemic use of BMP-7 for the prevention of bone and blood vessel complications associated with chronic kidney disease and treatments to promote recovery following stroke and brain injury.

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Genentech

In June 2003, we licensed our novel small molecule and antibody inhibitors of the Hedgehog signaling pathway to Genentech on an exclusive worldwide royalty-bearing basis for applications in cancer therapy. Under the terms of the agreement, Genentech paid us an upfront license fee of $5 million, purchased 1,323,835 shares of our common stock at a price of $2.644 per share for aggregate proceeds of $3.5 million, and is also obligated to pay us a total of $4 million in maintenance fees by July 2005. Genentech is also obligated to make cash payments to us upon the successful achievement of clinical development and drug approval milestones. In addition, Genentech will pay a royalty on potential future net product sales, which increases with increasing sales volume. We have retained the right to co-develop products in the field of basal cell carcinoma, in which event we will share in any profits related to the basal cell carcinoma program in a percentage that is equal to our co-development cost sharing contribution.

Wyeth Pharmaceuticals, a division of Wyeth

In January 2004, we entered into an agreement to license our Hedgehog proteins and novel small molecule Hedgehog pathway agonists to Wyeth on an exclusive worldwide, royalty-bearing basis for the development and commercialization of pharmaceutical products for the therapeutic applications in treatment of neurological disorders, including neurodegenerative diseases and neuropathies. Under the terms of the agreement, Wyeth Pharmaceuticals paid us a license fee of $1.5 million and purchased 315,524 shares of our common stock at a price of $4.754 per share for an aggregate purchase price of $1.5 million. Wyeth will provide research funding for a minimum of two years. In addition, Wyeth is obligated to make cash payments to us upon the successful achievement of clinical development and drug approval milestones and is obligated to pay a royalty on net product sales, if any, that escalates with increasing sales volume. Excluding product royalties, the transaction has a potential value to us of more than $170 million, assuming at least two products are successfully developed and commercialized.

Amylin Pharmaceuticals

In December 2002, we granted Amylin Pharmaceuticals an exclusive worldwide, royalty-bearing license to our PYY patent applications for use in the research, development and commercialization of products in exchange for an up-front fee, milestone payments upon the achievement of specified development objectives, and royalties on potential future product sales, if any. PYY is a gut peptide that has been shown in animals and humans to suppress appetite and reduce food intake. Amylin has exclusive responsibility for expenses related to further development of the PYY compound.

Intellectual Property

Our policy is to prosecute and enforce the patents and proprietary technology rights that are key to our business. We intend to continue to file United States and foreign patent applications to protect technology, inventions and improvements that are considered important to the development of our business. We will be able to protect our proprietary technologies from unauthorized use by third parties only to the extent that our proprietary rights are covered by valid and enforceable patents or are effectively maintained as trade secrets.

We have 164 issued patents and 121 pending patent applications in the United States expiring on various dates between 2007 and 2021 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.

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Hedgehog Pathway.    We have 38 issued U.S. patents and 5 allowed U.S. applications expiring on various dates between 2015 and 2021, which relate to the Hedgehog pathway. These patents and patent applications cover proteins, nucleic acids, antibodies, and certain small molecule agonists and antagonists of the Hedgehog pathway, drug screening and discovery methods, methods of protein manufacturing, as well as methods of using the aforementioned proteins, nucleic acids, antibodies or small molecules to activate or inhibit the Hedgehog pathway for a variety of therapeutic indications or diagnostic uses. In addition, we have filed foreign patent applications corresponding to many of the aforementioned U.S. filings that could provide additional patent protection for products that activate or inhibit the Hedgehog pathway.

Bone Morphogenetic Pathway.    We have 107 issued U.S. patents and 3 allowed U.S. applications expiring on various dates between 2007 and 2021, which relate to the BMP pathway. These patents and patent applications cover certain BMP proteins, nucleic acids, antibodies, drug screening and discovery methods, methods of protein manufacturing, as well as methods of using these BMP proteins, nucleic acids or antibodies for a variety of therapeutic indications or diagnostic uses. In addition, we have filed foreign patent applications corresponding to many of the aforementioned U.S. filings that could provide additional patent protection for BMP-related products.

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 arising from their efforts. Any such publication could affect our ability to obtain patent protection in the areas in which we may have an interest. In addition, these collaboration agreements typically contain provisions that provide us with, at a minimum, an option to license the institution’s rights to intellectual property arising from the collaboration.

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 includes up-front fees, issuances of shares of common stock, annual royalties, milestone payments and running royalties on net sales by our sub-licensees and us. 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.

In addition, we depend upon trade secrets, know-how and continuing technological advances to develop and maintain our competitive position. To maintain the confidentiality of trade secrets and proprietary information, we require our employees, scientific advisors, consultants and collaborators, upon commencement of a relationship with us, to execute confidentiality agreements and, in the case of parties other than our research and development collaborators, to agree to assign their inventions to us. These agreements are designed to protect our proprietary information and to grant us ownership of technologies that are developed in connection with their relationship with us.

Research Program

We have a research group that seeks to identify and develop new therapeutic applications for our existing patent portfolio and seeks to identify new signaling pathways that may have therapeutic potential. Our research group, working closely with our business development group, also strives to identify external technologies that might provide in-licensing opportunities, consistent with our broad interest in regenerative signaling pathways. As of December 31, 2003, our research group consists of 43 employees, consisting of molecular biologists, cell biologists, pharmacologists and other scientific disciplines.

During the years ended December, 2003, 2002 and 2001, we estimate that our total company-sponsored research and development expenses were approximately $10.8 million, $8.7 million and $26.3 million,

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respectively, and that our collaborator-sponsored research and development expenses were approximately $2.6 million, $5.3 million and $2.7 million, respectively.

Regulatory Matters

FDA Requirements for New Drug Compounds

The research, testing, manufacture and marketing of drug products are extensively regulated by numerous governmental authorities in the United States and other countries. In the United States, drugs are subject to rigorous regulation by the FDA. The Federal Food, Drug, and Cosmetic Act, and other federal and state statutes and regulations, govern, among other things, the research, development, testing, manufacture, storage, recordkeeping, labeling, promotion and marketing and distribution of pharmaceutical products. Failure to comply with applicable regulatory requirements may subject a company to a variety of administrative or judicially-imposed sanctions and/or the inability to obtain or maintain required approvals or to market approved drug products.

The steps ordinarily required before a new pharmaceutical product may be marketed in the United States include preclinical laboratory tests, animal tests and formulation studies, the submission to the FDA of a notice of claimed investigational exemption or an investigational new drug application, which must become effective before clinical testing may commence, and adequate and well-controlled clinical trials to establish the safety and effectiveness of the drug for each indication for which FDA approval is sought. Satisfaction of FDA pre-market approval requirements typically takes several years and the actual time required may vary substantially based upon the type, complexity and novelty of the product or disease. Government regulation may delay or prevent marketing of potential products for a considerable period of time and impose costly procedures upon a manufacturer’s activities. Success in early stage clinical trials does not assure success in later stage clinical trials. Data obtained from clinical activities is not always conclusive and may be susceptible to varying interpretations that could delay, limit or prevent regulatory approval. Even if a product receives regulatory approval, later discovery of previously unknown problems with a product may result in restrictions on the product or even complete withdrawal of the product from the market.

Preclinical tests include laboratory evaluation of product chemistry and formulation, as well as animal trials to assess the potential safety and efficacy of the product. The conduct of the preclinical tests and formulation of compounds for testing must comply with federal regulations and requirements. The results of preclinical testing are submitted to the FDA as part of an investigational new drug application.

Clinical trials involve the administration of the investigational new drug to healthy volunteers or patients under the supervision of a qualified investigator. Clinical trials must be conducted in compliance with federal regulations and requirements, under protocols detailing the objectives of the trial, the parameters to be used in monitoring safety and the effectiveness criteria to be evaluated. Each protocol involving testing on U.S. subjects must be submitted to the FDA as part of the investigational new drug application. The study protocol and informed consent information for patients in clinical trials must be submitted to institutional review boards for approval.

Clinical trials to support new drug applications for marketing approval are typically conducted in three sequential phases, but the phases may overlap. In phase I, the initial introduction of the drug into healthy human subjects or patients, the drug is tested to assess metabolism, pharmacokinetics and pharmacological actions and safety, including side effects associated with increasing doses. Phase II usually involves trials in a limited patient population, to determine dosage tolerance and optimum dosage, identify possible adverse effects and safety risks, and provide preliminary support for the efficacy of the drug in the indication being studied. If a compound demonstrates evidence of effectiveness and an acceptable safety profile in phase II evaluations, phase III trials are undertaken to further evaluate clinical efficacy and to further test for safety within an expanded patient population, typically at geographically dispersed clinical trial sites. Phase I, phase II or phase III testing of any product candidates may not be completed successfully within any specified time period, if at all.

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After successful completion of the required clinical testing, generally a new drug application is prepared and submitted to the FDA. FDA approval of the new drug application is required before marketing of the product may begin in the United States. The new drug application must include the results of extensive clinical and other testing and a compilation of data relating to the product’s pharmacology, chemistry, manufacture, and controls.

If FDA evaluations of the new drug application and the manufacturing facilities are favorable, the FDA may issue an approval letter, or, in some cases, an approvable letter followed by an approval letter. An approvable letter generally contains a statement of specific conditions that must be met in order to secure final approval of the new drug application. If and when those conditions have been met to the FDA’s satisfaction, the FDA will typically issue an approval letter. An approval letter authorizes commercial marketing of the drug with specific prescribing information for specific indications. As a condition of new drug application approval, the FDA may require post approval testing and surveillance to monitor the drug’s safety or efficacy and may impose other conditions, including labeling restrictions which can materially impact the potential market and profitability of the drug. Once granted, product approvals may be withdrawn if compliance with regulatory standards is not maintained or problems are identified following initial marketing.

Once the new drug application is approved, a product will be subject to certain post-approval requirements, including requirements for adverse event reporting and submission of periodic reports. Additionally, the FDA also strictly regulates the promotional claims that may be made about prescription drug products. In particular, the FDA requires substantiation of any claims of superiority of one product over another including, in many cases, requirements that such claims be proven by adequate and well controlled head-to-head clinical trials.

If the FDA’s evaluation of the new drug application submission or manufacturing facilities is not favorable, the FDA may refuse to approve the new drug application or issue a not approvable letter. The not approvable letter outlines the deficiencies in the submission and often requires additional testing or information in order for the FDA to reconsider the application. Even with submission of this additional information, the FDA ultimately may decide that the application does not satisfy the regulatory criteria for approval. With limited exceptions, FDA may withhold approval of a new drug application regardless of prior advice it may have provided or commitments it may have made to the sponsor.

Foreign Regulation of New Drug Compounds

Approval of a product by comparable regulatory authorities may be necessary in foreign countries prior to the commencement of marketing of the product in those countries, whether or not FDA approval has been obtained. The approval procedure varies among countries and can involve requirements for additional testing. The time required may differ from that required for FDA approval. Although there are some procedures for unified filings for some European countries with the sponsorship of the country which first granted marketing approval, in general each country has its own procedures and requirements, many of which are time consuming and expensive. Thus, there can be substantial delays in obtaining required approvals from foreign regulatory authorities after the relevant applications are filed.

In Europe, marketing authorizations may be submitted at a centralized, a decentralized or a national level. The centralized procedure is mandatory for the approval of biotechnology products and provides for the grant of a single marketing authorization which is valid in all European Union member states. As of January 1995, a mutual recognition procedure is available at the request of the applicant for all medicinal products which are not subject to the centralized procedure.

Hazardous Materials

Our research and development processes involve the controlled use of hazardous materials, chemicals and radioactive materials and produce waste products. We are subject to federal, state and local laws and regulations governing the use, manufacture, storage, handling and disposal of hazardous materials and waste products. We do not expect the cost of complying with these laws and regulations to be material.

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Competition

Our product candidates will compete with existing and new products being developed by others for treatment of the same indications. Competition in the development of human therapeutics and, in particular, human therapeutics based upon signaling pathways, is intense. Our competitors will include many large pharmaceutical and biopharmaceutical companies, as well as specialized biotechnology and medical device firms.

Many of the companies competing against us have financial, marketing and human resource capacities that are substantially greater than our own, which may provide these competitors significant competitive advantages over us. 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 relative to ours. 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. Accordingly, our technological and commercial success will be based, among other things, 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 our collaborative partners or we 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. For example, 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. 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.

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 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.

Manufacturing

We have no experience or capabilities in manufacturing. 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 or 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.

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Scientific Advisory Board

We have established a scientific advisory board made up of leading scientists and physicians in the field of signaling pathways. Members of our scientific advisory board consult with us on matters relating to our research and development programs, new technologies relevant to our research and development programs and other scientific and technical issues relevant to our business.

The current members of our scientific advisory board are as follows:

Employees

As of December 31, 2003, we had 64 full-time employees, of whom 38 hold Ph.D. or other advanced degrees. Of these employees, 43 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. Except for 17,280 square feet which we have sublet, we currently use our space to conduct our research and development initiatives and to manage the administrative aspects of our business.

ITEM 3.    LEGAL PROCEEDINGS

We are currently not party to any material legal proceedings.

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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.

EXECUTIVE OFFICERS OF THE REGISTRANT

Our executive officers are as follows:

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PART II

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

STOCKHOLDERS MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

(a) Market Information.    Our common stock is traded on The NASDAQ National Market under the trading symbol “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:

(b) Holders of Record.    On February 23, 2004, the last reported sale price of our common stock on The Nasdaq National Market was $4.96 and there were 329 holders of record of our common stock. 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.

(c) Dividends.    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 our board of directors after taking into account various factors, including our financial condition, operating results, capital requirements and any plans for expansion.

(d) Recent Sales of Unregistered Securities.    Effective September 30, 2003, we issued an aggregate of 100,000 shares of our common stock to Johns Hopkins University, University of Washington, Philip A. Beachy and Jeffrey Porter as partial consideration for the amendment of a license agreement. We issued and delivered these securities in reliance upon an exemption from registration under Section 4(2) of the Securities Act of 1933.

Effective September 30, 2003, we issued an aggregate of 100,000 shares of our common stock to the President and Fellows of Harvard College as partial consideration for the amendment of a license agreement. We issued and delivered these securities in reliance upon an exemption from registration under Section 4(2) of the Securities Act of 1933.

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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 elsewhere in this report.

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

The following discussion and analysis of financial condition and results of operations should be read together with “Selected Financial Data,” and our financial statements and accompanying notes appearing elsewhere in this annual report on Form 10-K. This discussion contains forward-looking statements, based on current expectations and related to future events and our future financial performance, that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of many important factors, including those set forth below under “Factors That May Affect Results” and elsewhere in this report.

Overview

We are a therapeutic drug development company principally focused on the discovery, development and future commercialization of products that modulate key regulatory signaling pathways controlling the repair and regeneration of human tissues and organs. Our product development approach involves using small molecules, proteins or antibodies to modulate these regulatory signaling pathways. We have successfully developed several promising preclinical product candidates in the fields of kidney disease, cancer, neurological disorders, cardiovascular disease and hair growth regulation.

Since our inception, we have funded our operations primarily through license fees, research and development funding from our collaborative partners, the private and public placement of our equity securities, debt financings and the monitization of certain royalty rights. We have never been profitable and have incurred an accumulated deficit of $649,068,000 as of December 31, 2003. We expect to incur significant operating losses for the next several years as we devote substantially all of our resources to research and development of our product candidates. We will need to generate significant revenues to achieve profitability and do not expect to achieve profitability in the foreseeable future, if at all.

We currently have strategic collaborations with Ortho Biotech, Genentech and Wyeth. Our strategic alliances and collaborations generally provide for our research, development and commercialization programs to be funded by our collaborators and provide us with the opportunity to receive additional payments if specified milestones are achieved, as well as royalty payments upon the successful commercialization of any products based upon the collaboration. In some cases, we have retained development and commercialization rights in areas where we believe we can attain the greatest potential long-term value through the application of our own internal resources. In the future, we plan to continue to seek corporate partners for the further development and commercialization of some of our technologies. Even though we are seeking partners to help develop some of our technologies, we expect to select at least one program that we will develop further on our own.

Financial Operations Overview

General.    Our future operating results will depend largely on the magnitude of payments from our current and potential future corporate partners and the progress of other product candidates currently in our research and development pipeline. 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, 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 half of 2006.

Revenue.    Other than royalty revenue from Stryker Corporation’s sales of OP-1, a bone-inducing protein, we have not generated any revenue from product sales since our inception and do not expect to generate any revenue from the sale of products for several years, if ever. In late 2002, Stryker paid us $14,000,000 in exchange for the termination of its future royalty obligations on OP-1. Accordingly, we will receive no future royalties on sales by Stryker of OP-1. Other than revenues from our agreements with Stryker, substantially all of our revenue

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to date has been derived from license fees and research and development payments that we have received from our corporate collaborators. In the future, we will seek to generate revenue from a combination of up-front fees, research and development funding and milestone payments in connection with strategic collaborations, and royalties resulting from the sale of products which incorporate our intellectual property. We expect that any revenue we generate will fluctuate from quarter to quarter as a result of the timing and amount of payments received under our strategic collaborations, and the amount and timing of payments we receive upon the sale of our products, to the extent that any are successfully commercialized.

Research and Development.    Research and development expense consists of costs incurred to discover, research and develop product candidates. These expenses consist primarily of salaries and related expenses for personnel, outside service costs including medicinal chemistry, consulting and sponsored research collaborations, occupancy and depreciation charges and the legal costs of pursuing patent protection of our intellectual property. We expense research and development costs, including patent-related costs, as incurred.

The following table summarizes our primary research and development programs, including the current development status of each program. In the table below, the term early preclinical means we are seeking to obtain initial demonstrations of therapeutic efficacy in preclinical models of human disease, mid preclinical means we are seeking to obtain multiple demonstrations of efficacy in preclinical models of human disease, and late preclinical means we are seeking to obtain both multiple demonstrations of efficacy in preclinical models of human disease and relevant toxicology and safety data required for an investigational new drug application, or IND, filing with the FDA seeking to commence a phase I clinical trial to assess safety in humans. We have set forth below under “Results of Operations” the expenses incurred with respect to each product candidate for the fiscal years ended December 31, 2003, 2002 and 2001. We have not provided program costs since inception because prior to 2001 we did not track and accumulate cost information by research program.

There is a risk that any drug discovery and development program may not produce products or revenue. Moreover, because of uncertainties inherent in drug discovery and development, including those factors described below under “Risk Factors That May Affect Results,” we and our collaborative partners may not be able to successfully develop and commercialize any of the product candidates included in the table above.

All of our product development initiatives are in various stages of preclinical testing, other than our PYY peptide, which has been licensed to Amylin Pharmaceuticals and which is currently the subject of an investigational new drug application seeking FDA approval to begin human clinical trials. Because all of our product development initiatives are in early stages of development, the successful development of our product candidates is highly uncertain. We cannot reasonably estimate or know the nature, timing and estimated costs of the efforts necessary to complete the development of, or the period in which material net cash inflows are expected to commence from, any of our product candidates due to the numerous risks and uncertainties associated with developing drugs, including the uncertainty of:

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Any failure to complete the development of our product candidates in a timely manner could have a material adverse effect on our operations, financial position and liquidity. A discussion of the risks and uncertainties associated with completing our projects on schedule, or at all, and some consequences of failing to do so, are set forth below in “Risk Factors That May Affect Results.”

General and Administrative.    General and administrative expense consists primarily of salaries and other related costs for personnel in executive, finance, accounting, business development, legal, information technology, corporate communications and human resource functions. Other costs include facility costs not otherwise included in research and development expense and professional fees for legal and accounting services.

Strategic Alliances and License Agreements.    Since inception, substantially all of our revenue has been derived from collaborations and other research and development arrangements with third parties. Our current strategic alliances and key license agreements are as follows:

Ortho Biotech Collaboration.    In November 2002, we licensed our broad BMP technology portfolio to Ortho Biotech on an exclusive, worldwide royalty-bearing basis, for all non-orthopedic and non-dental therapeutic applications in exchange for a $3,500,000 up-front fee, a series of cash milestones if specified clinical research objectives and regulatory approvals 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 are entitled to receive additional milestone payments for the kidney disease related product candidate and milestone payments for the first neurology product candidate.

Genentech, Inc. Collaboration.    In June 2003, we licensed our novel small molecule and antibody inhibitors of the Hedgehog signaling pathway to Genentech on an exclusive worldwide royalty-bearing basis for applications in cancer therapy. Under the terms of the agreement, Genentech paid us an upfront license fee of $5,000,000, purchased 1,323,835 shares of our common stock at a price of $2.644 per share for aggregate proceeds of $3,500,000, and is also obligated to pay us a total of $4,000,000 in maintenance fees by July 2005. Genentech is also obligated to make cash payments to us upon the successful achievement of clinical development and drug approval milestones. In addition, Genentech will pay a royalty on potential future net product sales, which increases with increasing sales volume. We have retained the right to co-develop products in the field of basal cell carcinoma, in which event we will share in any profits related to the basal cell carcinoma program in a percentage that is equal to our co-development cost sharing contribution.

Wyeth Pharmaceuticals Collaboration.    In January 2004, we entered into an agreement to license our Hedgehog proteins and novel small molecule Hedgehog pathway agonists to Wyeth on an exclusive worldwide, royalty-bearing basis for the development and commercialization of pharmaceutical products for the therapeutic applications in treatment of neurological disorders, including neurodegenerative diseases and neuropathies. Under the terms of the agreement, Wyeth Pharmaceuticals paid us a license fee of $1,500,000 and purchased 315,524 shares of our common stock at a price of $4.754 per share for an aggregate purchase

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price of $1,500,000. Wyeth will provide research funding for a minimum of two years. In addition, Wyeth is obligated to make cash payments to us upon the successful achievement of clinical development and drug approval milestones and is obligated to pay a royalty on net product sales, if any, that escalates with increasing sales volume.

Amylin Pharmaceuticals Licenses.    In December 2002, we granted Amylin Pharmaceuticals an exclusive worldwide, royalty-bearing license to our PYY patent applications for use in the research, development and commercialization of products in exchange for an up-front fee, milestone payments upon the achievement of specified development objectives, and royalties on potential future product sales, if any. PYY is a gut peptide that has been shown in animals and humans to suppress appetite and reduce food intake. Amylin has exclusive responsibility for expenses related to further development of the PYY compound.

Critical Accounting Policies

While our significant accounting policies are more fully described in our consolidated financial statements, we believe the following accounting policies to be critical to understanding the judgments and estimates we use in preparing our financial statements:

Long-Lived Assets.    Long-lived assets consist of goodwill, long-term receivables, equity securities held in Micromet, ES Cell International and Aegera Therapeutics, 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. In addition, we perform a goodwill impairment test annually. 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 of the adoption of SFAS No. 142, effective January 1, 2002, we ceased amortization of goodwill and performed an initial assessment of impairment of our goodwill in the first quarter of 2002. This initial assessment involved comparing our fair value to our net assets. We determined our fair value based on quoted market prices adjusted to provide for a control premium. Our fair value was in excess of our 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. During the three-month period ended June 30, 2002, we concluded that the decline in our market capitalization 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 as a single reporting unit, 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 in the quarter ended June 30, 2002, of $64,098,000 to write-down our existing goodwill.

The goodwill impairment analysis as of June 30, 2002 involved 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 were based on a consideration of the risks associated with

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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 our fair value, 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.

We completed our annual goodwill impairment test in December 2003, and determined that as of that date our fair value exceeded the carrying value of our net assets. Accordingly, no goodwill impairment was recognized in 2003.

During the year ended December 31, 2003, we recorded, in other expense, charges of $1,708,000 related to the write-off of a euro-denominated note receivable that is due in June 2005 from Micromet, a former collaborator, and $286,000 related to a reduction in the carrying value of Micromet equity securities held by us. We determined that these charges were necessary due to Micromet’s recent announcement that it was terminating one-third of its workforce as the result of a contract dispute with a co-development partner. Micromet has stated that this dispute will result in a significant decrease of previously budgeted cash inflows in 2004, which, in our estimate, materially and adversely affects the likelihood of collection of the note receivable.

During the fourth quarter of the year ended December 31, 2002, we recorded an impairment charge of $271,000 to write-off the carrying value of patents associated with our OP-1 technology, which is licensed to Stryker. The charge was recorded as a result of our transaction with Stryker under which, in exchange for $14,000,000, we sold our rights to future royalties from Stryker on sales of OP-1. We wrote these patents off because we will not receive any future royalties or other revenue from Stryker and because these patents cannot be utilized for alternative uses in either current or future operations.

During the first quarter of the year ended December 31, 2002, we recorded impairment charges of property and equipment assets related to our business realignment of $5,337,000. These charges related to impairment on assets at our former manufacturing and development facility located at 21 Erie Street in Cambridge, Massachusetts. Of the total impairment charge, $4,761,000 relates to the write-off of tenant improvements made to the Erie Street facility, since such were affixed to the facility and therefore could not have been 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 salvage value.

Revenue recognition.    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. 104 (SAB No. 104), Revenue Recognition, and EITF 00-21, Accounting for Revenue Arrangements with Multiple Deliverables. In accordance with SAB No. 104, we recognize revenue 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.

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We recognized $728,000 in revenue related to our collaboration with Genentech for the year ended December 31, 2003. This amount primarily consists of revenue recognized under the amortization of a $5,000,000 up-front license fee received from Genentech in July 2003 and future maintenance fees totaling $4,000,000 that will be paid over the first two years of the collaboration. The remainder will be recognized proportionately as the remaining services are performed. Revenues for research and development services are recognized as such services are performed.

For the year ended December 31, 2003, we recognized $1,470,000 of revenues relating to research and development services performed under an agreement with ES Cell International.

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. No royalty revenue was recognized during the year ended December 31, 2003.

Amounts received prior to satisfying the above revenue recognition criteria are recorded as deferred revenue in the accompanying balance sheets. Amounts that we expect will not be recognized prior to December 31, 2004 are classified as long-term deferred revenue. As of December 31, 2003, we have recorded short- and long-term deferred revenue of $1,241,000 and $7,089,000, respectively, both of which are solely related to the $5,000,000 up-front payment and the $4,000,000 in future maintenance fee payments under our collaboration with Genentech.

We follow detailed guidelines in measuring revenue; however, certain judgments affect the application of our revenue policy. For example, in connection with our collaboration agreement with Genentech, we have recorded on our balance sheet short- and long-term deferred revenue based on our best estimate of when such revenue will be recognized. The estimate of deferred revenue reflects management’s estimate of the period of our involvement with the collaboration. Our period of involvement is largely determined by the time to commercialize clinical candidates that we may co-develop with Genentech. Since the timing of clinical development is difficult to estimate, our estimates may change in the future. Such changes to estimates would result in a change in revenue recognition rates. As of December 31, 2003, $670,000 has been recognized as revenue related to the amortization of the up-front license fee and future maintenance fees. The remaining $8,330,000 is recorded as deferred revenue on our balance sheet at December 31, 2003. Under our current operating plan, we plan to recognize this revenue on a straight-line basis through the third quarter of 2010.

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.

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 liabilities. Actual results may differ from such estimates. Our more significant estimates are as follows:

Valuation of investments in privately-held companies.    We have investments in Aegera, Micromet and ES Cell International with original cost bases of $167,000, $400,000 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 consider available information in estimating the fair value of these investments and, as of December 31, 2003, believe that the fair value of our investments in Aegera and ES Cell are not less than their carrying value.

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However, Micromet recently announced that it terminated one-third of its workforce as the result of a contract dispute with a co-development partner that resulted in a significant decrease of previously budgeted cash inflows in 2004. Accordingly, we concluded that the carrying value of our investment in Micromet common stock had been impaired, and we recorded $286,000 in other expense to reduce the carrying value to the estimated fair value of $400,000. If the financial condition or results of Aegera or ES Cell decline significantly or if Micromet’s financial condition continues to decline, 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.

Timing of deferred revenue recognition.    We have recorded short-term deferred revenue of $1,241,000 and long-term deferred revenue of $7,089,000 as of December 31, 2003. Short-term deferred revenue consists of amounts that are expected to be recognized as revenue by December 31, 2004. However, this estimate is based on our current operating plan as of December 31, 2003. If this operating plan should change in the future, we may recognize a different amount of deferred revenue over the twelve-month period from January 1, 2004, through December 31, 2004.

Results of Operations

Years Ended December 31, 2003 and 2002

Revenues

Total revenues are summarized as follows:

The increase in revenue from research and development contracts and government grants for the year ended December 31, 2003, as compared to the year ended December 31, 2002, was primarily due to our recognition of $1,470,000 in the year ended December 31, 2003, relating to research and development services performed by us under our licensing agreement with ES Cell International. Effective December 2003, and consistent with the terms of this agreement, we are no longer providing research and development services and will therefore not recognize future revenues related to this collaboration. The research and development contract and government grant revenue for the year ended December 31, 2002, was derived entirely from revenue recognized under our licensing agreement with ES Cell International and our former collaboration with Micromet.

Our license fee revenue for the year ended December 31, 2003, primarily consisted of $8,555,000 in previously deferred revenue which was recognized upon the termination of our collaboration with Micromet during the third quarter of 2003. The decrease in license fees and royalty revenue for the year ended December 31, 2003, as compared to the year ended December 31, 2002, was primarily due to the recognition of revenue upon the completion of various transactions in 2002, including $14,000,000 in revenue we recognized upon Stryker’s buy-out of its royalty obligation to us for OP-1 and $3,500,000 in revenue we recognized from an up-front payment received by us in connection with the licensing of certain of our BMP technologies to Ortho Biotech. In addition, we received $387,000 in royalty revenue from Stryker on sales of OP-1 for the year ended December 31, 2002. As part of the Stryker transaction, we will receive no future royalties on sales by Stryker of OP-1. The decrease in license fee and royalty revenue from transactions in 2002 was partially offset by the Micromet revenue described above.

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Operating Expenses

Research and development expenses are summarized as follows:

In the foregoing table, “Other programs” includes expenses related to our Hh agonist/protein/gene product candidate for cardiovascular disease, as well as research and development expenses relating to adult stem cell and cell therapy programs. For the years ended December 31, 2003 and 2002, $1,892,000 and $5,255,000, respectively, related to our adult stem cell and cell therapy programs. As further described below, we reduced expenses incurred under our adult stem cell and cell therapy programs in connection with our business realignment in 2002. To date, we have not incurred material research and development expenses for our Hh small molecule antagonist product candidate for hair growth inhibition. All expenses relating to the development of our BMP-7 protein product candidate for kidney disease are borne by our partner, Ortho Biotech. Costs allocated to the Curis Newco joint venture relate to research expenses incurred by us and charged to Curis Newco, a joint venture that, until May 16, 2003, was operated by us and affiliates of Elan Corporation. Of this aggregate amount, $2,984,000 was related to our central nervous system disorders program and $2,279,000 was related to our peripheral nervous system disorders program.

The decrease in research and development expenses for the year ended December 31, 2003, as compared to the year ended December 31, 2002, was primarily due to a reduction in ongoing operating costs as a result of our business realignment in the first quarter of 2002, including reductions in amounts spent on stem cell and cell therapy programs. As a result of this realignment, our research and development expenses were focused principally on regulatory signaling pathways, particulary the Hedgehog Pathway, for the year ended

December 31, 2003, and spending on our stem cell, cell therapy and other programs decreased by an aggregate of $4,215,000, to $2,247,000 for the year ended December 31, 2003, as compared to $6,462,000 for the year ended December 31, 2002. Reductions in spending on our stem cell, cell therapy and other programs were offset by the termination of our collaboration with Elan, which resulted in no research and development expense being charged to Curis Newco in 2003 verse $5,263,000 in 2002. In 2002, our research and development expenses were presented net of these expenses charged to Curis Newco.

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General and administrative expenses are summarized as follows:

The decrease in general and administrative expenses for the year ended December 31, 2003, as compared to the year ended December 31, 2002, was primarily due to a reduction in ongoing operating costs as a result of our business realignment in the first quarter of 2002, including reductions in personnel costs and legal and professional services. In addition, the amount charged to reserve for the possible non-collection of notes receivable outstanding to two former officers decreased by $652,000 to $34,000 for the year ended December 31, 2003, from $686,000 for the year ended December 31, 2002.

Stock-based compensation decreased by $529,000, or 24%, to $1,631,000 for the year ended December 31, 2003, as compared to $2,160,000 for the year ended December 31, 2002. The decrease was primarily attributable to 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. We recorded $1,100,000 and $1,893,000 in stock-based compensation related to these options for the years ended December 31, 2003 and 2002, respectively. 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 additional paid-in capital rather than stock-based compensation. Accordingly, the departure of four officers and 55 additional employees as a result of the realignment of our business and a subsequent staff reduction in December 2002 has resulted in a decrease in stock-based compensation expense, as the remaining deferred compensation balance associated with each terminated employees’ August 18, 2000, stock options was immediately charged to additional paid-in capital.

Amortization of intangible assets decreased by $399,000, or 84%, to $75,000 for the year ended December 31, 2003, from $474,000 for the year ended December 31, 2002. The decrease was primarily due to an impairment charge of approximately $271,000 that we recorded during the fourth quarter of the year ended December 31, 2002, to reduce the carrying value of patents associated with our OP-1 technology that is licensed to Stryker. The charge was recorded as a result of our transaction with Stryker, under which Stryker bought out its future royalty obligation to us on sales of OP-1 for $14,000,000. We wrote these patents off because we will not receive any future royalties or other revenue from Stryker and because these patents cannot be utilized for alternative uses in either current or future operations.

Loss on property and equipment for the year ended December 31, 2002, of $5,337,000 related to impairment on assets at our facility at 21 Erie Street in Cambridge, Massachusetts. The 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 were deemed to be unlikely to be used in our future operations. Of the impairment charge, $4,761,000 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 have been sold separately. The remaining

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$576,000 of impairment charge was to write down furniture and equipment assets to their estimated salvage value. We do not expect to incur additional impairment on property and equipment related to the realignment in future periods. The amount we received from the sale of these assets was not significantly different from the originally estimated salvage value.

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 might be impaired. Accordingly, we conducted an 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 $1,139,000 associated with workforce reductions of 46 people, including 4 officers, $2,306,000 associated with the closing of clinical programs and decommissioning of a manufacturing and development facility and other costs of $45,000. As of December 31, 2002, we expended approximately all of the $3,490,000 in realignment expenses. We do not expect to incur additional expenses related to this realignment in future periods.

Equity in Loss from Joint Venture

We recorded no equity in loss from joint venture during the year ended December 31, 2003, as compared to $4,311,000 during the year ended December 31, 2002. The equity in loss from joint venture relates to a joint venture, Curis Newco, which we formed in July 2001 with affiliates of Elan Corporation. This joint venture was terminated on May 16, 2003. As a result of the termination, we now own 100% of the outstanding shares of Curis Newco.

Other Income (Expense)

For the year ended December 31, 2003, interest income was $428,000 as compared to $1,067,000 for the year ended December 31, 2002, a decrease of $639,000, or 60%. The decrease in interest income resulted from a lower available investment balance and lower average investment yields for the year ended December 31, 2003, as compared to the year ended December 31, 2002.

For the year ended December 31, 2003, other expense was $1,445,000 as compared to other income of $1,262,000 for the year ended December 31, 2002, a decrease of $2,707,000. This decrease was principally due to an impairment charge of $1,994,000 for the write-off of a euro-denominated note receivable from Micromet, a former collaborator, during the fourth quarter of the year ended December 31, 2003, as well as a decrease in the gain recognized on currency rate fluctuations on the Micromet note receivable of $207,000. In addition, the amount of gain recognized on sales of securities decreased by $504,000 in the year ended December 31, 2003, as compared to the year ended December 31, 2002. We recognized gains on sales of securities of $97,000 for the year ended December 31, 2003, as compared to $601,000 for the year ended December 31, 2002.

For the year ended December 31, 2003, interest expense was $694,000, as compared to $947,000 for the year ended December 31, 2002, a decrease of $253,000, or 27%. The decrease in interest expense resulted from the decrease in the amount of interest expense that we paid on capital leases in 2003 compared to 2002.

Accretion on Series A Convertible Exchangeable Preferred Stock

Accretion of preferred stock dividend for the year ended December 31, 2003 was $271,000, as compared to $723,000 for the year ended December 31, 2002, a decrease of $452,000, or 63%. This charge relates to the

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accretion of a mandatory 6% dividend on shares of convertible exchangeable preferred stock issued to an affiliate of Elan as part of a joint venture with Elan. The decrease is attributed to the termination of the joint venture on May 16, 2003, in which the convertible exchangeable preferred stock was cancelled as part of the termination. The amounts are included in the net loss applicable to common stockholders for the years ended December 31, 2003 and 2002.

Net Loss Applicable to Common Stockholders

As a result of the foregoing, we incurred a net loss applicable to common stockholders of $11,895,000 for the year ended December 31, 2003, as compared to $83,038,000 for the year ended December 31, 2002.

Years Ended December 31, 2002 and 2001

Revenues

Total revenues are summarized as follows:

Revenue from research and development contracts and government grants for the year ended December 31, 2002, was derived entirely from revenue recognized under our licensing agreement with ES Cell International and our former collaboration with Micromet. For the year ended December 31, 2001, this revenue was derived solely from government grants.

The increase in license fees and royalties for the year ended December 31, 2002, as compared to the year ended December 31, 2001, was primarily due to the recognition of revenue upon the completion of various transactions in 2002 including $14,000,000 in revenue we recognized upon Stryker’s buy-out of its royalty obligation to us for OP-1, $3,500,000 in revenue we recognized from an up-front payment received by us in connection with the licensing of certain of our BMP technology to Ortho Biotech and $258,000 we 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 are summarized as follows:

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In the foregoing table, “Other programs” includes expenses related to our Hh agonist/protein/gene product candidate for cardiovascular disease, as well as research and development expenses relating to adult stem cell and cell therapy programs. For the years ended December 31, 2002 and 2001, $5,255,000 and $16,160,000, respectively, related to our adult stem cell and cell therapy programs. As further described below, we reduced expenses incurred under our adult stem cell and cell therapy programs in connection with our business realignment in 2002. To date, we have not incurred material research and development expenses for our Hh small molecule antagonist product candidate for hair growth inhibition. All expenses relating to the development of our BMP-7 protein product candidate for kidney disease are borne by our partner, Ortho Biotech. Costs allocated to the Curis Newco joint venture relate to research expenses incurred by us and charged to Curis Newco. For the year ended December 31, 2002, $2,984,000 was related to our central nervous system disorders program and $2,279,000 was related to our peripheral nervous system disorders program. For the year ended December 31, 2001, $764,000 was related to our central nervous system disorders program and $1,010,000 was related to our peripheral nervous system disorders program.

The decrease in research and development expenses for the year ended December 31, 2002, as compared to the year ended December 31, 2001, was primarily due to a reduction in ongoing operating costs as a result of our business realignment in the first quarter of 2002, particularly for reductions in amounts spent on our cell therapy programs since all such programs were terminated as a result of this realignment. Spending on our cell therapy programs decreased by $12,174,000, to $742,000 for the year ended December 31, 2002, as compared to $12,916,000 for the year ended December 31, 2001. In addition, our research expenses charged to Curis Newco increased by $3,489,000, from $1,774,000 for year ended December 31, 2001, to $5,263,000 for the year ended December 31, 2002. This resulted in lower research and development expenses in 2002, as compared to 2001, since research and development expenses at our consolidated statement of operations are presented net of expenses charged to Curis Newco.

General and administrative expenses are summarized as follows:

The decrease in general and administrative expenses in the year ended December 31, 2002, as compared to the year ended December 31, 2001, was primarily due to a reduction in ongoing operating costs as a result of our business realignment in the first quarter of 2002, including reductions in consulting and legal and professional services. We also entered into two agreements in 2002 for the sublease of 17,000 square feet of lab and office space, resulting in decreases to our occupancy costs in 2002.

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 our merger in 2000. This stock-based compensation, which was $6,257,000 for the year ended December 31, 2001, was amortized over the vesting period of the underlying options through August 1, 2001. Because the amortization period ended on August 1, 2001, we recorded no stock-based compensation related to these options for the year ended December 31, 2002. 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. We recorded

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$1,893,000 and $3,964,000 in stock-based compensation related to these options for the years ended December 31, 2002 and 2001, respectively. 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 additional paid-in capital rather than to stock-based compensation. 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. The remaining deferred compensation related to the August 12, 2000, options will be amortized in 2004.

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 currently amortize 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 $5,337,000 related to impairment on assets at our facility at 21 Erie Street in Cambridge, Massachusetts, as described above.

Impairment of goodwill for the year ended December 31, 2002 was $64,098,000, as described above.

Realignment expenses of $3,490,000 were recorded for the year ended December 31, 2002. These charges relate to: (i) $1,139,000 associated with workforce reductions of 46 people, including 4 officers, (ii) $2,306,000 associated with the closing of clinical programs and decommissioning of a manufacturing and development facility and other costs of $45,000. As of December 31, 2002, we 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 related to our joint venture with affiliates of Elan. The decrease was 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 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 note receivable issued to us by Micromet in connection with a collaboration. We recognized gains on currency rate fluctuations of $660,000 and $145,000, respectively, for the years ended December 31, 2002 and 2001.

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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 owed 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.

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.

Liquidity and Capital Resources

Our liquidity requirements have historically consisted of research and development expenses, capital expenditures, working capital and general corporate expenses. At December 31, 2003, our principal sources of liquidity consisted of cash, cash equivalents, marketable securities and long-term investments of $37,538,000, excluding restricted cash and cash equivalents of $191,000. Since inception, we have financed our operations primarily through license fees, research and development funding from our collaborative partners, the private and public placement of our equity securities, debt financing and the amortization of certain royalty rights.

Net cash used in operating activities was $9,761,000 for the year ended December 31, 2003, as compared to $6,918,000 for the year ended December 31, 2002. Cash used in operating activities during the year ended December 31, 2003 was primarily to fund our net loss of $11,623,000, partially offset by $5,588,000 in non-cash charges including stock-based compensation expense, depreciation and amortization, non-cash interest expense on notes payable, amortization of intangible assets and an impairment of a long-term note receivable and investment in Micronet, a former collaborator of ours. In addition, we used $3,273,000 of operating cash as a result of changes in certain of our operating assets and liabilities during the year ended December 31, 2003. 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 and our use of operating cash as a result of changes in certain of our assets and liabilities.

Investing activities generated $1,645,000 of net cash for the year ended December 31, 2003, as compared to net cash used in investing activities of $1,066,000 for the year ended December 31, 2002. Net cash generated for the year ended December 31, 2003, was driven by a reduction in restricted cash balances of $4,213,000, resulting from the full repayment of our loan agreement with the Boston Private Bank & Trust Company. 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 the Boston Private Bank & Trust Company, offset in part by net proceeds from the sale of marketable securities.

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Financing activities generated $8,930,000 of net cash for the year ended December 31, 2003, as compared to net cash used in financing activities of $3,374,000 for the year ended December 31, 2002. The cash generated by financing activities during 2003 was principally the result of the sale of $15,401,000 of our common stock, including $9,805,000 from a private placement of 3,589,700 shares of common stock, and warrants to purchase 1,076,910 shares of common stock, in August 2003, $3,500,000 from the sale of 1,323,835 shares of common stock to Genentech, and $1,057,000 in proceeds received upon stock option exercises. These amounts were partially offset by repayments of debt totaling $6,820,000, including $4,213,000 in full repayment of our debt with the Boston Private Bank & Trust Company, $1,500,000 as partial repayment of our convertible promissory note payable to Elan pursuant to our May 16, 2003 termination agreement, and $1,224,000 in repayments of notes payable and capital leases. 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.

In June, 2003, we licensed our small molecule and antibody antagonists of the Hedgehog signaling pathway to Genentech for applications in cancer therapy pursuant to the terms of a collaborative research, development and license agreement. The collaboration agreement provides for cash payments from Genentech, including an up-front payment of $5,000,000, maintenance fee payments totaling $4,000,000 over the first two years of the collaboration, none of which was received in 2003, and milestone payments at various intervals during the regulatory approval process of small molecule and antibody product candidates, assuming specified research objectives are met. Genentech is also obligated to pay us a royalty on potential future product sales. Under the terms of the collaboration agreement, we are required to commit eight employees to the small molecule and/or antibody programs for a period of two years. We are recognizing revenue related to the $5,000,000 up-front payment and the $4,000,000 maintenance fee payments receivable over our estimated period of involvement related to the collaboration. Under our current operating plan, we expect to recognize approximately $1,200,000 in 2004 related to these payments.In addition, as partial consideration for the rights and licenses granted under the collaboration agreement, with respect to certain types of licensed compounds, we sold 1,323,835 shares of our common stock to Genentech at a purchase price of $2.644 per share for aggregate proceeds of $3,500,000, pursuant to the terms of a stock purchase agreement. We also entered into a registration rights agreement with Genentech covering the registration of the shares of common stock for resale under specified conditions.

In April 2003, we amended our loan agreement with the Boston Private Bank & Trust Company. Under the terms of the amended loan amendment, we ceased making our quarterly principal payments. Instead, the loan was structured as a revolving credit facility under which up to $7,000,000 could have been borrowed and remained outstanding until the repayment date of April 1, 2005. We continued to pay interest monthly in arrears at variable interest rates during 2003. This loan was fully collateralized with a money market account maintained at the Boston Private Bank & Trust Company. In December 2003, we paid in full the outstanding loan balance of $3,996,000 with funds held in our fully collateralized money market account at the Boston Private Bank & Trust Company. We had paid $217,000 earlier in 2003.

In July 2001, we issued to Elan shares of our Series A convertible/exchangeable preferred stock valued at $12,015,000 to fund our pro rata share of the initial capitalization of Curis Newco. We recorded a charge to accumulated deficit of $271,000 for the year ended December 31, 2003, for the accretion of a mandatory 6% dividend on the preferred stock. Such amounts are included in the net loss applicable to common stockholders for the year ended December 31, 2003. The preferred stock, which had a carrying value of $13,336,000, was cancelled on the May 16, 2003 termination date of the joint venture program with Elan. As partial consideration for the rights and benefits described in the termination agreement, including the cancellation of the preferred stock, we issued 2,878,782 shares of our common stock to Elan, having a fair value of $8,377,000 based on the May 16, 2003 closing price of our common stock on The Nasdaq National Market. Upon the termination of the Elan agreement, we recorded a credit to additional paid-in-capital of $13,736,000 to reflect the cancellation of the Preferred Stock and the forgiveness of debt in exchange for the issuance of our common stock. Lastly, as a result of the termination, all rights granted by both us and Elan at the formation of Curis Newco under separate license agreements with Curis Newco terminated. In addition, intellectual property created by Curis Newco is owned by us, both in our own right and as sole shareholder of Curis Newco. According to provisions in the termination agreement, we will pay Elan future compensation, in the form of future royalty payments, in the event of any direct sales or third party commercialization agreements related to certain compounds.

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In June 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 payable is repayable at any time up to its maturity date of June 26, 2006, by us, at our discretion, in either cash or issuance to Becton Dickinson of shares of our common stock. The note payable bears interest at 7%. As of December 31, 2003, there was $2,352,000, including $352,000 in accrued interest, outstanding under the note payable.

We lease equipment under various capital lease arrangements. Monthly payments on leases outstanding as of December 31, 2003 range from $1,880 to $21,170 and maturities range from March 2004 to July 2004. The initial terms of the leases range from 36 months to 60 months and bear interest at rates ranging from 12.5% to 16.3%. As of December 31, 2003, $323,000 was outstanding under these agreements and we were in compliance with all material covenants under these agreements.

As of December 31, 2003, we had future payments required under contractual obligations and other commitments as follows:

We anticipate that existing capital resources should enable us to maintain current and planned operations into the first half of 2006. 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 half of 2006 is dependent upon the success of our collaborations, our ability to maintain or 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 of either us or our collaborators 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. Due to 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. 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.

Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements as of December 31, 2003.

Inflation

We believe that inflation has not had a significant impact on our revenue and results of operations since inception.

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New Accounting Pronouncements

In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities and, in December 2003, issued a revision to that interpretation FIN 46R. FIN 46R replaces FIN 46 and addresses consolidation by business enterprises of variable interest entities that possess certain characteristics. A variable interest entity (“VIE”) is defined as (a) an ownership, contractual or monetary interest in an entity where the ability to influence financial decisions is not proportional to the investment interest, or (b) an entity lacking the invested capital sufficient to fund future activities without the support of a third party. FIN 46R establishes standards for determining under what circumstances VIEs should be consolidated with their primary beneficiary, including those to which the usual condition for consolidation does not apply. Our adoption of FIN 46R is not expected to have any effect on our financial position or results of operations.

In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities. This statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts, collectively referred to as derivatives, and for hedging activities under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. SFAS No. 149 is effective for contracts entered into or modified and for hedging relationships designated after June 30, 2003. At December 31, 2003, we had no financial instruments falling within the scope of SFAS No. 149.

In May 2003, the FASB issued SFAS 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. SFAS 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). Many of those instruments were previously classified as equity. This statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after December 15, 2003. The adoption of SFAS 150 did not have a material effect on our financial statements.

In May 2003, the FASB also issued EITF 01-8, Determining Whether an Arrangement Contains a Lease, which requires capital lease treatment for arrangements containing an embedded lease, thereby conveying the right to control the use of property, plant or equipment (collectively, “property”) whether the right to control the use of the property is explicitly or implicitly specified. The right is conveyed if the purchaser (lessee) obtains physical or operational control of the underlying property or takes substantially all of its output. This pronouncement applies prospectively to new or modified arrangements beginning after May 28, 2003. The adoption of EITF 01-8 had no impact on our financial statements.

Effective July 1, 2003, we adopted EITF 00-21, Accounting For Revenue Arrangements with Multiple Deliverables, which establishes criteria for whether revenue on a deliverable can be recognized separately from other deliverables in a multiple deliverable arrangement. The criteria considers whether the delivered item has stand-alone value to the customer, whether the fair value of the delivered item can be reliably determined and the customer’s right of return for the delivered item. The adoption of EITF 00-21 did not have a material impact on our financial statements.

On December 17, 2003, the Staff of the Securities and Exchange Commission (SEC or the Staff) issued SAB 104, Revenue Recognition , which amends SAB 101, Revenue Recognition in Financial Statements. SAB 104’s primary purpose is to rescind accounting guidance contained in SAB 101 related to multiple element revenue arrangements, superseded as a result of the issuance of EITF 00-21. Additionally, SAB 104 rescinds the SEC’s Revenue Recognition in Financial Statements Frequently Asked Questions and Answers (the FAQ) issued with SAB 101 that had been codified in SEC Topic 13, Revenue Recognition. Selected portions of the FAQ have been incorporated into SAB 104. While the wording of SAB 104 has changed to reflect the issuance of EITF 00-21, the revenue recognition principles of SAB 101 remain largely unchanged by the issuance of SAB 104. The adoption of SAB 104 did not have a material impact on our financial statements.

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Factors That May Affect Results

Risks Relating To Our Financial Results And Need For 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. As of December 31, 2003, we had an accumulated deficit of approximately $649.1 million. 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.

Even if our collaboration agreements provide funding for a portion of our research and development expenses for some of our programs, we expect to spend significant capital to fund our internal 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. Our failure to become and remain profitable may depress the market price of our common stock and could impair our ability to raise capital, expand our business, diversify our product offerings or continue our operations.

We are likely to 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. We believe that our existing cash and working capital should be sufficient to fund our operations until the first half of 2006. However, our future capital requirements may vary from what we expect and will depend on numerous factors, many of which are outside our control, including the following:

We expect to seek additional funding through collaborative arrangements with strategic partners and may seek additional funding through public or private financings. However, the biotechnology market in general, and the market for our common stock, in particular, is highly volatile. Due to 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.

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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.

If the estimates we make and the assumptions on which we rely in preparing our financial statements prove inaccurate, our actual results may vary significantly.

Our financial statements have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of our assets, liabilities, revenues and expenses, the amounts of charges taken by us and related disclosure. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. There can be no assurance, however, that our estimates, or the assumptions underlying them, will be correct. Our actual financial results may vary significantly from the estimates contained in our financial statements.

Risks Relating To Our Collaborations

We are dependent on collaborative partners for the development and commercialization of many of our product candidates. If we lose any of these partners, of if they fail or delay in developing or commercializing our product candidates, our anticipated product pipeline and operating results would suffer.

The success of our strategy for development and commercialization of product candidates depends upon our ability to form and maintain productive strategic collaborations. We currently have strategic collaborations with Genentech, Ortho Biotech Products, and Wyeth. We expect to enter into additional collaborations in the future. Our existing and any future alliances may not be scientifically or commercially successful.

The risks that we face in connection with these alliances include the following:

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We may not be successful in establishing additional strategic alliances, which could adversely affect our ability to develop and commercialize products and services.

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. We face significant competition in seeking appropriate collaborators and the negotiation process is time-consuming and complex. We may not be successful in our efforts to establish additional strategic alliances or other alternative arrangements. Even if we are successful in our efforts to establish an alliance or agreement, the terms that we establish may not be favorable to us. Finally, such strategic alliances or other arrangements may not result in successful products and associated revenue.

Risks Related To Our Business, Industry, Strategy And Operations

Other than OP-1, which we and Stryker commercialized under our former collaboration, we have not commercialized any products to date, either alone or with a collaborator. If we are not able to commercialize any products, we will not be profitable.

Most of our product opportunities are in various stages of preclinical development. 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 of our product opportunities are commercialized, we will not be profitable.

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

Our product candidates face competition with existing and new products being developed by biotechnology, medical device and pharmaceutical companies, as well as universities and other research institutions. For example, research in the fields of regulatory signaling pathways and functional genomics, which includes our work in cancer, with Genentech and renal disease, with Ortho Biotech, is highly competitive. 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. 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 alone or with a collaboration partner. For those programs that we have selected for further internal development, we face competition from companies that 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. For those programs that are subject to a collaboration agreement, competitors may discover, develop and commercialize products which render our products non-competitive or obsolete. 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. While our technologies may permit us to work in multiple areas, resource commitments may require trade-offs resulting in delays in the development of certain programs or research areas, which may place us at a competitive disadvantage. Our decisions as to resource allocation may not lead to the development of viable commercial

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products and may divert resources away from other market opportunities which ultimately prove to be more profitable.

If we or our collaborators fail to achieve market acceptance for our products under development, our future revenue and ability to achieve profitability may be adversely affected.

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.

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 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 under development, 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.

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. 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 and compliance, would require us to either hire new key personnel or obtain such services via an outsourcing arrangement. The pool of personnel with the skills that we require is limited. We may not be able to hire or contract such additional personnel.

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 or our collaborators are not able to obtain the necessary regulatory approvals, we will not be able to commercialize our product candidates.

In order to obtain regulatory approval for the commercial sale of our product candidates, we and our collaborators will be required to complete extensive preclinical studies as well as clinical trials in humans to demonstrate to the FDA and foreign regulatory authorities that our product candidates are safe and effective. 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.

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Clinical development, including preclinical testing, is a long, expensive and uncertain process. Accordingly, clinical trials, if any, of our product candidates under development may not be successful. We and our collaborators could experience delays in preclinical or clinical 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. Furthermore, the timing and completion of clinical trials, if any, of our product candidates 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, our products under development 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. 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. If we and our collaborative partners do not obtain necessary regulatory approvals, then our business will be unsuccessful and the market price of our common stock will substantially decline.

To the extent that we are able to advance an internal program through the clinic, we will be required to obtain regulatory approval for any product we develop in such program. In instances where our product candidates are being developed by our collaborators, our partners will be required to obtain regulatory approval for marketing and selling efforts.

The process of obtaining FDA and other required regulatory approvals is 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 under development 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. To date, we have limited experience in filing and prosecuting applications to obtain marketing 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. In addition, regulatory agencies may not grant approvals on a timely basis or may revoke or significantly modify previously granted approvals.

We also are subject to numerous foreign regulatory requirements governing 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 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.

As a result of these factors, we or our collaborators may not successfully begin or complete clinical trials in the time periods estimated, if at all. Moreover, if we or our collaborators incur costs and delays in development programs or fail to successfully develop and commercialize products based upon our technologies, our stock price could decline.

Even if marketing approval is obtained, internally developed or licensed products will be subject to ongoing regulatory oversight which may affect the successful commercialization of our products.

Even if regulatory approval of a product candidate is obtained by us or our collaborators, 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 marketing approval for any product is obtained, 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

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manufacturer or facility, may result in restrictions on the product or manufacturer, including withdrawal of the product from the market.

If there is a failure to comply with applicable regulatory requirements, we or our collaborator 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 regulations. 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 our collaborators and third-party manufacturers to produce most, if not all, of our products under development, and if these third parties do not successfully manufacture these products our business will be harmed.

We have no manufacturing experience or manufacturing capabilities. In order to continue to develop products, apply for regulatory approvals, and commercialize our products, we or our collaborators must be able to manufacture products in commercial quantities, in compliance with regulatory requirements, at acceptable costs and in a timely manner. The manufacture of our product candidates may be complex, difficult to accomplish and difficult to scale-up when large-scale production is required. Manufacture may be subject to delays, inefficiencies and poor or low yields of quality products. The cost of manufacturing some of our products may make them prohibitively expensive. If supplies of any of our product candidates or related materials become unavailable on a timely basis or at all or are contaminated or otherwise lost, clinical trials by us and our collaborators could be seriously delayed. This is due to the fact that such materials are time-consuming to manufacture and cannot be readily obtained from third-party sources.

To the extent that we or our collaborators seek to enter into manufacturing arrangements with third parties, there will be a dependency upon these third parties to perform their obligations in a timely and effective manner and in accordance with government regulations. If third-party manufacturers 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 or marketing experience and, as such, will depend significantly on third parties who may not successfully sell our products.

We have no sales, marketing or product distribution experience. If we receive required regulatory approvals, we plan to rely primarily on sales, marketing and distribution arrangements with third parties, including our collaborative partners. For example, as part of our agreements with Genentech, Ortho Biotech and Wyeth, we have granted our collaborators exclusive rights to distribute certain products resulting from such collaborations, 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

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 or our collaborators fail to perform under these agreements or otherwise breach obligations thereunder, we could lose intellectual property rights that are important to our business.

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

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United States are maintained in secrecy until 18 months after filing, 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 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 proprietary technology, information, processes and know-how that is not subject to patent protection. 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 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 has 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.

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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.

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

We expect that our stock price will fluctuate significantly and the market price of our common stock could drop below the price you paid.

The trading price of our common stock has been volatile and may continue to be volatile in the future. For example, our stock has traded as high as $5.92 and as low as $0.65 per share in the year ended December 31, 2003. The stock market, particularly in recent years, has experienced significant volatility 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. Prices for our stock will be determined in the market place and may be influenced by many factors, including: