Back to GetFilings.com

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

For the fiscal year ended December 31, 2002

OR

For the transition period from              to             

Commission File Number 0-23223

CURAGEN CORPORATION

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: (203) 401-3330

Securities registered pursuant to Section 12(b) of the Act: None

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

Common Stock, $0.01 par value

Preferred Stock Purchase Rights

(Title of Class)

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

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

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

The aggregate market value of common stock held by non-affiliates of the registrant (without admitting that any person whose shares are not included in determining such value is an affiliate) computed by reference to the price at which the common stock was last sold, or the average bid and asked price of the common stock, as of the last business day of the registrant’s most recently completed second fiscal quarter was $245,138,290.

The number of shares outstanding of the registrant’s common stock as of February 28, 2003 was 49,417,677.

Documents Incorporated by Reference

The registrant intends to file a definitive proxy statement pursuant to Regulation 14A within 120 days of the end of the fiscal year ended December 31, 2002. Portions of such proxy statement are incorporated by reference into Part III of this report.

Table of Contents

CURAGEN CORPORATION

FORM 10-K

INDEX

1

Table of Contents

PART I

Item 1.    Business

The following Business Section contains forward-looking statements, which involve risks and uncertainties. The Registrant’s actual results could differ materially from those anticipated in these forward-looking statements as a result of certain factors. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Certain Factors That May Affect Results of Operations.”

BUSINESS

General

We are a genomics based pharmaceutical development company. We apply our integrated functional genomic technologies and Internet-based bioinformatic systems to discover and develop pharmaceutical products to treat unmet medical needs. Through the application of our proprietary technologies, we are gaining an understanding of how genes and proteins function in the context of disease, and are applying this knowledge to the development of protein, antibody, and small molecule therapeutics.

Our integrated functional genomic technologies are enabling our scientists to conduct research throughout each stage of the drug discovery, drug development and pharmacogenomics screening and evaluation process. We have established internal programs to develop products to treat metabolic diseases, cancer, inflammatory diseases, and central nervous system (“CNS”) disorders.

Our efforts are focused on the development of pharmaceutical products that address unmet medical needs. At each stage of the drug development process, we reevaluate the relative merits of continuing our progress solely through internal efforts or through strategic drug development alliances. By leveraging our knowledge of the human genome, we expect to gain a greater understanding of the molecular basis of disease. And, by combining this comprehensive understanding of disease mechanisms with our functional genomic technologies, Internet-based bioinformatic systems, and industrialized discovery and development processes, we believe we can develop pharmaceutical products with greater efficacy, and fewer side effects and increase the probability that the most appropriate drugs will be administered to patients.

Overview

The large-scale study of genes and genetic information is known as genomics. In recent years, scientists have analyzed large portions of the genetic information contained within the human genome, resulting in a nearly complete set of human genes. The most prominent of these projects was the publicly funded Human Genome Project. Through the study of genomics, scientists seek to understand the molecular basis of disease and to develop more effective treatments than those that are currently available. Historically, the pharmaceutical, animal health and agricultural industries have not used genomic approaches broadly to investigate the molecular basis of disease when developing new products primarily because:

1

Table of Contents

We believe that we have addressed these issues through the application of proprietary technologies to better understand the molecular basis of disease, and we are actively applying this knowledge to discover and develop novel pharmaceutical products. We intend to apply our proprietary genomic technologies to uncover and understand the molecular basis of disease, and we expect to be able to exploit a unique opportunity to develop the next generation of therapeutic products to treat important diseases that are not being adequately addressed by existing therapeutics or treatment regimens.

Many important and complex diseases often arise through a combination of genetic and environmental factors. The successful treatment of such diseases often depends upon an understanding of how the human body interprets its genetic information, how disruptions in this information can lead to disease and, in turn, how drugs can arrest or reverse disease progression. Metabolic diseases, cancer, inflammatory diseases and CNS disorders are examples of such complex diseases. As scientific advances improve our understanding of the molecular basis of many diseases, we believe that the methods used by the pharmaceutical industry to develop new drugs will undergo a fundamental transformation.

Developing successful treatments for complex diseases remains a major technological challenge and will require an integrated set of genomics technologies, processes and information systems. We believe that increased information about gene sequences, variations in gene sequences, gene expression, biological pathways and the proteins affecting these pathways, and about their interplay with drugs and the environment, coupled with information systems that enable the comprehensive understanding of this information, will accelerate drug discovery and development. We have developed our technologies, and related processes and information systems to generate this information and enable our improved understanding, and we are actively applying our knowledge to develop pharmaceutical products.

Our Drug Discovery, Drug Development, and Pharmacogenomic Programs

We are focusing our drug discovery, drug development and pharmacogenomic programs to develop pharmaceutical products to address unmet or insufficiently addressed medical needs, including the need for more efficient and accurate drug target identification and validation and a more systematic means of analyzing the molecular basis of certain diseases and conditions. Our discovery programs focus on identifying and validating drug targets derived from the human genome. We then apply our functional genomics technologies to proprietary research programs to systematically analyze the molecular basis of metabolic diseases, cancer, inflammatory diseases, and CNS disorders, in order to determine their distinct mechanisms of action. Our discovery approach has enabled the rapid identification of a large number of commercially valuable disease-related genes and potential drug targets.

Our scientists analyze human diseases that have the potential to yield protein therapeutics, monoclonal antibodies and small molecule targets, and seek to uncover variations of genes that may predispose or protect individuals from susceptibility, onset, or progression of disease. We are using this knowledge to develop drugs that are potentially safer and more effective than previously made. As part of our internal drug development programs, we also seek patent protection for newly discovered disease-related genes and proteins, as well as for novel uses of known genes and the proteins they encode.

We have expertise in pharmacogenomics, a process of: determining how drugs work and why they fail within the human body; understanding why certain drugs may be unsafe due to adverse side effects that may be associated with a person’s genetic inheritance; and, determining which drugs are appropriate for specific patients. We are using pharmacogenomic studies to find additional drug targets, to understand how current drugs work, to identify potential toxicities, and to prioritize the development of our own drugs.

Drug Discovery Programs

Metabolic Diseases.    Within the field of metabolic diseases, we are analyzing a variety of primary human disease tissues and genetic and cell-based models relating to specific metabolic diseases, including obesity and

2

Table of Contents

adult onset diabetes. We believe that our technologies are well suited to identify the genes and pathways involved in these diseases, which are known to involve errors in cellular communication mechanisms and the regulation of metabolic pathways. To date, we have used our functional genomic technologies to discover genes associated with these diseases and to identify disease-related pathways and additional targets for drug discovery.

Cancer.    Cancer encompasses disease processes of almost every organ system and involves a loss of control in multiple, diverse cellular communication mechanisms and pathway regulation. We are applying our functional genomic technologies to identify the genes and pathways involved in the early development of cancer and its progression to metastatic disease. We have analyzed a number of models of cancer and have identified pathways incorporating proteins common to many of the models. We believe that genes that are highly active in cancerous tissue may be excellent targets for the development of monoclonal antibody drugs.

Inflammatory Diseases.    Although inflammatory diseases such as asthma, osteoarthritis and rheumatoid arthritis are among the most common and chronic, existing drugs have exhibited limited efficacy and debilitating side effects. We are actively identifying and validating potential drug targets associated with these diseases and have filed for patent protection related to discoveries made thus far.

CNS Disorders.    We are currently examining both psychiatric and neurological disorders in order to identify potential targets in these areas. Our efforts combine the understanding of currently marketed drugs with the best human and animal models of the disease. To date, we have studied numerous human tissues, cell lines, animal models and existing drugs with specific action in the CNS and discovered a number of novel genes, pathways and potential targets.

Drug Development Programs

The goal of our drug development programs is to advance promising therapeutic candidates into clinical trials in the United States (“U.S.”) and worldwide, ultimately leading to product registration. We are focusing on developing three broad classes of therapeutics:

Therapeutic Proteins.    In order to determine the therapeutic potential of genes that encode secreted proteins, we have implemented high-throughput protocols for the production, purification and testing of these proteins. We have established high-throughput cell-based assays for characterizing the therapeutic potential of secreted proteins. By using animal models, we are currently evaluating the efficacy of a number of secreted proteins as potential human therapeutics. Proteins that have excellent efficacy and favorable toxicity profiles will be selected as protein drugs for clinical development.

As of December 31, 2002, our scientists have elected approximately 60 potential protein therapeutic projects and are now focused on advancing 20 of these projects that have been given the highest priority. Five of these proteins have been validated in relevant cellular assays and on March 3, 2003, the U.S. Food and Drug Administration (“FDA”) approved our Investigational New Drug (“IND”) application to initiate clinical trials for one of these five proteins, CG53135 (or FGF20), a potential protein therapeutic being investigated as a treatment for oral mucositis. Oral mucositis is a side effect of chemotherapy and radiotherapy that results in the degradation of mucosal tissue that can range from redness and irritation to severe ulcerations of the mouth and throat. We now plan to proceed with a multi-center Phase I clinical trial during April 2003, to evaluate safety and pharmacokinetics in patients with cancer who are at risk for mucositis following chemotherapy.

Therapeutic Antibodies.    We are employing a genomics based approach for the development of monoclonal antibody therapeutics. We have identified genes that make suitable targets for monoclonal antibody

3

Table of Contents

therapy, may be associated with disease, and on which we have filed patent applications. These proteins are used to make fully human monoclonal antibodies by Abgenix, Inc. (“Abgenix”). Antibodies are naturally occurring proteins used by the body’s immune system to combat many diseases. As therapeutic products, antibodies have several potential advantages over other therapies. The highly specific interaction between an antibody and its target may, for example, reduce unwanted side effects that may occur with the use of other therapies. Fully human antibodies are desirable because they reduce the risk of rejection by the human body that is present with mouse or partially “humanized” antibodies.

We have an alliance with Abgenix to create fully human monoclonal antibodies against targets that we have identified (see “Strategic Research and Development Alliances”). We will be jointly and systematically testing human monoclonal antibodies for efficacy in human cells and animal models of disease. We intend to select human monoclonal antibodies that demonstrate excellent efficacy combined with a favorable toxicity profile as antibody drugs for clinical development.

As of December 31, 2002, we have selected approximately 90 antibody targets with Abgenix. This collaboration has produced fully human monoclonal antibodies against 28 of these targets, six of which have been validated in relevant cellular assays. In early January 2003, we contracted with Abgenix for the clinical manufacture of CR002, the first antibody that we selected to develop as a CuraGen product from the Abgenix collaboration. We expect to advance CR002 into clinical trials during 2004 as a potential treatment for kidney disease.

Small Molecule Therapeutics.    We are also applying our expertise in genomics and knowledge of disease to develop small molecule therapeutics. Specifically, we are identifying and validating drug targets for use in small molecule drug development. We currently do not have expertise in combinatorial and medicinal chemistry. We have entered into an alliance with Bayer AG (“Bayer”) to develop small molecule drugs in the areas of obesity and adult onset diabetes (see “Strategic Research and Development Alliances”). Bayer is screening targets identified by us against its compound library and developing promising leads into pre-clinical candidates. Therefore, we continue to seek alliances similar to our Bayer alliance that will provide us access to this expertise, in exchange for sharing the profits on therapeutics that may be developed as a result of these alliances.

The therapeutic candidates that show superior efficacy will be further evaluated using our pharmacogenomics technologies. We contribute to clinical development costs and are sharing the profits on therapeutics that may be developed as a result of this alliance.

As of December 31, 2002, our scientists and Bayer have elected approximately 60 small molecule projects, conducted screening on 20 of these, and advanced nine into chemical optimization and proof-of-principle experiments.

Pharmacogenomic Programs

Using our functional genomic technologies, the tissues targeted by a drug, as well as the organs that might exhibit side effects, including liver, heart, and kidney, can be studied in animal models thought to be indicative of human response. We believe that this information may help us and other pharmaceutical companies select and optimize drug candidates based on improved efficacy and reduced side effects. We further believe that this information will help the pharmaceutical industry to significantly reduce the time and cost of drug development. For drugs already on the market, an understanding of the mechanism of action through pharmacogenomics can help identify appropriate patient populations and lead to an improved second generation of drugs.

We have analyzed drugs whose commercial viability or clinical indications are threatened either by a lack of understanding of how they work within the human body, the mechanism of action, or by severe side effects. Our goal is to continue to generate data to provide pharmacology and toxicology information, to understand the mechanism of drug action, to identify patient populations that are likely to respond favorably to a particular medication and, potentially, to identify new indications or more optimal targets.

4

Table of Contents

In September 2002, we introduced the Predictive Toxicogenomics Screen (“PTS”), which is a technology that is potentially capable of predicting a drug compound’s toxicity by testing very small quantities of compounds, such as the quantities that are available after high-throughput drug screening. In collaboration with Bayer, our scientists tested the PTS technology by evaluating more than 150 preclinical drug compounds and ranking these compounds according to their potential for toxicity.

This unique technology was developed by analyzing more than 100 known toxic compounds and identifying specific marker genes whose activity correlates with known forms of liver toxicity. These marker genes have been affixed to gene expression microarrays (chips) for use in high-throughput comparative analysis. By comparing the gene expression of cells exposed to small quantities of compounds that are in development against these gene markers of toxicity, scientists are potentially able to rank-order tested compounds based upon their potential for toxicity. The resulting information can be used to aid scientists in determining which compounds have the highest likelihood for success in clinical development.

In addition to understanding the genes that respond to drug treatments we are linking these genes to our database containing thousands of human genetic variations, or single nucleotide polymorphisms (“cSNPs”). The discovery of cSNPs that have a role in drug efficacy or toxicity may be of tremendous value in personalizing medicine at the genetic level to the extent that researchers or physicians may use them to:

To date, we have identified thousands of cSNPs in potential drug targets and drug response genes.

Strategic Research and Development Alliances

As part of our business strategy, we seek to establish strategic research and development alliances with companies to gain access to expertise that is currently unavailable to us. We expect that these alliances with other pharmaceutical and biotechnology companies may provide us with access to unique technologies, capital, near term revenues, milestone and/or royalty payments, and potential profit sharing arrangements. In return, we provide access to unique technologies, expertise in genomics, and information on the molecular basis of disease, drug targets, and drug candidates. To date, we have entered into significant strategic alliances with Abgenix and Bayer, in addition to numerous smaller agreements to facilitate these efforts. In these strategic alliances, either party can terminate the agreement at any time the alliance permits them to or if either party materially breaches the contract. We may not be able to maintain or expand existing alliances or establish any additional alliances.

If any of our existing alliance partners were to breach, terminate or not renew their agreements with us or otherwise fail to conduct activities successfully and in a timely manner, the preclinical or clinical development or commercialization of product candidates or research programs may be delayed or terminated.

Abgenix

In December 1999, we entered into a strategic alliance with Abgenix to develop and commercialize genomics based antibody drugs using Abgenix’ XenoMouse^™ technology. This five-year alliance was established initially to identify up to 120 fully human antibody drug candidates intended for treating a broad range of complex diseases including cancer and autoimmune disorders. Antibodies determined to have commercial product potential will be allocated between the parties for further development. We will reciprocate milestone and royalty payments with Abgenix for products resulting from this drug development alliance. In addition, under the agreement, Abgenix purchased 837,990 shares of our common stock at a price of $17.90 per share for $15.0 million through a private placement.

5

Table of Contents

In November 2000, we expanded our alliance with Abgenix to develop and commercialize up to 250 fully human antibody drug candidates across all disease areas. As part of this expanded alliance, Abgenix purchased an additional 1,441,442 shares of our common stock at a price of approximately $34.69 per share for $50.0 million in a private placement.

Bayer

In January 2001, we signed two comprehensive drug discovery, evaluation, development, and co-commercialization agreements with Bayer. As part of these agreements, Bayer purchased 3,112,482 shares of our common stock at a price of approximately $27.31 per share in a private placement totaling $85.0 million.

The first agreement is a comprehensive alliance to discover, develop, and jointly commercialize small molecule drugs to treat obesity and adult onset diabetes. We are to provide 80 drug targets over the first five years of the collaboration, as well as grant access to our comprehensive suite of functional genomic technologies, bioinformatics and pharmacogenomic expertise to select, prioritize and ensure that the resulting drugs are administered to the appropriate patients. Bayer will utilize its high-throughput screening, combinatorial chemistry, medicinal chemistry, pharmacology, and development expertise to develop small molecule compounds against the targets supplied by us. We will share expenses with Bayer related to later stage preclinical and clinical compound development, and both companies anticipate bringing 12 candidates in obesity and diabetes to clinical development. Both parties will jointly fund the relevant research, development and commercialization activities up to $1.34 billion over a 15-year period. Ultimately, we will jointly commercialize drugs resulting from this alliance with Bayer, and then share profits 56% to Bayer and 44% to us. Under the termination provisions in the agreement, either party can terminate upon breach of contract or if there is a change in corporate control, upon providing 30 days written notice to the other party.

The second agreement is a broad, five-year pharmacogenomic and toxicogenomic collaboration. We will apply our functional genomic technologies and pharmacogenomics expertise to evaluate Bayer’s developmental and preclinical pipeline of pharmaceutical compounds across all disease areas. Through the efforts of this collaboration, we and Bayer expect to reduce drug development costs, reduce the time to market, and create safer and more efficacious drugs. In addition, we and Bayer intend to compile a database of gene-based markers and information that will enable scientists to predict potential drug toxicities, understand how particular drugs work, and identify new disease indications. Both parties have exclusive rights to use the established database; however, we have the right to externally market toxicity screening services, which incorporate information from this database and give rise to royalties payable to Bayer on the resulting revenues. During the later stages of this collaboration, Bayer has an option to negotiate a technology transfer agreement. During years one and two, the collaboration generated approximately $14.0 million in revenue from completion of the set-up phase and initiation of the production phase. In accordance with the terms and conditions of the collaborative agreement, the maximum amount of remaining production phase funding is approximately $25.0 million, which may be adjusted during the production phase, but will in no event generate less than $12.0 million in revenues over the remaining term of the agreement. Under the termination provisions in the agreement, either party can terminate at any time upon mutually agreeing to do so, or after 30 days written notice of breach of contract. Under the termination provisions in the agreement, either party can terminate at any time upon mutually agreeing to do so, or after 30 days written notice of breach of contract.

Other

In addition to the above listed alliances, we have smaller, ongoing collaborative relationships with Alexion Pharmaceuticals, Altria Group, Inc. (formerly Philip Morris USA), Genentech, Inc., Mitsubishi Pharma Company, Ono Pharmaceuticals, Pfizer, Inc. and Sequenom, Inc. We have also established relationships with more than 100 universities, academic institutions, and individual companies to gain access to disease tissue samples, disease models, and select technologies. Individually, we do not consider these relationships to be of a material nature, but as a group they form an important component of our business. We have also successfully

6

Table of Contents

conducted research with, and have the potential to receive future milestones and royalties from companies including Biogen, Inc., DuPont/Pioneer Hi-Bred International, Inc., GlaxoSmithKline, Inc., Hoffmann-La Roche Inc. and its affiliate, Roche Vitamins, Inc., Millennium Pharmaceuticals, Inc. (formerly COR Therapeutics, Inc.), and Monsanto Company. Refer to Note 4 of our consolidated financial statements for revenue information on major collaborators.

Integrated Functional Genomic Technologies

Our Internet-enabled functional genomic technologies, processes and information systems are fully integrated through a bioinformatics operating system that enables the rapid generation of comprehensive information about gene and protein function and about their interactions with drugs, the environment, and diverse patient populations.

Our genomic technologies, processes and information systems are designed to overcome significant technological limitations present in existing gene-based drug discovery and development methods. Our technology platform rapidly generates comprehensive information about gene sequences, variations in gene sequences, gene expression, biological pathways and the proteins affecting these pathways, and information about their interplay with drugs, the environment and diverse patient populations. Our technology platform has been used by our collaborators and ourselves to analyze many diseases and has led to the discovery of a number of disease-related genes, drug targets and potential drugs.

Drug Target Identification, Qualification, and Validation

Our gene sequencing technology generates comprehensive sequence databases of expressed genes from any species and is used to identify cSNPs. Our gene expression technology measures substantially all of the differences in gene expression levels between biological samples in order to discover disease-related genes and to measure their activity. Specifically, we designed our gene discovery and analysis technologies to:

The combination of these traits enables us to rapidly generate large databases of gene expression profiles. These technologies also permit us to pursue research programs for many disease systems and systematically process many samples in parallel. As a result, we are able to discover and seek patent protection for many commercially valuable disease-related genes and gene products.

We have developed our proprietary technologies to reduce the time and cost associated with the identification and functional understanding of targets for therapeutic intervention. Genes identified through the application of our technologies may potentially act as drug targets. Our protein pathway analysis technology is an automated, high-throughput process that identifies interactions between combinations of proteins and assembles these protein-protein interactions into our proteomics database. By identifying such protein-protein interactions and comparing them with known pathways within the proteomics database, we can determine the role of these proteins within a given biological pathway. We have designed our proteomic technologies to permit disease-related genes to be linked rapidly to specific biological pathways, providing valuable information that can lead to the discovery of new genes and additional targets for therapeutic intervention.

Once potential drug targets are identified, we apply technologies and processes to qualify and validate the discoveries as actual drug targets. To accomplish these, we have industrialized a series of “wet” biology approaches that include gene analysis across human disease tissue samples, cellular and biochemical assays, and in vitro and in vivo models of disease. Each of these processes further characterizes the drug targets, and provides scientists with a greater insight into their biological role.

7

Table of Contents

Pharmacogenomics, Pharmacogenetics, and Toxicogenomics

In addition to accelerating the discovery of new drug candidates, we are also using our technologies to predict the efficacy and safety of drug candidates currently in pharmaceutical development pipelines, and to review the performance and side effects of drugs already being marketed. This approach, referred to as pharmacogenomics, is aiding in the development of more effective and safer drugs. When this approach focuses exclusively on drug toxicity, it is referred to as toxicogenomics. Pharmacogenomics can also potentially be utilized to identify more appropriate patient populations for use in clinical drug studies.

Our functional genomic technologies can also be used in preclinical and clinical trials to predict which drugs are more likely to be effective by analyzing gene expression changes induced by drug treatment in humans and animal models. We have generated gene expression databases for numerous drugs already on the market to accelerate the development of an improved generation of drugs with fewer side effects and to assist in the selection of appropriate patient populations. By correlating gene expression levels and the activities of biological pathways following treatment with specific drugs, we may be able to minimize the side effects of drugs, to identify appropriate patient populations for existing drugs and to aid in the development of safer and more effective drugs. In addition, we use our gene sequence database to identify cSNPs in genes that respond to drugs, and can use these variations for identifying the most appropriate patients for a specific drug treatment.

Technology Integration and Information Systems (Our GeneScape Bioinformatics Platform)

We have integrated our functional genomic technologies, processes and databases through a computer operating system that we refer to as the GeneScape bioinformatics platform, which tracks and analyzes data and integrates all aspects of process management, data analysis and visualization. GeneScape is also a web-based portal that provides simultaneous, real-time access to our technologies, systems, databases and bioinformatics to researchers at multiple sites, allowing them to work together on discovery and development projects. We plan to continue enhancing the functionality and integrating additional technologies on our GeneScape operating platform.

We designed GeneScape to meet the needs of researchers using a single operating system, which integrates research requests, project management, database access and data analysis and visualization. GeneScape provides the user with a web-based standardized interface to our processes and databases, operating over the Internet on any computer platform that supports a standard web browser. By providing simultaneous, real-time access to our technologies, systems and databases to researchers at multiple sites, GeneScape is a powerful tool that permits researchers to work together on discovery and development projects. These technologies can be used alone or in concert in discovery efforts as well as preclinical and clinical trials to predict which drugs are more likely to succeed by analyzing gene expression changes induced by drug treatment in humans and animal models. As GeneScape is modular and may be expanded to incorporate other technologies, systems and databases, we intend to continually enhance this technology platform by adding additional technologies as they become applicable.

Technology Subsidiary

In June 2000, we announced the formation of 454 Corporation (currently doing business as 454 Life Sciences) (“454”), a 60%-owned subsidiary established to develop novel technologies for rapidly and comprehensively analyzing entire genomes. The technologies being developed at 454 are expected to have broad applications in industrial engineering, agriculture, animal health, and human health care including drug discovery and development, and disease diagnosis. This subsidiary was funded primarily with $40.0 million from investors including ourselves, Soros Fund Management, L.L.C., Cooper Hill Partners, L.L.C, and members of our senior management team.

The operations of 454 are run by a separate management team and governed by a Board of Directors made up of members of our management team and Board of Directors. Over the last two and a half years, 454 has made significant progress in developing technologies to rapidly sequence entire genomes. In August 2002,

8

Table of Contents

454 successfully sequenced a viral genome on their technology platform. As this new technology is refined and its applications across the life sciences industry become more apparent, we anticipate that 454 will positively impact our overall corporate valuation.

Competition

We currently face, and will continue to face, intense competition from one or more of the following entities:

We are also subject to significant competition from organizations that are pursuing technologies and products that are the same as or similar to our technology and products. Many of the organizations competing with us have greater capital resources, research and development staffs and facilities and marketing capabilities. In addition, research in the field of genomics generally is highly competitive. Our competitors in the genomics area include:

A number of our competitors are attempting to rapidly identify and patent genes and gene fragments sequenced at random, typically without specific knowledge of the function of such genes or gene fragments. If our competitors discover or characterize important genes or gene fragments before we do, it could adversely affect any of our related disease research programs. We expect that competition in genomics research will intensify as technical advances are made and become more widely known. The competition listed above was selected based upon identifying those companies that we feel have business models that are similar to ours.

Intellectual Property

Our business and competitive position depend on our ability to protect our genomic technologies, gene sequences, products, information systems and proprietary databases, software and other methods and technology. We continually file patent applications for our proprietary methods and devices for sequencing, gene expression analysis, discovery of biological pathways and drug screening and development. As of the date of this report, we had approximately 900 patent applications pending covering genes and gene transcripts, as well as for our technologies, discoveries and products with the United States Patent and Trademark Office (“USPTO”), as well as numerous corresponding international and foreign patent applications. As of the date of this report, we had been issued 38 patents with respect to aspects of our technologies, discoveries and products with expiration dates extending from 2015 onward.

In 2001, the USPTO issued new guidelines for patent applications reflecting the USPTO’s current policy regarding statutory written description and utility requirements for patentability. The implementation of these new guidelines may cause the USPTO initially to reject some of our pending new gene and protein patent applications. Although we believe that we will overcome such rejections to any of our new gene and protein

9

Table of Contents

cases, there is no guarantee that the USPTO will approve them. We strive especially to gain issued patents for our commercially important genes and proteins. The new guidelines are not expected to impact pending cases directed to technology platforms.

CuraGen^®, GeneScape^®, GeneCalling^®, SeqCalling^™, PathCalling^®, HitCalling^™, SNPCalling^™, CuraTools^®, CuraMap^®, CuraChip^™, PTS^™, Predictive Toxicogenomics Screen^™ and other trademarks of CuraGen Corporation mentioned in this report are the property of CuraGen Corporation. All other trademarks or trade names referred to herein are the property of their respective owners.

Government Regulation

Prior to the marketing of any new drug developed by us, or by our collaborators, that new drug must undergo an extensive regulatory approval process in the United States and other countries. This regulatory process, which includes preclinical and clinical studies to establish a compound’s safety and efficacy, can take many years and require the expenditure of substantial resources. Data obtained from such studies are susceptible to varying interpretations that could delay, limit or prevent regulatory approval. The rate of completion of clinical trials is dependent upon, among other factors, the enrollment of patients. Patient recruitment is a function of many factors, including the:

We have received FDA approval to conduct clinical trials for CG53135, a potential protein therapeutic for the treatment of oral mucositis in cancer patients that are undergoing chemotherapy and radiotherapy. None of our product candidates have been approved for commercialization in the United States or elsewhere. We, or any of our collaborators, may not be able to conduct clinical testing or obtain the necessary approvals from the FDA or other regulatory authorities for some products. Failure by us, or our collaborators, to obtain required governmental approvals will delay or preclude our collaborators or us from marketing drugs or diagnostic products developed with us or limit the commercial use of such products and could have a material adverse effect on our business, financial condition and results of operations.

Our research and development activities involve the controlled use of hazardous materials, chemicals and controlled substances. We are subject to federal, state and local laws and regulations governing the acquisition, use, storage, handling and disposal of such materials and certain waste products.

Available Information

We were incorporated in Delaware in November 1991. Our principal executive offices are located at 555 Long Wharf Drive, 11th Floor, New Haven, Connecticut 06511. Our telephone number is (203) 401-3330. We maintain a web site on the Internet at http://www.curagen.com. Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports, are available to you free of charge through the Investor Relations section of our website as soon as reasonably practicable after such materials have been electronically filed with, or furnished to, the Securities and Exchange Commission (“SEC”). These documents are also available in the SEC’s Public Reference Room.

Employees

As of December 31, 2002, we and 454 had 403 full and part-time employees, 173 of whom hold Ph.D., M.D. or J.D. degrees. Our employees include engineers, physicians, molecular biologists, chemists, lawyers and

10

Table of Contents

computer scientists. We believe that we maintain good relationships with our employees. We believe that our future success will depend in large part on our ability to attract and retain experienced and skilled employees.

Seasonality

Our business is not subject to any material fluctuations based on the season of the year.

Item 2.    Properties

We maintain our principal administrative offices along with research facilities at locations in both Branford and New Haven, Connecticut. We lease a total of approximately 146,000 square feet at all locations. The leases are for terms of two to six years, and generally provide renewal options for terms of up to five years. Our plans to construct a new corporate headquarters and protein production facility in Branford have been deferred indefinitely, pending improvements in the external financing environment which would afford us the ability to finance the future construction costs. We believe that our facilities are adequate for our current operations or that suitable additional leased space will be available as needed.

Item 3.    Legal Proceedings

We are not currently a party to any material legal proceedings.

Item 4.    Submission Of Matters To A Vote Of Security Holders

No matters were submitted to a vote of our security holders during the quarter ended December 31, 2002.

11

Table of Contents

PART II

Item 5.    Market For Registrant’s Common Equity And Related Stockholder Matters

Market Information

Our common stock is traded on the Nasdaq National Market under the symbol “CRGN”. The following table sets forth, for the periods indicated, the low and high closing prices per share for our common stock, as reported by the Nasdaq National Market:

On February 28, 2003, the closing price of our common stock on the Nasdaq National Market was $3.43 per share.

Stockholders

As of February 28, 2003, there were approximately 237 shareholders of record of our common stock and, according to our estimates, 11,662 beneficial owners of our common stock.

Dividends

We have never paid cash dividends on our common stock and do not anticipate declaring any cash dividends in the foreseeable future. We currently intend to retain earnings, if any, to finance the development of our business.

12

Table of Contents

Item 6.    Selected Financial Data

The selected consolidated financial data set forth below for each of the three years in the period ended December 31, 2002 are derived from our consolidated balance sheets as of December 31, 2002 and 2001 and the related audited consolidated statements of operations, of stockholders’ equity and of cash flows for each of the three years ended December 31, 2002, 2001 and 2000 and notes thereto, which are included elsewhere in this report. The consolidated balance sheet data as of December 31, 2000, 1999 and 1998 and the consolidated statements of operations data for each of the two years in the periods ended December 31, 1999 and 1998 have been derived from our related financial statements. The selected consolidated financial data set forth below should be read in conjunction with, and are qualified by reference to, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our audited consolidated financial statements.

Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

We are a genomics based pharmaceutical development company. We apply our integrated functional genomic technologies and Internet-based bioinformatic systems to discover and develop pharmaceutical products to treat unmet medical needs. We use this information to develop protein, antibody, and small molecule therapeutics to treat metabolic diseases, cancer, inflammatory diseases, and central nervous system disorders. We are developing protein drugs on our own behalf. We have established a strategic alliance with Abgenix, Inc. (“Abgenix”) to develop antibody drugs across all diseases areas, and have established a strategic alliance with Bayer AG (“Bayer”) to develop small molecule drugs to treat obesity and adult onset diabetes. We are currently pursuing additional alliances to develop small molecule drugs across other disease areas.

We were incorporated in November 1991 and, until March 1993, were engaged primarily in organizational activities, research and development of our technologies, grant preparation and obtaining financing. We have incurred losses since inception, principally as a result of research and development and general and administrative expenses in support of our operations. We anticipate incurring additional losses over the next

13

Table of Contents

several years as we focus our resources on prioritizing, selecting and rapidly advancing our most promising drug candidates. We expect that losses will fluctuate from quarter to quarter and that such fluctuations may be substantial.

Our ability to earn revenues and become profitable is dependent primarily on our ability to successfully develop and commercialize pharmaceutical products based upon our expertise in genomics, our technologies, and our drug discovery and development programs. Accomplishing this goal also depends in part on our ability to maintain our existing strategic alliances with Abgenix and Bayer, and on our ability to establish new alliances to aid us in developing and commercializing small molecule therapeutics. We cannot guarantee that any such strategic alliances, either new or existing, will be successful. We have also established a majority-owned subsidiary, 454 Corporation (currently doing business as 454 Life Sciences) (“454”), to develop novel technologies for rapidly and comprehensively analyzing entire genomes. We expect that 454 will commercialize these products upon their development, which may be a future source of revenues for us.

Our failure to successfully develop and market pharmaceutical products over the next several years would materially adversely affect our business, financial condition and results of operations. Royalties or other revenue generated from commercial sales of products developed through the application of our technologies and expertise are not expected for several years, if at all.

The 2001 and 2000 consolidated financial statements have been reclassified to conform to the classifications used in 2002. All dollar amounts in tabular presentations are shown in thousands.

Critical Accounting Policies

The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amount of assets and liabilities, revenues and expenses and as such, actual results may differ from these estimates under different assumptions or conditions.

While our significant accounting policies are more fully described in Note 1 to our consolidated financial statements, we believe the following to be our critical accounting policies:

Revenue Recognition—We have entered into certain collaborative research agreements that provide for the partial or complete funding of specified projects in exchange for access to, and certain rights in, the data discovered under the related projects. Revenue is recognized based upon defined metrics of completion that include percentage of completion milestones, and project specific initiatives as defined in each of the respective research plans. The defined metrics are reviewed internally each month to determine the work performed and the appropriate revenue to be recognized. We have also entered into a collaborative research exchange agreement in which services and technology access are exchanged between the collaborative partner and us. Revenues and expenses under this exchange agreement include the fair value of the work performed by each collaborative partner. Deferred revenue arising from payments received from collaborative research agreements is recognized as income when earned.

Cash and Investments—We consider investments readily convertible into cash, with an original maturity of three months or less, to be cash equivalents. Investments with an original maturity greater than three months but less than one year are considered short-term investments. The carrying amount of these investments approximates fair value due to their short maturity. Investments with an original maturity greater than one year are designated as marketable securities, are classified as available-for-sale securities, and are carried at fair value with the unrealized gains and losses reported in stockholders’ equity under the caption “Accumulated Other Comprehensive Income”. The cost of debt securities is adjusted for amortization of premiums and accretion of discounts to maturity. Interest on debt securities, amortization of premiums and accretion of discounts are included in interest income.

14

Table of Contents

Impairment of Long-Lived Assets—We regularly evaluate the recoverability of the net carrying value of our property, and intangible assets, when an indicator of impairment is present by comparing the carrying values to the estimated future undiscounted cash flows and fair value of the long-lived asset. An impairment loss is recognized when the carrying value of the long-lived asset exceeds its undiscounted future cash flows and its fair value. The impairment write-down would be the difference between the carrying amounts and the fair value of these long-lived assets. A loss on impairment would be recognized by a charge to earnings.

Patent Application Costs—Costs incurred in filing for patents are charged to operations, until such time as it is determined that the filing will be successful. When it becomes evident with reasonable certainty that an application will be successful, the costs incurred in filing for patents will begin to be capitalized. Capitalized costs related to successful patent applications will be amortized over a period not to exceed twenty years or the remaining life of the patent, whichever is shorter, using the straight-line method.

Stock-Based Compensation—In October 1995, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”), which was effective for us beginning January 1, 1996. SFAS 123 requires expanded disclosures of stock-based compensation arrangements with employees and non-employees and encourages (but does not require) compensation cost to be measured based on the fair value of the equity instruments awarded to employees.

In December 2002, the FASB issued Statement of Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure”, an Amendment of SFAS 123 (“SFAS 148”). SFAS 148 permits two additional transition methods for entities that voluntarily change to the fair value based method of accounting for stock based compensation. In addition, SFAS 148 amends the disclosure requirements of SFAS 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock based employee compensation and the effect of the method used on reported results. SFAS 148 became effective for financial statements issued after December 15, 2002. Companies are permitted to continue to apply Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”), which recognizes compensation cost based on the intrinsic value of the equity instruments awarded. We will continue to apply APB 25 to our stock-based compensation awards to employees.

Results of Operations

Years Ended December 31, 2002 and 2001

Revenue.    Collaboration revenue for the year ended December 31, 2002 was $18.2 million, a decrease of $5.3 million, or 23%, as compared to $23.5 million for the corresponding period in 2001, reflecting our current business strategy to establish strategic research and development alliances with companies, rather than focusing on shorter term service based collaborations. Therefore, the decrease in collaboration revenue from 2001 to 2002, was primarily due to the completion in 2001 of the service based collaborations with GlaxoSmithKline, Inc. (“GSK”), Hoffmann-La Roche Inc. and its affiliate, Roche Vitamins, Inc (“Roche”) and Millennium Pharmaceuticals, Inc. (formerly COR Therapeutics, Inc.) (“Millennium”), which generated an aggregate of approximately $7.0 million in collaboration revenue during 2001. The decrease in collaboration revenue was also a result of the progression of the Bayer alliance during 2002 from the set-up phase to the production phase, offset by additional revenue recognized from the Abgenix strategic alliance.

Revenues recorded in the twelve month period ended December 31, 2002 were primarily related to our collaborative agreements with Abgenix, Bayer, and Genentech, Inc. (“Genentech”) while the same period in 2001 primarily included revenue from our collaborative agreements with Abgenix, Bayer, GSK, Millennium and Roche. Revenue from each of Abgenix and Bayer accounted for 10% or more of our total revenue in fiscal 2002. Abgenix, Bayer and GSK each accounted for 10% or more of our total revenue in 2001.

We expect that 2003 collaboration revenues will continue to decrease significantly compared to 2002 revenues, unless we receive royalties or milestone payments from products currently under development by our current and former collaborative partners. We will continue to focus on the establishment of strategic research

15

Table of Contents

and development alliances with companies to gain access to expertise that is currently unavailable to us. We expect these alliances with other pharmaceutical and biotechnology companies to provide us with access to unique technologies, access to capital, near term revenues, milestone and/or royalty payments, and potential profit sharing arrangements. Future revenues will be dependent upon our ability to enter into additional alliances and collaborations, maintain and expand current collaborations, receive royalties and milestone payments from products currently under development by our current and former collaborators, successfully sell technologies being developed by 454 and successfully develop and market products that may arise from our own internal drug development pipeline.

Operating Expenses.    Research and development expenses for the year ended December 31, 2002 were $81.7 million compared to $65.8 million for the same period in 2001. The increase of $15.9 million, or 24%, was primarily attributable to increased internal research efforts and our obligations to fulfill research requirements under existing collaborations and strategic alliances, which included payments for contractual services, increased equipment depreciation expense and additional personnel costs. Research and development expenses for 2003 are expected to decrease slightly in comparison to 2002, reflecting the expected reduction in costs as a result of the recent corporate restructuring, partially offset by the expected increase in clinical trial costs and 454’s increased operating expenses as its operations continue to expand.

General and administrative expenses for the year ended December 31, 2002 increased $4.2 million, or 22%, to $23.0 million as compared to $18.8 million for the same period in 2001. The increase was primarily attributable to legal expenses in support of the development of our intellectual property portfolio and additional personnel costs. General and administrative expenses for 2003 are expected to decrease slightly in comparison to 2002, reflecting the recent corporate restructuring, including decreases in personnel costs, depreciation expense, consulting costs, and facility repairs and maintenance costs.

Restructuring and related charges.    Restructuring and related charges of approximately $11.0 million were incurred in 2002 as a part of our restructuring plan which was intended to reduce costs and focus resources on prioritizing, selecting and rapidly advancing our most promising drug candidates. As a result of the restructuring plan, our employee base was reduced by approximately 125 personnel, representing approximately 24% of our workforce. The reduction in personnel included early-stage drug-discovery employees and general and administrative support positions. In connection with this restructuring plan, we incurred $1.8 million related to employee separation costs and $1.1 million of asset impairment costs related to equipment no longer in service. The employee separation costs were recorded under Statement of Financial Accounting Standards No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” (“SFAS 146”) and included amounts to be paid for severance and related benefits, the services for which had been performed in full as of the end of 2002. The cash requirements under the restructuring plan were $1.9 million, of which $1.2 million was paid prior to December 31, 2002. We expect to pay the majority of our remaining cash obligations related to the 2002 restructuring plan during the first quarter of 2003 and currently do not anticipate any additional restructuring plans.

Also included in restructuring and related charges was an asset impairment of $8.1 million, consisting of costs previously incurred in conjunction with the planned construction of a campus facility, including a new corporate headquarters and protein production facility in Branford, Connecticut. Plans to construct these facilities have been deferred indefinitely, pending improvements in the external financing environment, which would afford us the ability to finance the future construction costs.

Interest Income, net.    Net interest income for the year ended December 31, 2002 of $1.5 million decreased $11.7 million, or 89%, as compared to $13.2 million for the same period in 2001. Interest income for the year ended December 31, 2002 of $11.7 million decreased $12.1 million, or 51%, as compared to $23.8 million for the same period in 2001. The decrease in interest income was primarily due to lower yields in our investment portfolio and a decrease in cash and investment balances during 2002. We earned an average yield of 2.7% in 2002 as compared to 4.0% in 2001. The decrease in cash and investments during 2002 was primarily a result of

16

Table of Contents

operating losses in support of our research and development activities, acquisitions of additional property and equipment and payment of interest to the holders of our convertible subordinated debt which we issued on February 2, 2000. We anticipate that interest income in 2003 will continue to decrease significantly as compared to 2002, as cash and investment balances are utilized in the normal course of operations and the yields in our investment portfolio continue to decrease slightly.

Interest expense for the year ended December 31, 2002 of $10.2 million represented a decrease of $0.4 million, or 4%, as compared to $10.6 million for the year ended December 31, 2001. Interest expense was primarily attributable to accrued interest and interest paid to the holders of our convertible subordinated debt which we issued on February 2, 2000. We expect that interest expense will remain relatively constant in 2003.

Income Tax Benefit.    For the year ended December 31, 2002, we recorded a Connecticut income tax benefit of $1.5 million, representing a decrease of $2.1 million, as compared to a Connecticut income tax benefit of $3.6 million in 2001. The decrease in the income tax benefit was a result of the decline in various expenses which qualify for the annual research and development credit, primarily tax based compensation and consulting expenses resulting from the exercise of stock options by employees and non-employees. We recorded the income tax benefit as a result of Connecticut legislation, which allows companies to obtain cash refunds from the State of Connecticut at a rate of 65% of their annual research and development expense credit, in exchange for forgoing carryforward of the credit. We expect to record a Connecticut income tax benefit during 2003 of significantly less than the 2002 amount, due to an anticipated reduction in qualified Connecticut research and development expenses.

We determine our income taxes using the asset and liability method. Realization of deferred tax assets is dependent on future earnings, if any, the timing and amount of which are uncertain. As we have no prior earnings history, a valuation allowance in an amount equal to the deferred income tax assets has been established to reflect these uncertainties. The increase in the valuation allowance was $40.7 million for the year ended December 31, 2002.

Minority Interest in Subsidiary Loss.    Minority interest in subsidiary loss for the year ended December 31, 2002, which is the portion of 454’s loss attributable to stockholders of 454 other than us, was $3.9 million as compared to $1.5 million for the same period in 2001. The increase of $2.4 million, or 160%, was primarily due to 454’s additional personnel costs, increased purchases of laboratory supplies, increased equipment depreciation expense and payments for consulting and contractual services. During 2003, losses attributed to the minority ownership in 454 are expected to continue to increase as compared to 2002, as 454 continues to make significant progress in developing new technologies.

Net Loss.    For the year ended December 31, 2002, we reported a net loss of $90.4 million, or $1.85 per share as compared to $42.9 million, or $0.89 per share, for the same period in 2001. Our net loss for 2003 is expected to decrease slightly as compared to 2002. Since inception, we have incurred operating losses, and as of December 31, 2002, we had an accumulated deficit of $215.0 million. To date, we have not paid any federal income taxes.

Years Ended December 31, 2001 and 2000

Revenue.    Collaboration revenue for the year ended December 31, 2001 was $23.5 million, an increase of $2.7 million, or 13%, as compared to $20.8 million for the corresponding period in 2000. Revenues recorded in the twelve month period ended December 31, 2001 were primarily related to our collaborative arrangements with Abgenix, Bayer, GSK, Millennium and Roche, while the same period in 2000 primarily included revenue from our collaborative arrangements with Abgenix, Genentech, GSK and Millennium. Revenue from each of Abgenix, Bayer, and GSK accounted for 10% or more of our total revenue in fiscal 2001. Abgenix, DuPont/Pioneer Hi-Bred International, Inc., Genentech, GSK, Millennium and Roche each accounted for 10% or more of our total revenue in 2000.

17

Table of Contents

Operating Expenses.    Research and development expenses for the year ended December 31, 2001 were $65.8 million compared to $40.9 million for the same period in 2000. The increase of $24.9 million, or 61%, was primarily attributable to increased internal research efforts and our obligations to fulfill research requirements under new and existing collaborations, which resulted in increased purchases of laboratory supplies, increased equipment depreciation and facilities expenses, and additional personnel costs.

General and administrative expenses for the year ended December 31, 2001 increased $4.6 million, or 32%, to $18.8 million as compared to $14.2 million for the same period in 2000. The increase was primarily attributable to higher recruiting, personnel, payroll and marketing costs, expenses in connection with upgrades and expansion of our facilities and related increased rent expenses, as well as legal expenses in support of the development of our intellectual property portfolio.

Interest Income, net.    Net interest income for the year ended December 31, 2001 of $13.2 million increased $7.6 million, or 134%, as compared to $5.6 million for the same period in 2000. Interest income for the year ended December 31, 2001 of $23.8 increased $8.1 million, or 51%, as compared to $15.7 million for the same period in 2000. The increase in interest income was primarily due to higher cash and investment balances as a result of funds we received from the proceeds of our public offering in November 2000 and from the combined net proceeds from our private placements with Abgenix in November 2000 and Bayer in January 2001, offset by recent declines in interest rates. Interest expense for the year ended December 31, 2001 of $10.6 million represented an increase of $0.5 million, or 5%, as compared to $10.1 million for the year ended December 31, 2000. This increase in interest expense was primarily attributable to accrued interest and interest paid to the holders of our convertible subordinated debt which we issued on February 2, 2000.

Income Tax Benefit.    For the year ended December 31, 2001, we recorded a Connecticut income tax benefit of $3.6 million, an increase of $2.1 million over the amount recorded in 2000. This increase was a result of the increase in various expenses which qualified for the annual research and development credit, including tax based compensation and consulting expenses resulting from the exercise of stock options by employees and non-employees. The income tax benefit was recorded as a result of Connecticut legislation, which allows companies to obtain cash refunds from the State of Connecticut at a rate of 65% of their annual research and development expense credit, in exchange for forgoing carryforward of their research and development credit.

We determine our income taxes using the asset and liability method. Realization of deferred tax assets is dependent on future earnings, if any, the timing and amount of which are uncertain. Accordingly, valuation allowances in amounts equal to the deferred income tax assets have been established to reflect these uncertainties in all periods presented. The increase in the valuation allowance was $22.2 million for the year ended December 31, 2001.

Minority Interest in Subsidiary Loss.    Minority interest in subsidiary loss for the year ended December 31, 2001, which is the portion of 454’s loss attributable to stockholders of 454 other than us, was $1.5 million as compared to $0.3 million for the same period in 2000. The increase of $1.2 million, or 359%, was primarily due to 454’s increased purchases of laboratory supplies, increased equipment depreciation and facilities expenses, as well as additional personnel costs, all of which were incurred during a full twelve month period in 2001, as compared to seven months during 2000, as 454 was formed in June 2000.

Net Loss.    For the year ended December 31, 2001, we reported a net loss of $42.9 million, or $0.89 per share as compared to $27.0 million, or $0.70 per share, for the same period in 2000. Since inception, we have incurred operating losses, and as of December 31, 2001, we had an accumulated deficit of $124.6 million. To date, we have not paid any federal income taxes.

18

Table of Contents

Liquidity and Capital Resources

As of December 31, 2002, we had $414.8 million in cash and investments, compared to $508.3 million as of December 31, 2001. The decrease of $93.5 million in cash and investments during 2002 was primarily a result of additional operating losses in support of our research and development activities, acquisitions of additional property and equipment and payment of interest to the holders of our convertible subordinated debt issued in February 2000. We have financed our operations since inception primarily through public equity offerings, our convertible subordinated debt offering, revenues received under our collaborative research agreements, private placements of equity securities, government grants, and capital leases. As of December 31, 2002, we had recognized $99.1 million of cumulative sponsored research revenues from collaborative research agreements and government grants. To date, inflation has not had a material effect on our business.

Our cash investing activities have consisted primarily of acquisitions of equipment and expenditures for leasehold improvements and net outflows from purchases and maturities of short-term investments and marketable securities. At December 31, 2002, our gross investment in lab and office equipment, computers, land and leasehold improvements was $42.9 million. At December 31, 2002, equipment with a gross book value of $4.5 million secures our equipment financing loan facilities. We had approximately $1.3 million in material commitments for capital expenditures at December 31, 2002.

In accordance with our investment policy, we are utilizing the following investment objectives for cash and investments: (1) investment decisions are made with the expectation of minimum risk of principal loss, even with a modest penalty in yield; (2) appropriate cash balances and related short-term funds are maintained for immediate liquidity needs, and appropriate liquidity is available for medium-term cash needs; and (3) maximum after-tax yield is achieved.

Cash Flows For The Year Ended December 31, 2002

Operating Activities.    Net cash used in operating activities was $74.6 million for the year ended December 31, 2002 and was primarily due to the net cash loss from operations of $74.3 million, increases in income taxes receivable of $1.5 million and prepaid expenses of $0.6 million and a decrease in accounts payable of $1.1 million, offset by a decrease in deferred revenue of $0.6 million, plus increases in accrued expenses of $0.8 million and other current liabilities of $0.8 million.

Investing Activities.    Net cash used in investing activities was $90.7 million for the year ended December 31, 2002 and was primarily due to net outflows from purchases and maturities of short-term investments and marketable securities of $70.4 million and acquisitions of property and equipment, including expenditures for leasehold improvements, of $20.3 million.

Financing Activities.    Net cash used in financing activities was $1.9 million for the year ended December 31, 2002 and primarily included payments on capital lease obligations of $3.0 million offset by proceeds from exercises of stock options in the amount of $1.1 million.

Future Liquidity

Sources of Liquidity.    During 2003, we expect to fund our operations through a combination of the following sources: cash and investment balances; collaboration revenue; gross interest income; and potential public securities offerings and/or private strategic-driven common stock offerings.

Uses of Liquidity.    Throughout 2003, we plan to continue making substantial investments in our emerging preclinical and clinical drug pipeline. In that regard, we foresee the following as significant uses of liquidity: salaries and benefits, supplies and reagents, contractual services, clinical trials on our recently approved protein therapeutic CG53135, legal expenses in support of the development of our intellectual property portfolio, and interest expense related to payments made to the holders of our convertible subordinated debt issued in February 2000. In addition, we anticipate that we will also incur additional capital expenditures in 2003 primarily for the

19

Table of Contents

purchase of equipment and leasehold improvements at our New Haven and Branford research facilities and administrative offices, including the expansion of our existing protein production laboratory.

The following table represents our contractual obligations as of December 31, 2002:

We believe that our existing cash and investment balances and other sources of liquidity will be sufficient to meet our requirements through the end of 2003. Our operating and capital expenditures are considered to be crucial to our future success, and by continuing to make strategic investments in research and development programs, we believe that we are building substantial value for our shareholders. Our future operating and capital requirements, and the adequacy of our available funds will depend on many factors, including the progress we make in our drug discovery, drug development, and pharmacogenomic programs, the magnitude of these programs, the success of our strategic research and development alliance partners in developing and commercializing drugs from existing programs and our ability to establish additional collaborative and licensing arrangements. While we will continue to explore alternative sources for financing our business activities, including the possibility of public securities offerings and/or private strategic-driven common stock offerings, we cannot be certain that in the future these sources of liquidity will be available when needed or that our actual cash requirements will not be greater than anticipated. In appropriate strategic situations, we may seek financial assistance from other sources, including contributions by others to joint ventures and other collaborative or licensing arrangements for the development and testing of products under development. However, should we be unable to obtain future financing either through the methods described above or through other means, we may be unable to meet the critical objectives of our long-term business plan, which are to successfully develop and market pharmaceutical products.

Income Taxes

We and 454 have the following tax net operating loss carryforwards available to reduce future federal and Connecticut taxable income and research and development tax credit carryforwards available to offset future federal and Connecticut income taxes:

For income tax purposes, we do not file consolidated income tax returns with 454.

20

Table of Contents

Minority Interest in Subsidiary

As of December 31, 2002, minority interest in subsidiary was $10.1 million. Minority interest in subsidiary is related to the establishment of 454, a majority-owned subsidiary, during 2000 and reflects the initial minority shareholders’ capitalization less a gain recognition of $3.9 million as a result of our contribution of technology to 454, less the minority shareholders’ portion of losses incurred to date. The loss attributed to the minority ownership in 454 is expected to continue to increase during 2003, as 454’s expenditures associated with technology development continue to increase.

Recently Enacted Pronouncements

In April 2002, the FASB issued Statement of Financial Accounting Standards No. 145, “Rescission of FASB Statement No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections” (“SFAS 145”). SFAS 145 rescinds FASB Statement No. 4, “Reporting Gains and Losses from Extinguishment of Debt”, and an amendment of that Statement, FASB Statement No. 64, “Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements”. SFAS 145 also rescinds FASB Statement No. 44, “Accounting for Intangible Assets of Motor Carriers”. SFAS 145 also amends FASB Statement No. 13, “Accounting for Leases”, to eliminate an inconsistency between the required accounting for sale-leaseback transactions and the required accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. This statement also amends other existing authoritative pronouncements to make various technical corrections, clarify meanings, or describe their applicability under changed conditions. The provisions of SFAS 145 are effective for annual financial statements issued on or after May 15, 2002, and the adoption of SFAS 145 did not have a material effect on our financial statements.

In July 2002, the FASB issued SFAS 146 which requires that a liability for a cost associated with an exit or disposal activity be recognized at its fair market value when the liability is incurred, rather than at the date of an entity’s commitment to an exit plan. The provisions of SFAS 146 are effective for exit or disposal activities that are initiated after December 31, 2002. We have recorded the effect of our November 2002 restructuring plan, as discussed above and in Note 11 of our consolidated financial statements, under the early adoption provisions of SFAS 146.

In December 2002, the FASB issued SFAS 148, which permits two additional transition methods for entities, that voluntarily change to the fair value based method of accounting for stock based compensation. In addition, SFAS 148 amends the disclosure requirements of SFAS 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock based employee compensation and the effect of the method used on reported results. SFAS 148 became effective for financial statements issued after December 15, 2002, and the adoption of SFAS 148 did not have a material effect on our financial statements, as we have not yet adopted SFAS 123.

In November 2002, the FASB issued FASB Interpretation (“FIN”) No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” FIN No. 45 clarifies and expands existing disclosure requirements for guarantees, including loan guarantees. The provisions of FIN No. 45 are effective for financial statements issued after December 15, 2002, and the adoption of FIN No. 45 did not have a material effect on our financial statements.

In January 2003, the FASB issued FIN No. 46, “Consolidation of Variable Interest Entities—an Interpretation of Accounting Research Bulletin No. 51.” FIN No. 46 clarifies rules for consolidation of special purpose entities. The provisions of FIN No. 46 are effective for financial statements issued after January 31, 2003. We do not expect the adoption of this statement to have a material impact on our financial statements.

21

Table of Contents

Certain Factors That May Affect Results of Operations

This report contains forward-looking statements that are subject to certain risks and uncertainties. These statements include statements regarding: (i) our ability to apply proprietary genomic technologies to understand the molecular basis of disease and develop the next generation of therapeutic products for important diseases; (ii) our ability to develop pharmaceutical products with greater efficacy and fewer side effects and increase the probability that the most appropriate drugs will be administered to patients; (iii) our expectation that CG53135 (or FGF20) will be advanced into clinical trials during April 2003; (iv) our expectation that CR002 will be advanced into clinical trials during 2004 as a potential treatment for kidney disease; (v) our ability to generate data and information that will help the pharmaceutical industry to significantly reduce the time and cost of drug development; (vi) our expectation of bringing 12 candidates in obesity and diabetes to clinical development under our collaboration with Bayer; (vii) our ability to establish our fully integrated technologies and GeneScape operating system as the preferred platform for genomics, drug discovery, drug development and pharmacogenomics; (viii) the ability of 454 Corporation to develop technologies that have broad applications in drug discovery, preclinical drug development and the field of pharmacogenetics and to create a future source of revenues for us; (ix) the likely success of our technologies; (x) the expected benefits, effects, efficiency and performance of our services and products; (xi) the expected future levels of losses, operating expenses and material commitments; (xii) our ability to enter into additional collaborations and strategic alliances, maintain and expand current collaborations, garner royalties and milestone payments from products currently under development by current and former collaborators and successfully develop and market products from our internal product pipeline; (xiii) our expectation that our research and development expenses for 2003 are expected to decrease slightly in comparison to 2002; (xiv) our expectation that our general and administrative expenses for 2003 are expected to decrease slightly in comparison to 2002; (xv) the expectation that a majority of our remaining cash obligations related to the restructuring plan will be paid in the first quarter of 2003; (xvi) our expectation that interest expense will remain relatively constant in 2003; (xvii) our expected sources and uses of liquidity in 2003 and (xviii) our belief that our existing cash and investment balances and other sources of liquidity will be sufficient to meet our requirements through the end of 2003. Such statements are based on our management’s current expectations and are subject to a number of factors and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. We caution investors that there can be no assurance that actual results or business conditions will not differ materially from those projected or suggested in such forward-looking statements as a result of various factors, including, but not limited to, the following: our stage of development as a genomics based pharmaceutical company; uncertainties of preclinical and clinical testing and trials; government regulation and healthcare reform; technological uncertainty and product development risks; product liability exposure; uncertainty of additional funding; our history of incurring losses and the uncertainty of achieving profitability; reliance on research collaborations and strategic alliances; competition; the ability of our third party manufacturers to deliver materials on a timely basis and to comply with applicable regulatory requirements, including the FDA’s current Good Manufacturing Practices, or GMP, and our ability to protect our patents and proprietary rights and uncertainties relating to commercialization rights including the acquisition of licenses; the availability and terms of which cannot be predicted. We disclaim any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.

For further information, refer to the more specific risk and uncertainties discussed throughout this discussion and analysis.

22

Table of Contents

Item 7a.    Quantitative and Qualitative Disclosures About Market Risk

Currently, we maintain approximately 15% of our cash and investments in financial instruments with original maturity dates of less than three months, 50% of our cash and investments in financial instruments with original maturity dates of greater than three months and less than one year, and the remaining 35% in financial instruments with original maturity dates of greater than one year and less than five years. These financial instruments are subject to interest rate risk and will decline in value if interest rates increase. We estimate that a change of 100 basis points in interest rates would result in a $3.5 million decrease in the fair value of our cash and investments.

Our outstanding long-term liabilities as of December 31, 2002 consist of our 6% convertible subordinated debentures due February 2, 2007 and capital lease obligations, both of which bear interest at fixed rates, therefore, our results of operations would not be affected by interest rate changes. Although future borrowings would be affected by interest rate changes, at this point we do not anticipate any significant future borrowings, and therefore do not believe that a change of 100 basis points in interest rates would have a material effect on our financial condition.

Accordingly, we do not believe that there is any material market risk exposure with respect to derivative or other financial instruments that would require disclosure under this item.

As of December 31, 2002, the market value of our convertible subordinated debentures based on quoted market prices was estimated at $95.0 million.

As of December 31, 2002, we did not have any off-balance sheet arrangements.

Item 8.    Financial Statements and Supplementary Data

23

Table of Contents

CURAGEN CORPORATION AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

(in thousands, except par value and share data)

See accompanying notes to consolidated financial statements

24

Table of Contents

CURAGEN CORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

See accompanying notes to consolidated financial statements

25

Table of Contents

CURAGEN CORPORATION AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY

(in thousands, except number of shares)