CURIS INC - Quarter Report: 2006 September (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark one)

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2006

OR

Commission File Number: 000-30347

CURIS, INC.

(Exact Name of Registrant as Specified in Its Charter)

Registrant’s Telephone Number, Including Area Code: (617) 503-6500

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.    x  Yes    ¨  No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    ¨  Yes    x  No

As of November 6, 2006, there were 49,234,657 shares of the registrant’s common stock outstanding.

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CURIS, INC. AND SUBSIDIARIES QUARTERLY REPORT ON FORM 10-Q

INDEX

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Item 1. FINANCIAL STATEMENTS

CURIS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS

(unaudited)

See accompanying notes to unaudited condensed consolidated financial statements.

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CURIS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS (unaudited)

See accompanying notes to unaudited condensed consolidated financial statements.

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CURIS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)

See accompanying notes to unaudited condensed consolidated financial statements.

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CURIS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

1. Nature of Business

Curis, Inc. (the “Company” or “Curis”) is a therapeutic drug development company focusing on cancer, neurological and dermatological disease indications, with technologies that modulate certain biological pathways that control the growth, repair and regeneration of tissues and organs. Curis’ product development involves the use of small molecules, proteins or antibodies to modulate these pathways, for example by increasing the pathway signals when they are insufficient or by decreasing them when they are up-regulated or unregulated. The Company has successfully used this technology and product development approach to produce several drug product candidates. This technology and approach have been used in the fields of cancer (under two collaborations with Genentech, as well as under internal preclinical development for new proprietary cancer programs that target multiple validated cancer pathways), neurological disorders (under collaboration with Wyeth), hair growth (under collaboration with Procter & Gamble), kidney and other diseases (licensed to Ortho Biotech Products and under development at Centocor, both subsidiaries of Johnson & Johnson), as well as cardiovascular disease. The Company expects that any successful products would be used in the health care industry and would be regulated in the United States by the U.S. Food and Drug Administration, or FDA, and in overseas markets by similar regulatory agencies.

The Company is subject to risks common to companies in the biotechnology industry including, but not limited to, development by its competitors of new technological innovations, dependence on key personnel, its ability to protect proprietary technology, reliance on corporate collaborators and licensors to successfully research, develop and commercialize products based on the Company’s technologies, its ability to comply with FDA government regulations and approval requirements as well as its ability to grow its business and obtain adequate financing to fund this growth.

2. Basis of Presentation

The accompanying unaudited consolidated financial statements of the Company have been prepared in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X. These statements, however, are condensed and do not include all disclosures required by accounting principles generally accepted in the United States for complete financial statements and should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2005, as filed with the Securities and Exchange Commission on March 31, 2006. The year-end condensed balance sheet data was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America.

In the opinion of the Company, the unaudited consolidated financial statements contain all adjustments (all of which were considered normal and recurring) necessary to present fairly the Company’s financial position at September 30, 2006, the results of operations for the three- and nine-month periods ended September 30, 2006 and 2005, and cash flows for the nine-month periods ended September 30, 2006 and 2005. The preparation of the Company’s consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts and disclosure of certain assets and liabilities at the balance sheet date. Such estimates include the carrying value of property and equipment and intangible assets and the value of certain liabilities. Actual results may differ from such estimates.

These interim results are not necessarily indicative of results to be expected for the full year or subsequent interim periods.

3. Creation of Curis Shanghai

In August 2006, the Company established a wholly-owned subsidiary in Shanghai, China called Curis Pharmaceuticals (Shanghai) Co., Ltd., or Curis Shanghai. Upon establishment of the subsidiary, the Company is

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required by the Chinese government to contribute $2,100,000 to Curis Shanghai, of which the first contribution of $420,000 is due in November 2006. The remaining capital must be funded by August 2008 and the Company expects to fund Curis Shanghai as needed to meet its obligations. Once capital has been contributed to Curis Shanghai, it will be restricted for use to satisfy only those obligations incurred in China and cannot be transferred back to Curis, Inc. The Company has not made any payments to Curis Shanghai to date.

As of September 30, 2006, Curis Shanghai was not operational. There were no transactions, including any intercompany transactions, at Curis Shanghai for the quarter ended September 30, 2006. Curis Shanghai currently has no employees and the Company does not plan to hire any subsidiary employees for the foreseeable future. The Company currently expects that certain operational aspects, including oversight of the third party chemistry provider, will be managed from the Company’s Cambridge, Massachusetts location. It is anticipated that payments made to the third party chemistry provider will be made by Curis Shanghai from the Company’s capital contributions.

4. Revenue Recognition

The Company’s business strategy includes entering into collaborative license and development agreements with biotechnology and pharmaceutical companies for the development and commercialization of the Company’s product candidates. The terms of the agreements typically include non-refundable license fees, funding of research and development, payments based upon achievement of clinical development objectives and royalties on product sales. The Company follows the provisions of the Securities and Exchange Commission’s Staff Accounting Bulletin (SAB) No. 104 (SAB No. 104), Revenue Recognition, Emerging Issues Task Force (EITF) Issue No. 00-21 (EITF 00-21), Accounting for Revenue Arrangements with Multiple Deliverables, EITF Issue No. 99-19 (EITF 99-19), Reporting Revenue Gross as a Principal Versus Net as an Agent, and EITF Issue No. 01-9 (EITF 01-9), Accounting for Consideration Given by a Vendor to a Customer (Including a Reseller of the Vendor’s Products). For a complete discussion of the Company’s revenue recognition policy, see Note 4(c) included in its annual report on Form 10-K, as previously filed with the Securities and Exchange Commission on March 31, 2006.

(i) Genentech Collaborations

Basal Cell Carcinoma Co-Development Accounting. The Company has two collaboration agreements with Genentech. The first agreement, entered into in June 2003, relates to the development of Hedgehog antagonist technologies, including the development of a basal cell carcinoma product candidate, for which, prior to September 2006, the Company was sharing development costs equally with Genentech. The second agreement, entered into in April 2005, relates to the development of drug candidates that modulate another signaling pathway that plays an important role in cell proliferation and has been implicated in certain cancers.

In July 2006, the Company and Genentech elected to halt a Phase I clinical trial on the basal cell carcinoma product candidate. Effective August 31, 2006, the Company elected to cease its participation in the co-development of this drug candidate and, as of August 31, 2006, Genentech will be solely responsible for all future costs and development decisions regarding the basal cell carcinoma program. The Company does not expect to incur any additional costs related to co-development of this drug candidate. The June 2003 and April 2005 collaborations are both continuing to progress and the Company believes that its decision to opt out of co-development does not otherwise impact these ongoing collaborations. Should Genentech determine to proceed with development of a topically administered Hedgehog antagonist for the treatment of basal cell carcinoma, the Company would be eligible for cash payments on the achievement of certain future clinical development objectives, if any, as well as a royalty on future product sales.

In connection with its co-development arrangement with Genentech under the June 2003 agreement, the Company has recorded cumulative revenues under both of its collaboration agreements with Genentech of

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$11,308,000 through September 30, 2006. In addition, at September 30, 2006, the Company’s deferred revenue under its collaborations with Genentech totaled $9,722,000. For the period July, 1, 2006 through August 31, 2006, the Company incurred $355,000 in costs related to the co-development of the basal cell carcinoma therapeutic product candidate, which represents amounts owed to Genentech for the reimbursement of the Company’s equal share of costs incurred by Genentech under the agreement through the co-development termination date. The cumulative costs incurred on this program were $8,727,000 as of September 30, 2006. Since the sum of cumulative revenue recorded through September 30, 2006 of $11,308,000 and the deferred revenue of $9,722,000 at September 30, 2006 exceeded cumulative co-development costs incurred through September 30, 2006 of $8,727,000, the Company has recorded a reduction to revenues, or contra-revenue, of $355,000 and $1,728,000 in its consolidated statements of operations and comprehensive loss for the three- and nine-month periods ended September 30, 2006, respectively.

(ii) Preclinical milestone received from Procter & Gamble.

As part of a September 2005 agreement, Procter & Gamble Pharmaceuticals, a division of The Procter & Gamble Company, agreed to pay Curis up to $2,800,000 in cash payments that are contingent on the achievement of certain preclinical development objectives in its hair growth program. The program is focused upon the development of topically applied Hedgehog agonists for hair growth disorders, such as male pattern baldness and female pattern hair loss. In March 2006, the first of two preclinical development objectives was successfully completed and resulted in a payment to Curis of $1,000,000.

The Company determined that this payment does not constitute a substantive milestone payment for accounting purposes because it did not meet all of the conditions outlined in the Company’s revenue recognition policy. Accordingly, the Company considered this payment as part of the single unit of accounting for its Procter & Gamble collaboration and the Company is recognizing the payment as its performance obligations are satisfied. The Company currently estimates that its performance obligations will be satisfied in September 2011.

(iii) Payments due from Micromet

On October 21, 2004, the Company amended a note receivable with Micromet, a former collaborator. The original note had been received as partial payment for a technology license. Under the amended note, Micromet is obligated to pay Curis a total amount of €4,500,000, subject to certain conditions. This note had been fully written down by the Company in 2003.

The Company received two equal payments of €1,250,000 in 2004 and 2005. The remaining €2,000,000 under the amended note payable is due upon the achievement by Micromet of certain financing objectives or upon an exit event, as defined in the agreement. The Company believed that €533,000 of the remaining €2,000,000 became due as a result of Micromet’s achievement of a financing milestone. The Company also believed that the merger of Micromet with CancerVax, Inc., a U.S. publicly traded biotechnology company, obligated Micromet to pay Curis the remaining €1,467,000 within 30 days of the merger’s May 5, 2006 closing date. Micromet had disputed this claim and the Company filed suit in Germany in the second quarter of 2006.

In September 2006, the Company agreed to a court-proposed settlement agreement with Micromet, pursuant to which Micromet is required to repay a note receivable in two installments of €1,000,000, on each of November 1, 2006 and May 31, 2007. Under the terms of the settlement agreement, should Micromet make the second payment on or before April 30, 2007, the second payment would decrease to €800,000. The Company believes that it is probable that Micromet will honor its obligation under the court ruling and pay Curis €1,000,000 (approximately $1,269,000 at September 30, 2006) by November 1, 2006 and €800,000 (approximately $1,015,000 at September 30, 2006) by April 30, 2007, to take advantage of the 30-day discount term offered by the German court. As a result of this recovery of amounts owed under the note, the Company has recorded license fee revenues of $2,284,000 for the three- and nine-month periods ended September 30, 2006 based on the Euro-to-U.S. dollar exchange rate as of September 30, 2006. Corresponding amounts related to

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these payments are included under “Accounts receivable” within “Current assets” in the Company’s consolidated balance sheet as of September 30, 2006. The first payment of €1,000,000, or $1,252,000, was received on October 17, 2006.

5. Investments in Privately-Held Companies

As of September 30, 2006, the Company holds equity investments in two privately-held former collaborators of the Company, Aegera Therapeutics and ES Cell International. Equity investments in privately-held companies are reflected in the accompanying consolidated financial statements at a value based on the Company’s best estimate of the fair value of such investments. When determining the fair values of such investments, the Company generally considers such factors as the fair value paid by outside investors for similar equity in such companies, the liquidity of the investment and both company-specific and macroeconomic factors that may have affected values since the last such investment by outside investors. On a quarterly basis, the Company reevaluates the book valuation of its investments in privately-held companies to determine if its carrying value should be changed.

In September 2006, the Company was notified of Aegera’s need to secure additional financing at a value that was significantly less than the current carrying value of Aegera stock recorded at the Company’s consolidated balance sheet. The Company believes that the terms of any future financing will adversely affect the carrying value of the equity investment in Aegera. Accordingly, during the quarter ended September 30, 2006, the Company, recorded a charge to “Other expense” of $164,000 by writing down the carrying value of its investment in Aegera equity securities to $3,000 from $167,000.

At December 31, 2005, the Company held an equity investment in Micromet AG, a privately-held former collaborator, valued at $100,000. In May 2006, Micromet merged with CancerVax, Inc., a U.S. publicly traded biotechnology company. The shares the Company held in Micromet were converted to shares of the combined company, Micromet, Inc., which began trading on the NASDAQ market on May 8, 2006. During the quarter ended September 30, 2006, the Company sold its equity investment in Micromet for proceeds totaling $85,000, recognizing a loss of $15,000 reflected in “Other expense” in the consolidated statement of operations.

6. Long-Term Debt Obligations

Long-term debt obligations, including accrued interest, consisted of the following at September 30, 2006 and December 31, 2005:

Boston Private Bank & Trust Company. On March 23, 2005, the Company converted $2,250,000 borrowed under an amended loan agreement with the Boston Private Bank & Trust Company into a 36-month term note that bears interest at a fixed rate of 7.36% for the repayment period. Under the terms of the note payable, the Company is required to make equal monthly payments of $62,500 plus any accrued interest beginning on May 1, 2005, and extending through the 36-month term. This loan is collateralized by all of the Company’s property, plant and equipment assets, except for fixtures and those that are purchased after March 23, 2005 under purchase money arrangements with equipment lenders.

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On December 9, 2005, the Company converted $1,450,000 borrowed under a separate loan agreement with the Boston Private Bank & Trust Company into a 36-month term note that bears interest at a fixed rate of 7.95% for the repayment period. Under the terms of the note payable, the Company is required to make equal monthly payments of $40,278 plus any accrued interest beginning on January 1, 2006, and extending through the 36-month term. This loan is collateralized by any equipment and leasehold improvements financed thereunder.

As of September 30, 2006, the Company is in compliance with the sole covenant under each of the agreements with the Boston Private Bank & Trust Company. The covenant requires the Company to maintain a minimum working capital ratio. Should the Company fail to pay amounts when due or fail to maintain compliance with the covenant under the agreements, the entire obligation becomes immediately due at the option of the Boston Private Bank & Trust Company.

Becton Dickinson. On June 26, 2001, the Company received $2,000,000 from Becton Dickinson under a convertible subordinated note payable in connection with the exercise of an option to negotiate a collaboration agreement. The note payable was repayable at the option of the Company in either cash or issuance of the Company’s common stock, also at the option of the Company, at any time up to its maturity date of June 26, 2006. On January 20, 2006, the Company elected to prepay the then-outstanding principal and interest due under the note in the amount of $2,639,000 by issuing to Becton Dickinson 669,656 shares of the Company’s common stock, based on a 10-day trailing average of the Company’s closing stock prices resulting in a conversion price of $3.94 per share. The Company has no further obligations under this convertible note payable.

7. Accounting for Employee Stock-Based Compensation

On January 1, 2006, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 123 (revised 2004), Share-Based Payment (SFAS 123(R)), which establishes standards for the accounting of transactions in which an entity exchanges its equity instruments for goods or services. This Statement focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. SFAS No. 123(R) requires that the fair value of such equity instruments be recognized as an expense in the financial statements as services are performed. Prior to January 1, 2006, the Company accounted for share-based payments under the recognition and measurement provisions of APB Opinion No. 25, Accounting for Stock Issued to Employees (APB 25), and related Interpretations, as permitted by SFAS Statement No. 123, Accounting for Stock-Based Compensation (SFAS 123). In accordance with APB 25, no compensation cost was required to be recognized for options granted to employees that had an exercise price equal to the market value of the underlying common stock on the date of grant and only certain pro forma disclosures were required.

The Company adopted SFAS 123(R) using the modified-prospective-transition method. Under that transition method, compensation cost recognized for the nine-month period ended September 30, 2006 includes (i) compensation cost for all share-based payments granted prior to, but not yet vested, as of January 1, 2006, based on the grant-date fair value estimated in accordance with the original provisions of SFAS 123; and (ii) compensation cost for all share-based payments granted subsequent to January 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of SFAS 123(R). The results for the prior periods have not been restated.

Effective January 1, 2006, the Company adopted the straight-line attribution method for recognizing compensation expense. Previously, under the pro forma disclosure-only provisions of SFAS 123, the Company used the straight-line attribution method for expense recognition. For all unvested options outstanding as of January 1, 2006, the previously measured but unrecognized compensation expense, based on the fair value at the original grant date, will be recognized on a straight-line basis over the remaining vesting period. For share-based payments granted subsequent to January 1, 2006, compensation expense, based on the fair value on the date of grant, will be recognized on a straight-line basis over the vesting period.

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2000 Stock Incentive Plan

In March 2000, the Board of Directors adopted and, in June 2000, the stockholders approved, the 2000 Stock Incentive Plan (the 2000 Plan), which permits the grant of incentive and non-qualified options to purchase the Company’s common stock as well as the issuance of restricted shares of common stock. Beginning on January 1, 2001 and continuing through January 1, 2010, the number of shares of common stock reserved for issuance under the 2000 Plan is automatically increased by the lesser of 1,000,000 shares or 4% of outstanding stock on January 1 of each year. As of September 30, 2006, the number of shares of common stock reserved for issuance under the 2000 Plan is 16,000,000 and 2,568,948 shares are available for grant under the 2000 Plan.

The 2000 Plan permits the granting of incentive and non-qualified stock options and stock awards to employees, officers, directors, and consultants of the Company and its subsidiaries at prices determined by the Company’s Board of Directors. Awards of stock may be made to consultants, directors, employees or officers of the Company and its subsidiaries, and direct purchases of stock may be made by such individuals also at prices determined by the Board of Directors. Options become exercisable as determined by the Board of Directors and expire up to 10 years from the date of grant. Awards issued under the 2000 Plan have generally consisted of stock options that vest over a four-year period and are issued with exercise prices equal to the closing market price of the Company’s common stock on the NASDAQ Global Market on the grant date.

On May 31, 2006, the Company granted stock options to its employees to purchase 540,000 shares of its common stock, which vest over one to two years. On June 1, 2006, the Company also granted options to its Board of Directors to purchase 145,000 shares of its common stock, which fully vested on the grant date, and options to the executive officers of the Company to purchase 700,000 shares of its common stock, which vest over a four-year period. All of these grants were issued at exercise prices equal to the closing market price of the Company’s common stock on the NASDAQ Global Market on date of grant.

On May 31, 2006, the Board of Directors granted to the Chief Executive Officer a restricted stock award under the 2000 Plan for 10,000 shares of common stock at a purchase price of $0.01 per share. The restricted common stock is subject to a right of repurchase by the Company, which lapses after one-year. The Company does not intend to exercise its repurchase right to these shares. The closing price of the common stock on May 31, 2006 was $1.57 per share, which is also the weighted average grant date fair value of the restricted stock. The only substantive restriction on the award relates to a one-year service condition. Accordingly, the Company will recognize $16,000 in compensation expense over a one-year period, assuming a 0% forfeiture rate. For the three- and nine-month periods ended September 30, 2006, the Company recognized $4,000 and $5,000, respectively, related to this award.

On June 1, 2006, the Company’s non-employee directors were granted a total of 60,000 shares of common stock under the 2000 Plan at par value, or $0.01 per share. The market value of the common stock on June 1, 2006 was $1.67 per share. There were no restrictions or vesting requirements related to these awards. Accordingly, the Company recognized $100,000 in related compensation expense during the second quarter of 2006.

During the quarter ended September 30, 2006, 154,000 shares were issued to employees under the 2000 Plan on various dates, all of which vest over a four-year period and were issued with exercise prices that were equal to the closing price of the Company’s common stock on the NASDAQ Global Market on the grant date. On August 13, 2006, the Company also granted an additional option to purchase 10,000 shares of its common stock to one of its non-employee directors, which was granted at the closing price on the date of grant and was fully vested on the grant date.

2000 Director Stock Option Plan

In March 2000, the 2000 Director Stock Option Plan (the 2000 Director Plan) was adopted by the Board of Directors and in June 2000, was approved by the stockholders. The 2000 Director Plan provides for the grant of

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non-qualified options to non-employee directors. Awards issued under the 2000 Director Plan are generally as follows: (i) new directors receive an option to purchase 25,000 shares of the Company’s common stock that vest over a four-year period and that are issued with exercise prices that are equal to the closing price of the Company’s common stock on the grant date; and (ii) each director receives an annual grant from the 2000 Director Plan of a stock option to purchase 5,000 shares of the Company’s common stock that vests and becomes exercisable upon the grant date and that is issued with an exercise price that is equal to the closing price of the Company’s common stock on the grant date.

On June 1, 2006, the Company’s non-employee directors received the annual grant of options to purchase a total of 35,000 shares of common stock. During the quarter ended September 30, 2006, no shares were issued under the 2000 Director Plan. As of September 30, 2006, the number of shares of common stock subject to issuance under the 2000 Director Plan is 500,000 and there are 105,000 shares available for grant under the 2000 Director Plan.

2000 Employee Stock Purchase Plan

In March 2000, the Board of Directors adopted and, in June 2000, the stockholders approved, the 2000 Employee Stock Purchase Plan (the ESPP). The Company has reserved 1,000,000 of its shares of common stock for issuance under the ESPP. Eligible employees may purchase shares at 85% of the lower closing market price at the beginning or ending date of the purchase period, as defined. The Company has two six-month purchase periods per year. During the quarter ended September 30, 2006, no shares were issued under the ESPP and there are 670,601 shares available for future purchase under the ESPP.

A summary of stock option activity under the 2000 Plan and the 2000 Director Plan for the nine months ended September 30, 2006 is presented below:

The table below summarizes options outstanding and exercisable at September 30, 2006:

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The aggregate intrinsic value of options outstanding at September 30, 2006 was $182,000, of which $180,000 related to exercisable options. The weighted average grant-date fair values of stock options granted during the nine months ended September 30, 2006 and 2005 were $1.64 and $2.95, respectively. As of September 30, 2006, there was approximately $5,832,000, including the impact of estimated forfeitures, of unrecognized compensation cost related to unvested employee stock option awards outstanding under the 2000 Plan and 2000 Director Plan that is expected to be recognized as expense over a weighted average period of 3.47 years. The intrinsic value of employee stock options exercised during the nine-month periods ended September 30, 2006 and 2005, were $22,000 and $923,000, respectively. The total fair value of vested stock options for the nine-month periods ended September 30, 2006 and 2005 were $180,000 and $7,933,000, respectively.

In determining the fair value of stock options, the Company generally uses the Black-Scholes option pricing model. As discussed below, for stock options with a market performance condition, the Company uses a lattice-based option valuation model. The Black-Scholes option pricing model employs the following key assumptions for option grants.

For the period ended September 30, 2006, the expected term of the options granted was calculated using the “simplified approach,” as outlined in Staff Accounting Bulletin (SAB) No. 107, Share-Based Payment. Using this approach, for grants issued during the three and nine months ended September 30, 2006, the Company assigned an expected term of 6.25 years for grants with four-year graded vesting and 5.5 years for grants with one- and two-year vesting. For the three and nine months ended September 30, 2005, the expected term of the options granted was calculated using an estimate of the expected term as calculated under SFAS 123. The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant.

For the three and nine months ended September 30, 2006, expected volatility is based on the annualized daily historical volatility of the Company’s stock price through the end of the reporting period for a time period consistent with the expected term of a grant. Management believes that the historical volatility of the Company’s stock price best represents the volatility of the stock price. For the three and nine months ended September 30, 2005, the expected volatility of the options granted was calculated using an estimate of historical volatility as calculated under SFAS 123. The Company does not anticipate declaring dividends in the foreseeable future.

The stock price volatility and expected terms utilized in the calculation involve management’s best estimates at that time, both of which impact the fair value of the option calculated under the Black-Scholes methodology and, ultimately, the expense that will be recognized over the life of the option. SFAS 123(R) also requires that the Company recognize compensation expense for only the portion of options that are expected to vest. Therefore, management calculated an estimated annual forfeiture rate that is derived from historical employee termination behavior since the inception of the Company, as adjusted. The estimated annual forfeiture rate calculated and estimated for the third quarter of 2006 is 9.1%. If the actual number of forfeitures differs from those estimated by management, additional adjustments to compensation expense may be required in future periods. The Company does not have a policy to repurchase shares of its common stock upon employee stock option exercises. Further, no such repurchases have been made.

Under SFAS 123(R), the lattice-based model was used to value a limited number of stock options issued in June 2002 that remained unvested as of January 1, 2006, and that contain a market condition. These awards

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accounted for $18,000 and $54,000 of the employee stock-based compensation expense recorded by the Company for the three- and nine-month periods ended September 30, 2006, respectively. The lattice model utilizes assumptions including a 7-year expected life, 2.10% risk-free rate, 116% volatility, and a 0% dividend rate.

The Company recorded a total of $18,000 and $57,000 in compensation expense for the three and nine months ended September 30, 2006, respectively, related to the ESPP. The Company calculated the fair value of shares expected to be purchased under the ESPP using the Black-Scholes model with the following assumptions:

Stock-based compensation for employees for the three and nine months ended September 30, 2006 of $968,000 and $3,007,000, respectively, was calculated using the above valuation models and has been included in the Company’s results of operations. No income tax benefit has been recorded as the Company has recorded a full valuation allowance and management has concluded that it is not likely that the net deferred tax asset will be realized. Based on basic and diluted weighted average shares outstanding of 49,146,609 and 49,012,538, respectively, for the three and nine months ended September 30, 2006, the effect on the Company’s net loss per share of stock-based compensation expense recorded under SFAS 123(R) was approximately $0.02 and $0.06, respectively per share.

The following table shows the pro forma effect on the Company’s net income and net income per share for the three and nine months ended September 30, 2005, had compensation expense been determined based upon the fair value at the grant date for awards consistent with the methodology prescribed by SFAS 123. The pro forma effect may not be representative of expense in future periods since the estimated fair value of stock options on the date of grant is amortized to expense over the vesting period, and additional options may be granted or options may be cancelled in future years:

8. Loss of Subtenant Income

Effective August 15, 2002, the Company sublet 11,980 square feet, or 67%, of the rentable square footage of its facility at 61 Moulton Street, Cambridge, Massachusetts. The original sublease included a contracted rate of $40.00 per square foot through the end of the Company’s lease term of April 30, 2007. In addition to the sublease payments, the subtenant is required to pay its pro rata share of all building operating costs. The sublease income exceeded the Company’s cost of the sublet space so the Company did not record a loss on the lease at the time the Company ceased using the space. During the second quarter of 2006, the Company discontinued use of the remaining 33% of the leased space.

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In July 2005, the subtenant notified the Company that it expected that it would no longer be able to meet its obligations under the sublease. Effective August 1, 2005, the Company amended its sublease agreement to lower the monthly sublease rent payments to an amount equal to the rate the Company must pay through the remainder of the lease term. No other terms of the sublease agreement were changed. In August 2006, the subtenant defaulted on the sublease and vacated the property. The subtenant is attempting to sell its assets and is currently in discussions with various third parties. The Company currently cannot reasonably estimate the likelihood that the subtenant can successfully sell its assets, or if successful, whether the proceeds generated by the sale of the subtenant’s assets would be sufficient to enable the subtenant to satisfy its obligations under the sublease.

In July 2005, the Company estimated that it did not expect to utilize the space for its current or future operations, if vacated by the current tenant due to default of the amended sublease terms. In addition, the Company believes that its costs under the lease will exceed the estimated future sublease income for the duration of the lease. Based on these factors and the expected decline in sublease income, the Company recorded a charge of $500,000 in the “General and administrative expense” line item of its Consolidated Statement of Operations during the second quarter of 2005. The Company increased its estimate to $550,000 in the first quarter of 2006. During the second quarter of 2006, the Company wrote off $93,000 against this reserve, which represented the net book value of the leasehold improvements related to the leased space, which are no longer in use. The Company had originally estimated that the subtenant would pay its obligations, including rent and related facility expenses, through August 31, 2006. As a result of the default by the subtenant on August 1, 2006, the Company increased its reserve by $48,000 in the third quarter of 2006.

During the quarter ended September 30, 2006, $104,000 has been charged against the reserve representing the rent obligations and other related facility expenses incurred by the Company. Accordingly, the remaining $401,000 is included under “Accrued liabilities” within “Current liabilities” in the Company’s consolidated balance sheet as of September 30, 2006. The remaining reserve consists of the Company’s remaining lease obligations and an estimate of other related facility costs through April 2007, as it does not expect to be able to sublet the space for the remaining lease term and cannot reasonably predict the outcome of the subtenant’s efforts to sell its assets and satisfy its obligations under the lease.

9. Basic and Diluted Loss Per Common Share

The Company applies SFAS No. 128, Earnings per Share, which establishes standards for computing and presenting earnings per share. Basic and diluted net loss per share were determined by dividing net loss by the weighted average common shares outstanding during the period. Diluted net loss per common share is the same as basic net loss per common share for all periods presented, as the effect of the potential common stock equivalents is antidilutive due to the Company’s net loss position for all periods presented. Securities consisting of stock options, warrants, shares issuable under the Company’s ESPP and convertible debt outstanding throughout 2005 were excluded from diluted net loss per common share as they were antidilutive under the “if converted” method. Antidilutive securities were 12,680,681 and 12,021,324 as of September 30, 2006 and 2005, respectively.

10. Related Party Transactions

The Company and Joseph M. Davie, Ph.D., M.D., a member of the Company’s Board of Directors, entered into a consulting agreement, which was approved by the Board on August 23, 2006 with an effective date of June 19, 2006, the date on which Dr. Davie commenced the performance of consulting services for the Company as the Interim Chief Scientific Officer. The term of the Agreement is one year from the effective date. Either party may terminate the Agreement by providing thirty days’ written notice to the other party. In consideration for the services rendered by Dr. Davie to the Company, the Company agreed to pay Dr. Davie compensation in the amount of $4,000 per day for each day of consulting work, or $500 per hour for portions thereof, not to exceed an aggregate of $40,000 for the term of the agreement. For the three and nine month periods ended September 30, 2006, the Company had incurred $33,000 in related consulting expenses in its consolidated statement of operations.

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On October 30, 2006, the Company and Dr. Davie entered into an amendment to the consulting agreement, which eliminated the $40,000 cap on aggregate compensation to be paid by the Company to Dr. Davie under the consulting agreement.

On September 14, 2006, the Company and Dr. Davie entered into a Scientific Advisory and Consulting Agreement pursuant to which Dr. Davie agreed to serve as Chairman of the Company’s Scientific Advisory Board (“SAB”). The term of this agreement is for a period of five years. Either party may terminate this agreement by providing thirty days’ written notice to the other party. In consideration for the services rendered by Dr. Davie to the Company, the Company agreed to pay Dr. Davie an annual retainer of $25,000, such retainer to become effective only upon the termination or expiration of the consulting agreement, dated as of June 19, 2006. As of September 30, 2006, the Company had not made any cash payments to Dr. Davie in his role as Chairman of the SAB.

In connection with the SAB agreement, the Board also granted to Dr. Davie an option, pursuant to the 2000 Plan, to purchase 35,000 shares of common stock of the Company at an exercise price equal to $1.72, which was the closing price of the common stock of the Company on the NASDAQ Global Market on the date of grant. These options will vest quarterly over a four-year period.

11. New Accounting Standards

In July 2006, the FASB issued FASB Interpretation (“FIN”) No. 48 “Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement 109”. FIN 48 prescribes a comprehensive model for recognizing, measuring, presenting and disclosing in the financial statements tax positions taken or expected to be taken on a tax return, including a decision whether to file or not to file in a particular jurisdiction. FIN 48 is effective for fiscal years beginning after December 15, 2006. If there are changes in net assets as a result of application of FIN 48, these will be accounted for as an adjustment to retained earnings. The Company expects the adoption of FIN 48 will not have a material impact on its consolidated financial statements.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (SFAS No. 157). SFAS No. 157 establishes a common definition for fair value to be applied to US GAAP guidance requiring use of fair value, establishes a framework for measuring fair value, and expands disclosure about such fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. While the Company is currently evaluating the provisions of SFAS No. 157, the adoption is not expected to have a material impact on its consolidated financial statements.

In September 2006, the SEC staff issued Staff Accounting Bulletin (“SAB”) 108 “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (SAB 108). SAB 108 requires that public companies utilize a “dual-approach” to assessing the quantitative effects of financial misstatements. This dual approach includes both an income statement focused assessment and a balance sheet focused assessment. The guidance in SAB 108 must be applied to annual financial statements for fiscal years ending after November 15, 2006. The Company but does not expect that the adoption of SAB 108 will have a material effect on the Company’s consolidated financial position or results of operations.

12. Subsequent Events

(i) Preclinical payment received from Genentech

On October 2, 2006, Genentech filed an investigational new drug application with the FDA to initiate Phase I clinical testing of a systemically administered small molecule Hedgehog antagonist for the treatment of cancer covered by the Company’s June 2003 collaboration agreement with Genentech. This clinical development objective triggered the payment of $3,000,000 by Genentech, which the Company received on October 6, 2006.

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(ii) Research funding extension from Wyeth

On November 3, 2006, Wyeth exercised its option under the 2004 agreement to extend funding to continue development of therapeutic applications of the Hedgehog agonist with a primary focus on neurological disorders. By exercising this option, Wyeth has agreed to extend the research term by one year through February 9, 2008 (previously February 9, 2007). Under terms of the updated agreement, Wyeth can terminate the relationship within 60 days of written notice. Wyeth has elected to fund five researchers working on the program through the research term.

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Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND  RESULTS OF OPERATIONS

The following discussion of our financial condition and results of operations should be read in conjunction with the condensed consolidated financial statements and the related notes appearing elsewhere in this report.

Overview

We are a therapeutic drug development company focusing on cancer, neurological and dermatological disease indications, with technologies that modulate certain biological pathways that control the growth, repair and regeneration of tissues and organs. Our product development involves the use of small molecules, proteins or antibodies to modulate these pathways, for example by increasing the pathway signals when they are insufficient or by decreasing them when they are up-regulated or unregulated. We have successfully used this technology and product development approach to produce several promising drug product candidates in the fields of cancer (under two collaborations with Genentech, as well as new proprietary cancer programs that target multiple validated cancer pathways), neurological disorders (under collaboration with Wyeth), hair growth (under collaboration with Procter & Gamble), kidney and other diseases (licensed to Ortho Biotech Products and under development at Centocor, both subsidiaries of Johnson & Johnson), as well as cardiovascular disease. We operate in a single reportable segment: developmental biology products. We expect that any successful products would be used in the health care industry and would be regulated in the United States by the U.S. Food and Drug Administration, or FDA, and in overseas markets by similar regulatory agencies.

Since our inception, we have funded our operations primarily through license fees, research and development funding from our strategic collaborators, the private and public placement of our equity securities, debt financings and the monetization of certain royalty rights. We have never been profitable and have incurred an accumulated deficit of $689,564,000 as of September 30, 2006. 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.

In June 2006, we announced the initiation of a new strategic focus seeking to more rapidly develop later-stage drug development programs and to deemphasize our earlier-stage discovery research. As part of this transition, we are winding down certain discovery-stage research activities, such as our spinal muscular atrophy discovery research program, and have initiated development on new mid-preclinical stage cancer drug candidates.

As part of this strategic shift, we have also initiated changes in our scientific leadership. Our current board member, Dr. Joseph Davie, has been serving as interim chief scientific officer and will temporarily oversee our drug programs while also assisting us in our efforts to build a more development-focused scientific team. During the third quarter of 2006, we continued to make progress on building a development-focused company. We augmented our scientific advisory board by adding three recognized leaders in research and clinical development of cancer therapies. We have enhanced our internal chemistry capacity by hiring two Ph.D.-level chemists who are working closely to oversee the work of approximately 20 chemists at a third-party Chinese chemistry provider. We expect to continue building our internal capacities; we are actively seeking a Chief Scientific Officer and expect to begin building a small clinical development group in the near future.

Our research programs are conducted both internally and through strategic collaborations. We recently initiated pre-clinical development on several classes of new proprietary small molecule cancer drug candidates, each of which is designed to target at least one and preferably multiple distinct molecular pathways that are known to be involved in the growth and/or metastasis of various cancers. These new drug programs are currently in preclinical testing and we expect that a significant amount of our research efforts will be aimed at advancing these assets into later preclinical and clinical stages of development. We will seek to progress several classes of compounds simultaneously through preclinical development. Assuming successful preclinical development, we

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expect to select a lead clinical candidate during the first half of 2007 and to file an investigational new drug, or IND, application by the end of 2007 or early 2008. We currently plan to retain ownership of either all or a majority of these drug candidate classes.

In addition to our proprietary cancer programs, we currently have strategic collaborations with Genentech, Procter & Gamble, and Wyeth Pharmaceuticals to develop therapeutics that modulate the signaling of the Hedgehog pathway. We have a second collaboration with Genentech focusing on the discovery and development of small molecule modulators of another signaling pathway. We have licensed our bone morphogenetic protein, or BMP, pathway patent portfolio to Ortho Biotech Products, a subsidiary of Johnson & Johnson, for systemic administration in all non-orthopedic and non-dental therapeutic applications. This program is under development at Centocor, another subsidiary of Johnson & Johnson. In 2005, Centocor entered into a new agreement with us whereby Centocor will fund a portion of a new Curis BMP small molecule screening program.

Our current strategic collaborations and license agreements generally provide for our research, development and commercialization programs to be wholly or the majority funded by our collaborators and provide us with the opportunity to receive additional payments if specified development objectives are achieved, as well as royalty payments upon the successful commercialization of any products based upon the collaboration. These strategic collaboration and license agreements included $18,500,000 in up-front payments, of which we received $6,629,000 from the sale of shares of our common stock, and also include approximately $750,000,000 in contingent cash payments that are tied to future preclinical and clinical development and regulatory approval objectives, assuming that all of the collaborations continue for their full terms, multiple products for multiple indications are developed, and all contingent cash payments are received upon the successful completion of specified research and/or development objectives and regulatory approvals. In the future, we plan to continue to seek corporate collaborators for the further development and commercialization of some of our other technologies.

In some cases, we have retained rights under such programs, including co-development rights and development and commercialization rights in specific therapeutic areas where we believe we can attain additional value through the application of our own internal resources. Examples of retained rights within our programs under collaboration include co-development rights relating to a hair growth product candidate in exchange for a higher royalty rate under our dermatological Hedgehog agonist collaboration with Procter & Gamble, as well as retained rights to our Hedgehog agonist for topical applications, for local delivery in cardiovascular applications and for ex vivo use under our broad Hedgehog agonist collaboration with Wyeth.

Recent Developments

Hedgehog antagonist IND filing: In October 2006, Genentech filed an IND application with the Food and Drug Administration to initiate Phase I clinical testing of a systemically administered small molecule Hedgehog antagonist for the treatment of cancer. Pursuant to the terms of our June 2003 collaboration agreement, Genentech paid us a $3,000,000 after filing the IND application. Should this small molecule drug candidate successfully continue its development into subsequent stages of clinical testing and regulatory approval, we would be eligible for additional cash payments. Should this drug candidate be commercialized, we would also receive royalties on any product sales.

Initiation of new cancer programs: In September 2006, we announced that we are seeking to develop several classes of new proprietary small molecule drug candidates, each of which is being designed to target at least one and preferably multiple distinct molecular pathways. We believe that some of the most effective currently marketed therapies are those that attack cancer from multiple directions simultaneously. Our drugs are being developed as single molecules that preferably target multiple distinct molecular pathways that we believe will provide anti-tumor activity across a broad range of hematological (i.e., blood) and solid tumor cancers.

We anticipate that our multi-targeted pathway inhibitors may improve efficacy, prevent the emergence of drug resistance, and/or decrease the dose-limiting toxicities, possibly by virtue of the ability to reduce dosing

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frequency or amount, and/or avoid adverse drug-drug interactions that can result from the use of multiple chemotherapeutic agents. Further, we believe that these new inhibitors may represent a new paradigm in rational multi-pathway targeting cancer drug development.

These new drug programs are currently in preclinical testing. We will seek to progress several classes of compounds simultaneously through preclinical development. Factors to be considered in prioritizing potential drug candidates include efficacy, pharmacology, patient needs, path to regulatory approval, scale-up of compound synthesis, and freedom to operate. Assuming successful preclinical development, we expect to select a lead clinical candidate during the first half of 2007 and to file an IND application by the end of 2007 or early 2008.

Establishment of Chinese operation: In August 2006, we established a wholly-owned subsidiary in Shanghai, China called Curis Pharmaceuticals (Shanghai) Co., Ltd., or Curis Shanghai. Upon establishment of the subsidiary, we are required by the Chinese government to contribute $2,100,000 to Curis Shanghai, of which the first contribution of $420,000 is due in November 2006. The remaining capital must be funded by August 2008 and we expect to fund Curis Shanghai as needed to meet its obligations. Once capital has been contributed to Curis Shanghai, it will be restricted for use to satisfy only those obligations incurred in China and cannot be transferred back to us. We have not made any payments to Curis Shanghai to date.

We have engaged approximately 20 chemists, through a Chinese third party chemistry provider, to work to advance our multi-targeted pathway inhibitor cancer programs. We anticipate that payments made to the third party chemistry provider will be made by Curis Shanghai from our capital contributions. In the near term, oversight of the medicinal chemistry services that are being conducted by the third party provider will be managed from our Cambridge, Massachusetts location.

As of September 30, 2006, Curis Shanghai was not operational. There were no transactions, including any intercompany transactions, at Curis Shanghai for the quarter ended September 30, 2006. Curis Shanghai has no employees and, currently, we do not plan to hire any subsidiary employees. In the future, we will evaluate whether it would be more advantageous to hire our own scientists and administrative staff in China for the purposes of performing the medicinal chemistry services that are currently provided by the third party provider.

Termination of basal cell carcinoma co-development program: On August 31, 2006, and pursuant to the terms of our June 2003 collaboration agreement with Genentech, we elected to cease our participation in the co-development of a basal cell carcinoma drug candidate. We previously announced that the parties had halted enrollment in the basal cell carcinoma phase I clinical trial and had made a decision not to move forward with the phase I molecule in its current formulation. While data from the phase I trial revealed no significant safety concerns in four weeks of topical treatment, the observed clinical and histological clearance of the basal cell carcinoma was far less than anticipated. The results from a final segment of the study showed that the molecule in its current formulation did not downregulate the targeted pharmacodynamic marker in this tumor, one possible explanation being that the drug candidate did not adequately penetrate human skin. We believe that the Phase I trial was halted due to a formulation/penetration problem and does not call into question the role of the Hedgehog pathway in basal cell carcinoma or other cancers.

Effective as of the August 31, 2006 co-development termination date, Genentech will be solely responsible for all future costs and development decisions regarding the basal cell carcinoma program. Should Genentech determine to proceed with development of a topically administered Hedgehog antagonist for the treatment of basal cell carcinoma, we would be eligible for cash payments on the achievement of certain future clinical development objectives, if any, as well as a royalty on future product sales.

Settlement on amended note payable from Micromet AG: In October 2006, we entered into a court-proposed settlement agreement with Micromet, a former collaborator. In accordance with the settlement, Micromet has

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agreed to repay a note receivable by paying to us €1,000,000, due on November 1, 2006, and €1,000,000, due on May 31, 2007. Should Micromet make the second payment on or before April 30, 2007, the second payment would decrease to €800,000. Using September 30, 2006 currency exchange rates, the total amount Micromet has agreed to pay us is approximately $2,500,000, or $2,300,000 if Micromet elects to prepay the second installment. Future changes in currency exchange rates may increase or decrease the actual amount of U.S. dollars received by us. We received the first payment of €1,000,000, or $1,252,000, on October 17, 2006.

Research funding extension from Wyeth: On November 3, 2006, Wyeth exercised its option under the 2004 agreement to extend funding to continue development of therapeutic applications of the Hedgehog agonist with a primary focus on neurological disorders. By exercising this option, Wyeth has agreed to extend the research term by one year through February 9, 2008 (previously February 9, 2007). Under terms of the updated agreement, Wyeth can terminate the relationship within 60 days of written notice. Wyeth has elected to fund five researchers working on the program through the research term.

Financial Operations Overview

General. Our future operating results will largely depend on the magnitude of payments from our current and potential future corporate collaborators 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 any clinical trials then being conducted. We believe that our existing capital resources at September 30, 2006, together with the payment of all contractually-defined payments under our collaborations and research programs with Genentech, Wyeth, and Procter & Gamble, assuming these programs continue as planned, should enable us to maintain current and planned operations into the second half of 2008. Our ability to continue funding our planned operations into the second half of 2008 is dependent upon the success of our collaborations, our ability to control our cash burn rate and our ability to raise additional funds through equity, debt or other sources of financing. A discussion of certain risks and uncertainties that could affect our liquidity, capital requirements and ability to raise additional funds is set forth below in Part II Item 1A “Risk Factors.”

Revenue. We do not expect to generate any revenue from the sale of products for several years, if ever. Substantially all of our gross revenues to date have been derived from license fees, research and development payments, and other amounts that we have received from our strategic collaborators and licensees, including Genentech, Wyeth, Ortho Biotech Products/Centocor and Procter & Gamble. Our share of the basal cell carcinoma co-development costs have been be recorded as a reduction to any revenue recognized under our collaborations with Genentech in accordance with EITF 01-9 through the termination date of August 31, 2006. We do not expect to record any additional contra-revenues, as we do not expect to incur any additional costs under this co-development program. Since we have opted out of co-development, Genentech will be solely responsible for all development costs subsequent to August 31, 2006, and we would be entitled to cash payments upon the occurrence of certain development objectives and royalties on product sales, if any should occur. In the future, we will seek to generate revenues from a combination of license fees, research and development funding, milestone payments and royalties resulting from the sale of products that incorporate our intellectual property in connection with strategic licenses and collaborations, and sales of any products we successfully develop and commercialize, either alone or in collaboration with third parties. We expect that any revenues 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 our product candidates. These expenses consist primarily of salaries and related expenses for personnel, including stock-based compensation expense for employee share-based payments beginning on January 1, 2006, supplies and reagents, outside service costs including medicinal chemistry, consulting and

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sponsored research collaborations, and occupancy and depreciation charges. We expense research and development costs as incurred. We believe that our research and development expenses will neither increase nor decrease significantly in the short-term. Longer-term changes in these expenses are contingent upon our then-current operating plan.

Except for our Hedgehog systemic small molecule antagonist, all of our programs are in various stages of preclinical drug development. The following table summarizes our primary research and development programs, including the current development status of each program. In the table below, the term discovery means that we are searching for compounds that may be relevant for treating a particular disease area and preclinical means we are seeking to obtain demonstrations of therapeutic efficacy in preclinical models of human disease. IND means that we or our collaborator have filed an IND with the FDA but have not yet initiated Phase I clinical trials.

All of our estimates below regarding planned filing dates for investigational new drug applications for our product development programs are solely our judgments. These estimates may not reflect the beliefs or expectations of our corporate collaborators or licensors, if applicable. Moreover, because of the early stages of development of these programs, our ability and that of our collaborators and licensors to successfully complete clinical and preclinical studies of these product candidates, and the timing of completion of such programs, is highly uncertain.

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Because of the early stages of these programs, the successful development of our product candidates is highly uncertain due to the numerous risks and uncertainties associated with developing drugs, including the uncertainty of:

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. 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 further discussion of some 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 Part II—Item 1A, “Risk Factors.”

General and Administrative Expense. 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. These expenses include stock-based compensation expense for employee share-based payments beginning on January 1, 2006. Other costs include facility costs not otherwise included in research and development expense, insurance, and professional fees for legal, patent and accounting services. We believe that our general and administrative expenses will neither increase nor decrease significantly in the short-term. Longer-term changes in these expenses are contingent upon our then-current operating plan.

Strategic Alliances and License Agreements. Since inception, substantially all of our revenues have been derived from collaborations and other research and development arrangements with third parties. We currently have collaborations with Genentech, Procter & Gamble, Wyeth Pharmaceuticals, and Ortho Biotech Products, as well as a screening program with Centocor. For a detailed discussion of these arrangements, please see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Strategic Alliances and License Agreements” in our annual report on Form 10-K for the year ended December 31, 2005, which is on file with the Securities and Exchange Commission, or SEC. For an update on certain of our programs with Genentech and the SMA program, see “Recent Developments” of this Quarterly Report on Form 10-Q.

Critical Accounting Policies and 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 and judgments include the carrying value of property and equipment and intangible assets, revenue recognition and the value of certain

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liabilities. We base our estimates on historical experience and on various other factors that we believe to be appropriate under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We set forth our critical accounting policies and estimates in our annual report on Form 10-K for the year ended December 31, 2005, which is on file with the SEC. The following sets forth material changes in our critical accounting policies and estimates described therein.

Stock-based compensation. Effective January 1, 2006, we adopted Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (SFAS 123(R)). Prior to the adoption of SFAS 123(R), we followed Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, (APB 25) and related interpretations in accounting for share-based payments and had elected the disclosure-only alternative under SFAS 123, Accounting for Stock-Based Compensation. Accordingly, when options granted to employees had an exercise price equal to the market value of the stock on the date of grant, no compensation expense was recognized in our financial statements. SFAS 123(R) eliminates the ability to account for share-based compensation transactions using APB 25, and generally requires, instead, that such transactions be accounted for using a fair-value-based method.

We have adopted the modified prospective transition method and determined fair value for a majority of our options using the Black-Scholes valuation model. In June 2002, we had granted options to our directors, officers and certain employees that contained a market condition. As of January 1, 2006, 397,500 shares related to these market-condition options remained unvested. SFAS 123(R) requires that awards with market conditions be valued using a lattice model. Accordingly, we measured the fair value of the market-condition options using a lattice model.

We have recorded employee stock-based compensation expense of $968,000 and $3,007,000, respectively, for the three- and nine-month periods ended September 30, 2006. Stock-based compensation expense of $2,000 and $6,000 for the same periods in 2005 was recorded applying APB 25. We are estimating that we will record approximately $3,600,000 to $4,100,000 in stock-based compensation expense under SFAS 123(R) in 2006.

The valuation of employee stock options is an inherently subjective process, since market values are generally not available for long-term, non-transferable employee stock options. Accordingly, an option-pricing model is utilized to derive an estimated fair value. In calculating the estimated fair value of our stock options, we used a Black-Scholes pricing model for a majority of our stock awards and, for a small subset of our awards that contained a market condition, a lattice model as discussed above. Both of these models require the consideration of the following six variables for purposes of estimating fair value:

Of the variables above, we believe that the selection of an expected term and expected stock price volatility are the most subjective. The majority of the employee stock option expense recorded in the three- and nine-month periods ended September 30, 2006 relates to continued vesting of stock options that were granted prior to January 1, 2006. In accordance with the transition provisions of SFAS 123(R), the grant date estimates of fair value associated with prior awards have not been changed. The specific valuation assumptions that were utilized for purposes of deriving an estimate of fair value at the time that prior awards were issued are as disclosed in our prior annual reports on Form 10-K, as filed with the SEC.

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Upon adoption of SFAS 123(R), we were also required to estimate the level of award forfeitures expected to occur, and record compensation expense only for those awards that we ultimately expect will vest. This requirement applies to all awards that are not yet vested, including awards granted prior to January 1, 2006. Accordingly, we performed a historical analysis of option awards that were forfeited prior to vesting, and ultimately recorded total stock option expense that reflected this estimated forfeiture rate. This analysis will be re-evaluated quarterly and the forfeiture rate will be adjusted as necessary. Ultimately, the actual expense recognized over the vesting period will only be for those shares that vest.

Long-term receivables. On October 21, 2004, we amended a note receivable with Micromet, a former collaborator. Under the amended note, Micromet is obligated to pay Curis a total amount of €4,500,000, subject to certain conditions. This note had been fully written down in 2003. We received payments totaling €2,500,000 from Micromet in 2004 and 2005. The remaining €2,000,000 due under the amended note was payable to us upon the achievement by Micromet of certain financing objectives or upon an exit event, as defined in the amended note. We asserted that the conditions precedent to the payment of the remaining €2,000,000 had been achieved through Micromet’s recent merger with CancerVax, a claim that Micromet disputed. As a result, we filed a lawsuit in Germany during the second quarter of 2006.

In September 2006, we agreed to a court-proposed settlement agreement with Micromet to resolve this claim. In accordance with the settlement, Micromet has agreed to pay us €1,000,000, due on November 1, 2006, and €1,000,000, due on May 31, 2007. Should Micromet make the second payment on or before April 30, 2007, the second payment would decrease to €800,000. Using September 30, 2006 currency exchange rates, the total amount Micromet has agreed to pay us is approximately $2,538,000, or $2,284,000 if Micromet elects to prepay the second installment. Future changes in currency exchange rates may increase or decrease the actual amount of U.S. dollars received by us.

In our judgment, the €2,000,000 was not reasonably assured of collection prior to this settlement. We have reevaluated the probability of collection as a result of the settlement of the suit and have concluded that payment of €1,800,000 by Micromet is now probable. Accordingly, we have recorded a receivable in our consolidated balance sheet and related license revenue in our consolidated statement of operations as of September 30, 2006.

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.

Recently Issued Accounting Standards

In July 2006, the FASB issued FASB Interpretation (“FIN”) No. 48 “Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement 109”. FIN 48 prescribes a comprehensive model for recognizing, measuring, presenting and disclosing in the financial statements tax positions taken or expected to be taken on a tax return, including a decision whether to file or not to file in a particular jurisdiction. FIN 48 is effective for fiscal years beginning after December 15, 2006. If there are changes in net assets as a result of application of FIN 48, these will be accounted for as an adjustment to retained earnings. We expect the adoption of FIN 48 will not have a material impact on our consolidated financial statements.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (SFAS No. 157). SFAS No. 157 establishes a common definition for fair value to be applied to US GAAP guidance requiring use of fair value, establishes a framework for measuring fair value, and expands disclosure about such fair value

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measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. While we are currently evaluating the provisions of SFAS No. 157, the adoption is not expected to have a material impact on our consolidated financial statements.

In September 2006, the SEC staff issued Staff Accounting Bulletin (“SAB”) 108 “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (SAB 108). SAB 108 requires that public companies utilize a “dual-approach” to assessing the quantitative effects of financial misstatements. This dual approach includes both an income statement focused assessment and a balance sheet focused assessment. The guidance in SAB 108 must be applied to annual financial statements for fiscal years ending after November 15, 2006. We do not expect that the adoption of SAB 108 will have a material effect on our consolidated financial position or results of operations.

Results of Operations

Three-Month Periods Ended September 30, 2006 and September 30, 2005

Revenues. Total revenues are summarized as follows:

Gross revenues increased primarily as the result of $2,284,000 in license fee revenue recognized as part of a settlement agreement with Micromet on an amended note payable from Micromet due to us. We had written off the corresponding receivable related to this note in prior periods. Research and development contract revenues for the three months ended September 30, 2006 decreased $606,000 primarily due to decreased funding of the Hh antagonist solid tumor program under collaboration with Genentech. Seven researchers were supporting this program for the three-month period ended September 30, 2006 compared to sixteen researchers in the same prior year period. Funding of the research services is tied to the number of researchers supporting the program.

Contra-revenues represent amounts owed for the reimbursement of our equal share of costs incurred by Genentech under our collaboration related to the co-development of a basal cell carcinoma therapeutic product candidate through August 31, 2006. Contra-revenues for the third quarter of 2005 were significantly higher than

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the same period in 2006 due to reduced clinical activity during the third quarter of 2006 as compared to the third quarter of 2005. In addition, we elected to cease our participation in the co-development of this drug candidate as of August 31, 2006, thereby incurring only two months of co-development costs during the third quarter of 2006. Beginning September 1, 2006, Genentech is solely responsible for all future costs and development decisions regarding the basal cell carcinoma program.

Research and Development Expenses. Research and development expenses are summarized as follows:

Our spending in research remained consistent from period to period due to the reallocation of resources to various programs, specifically to discovery programs, and decreases in outside services. Outside medicinal chemistry costs decreased from the prior year period by $360,000 for our cancer program under collaboration with Genentech and by $120,000 for our program under collaboration with Wyeth as product candidates under these two programs advanced beyond the need for further medicinal chemistry. Additional medicinal chemistry may be reinstated on either of these programs in the future.

In addition, we initiated a new internal, mid-preclinical program focusing on multi-targeted inhibitors in the second quarter of 2006. We incurred expenses of approximately $752,000 during the three months ended September 30, 2006 for this program. We also incurred $223,000 during the third quarter of 2006 under our December 2005 BMP small molecule screening agreement with Centocor. The increase in stock-based compensation of $178,000 is primarily a result of the adoption of SFAS 123R on January 1, 2006.

General and Administrative Expenses. General and administrative expenses are summarized as follows:

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The increase in general and administrative expenses of $469,000 for the three-month period ended September 30, 2006 was primarily due to an increase in employee stock-based compensation expense of $639,000 offset by decreased legal services of $256,000 due to decreased patent costs. Consulting and professional services increased $118,000 during the three-month period ended September 30, 2006 as compared to the same prior year period due primarily to specialized tax and audit advice related to the formation of our Chinese subsidiary.

Interest Income. Interest income for the three-month period ended September 30, 2006 was $405,000 as compared to $319,000 for the three-month period ended September 30, 2005, an increase of $86,000, or 27%. The increase in interest income resulted from higher interest rates for the three-month period ended September 30, 2006 as compared to the three-month period ended September 30, 2005.

Other Expense. Other expense for the three-month period ended September 30, 2006 was $179,000. During the quarter ended September 30, 2006, we wrote down the carrying value of our investment in Aegera equity securities from $167,000 to $3,000, recognizing a charge of $164,000. In addition, we sold our Micromet common stock for proceeds totaling $85,000, recognizing a loss of $15,000 during the three-month period ended September 30, 2006. We recorded no other income for the three-month period ended September 30, 2005.

Interest Expense. Interest expense for the three-month period ended September 30, 2006 was $61,000 as compared to $93,000 for the three-month period ended September 30, 2005, a decrease of $32,000, or 34%. The decrease resulted from lower outstanding debt obligations at September 30, 2006 as compared to September 30, 2005.

Nine-Month Periods Ended September 30, 2006 and September 30, 2005

Revenues. Total revenues are summarized as follows:

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Gross revenues increased primarily as the result of $2,284,000 in license fee revenue recognized as part of a settlement agreement with Micromet. Research and development contract revenues for the nine months ended September 30, 2006 were consistent with the same prior year period.

In addition, during 2006 there was a decrease of $250,000 in substantive milestone revenues. During the first quarter of 2005, we achieved a preclinical milestone under our Wyeth collaboration. We did not achieve any such milestones during the third quarter of 2006.

Contra-revenues represent amounts owed for the reimbursement of our equal share of costs incurred by Genentech under our collaboration related to the co-development of a basal cell carcinoma therapeutic product candidate through August 31, 2006. Contra-revenues for the nine months ended September 30, 2005 were significantly higher than the same period in 2006 due to significant preclinical costs that had been incurred by Genentech prior to our election to exercise our co-development option in January 2005. Upon our decision to exercise this co-development option, 50% of such costs were payable by us in the first quarter of 2005. In addition, we elected to cease our participation in the co-development of this drug candidate in the third quarter of 2006 and, as of the August 31, 2006 termination date, Genentech will be solely responsible for all future costs and development decisions regarding the basal cell carcinoma program.

Research and Development Expenses. Research and development expenses are summarized as follows:

The increase of $584,000, or 6%, in research and development expenses in the nine months ended September 30, 2006 was primarily due to an increase in stock-based compensation expense of $638,000. Our spending in research remained consistent from period to period due to the reallocation of resources to various programs, including our new proprietary cancer programs and certain collaborator-funded discovery programs. In addition, our outside service costs decreased, largely due to decreases in medicinal chemistry costs, which decreased from the prior year period by $1,080,000 for our Hedgehog antagonist cancer program under collaboration with Genentech and by $360,000 for our Hedgehog agonist stroke program under collaboration with Wyeth. These decreases resulted from product candidates under these two programs advancing beyond the need for further medicinal chemistry. Additional medicinal chemistry may be reinstated on either of these programs in the future.

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We initiated a new internal, preclinical program focusing on multi-targeted inhibitors in the second quarter of 2006. We incurred expenses of approximately $1,137,000 during the nine months ended September 30, 2006 related to this program. Our spending under our April 2005 discovery collaboration with Genentech increased by $915,000, to $2,145,000 during the nine months ended September 30, 2006, as compared to $1,230,000 for the same period in 2005. We also incurred expenses of $652,000 during the first nine months of 2006 under our December 2005 BMP small molecule screening agreement with Centocor.

General and Administrative Expenses. General and administrative expenses are summarized as follows:

The increase in general and administrative expenses of $2,009,000 for the nine-month period ended September 30, 2006 was primarily due to an increase in stock-based compensation expense of $2,028,000. In addition, legal costs increased $239,000 and professional and consulting services increased $364,000 related to the restatement of our financial statements in the first quarter of 2006 and costs associated with the formation of the Chinese subsidiary. These increases were offset by decreases in personnel costs of $364,000 and lower occupancy costs of $369,000. The decrease in personnel costs relates to executive bonuses incurred in 2005. We also recognized a $500,000 loss in 2005 on an operating lease resulting from the loss of subtenant income.

Interest Income. Interest income for the nine-month period ended September 30, 2006 was $1,173,000 as compared to $862,000 for the nine-month period ended September 30, 2005, an increase of $311,000, or 36%. The increase in interest income resulted from higher interest rates for the period ended September 30, 2006 as compared to September 30, 2005.

Other Income/Expense. Other expense for the nine-month period ended September 30, 2006 was $179,000 as compared to other income of $25,000 for the nine-month period ended September 30, 2005. During the nine-month period ended September 30, 2006, we wrote down the carrying value of our investment in Aegera equity securities, recognizing a charge of $164,000. In addition, we sold our equity investment in Micromet for proceeds totaling $85,000, recognizing a loss of $15,000 for the period ended September 30, 2006.

Interest Expense. Interest expense for the nine-month period ended September 30, 2006 was $200,000 as compared to $264,000 for the nine-month period ended September 30, 2005, a decrease of $64,000, or 24%. The decrease resulted from lower outstanding debt obligations at September 30, 2006 as compared to September 30, 2005.

Liquidity and Capital Resources

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 financings and the monetization of certain royalty rights.

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At September 30, 2006, our principal sources of liquidity consisted of cash, cash equivalents, and marketable securities of $35,187,000, excluding restricted long-term investments of $202,000. Our cash and cash equivalents are highly liquid investments with maturities of three months or less at date of purchase and may consist of time deposits and investments in money market funds with commercial banks and financial institutions, short-term commercial paper, and government obligations. We also maintain cash balances with financial institutions in excess of insured limits. We do not anticipate any losses with respect to such cash balances because the balances are invested in highly rated securities. Our marketable securities are investments with expected maturities of greater than three months, but less than twelve months, and consist of commercial paper, corporate debt securities, and government obligations.

The use of our cash flows for operations has primarily consisted of salaries and wages for our employees, facility and facility-related costs for our office and laboratory, fees paid in connection with preclinical studies, laboratory supplies, consulting fees, and legal fees. In addition, during 2005 and for the nine months ended September 30, 2006, we have incurred significant costs to fund the equal share of our co-development expenses of our basal cell carcinoma product candidate, which is under development with Genentech. On August 31, 2006, we opted out of co-development of the basal cell carcinoma product candidate and Genentech will be solely responsible for all future costs and development decisions regarding the basal cell carcinoma program. For the nine months ended September 30, 2006, we recorded $1,728,000 in contra-revenues at our consolidated statement of operations in connection with these co-development costs. To date, the primary source of our cash flows from operations has been payments received from our collaborators and licensors. In general, our only source of cash flows from operations for the foreseeable future will be up-front license payments from new collaborations, payments for the achievement of milestones if any are met and funded research and development that we may receive under collaboration agreements. The timing of or entrance into any new collaboration agreements and any payments under existing collaboration agreements cannot be easily predicted and may vary significantly from quarter to quarter. We are not currently in any advanced negotiations with new or existing collaborators.

Net cash used in operating activities was $8,183,000 for the nine-month period ended September 30, 2006 as compared to $9,544,000 for the nine-month period ended September 30, 2005. Cash used in operating activities during the nine-month periods ended September 30, 2006 and 2005 was primarily the result of our net loss for the period partially offset by non-cash charges including stock-based compensation, depreciation and non-cash interest expense. In addition, changes in certain operating assets and liabilities offset these increases in operating cash during the nine-month period ended September 30, 2006. Our accounts receivable increased $2,007,000 primarily as a result of our settlement with Micromet, of which $1,252,000 was paid in October 2006. Micromet is obligated to pay an additional €1,000,000 by May 31, 2007, which will be reduced to €800,000 if Micromet pays by April 30, 2007. In addition, our accounts payable and accrued liabilities decreased $1,139,000 primarily as a result of payment of co-development costs incurred under our collaboration with Genentech. As of August 31, 2006, we will no longer be responsible for development costs incurred for a basal cell carcinoma product candidate.

We expect to continue to use cash in operations as we continue to research and develop our product candidates and advance new product candidates into preclinical development. In addition, in the future we may owe royalties and other contingent payments to our licensors based on the achievement of developmental milestones, product sales and specified other objectives. We also expect that the increase in cash used will be partially offset by anticipated payments made under our collaborations with Genentech and Wyeth, assuming these collaborations and research programs continue in accordance with their terms.

Investing activities provided $7,781,000 of cash for the nine-month period ended September 30, 2006 as compared to $7,202,000 in the nine-month period ended September 30, 2005. Cash provided by investing activities resulted principally from $7,861,000 in net investment sales offset by $74,000 in fixed asset purchases for the nine-month period ended September 30, 2006. Cash provided by investing activities resulted principally from $9,470,000 in net investment sales offset by $2,268,000 in fixed asset purchases for the nine-month period ended September 30, 2005.

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Financing activities used $805,000 of cash for the nine-month period ended September 30, 2006, resulting from debt repayments of $925,000 on our notes with the Boston Private Bank & Trust Company and proceeds of $120,000 received upon stock option exercises. Financing activities provided approximately $2,547,000 of cash for the nine-month period ended September 30, 2005, principally resulting from net proceeds of $1,681,000 from the issuance of debt for the purchase of fixed assets and proceeds of $866,000 received upon stock option exercises.

On March 23, 2005, we converted $2,250,000 borrowed under an amended loan agreement with the Boston Private Bank & Trust Company, into a 36-month term note that bears interest at a fixed rate of 7.36% for the repayment period. Under the terms of the note payable, we are required to make equal monthly payments of $62,500 plus any accrued interest beginning on May 1, 2005 extending through the 36-month term. This loan is collateralized by all of our property, plant and equipment assets, except for fixtures and those that are purchased after March 23, 2005 under purchase money arrangements with equipment lenders. On December 9, 2005, we converted $1,450,000 borrowed under a separate loan agreement with the Boston Private Bank & Trust Company, into a 36-month term note that bears interest at a fixed rate of 7.95% for the repayment period. Under the terms of the note payable, we are required to make equal monthly payments of $40,278 plus any accrued interest beginning on January 1, 2006 extending through the 36-month term. This loan is collateralized by any equipment and leasehold improvements financed thereunder. As of September 30, 2006, we were in compliance with the sole covenant under each of the agreements. The covenant requires us to maintain a minimum working capital ratio. Should we fail to pay amounts when due or fail to maintain compliance with the covenant under the agreements, the entire obligation becomes immediately due at the option of the Boston Private Bank & Trust Company.

Since August 2002, we have sublet 11,980 of the 17,600 square feet of our facility at 61 Moulton Street in Cambridge, Massachusetts. Under the terms of our sublease, as amended, we received sublease payments, which totaled approximately $320,000 per year. In addition, we received approximately $50,000 for facilities-related services and a pro-rata portion of the 61 Moulton Street facility overhead, including real estate taxes and utilities. In July 2005, our subtenant informed us that it was terminating approximately 50% of its workforce and that it may encounter difficulties meeting its sublease obligations. In August 2006, the subtenant defaulted on the sublease and vacated the facility. Our lease obligation on our 61 Moulton Street facility extends to April 2007 and our lease obligation from October 2006 to April 2007 is approximately $275,000. As of September 30, 2006, we have $401,000 reflected under accrued liabilities at our consolidated balance sheet consisting of our remaining lease obligations and an estimate of other related facility costs through April 2007, as we do not expect to be able to sublet the space for the remaining lease term.

Pursuant to our co-development arrangement with Genentech, under which we share equally in U.S. development costs and any future net profits and/or losses derived from sales in the U.S. of a therapeutic product candidate for the topical treatment of basal cell carcinoma, we incurred $1,728,000 in development expenses through the nine-month period ended September 30, 2006. On August 31, 2006, we opted out of co-development of the basal cell carcinoma product candidate. Genentech will be solely responsible for all future costs and development decisions regarding the basal cell carcinoma program, and we would be entitled to cash payments upon the occurrence of certain development objectives and royalties on product sales, if any should occur.

In August 2006, we established a wholly-owned subsidiary in Shanghai, China called Curis Pharmaceuticals (Shanghai) Co., Ltd., or Curis Shanghai. Curis Shanghai currently has no employees and the Company does not plan to hire any subsidiary employees for the foreseeable future. The Company currently expects that certain operational aspects, including oversight of the third party chemistry provider, will be managed from the Company’s Cambridge, Massachusetts’ location. It is anticipated that payments made to the third party chemistry provider will be made by Curis Shanghai from the Company’s capital contributions. Upon establishment of the subsidiary, we are required by the Chinese government to contribute $2,100,000 to Curis Shanghai, of which the first contribution of $420,000 is due in November 2006. The remaining capital must be funded by August 2008 and we expect to fund Curis Shanghai as needed to meet its obligations. Once capital has been contributed to

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Curis Shanghai, it will be restricted for use to satisfy only those obligations incurred in China and cannot be transferred back to us. We have not made any payments to Curis Shanghai to date.

We anticipate that existing capital resources at September 30, 2006, together with the payment of all contractually-defined payments under our collaborations and research programs with Genentech and Wyeth, assuming these contracts are not earlier terminated, should enable us to maintain current and planned operations into the second half of 2008. 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 into the second half of 2008 is dependent upon the success of our collaborations, our ability to control 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 anticipate that we will seek 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.

Contractual Obligations

In addition to our loan agreement with Boston Private Bank & Trust Company, we also have contractual obligations related to our facility lease, research services agreements, consulting agreements, and license agreements. The following table summarizes our contractual obligations due by the period indicated at September 30, 2006: