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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark one)

For the fiscal year ended December 31, 2004

OR

Commission File Number 000-30347

CURIS, INC.

(Exact Name of Registrant as Specified in Its Charter)

61 Moulton Street

Cambridge, Massachusetts 02138

(Address of principal executive offices) (Zip Code)

617-503-6500

(Registrant’s telephone number, including area code)

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

None

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

Common Stock, $0.01 par value per share

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

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

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

As of June 30, 2004, the aggregate market value of the common stock held by non-affiliates of the registrant was approximately $178,167,000 based on the closing sale price of the registrant’s common stock on The Nasdaq National Market on such date.

As of March 8, 2005, there were 47,880,127 shares of the registrant’s common stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Specified portions of the registrant’s proxy statement for the annual meeting of stockholders scheduled to be held on June 1, 2005, which are to be filed with the Commission not later than 120 days after the close of the Registrant’s fiscal year ended December 31, 2004 pursuant to Regulation 14A, have been incorporated by reference in Item 5 of Part II and Items 10-14 of Part III of this Annual Report on Form 10-K.

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CURIS, INC.

TABLE OF CONTENTS

Form 10-K

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PART I

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

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

Our Company

We are a therapeutic drug development company principally focused on the discovery, development and future commercialization of products that modulate key regulatory signaling pathways controlling the repair and regeneration of human tissues and organs. Our product development approach involves using small molecules, proteins or antibodies to modulate these regulatory signaling pathways, for example, to increase the pathway signals when they are insufficient or to decrease them when they are excessive. Our lead product candidate is a topical therapy for the treatment of basal cell carcinoma and is currently under development with Genentech, Inc., a collaborator. Under the terms of our collaboration with Genentech, we retained a co-development option in the basal cell carcinoma program in the U.S. market pursuant to which we will share in the U.S. development costs and any future U.S. net profits and/or losses in this program. On January 28, 2005, we elected to exercise this co-development option and will now share equally in both the U.S. development costs and any future U.S. net profits or losses of the basal cell carcinoma program. In addition to our lead product candidate, we have successfully used our product development approach to produce multiple compounds with potential for use in several different disease indications. For example, we have developed several promising preclinical product candidates in the fields of cancer, kidney disease, neurological disorders, cardiovascular disease and hair growth regulation.

Regulatory signaling pathways, also referred to as signaling pathways, are prominent regulators of specific tissue and organ formation during prenatal development and are used by the body throughout life to repair and regulate human tissue. We, together with collaborators and licensors, are developing our product candidate programs around several major signaling pathways including the Hedgehog and Bone Morphogenetic Protein, or BMP, pathways. We have substantial intellectual property rights in these signaling pathways, which we believe will enable us to have a technological and competitive advantage in developing therapeutic products based upon these pathways. We have also used the knowledge we have gained about the Hedgehog and BMP pathways to begin researching additional signaling pathways, including the Wnt signaling pathway. Wnt is implicated in the vast majority of colorectal cancers and we believe that it may be implicated in additional cancers, similar to the Hedgehog signaling pathway. In addition to expanding our internal research capacities, we may seek to expand our technology offerings and associated intellectual property portfolio through in-licensing arrangements and the acquisition of complimentary technologies, particularly those focused on signaling pathways.

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Our research programs are conducted both internally and through strategic collaborations. We currently have strategic collaborations with Genentech and Wyeth Pharmaceuticals, or Wyeth, to develop therapeutics which modulate the signaling of the Hedgehog pathway. We have also licensed our BMP pathway portfolio to Ortho Biotech Products for systemic administration in all non-orthopedic and non-dental therapeutic applications. Our 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 milestones are achieved, as well as royalty payments upon the successful commercialization of any products based upon the collaboration. In some cases, we have retained rights under our programs under collaboration, 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 are as follows:

We believe that these various collaboration structures provide additional opportunities for our licensed assets. We believe that our approach allows us to augment our development capabilities and capacities through collaborations with leading pharmaceutical and biotechnology companies. For example, under our co-development arrangement with Genentech, we are able to retain a significant percentage ownership of our basal cell carcinoma product candidate, while working with Genentech, a company with established clinical development, regulatory, and commercialization skills. We believe that developing our assets in collaboration with companies possessing clinical development expertise increases the likelihood of development success. For products under collaborative development in a more traditional milestone and royalty structure, we are provided with the opportunity to discover and develop products while reducing our internal product development costs and related risks.

In addition to our collaborations, we received a grant from the Spinal Muscular Atrophy Foundation in September 2004 of up to $5,364,000 over a three-year period for the identification of therapeutic compounds to treat spinal muscular atrophy, a neurological disease that is the leading genetic cause of infant and toddler death. The study will utilize our proprietary technologies and expertise to develop assays in motor neurons and then use

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those assays to identify potential drug candidates. We will own any compounds that we generate under this collaboration and we will have the ability to bring any such compounds into the clinic, either on our own or with a collaborating third party.

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

We were organized as a Delaware corporation in February 2000. We began our operations in July 2000 upon the completion of the merger of Creative BioMolecules Inc., Ontogeny, Inc. and Reprogenesis, Inc. Our principal executive office is located at 61 Moulton Street, Cambridge, Massachusetts, 02138 and our telephone number is (617) 503-6500.

Curis^™ and the Curis logo are our trademarks. This annual report on Form 10-K may also contain trademarks and trade names of others.

Recent Development

Pursuant to the terms of our collaboration agreement with Genentech, on January 28, 2005 we elected to exercise a co-development option with Genentech pursuant to which we will now 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. Basal cell carcinoma, a skin cancer, is the most common form of all human cancers with approximately 800,000 to 1,000,000 new cases every year in the U.S.

We plan to assist Genentech in filing an investigational new drug application with the Food and Drug Administration, or FDA, in order to initiate human clinical investigation of the basal cell carcinoma product candidate. In June 2003, we established a collaboration with Genentech for the continued development of a set of anti-cancer technologies based on inhibition of the Hedgehog signaling pathway, including small molecule Hedgehog pathway inhibitors. Under the terms of the collaboration, we retained a co-development option pursuant to which we will share in the U.S. development costs and any future net profits and/or losses, specifically for one of the small molecule Hedgehog pathway inhibitors. This co-development right applies solely to the U.S. marketplace and includes applications for basal cell carcinoma and any additional indications for which this product candidate may be developed.

We expect that by exercising this co-development and equal cost-sharing option we will incur approximately $20,000,000 in development expenses through phase II clinical trials, a portion of which will be recorded in the first quarter of 2005. Assuming the acceptance of the investigational new drug application by the FDA and the successful advancement of the basal cell carcinoma product candidate through phase I and phase II clinical trials, we expect that the phase II clinical trial will be completed in mid-2007. We expect to incur additional costs to complete phase III clinical trials and complete the regulatory approval process, assuming that we and Genentech successfully complete phase II clinical trials.

Website Access to Reports

We maintain a website with the address www.curis.com. We are not including the information contained in our website as part of, or incorporating it by reference into, this annual report on Form 10-K. Our website address is included in this annual report on Form 10-K as an inactive textual reference only. We make available free of charge through our website our annual reports on Form 10-K, our quarterly reports on Form 10-Q, current reports on Form 8-K and any such amendments to those reports as soon as reasonably practicable after we electronically file such material with, or furnish such material to, the Securities and Exchange Commission. The Securities and Exchange Commission maintains a website, www.sec.gov, that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC. In addition, we provide paper copies of our filings free of charge upon request. We also make available on our website our corporate

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governance guidelines, the charters for our audit committee, compensation committee and nominating and corporate governance committee, and our code of business conduct and ethics, and such information is available in print to any stockholder of Curis who requests it.

Regulatory Signaling Pathways Background

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

The ability to modulate certain signaling pathways is of great interest to biotechnology and pharmaceutical companies as many diseases and disorders are now known to be associated with members of these signaling pathways. For example, one of the most successful biotechnology-derived drugs is a formulation of a signaling protein called erythropoietin. Erythropoietin is made in the kidney and controls a pathway that instructs the bone marrow to make new red blood cells. In dialysis patients with end-stage kidney disease, in which their kidneys have mostly or completely stopped functioning, the kidneys are unable to make erythropoietin. These patients therefore develop severe anemia, a critical medical condition caused by a lack of sufficient red blood cells. Administration of erythropoietin restores normal levels of red blood cells thus alleviating the patient’s anemia. The erythropoietin market for dialysis patients in the U.S. is estimated to approximate $2.5 billion annually.

Our BMP-7 program, which is licensed to Ortho Biotech Products for systemic administration in non-orthopedic, non-dental therapeutic indications, is similar to erythropoietin in several respects. BMP-7 is also a signaling protein made in the kidney that regulates tissue repair and maintenance. Dialysis patients develop several other serious complications in addition to severe anemia, including bone diseases such as renal osteodystrophy, a form of bone disease, and blood vessel calcification resulting in life-threatening cardiovascular complications. In preclinical models, administration of BMP-7 has been shown to prevent these bone metabolic and blood vessel complications that are associated with chronic kidney disease. Preclinical studies also suggest that BMP-7 may delay progression of kidney disease, delay the need for dialysis and stabilize kidney function for dialysis patients. If successfully developed, we estimate that the market size for BMP-7 in dialysis patients may approximate the market size for erythropoietin in dialysis patients. Under our license agreement with Ortho Biotech Products, we would receive a royalty on BMP-7 future net sales, if any.

There is also significant pharmaceutical interest in the inhibition of abnormally or inappropriately activated signaling pathways that have been implicated in certain cancers. For instance, Novartis, Inc.’s Glivec^® is a small molecule drug that inhibits a signaling pathway that is abnormally expressed in certain cancers. Glivec^® is among the first signaling pathway inhibitors to be approved by the FDA and is Novartis’ second largest-selling drug with estimated annual worldwide sales of approximately $1.5 billion.

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

We believe that our focus on developing drugs based primarily on regulatory signaling pathways will give us a competitive advantage over similar efforts by other biotechnology and pharmaceutical companies. Our

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approach has already enabled us to develop a clinical-stage lead compound for the treatment of basal cell carcinoma, and a diverse portfolio of preclinical product candidates in several important therapeutic areas including other cancers, kidney disease, neurological disorders, cardiovascular disease and hair growth regulation.

Our Strategy

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

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Product Development Programs

We are developing product candidates in several important medical fields where there are substantial unmet therapeutic needs. These product development initiatives, described in the chart below, are being pursued using our internal resources or through collaborations and licensing arrangements with pharmaceutical or biotechnology firms that are able to dedicate additional resources and clinical development expertise, and, in return, provide us with potential revenue from development milestones and royalties on future product sales. These product development initiatives are derived primarily from our substantial intellectual property portfolio in key regulatory signaling pathways.

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

Except for the public disclosures of Genentech, 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 plans of our corporate collaborators or licensors, if applicable. Moreover, because of the early stage of development of these programs, our, and our collaborators’ and licensors’ ability to successfully complete preclinical studies of these product candidates, and the timing of completion of such programs, is highly uncertain. Accordingly, the estimated period in which we or our collaborators or licensors may file an investigational new drug application for any of these product candidates may vary materially from the estimates set forth below:

Hedgehog Topical Small Molecule Antagonist Program

Under Collaboration with Genentech

The Hedgehog signaling pathway controls the development and growth of many kinds of tissues in the body by directly promoting cell division in specific cell types, and by activating other secondary signaling pathways that control the synthesis of growth factors and angiogenic factors. The growth factors stimulate new tissue formation, and the angiogenic factors stimulate new blood vessel growth to nourish the newly formed tissue.

Several years ago, our scientists and scientists at independent academic and medical research laboratories discovered that the Hedgehog signaling pathway is activated at very high levels in many, if not all, basal cell carcinomas. In many of these cases, excessive unregulated Hedgehog signaling activity is due to the presence of

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inactivating mutations in “patched,” or Ptch, a negative regulator of the pathway, or to constitutively activating mutations in “smoothened,” or Smo, an activator of the pathway. Unregulated activation of hedgehog signaling in the outer layer of skin cells leads to increased rates of cell division resulting in tumor formation. Thus, our small molecule Hedgehog signaling antagonists directly target the known mechanism of action underlying the formation of basal cell carcinomas.

Our preclinical evidence indicates that inhibition of the Hedgehog pathway with our Hedgehog antagonists in various models of basal cell carcinoma results in the selective death of tumor cells while sparing adjacent normal cells and maintaining the typical architecture of the skin at the treatment site. In contrast, most basal cell carcinoma patients are treated with surgery, which often results in significant scarring at the treatment site. We believe that the selective action of our Hedgehog antagonists in cancer cells will result in a better cosmetic outcome than that of other basal cell carcinoma treatments, and therefore may represent a significant competitive advantage for our basal cell carcinoma product candidate. In June 2003, we established a collaboration with Genentech for the continued development of our basal cell carcinoma product candidate. Under the terms of the collaboration, we retained a co-development option in the basal cell carcinoma program in the U.S. market that enables us to share in U.S. development costs and future U.S. net profits or losses in this program. On January 28, 2005, we elected to exercise this co-development option and will now share equally in both the U.S. development costs and any future U.S. net profits and/or losses of our basal cell carcinoma product candidate. This co-development right includes basal cell carcinoma and any additional indications for which this product candidate may be developed in the U.S. Genentech has stated that it expects to file an investigational new drug application with the FDA in the first quarter of 2005. Pending FDA approval of this investigational new drug application filing, Genentech will begin enrollment of a Phase I clinical trial for basal cell carcinoma. In addition, in certain international markets, we will receive milestones if specific clinical development objectives are achieved and a royalty on any international sales of the topical Hedgehog antagonist.

An independent third party study published in European Journal of Dermatology 2004 14: 96-104, demonstrated that in a small population of four patients with well established basal cell carcinoma, an inhibitor of the Hedgehog signaling pathway, cyclopamine, selectively induced regression of basal cell carcinoma tumors. The patients showed tumor regression within a few days of treatment with no adverse effects on nearby normal skin cells. Cyclopamine is a plant-derived Hedgehog inhibitor that could potentially be used to treat cancer and other disorders by inhibiting Hedgehog signaling. This technology, including cyclopamine and structurally-related derivatives, is exclusively licensed to us by Johns Hopkins University. We have sublicensed our rights to this cyclopamine intellectual property portfolio to Genentech as part of the 2003 agreement.

Hedgehog Systemic Small Molecule Antagonist and Antibody Antagonist Cancer Programs

Under Collaboration with Genentech

Scientists have discovered that abnormal Hedgehog signaling may be contributing to the growth of certain cancers, including small cell lung cancer, pancreatic cancer and other cancers. During 2004, scientists linked several additional types of cancers to abnormal Hedgehog pathway expression, including prostate cancer and medulloblastoma, an aggressive form of childhood brain cancer. The prostate cancer reports, from the Johns Hopkins University School of Medicine, New York University School of Medicine, and the University of Texas, were published in Nature. 2004 October 7;431(7009):707-12, the Proceedings of the National Academy of Science U S A. 2004 August 24;101(34):12561-6, and Molecular Cancer 2004 October 13;3(1):29. The medulloblastoma reports, from the St. Jude Children’s Research Hospital and the University La Sapienza, were published in Cancer Cell. 2004 September; 6(3):229-40, and the Proceedings of the National Academy of Science U S A. 2004 July 20;101(29):10833-8.

Our preclinical evidence suggests that Hedgehog protein produced by tumor cells may signal certain adjacent cells within the tumor environment to produce various growth and angiogenetic, or blood vessel forming, factors that can positively influence tumor maintenance and growth. Systemic administration of our

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Hedgehog signaling pathway inhibitors has been shown to slow or halt the progression of various types of tumors in our preclinical models of cancer. We believe that our hedgehog pathway antagonists are selectively targeting fundamental mechanisms involved in the maintenance and progression of tumor growth, and as such, may represent a new generation of cancer therapeutics.

In June 2003, we established a collaboration with Genentech for the continued development of these systemic drug candidates, in addition to the development of a topical treatment for basal cell carcinoma. The current focus of the collaboration, excluding the basal cell carcinoma clinical development, is to develop systemically administered Hedgehog antagonists for cancer indications. Genentech is a biotechnology company with broad expertise in the development of cancer therapeutics. Genentech will assume all future responsibility for the clinical development of the Hedgehog systemic small molecule and antibody antagonists. We will receive clinical milestone payments and royalties on product sales if clinical evaluations of any Hedgehog systemic antagonist products are successful.

BMP-7 Program

Licensed to Ortho Biotech Products, a Subsidiary of Johnson & Johnson

BMP-7 is a signaling protein that is synthesized in the kidney and has been implicated in the maintenance of the normal health of the kidney, the skeleton, and the vascular system. In recent years, several academic researchers from the Beth Israel Deaconess Medical Center, the Harvard Medical School and the Washington University School of Medicine, have demonstrated the potential of using BMP-7 as a treatment to both halt the progression and reverse the effects of chronic progressive kidney disease and prevent the development of renal osteodystrophy, a form of bone disease, and blood vessel complications that are associated with chronic kidney disease. In 2004 there were four additional reports of BMP-7 efficacy in preclinical kidney disease models. They were published in the Journal of Biological Chemistry 2004 December 9 online, the Journal of Molecular Medicine 2004 March;82(3):175-81, Current Opinion in Nephrology and Hypertension 2004 July;13(4):417-22 and in the Journal of the American Society of Nephrology 2004 February;15(2):359-69.

Some of this data suggests that BMP-7 may be similar in some respects to erythropoietin, one of the most successful biotechnology-derived drugs. Erythropoietin is a signaling protein that is made in the kidney. It is secreted into the blood system and controls the process that instructs bone marrow to make new red blood cells. In dialysis patients with end-stage kidney disease, in which their kidneys have mostly or completely stopped functioning, the kidneys are unable to make erythropoietin. These patients therefore develop severe anemia, a critical medical condition caused by a lack of sufficient red blood cells. Administration of erythropoietin restores normal levels of red blood cells thus alleviating the patient’s severe anemia. Dialysis patients develop several other serious complications in addition to severe anemia, including renal osteodystrophy, a form of osteoporosis, and severe vascular calcification resulting in life-threatening cardiovascular complications. The preclinical demonstration that BMP-7 prevents the osteoporosis and vascular calcification that are associated with chronic kidney disease suggests that the market size for BMP-7 in dialysis patients may approximate the market size in the U.S. for erythropoietin in dialysis patients, which is currently estimated to be approximately $2.5 billion annually, of which we would receive a royalty under our license agreement with Ortho Biotech Products on future net sales, if any.

In November 2002, we entered into an agreement with Ortho Biotech Products pursuant to which Ortho Biotech obtained the license rights to our BMP-7 technology and assumed control of the continued development of this kidney disease product candidate. Ortho Biotech Products is a pharmaceutical company with broad expertise in protein-based therapeutic drug development and has an established presence in the kidney disease marketplace. Ortho Biotech Products has assumed all future costs and responsibility for BMP-based product development. We will receive a series of clinical development milestone payments, assuming certain clinical and regulatory milestones are achieved, and royalties on product sales if any BMP-based products are successfully commercialized. Ortho Biotech Products has sole responsibility for deciding if and when human clinical trials of BMP-7 will begin.

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Hedgehog Small Molecule Agonist Neurological Disorders Programs

Under Collaboration with Wyeth

The Hedgehog signaling pathway is essential for the formation of normal nerves and nerve networks in the central and peripheral nervous systems. Our scientists and academic collaborators have shown that treatment with a Hedgehog protein appears to accelerate the restoration of nerve function in models of nerve trauma and disease. This finding suggests that the Hedgehog pathway may have a potential therapeutic effect in treating certain human neurological disorders.

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

In 2004, our scientists presented a series of abstracts at the annual meeting of the Society for Neuroscience demonstrating positive preclinical results using the Hedgehog small molecule agonists in models of stroke, Parkinson’s disease, and spinal cord injury. A third party has also reported on the use of a small molecule Hedgehog pathway agonist to promote the generation of new motor neurons in vitro. This motor neuron report was published in the Proceedings of the National Academy of Sciences U S A. 2004 May 4;101(18):7123-8. Motor neurons are nerve cells that are most typically found in the spinal cord, and their purpose is to establish functional connections with other tissues, usually muscles, to control movement and other functions. Damage to motor neurons can occur as result of injury, such as spinal cord injury, or as a result of disease, such as spinal muscular atrophy or amyotrophic lateral sclerosis, also known as ALS or Lou Gehrig’s disease.

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

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

Wyeth has agreed to assume all future responsibility for clinical development of the Hedgehog small molecule and protein agonists as systemic treatments for neurological and other disorders. As part of the agreement, we have retained development and licensing options for certain therapeutic applications of Hedgehog agonist technologies, including topical applications for hair growth and local delivery applications for treatment of cardiovascular disease. Wyeth has a right of first negotiation to obtain an exclusive license to the cardiovascular applications of the Hedgehog agonist technology. If Wyeth declines its option, or if we are unable to reach an agreement with Wyeth on terms within the contractually specified period, we are free to seek another collaborator for this program.

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Hedgehog Agonist Hair Growth Program

Retained by Curis

Our scientists and other researchers have demonstrated that small molecule Hedgehog agonists can induce hair growth in animal models. These results were presented in February of 2005 at the annual meeting of the American Academy of Dermatology in New Orleans, Louisiana.

The Hedgehog agonist program was exclusively licensed to Wyeth in February 2004. Under the terms of the license agreement, we retained the right to develop Hedgehog agonists for topical treatment of hair growth. The terms of the agreement include Wyeth’s right to authorize the reversion of any compounds that we will develop in this area. In December 2004, Wyeth approved the reversion of a group of Hedgehog agonist compounds for use in our hair program.

We are currently evaluating the market potential and the risk factors, capital resources and complexities of clinical development in hair growth indications in order to determine an appropriate strategy for the future of this program.

Hedgehog Agonist Cardiovascular Disease Program

Retained by Curis/Wyeth Right of First Negotiation

As part of our collaboration with Wyeth, we have retained the right to locally deliver Hedgehog agonists for the treatment of cardiovascular diseases including peripheral vascular disease and acute myocardial infarction, or heart attack. Wyeth has a right of first negotiation to obtain an exclusive license to the cardiovascular applications. If Wyeth declines to exercise its option, or if we are unable to reach an agreement with Wyeth on terms within the contractually specified period, we are free to seek another collaborator for this program.

In 2004, two independent third party reports documented the beneficial effects of Hedgehog pathway stimulation for increasing blood flow to damaged heart muscle and promoting improved cardiac function following both acute and chronic myocardial ischemia in preclinical models of heart disease. Myocardial ischemia, the interruption of blood flow and oxygen to heart muscle, is the leading cause of heart attacks with more than one million cases reported every year in the United States. These studies were presented as abstracts at the annual meeting of the American Heart Association’s Scientific Sessions in New Orleans, Louisiana. The authors concluded that activation of the Hedgehog signaling pathway after an acute heart attack or chronic cardiac ischemia promotes recovery of heart function by stimulating blood vessel growth factors and other regeneration factors that limit scar formation, preserve cardiac muscle tissue, and promote improved heart function.

In 2004, another independent third party report demonstrated that the Hedgehog signaling pathway plays an essential role in the formation of the blood vessels that form the vascular network throughout the body. That report was published in Development. 2004 September;131(17):4371-80. We are utilizing this biological property of the Hedgehog pathway to develop locally administered drug candidates to treat cardiovascular disorders such as heart attacks and peripheral vascular disease.

We have incurred nominal expenses related to our cardiovascular disease program for the year ended December 31, 2004. Our preclinical data relating to this program has been derived from studies conducted at Caritas St. Elizabeth’s Medical Center in Boston, Massachusetts. We have entered into agreements under which additional third-party collaborators are attempting to evaluate and re-test this preclinical data.

Other Programs

Spinal Muscular Atrophy Program (Retained by Curis).    In September 2004, we received a grant from the Spinal Muscular Atrophy Foundation. Under the agreement, the Foundation will grant us up to $5,364,000 over a three-year period for the identification of therapeutic compounds to treat spinal muscular atrophy, a neurological

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disease that is the leading genetic cause of infant and toddler death. The study will utilize our proprietary technologies and expertise to develop assays in motor neurons and then use those assays to identify potential drug candidates. We will own any compounds that we generate under this collaboration and we will have the ability to bring any such compounds into the clinic, either on our own or with a collaborating party.

Discovery Research (Retained by Curis).    In addition to the research and development programs listed above, we also plan to bolster our pipeline by expanding into other signaling pathways, including the Wnt pathway, which is an important target for colon cancer and other disorders.

Our Strategic Collaborations And License Agreements

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

Since inception in 2000, substantially all of our revenues have been derived from our collaborations and other agreements with third parties. We anticipate that for the next several years substantially all of our revenues will continue to be generated from these sources. For the year ended December 31, 2004, Genentech accounted for $1,829,000, or 37% of our revenues, Wyeth accounted for $2,523,000, or 51% of our revenues, and the Spinal Muscular Atrophy Foundation grant accounted for $551,000, or 11% of our revenues.

Our current strategic collaborations are described below.

Genentech

In June 2003, we licensed our proprietary Hedgehog pathway antagonists to Genentech for human therapeutic use. The primary focus of our collaborative research plan has been to develop these molecules for cancer indications. The collaboration consists of two main programs: the development of a small molecule formulated for topical treatment of basal cell carcinoma, and the development of systemically administered small molecule and antibody Hedgehog antagonists for the treatment of certain other solid tumor cancers. The development of the topical Hedgehog antagonist is subject to a co-development arrangement with Genentech. Pursuant to the collaborative research, development and license agreement entered into in June 2003, as amended in December 2004, Genentech paid us an up-front payment of $5,000,000, purchased 1,323,835 shares of our common stock at a price of $2.644 per share for aggregate proceeds of $3,500,000, and made a maintenance payment of $2,000,000. During the initial two-year term of the research program, Genentech has also agreed to make research and development funding payments totaling $4,000,000, of which $2,000,000 has been paid to date.

In March 2004, Genentech added one of our small molecule antagonists of the Hedgehog signaling pathway covered under our collaboration to its product candidate pipeline. This small molecule is under development for the topical treatment of basal cell carcinoma. Under the terms of our collaboration with Genentech, we retained the right to co-develop products in the field of basal cell carcinoma in the U.S. On January 28, 2005, we elected

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to exercise this co-development option and will now share equally in both the U.S. development costs and any future U.S. net profits and/or losses of our basal cell carcinoma product candidate. This co-development right includes basal cell carcinoma and any additional indications for which this product candidate may be developed in the U.S. Genentech has stated that it expects to file an investigational new drug application with the FDA in the first quarter of 2005. Pending FDA approval of this investigational new drug filing, Genentech will begin enrollment of a phase I clinical trial for a basal cell carcinoma product candidate. We currently estimate that our share of development costs for the basal cell carcinoma indication will approximate $20,000,000 through the phase II clinical trials. We expect that this endpoint will be achieved, if at all, in mid-2007. In addition, in certain major international markets, we will receive milestones if specific clinical development objectives are achieved and a royalty on any international sales of the topical Hedgehog antagonist.

Under the systemic Hedgehog antagonist portion of the collaboration, Genentech is also obligated to make cash payments to us upon the successful achievement of clinical development and drug approval milestones. In addition, Genentech will pay a royalty on potential future net product sales, which increases with increasing sales volume.

Ortho Biotech Products, a subsidiary of Johnson & Johnson

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

Wyeth Pharmaceuticals, a division of Wyeth

In January 2004, we entered into an agreement to license our Hedgehog proteins and small molecule Hedgehog pathway agonists to Wyeth on an exclusive worldwide, royalty-bearing basis for the development and commercialization of pharmaceutical products for the therapeutic applications in treatment of neurological disorders, including neurodegenerative diseases and neuropathies. Under the terms of the agreement, Wyeth paid us a license fee of $1,500,000 and purchased 315,524 shares of our common stock at a price of $4.754 per share for an aggregate purchase price of $1,500,000. Wyeth will provide research funding for a minimum of two years. In addition, Wyeth is obligated to make cash payments to us upon the successful achievement of clinical development and drug approval milestones and is obligated to pay a royalty on net product sales, if any, that escalates with increasing sales volume. Excluding product royalties, the transaction includes potential milestone payments to us of more than $170,000,000, assuming that two products are successfully developed and commercialized.

As part of our collaboration with Wyeth, we have retained development and licensing options for certain therapeutic applications of the Hedgehog agonist technologies, including those applications that qualify as orphan drug indications, topical applications for hair growth and local delivery applications for treatment of cardiovascular disease. Wyeth has a right of first negotiation to obtain an exclusive license to the cardiovascular applications. If Wyeth declines to exercise its option, or if we are unable to reach an agreement with Wyeth on terms within the contractually specified period, we are free to seek another collaborator for this program.

Intellectual Property

Our policy is to prosecute and enforce the patents and proprietary technology rights that are key to our business. We intend to continue to file United States and foreign patent applications to protect technology,

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inventions and improvements that are considered important to the development of our business. We will be able to protect our proprietary technologies from unauthorized use by third parties only to the extent that our proprietary rights are covered by valid and enforceable patents or are effectively maintained as trade secrets.

We have 200 issued patents in the United States expiring on various dates between 2006 and 2022 with pending United States and foreign counterpart patent filings for most of these patents and patent applications. These patents and patent applications are directed to compositions of matter, methods of making and using these compositions, methods of repairing, replacing, augmenting and creating tissue for multiple applications, methods for drug screening and discovery, developmental biological processes, and patents relating to our proprietary technologies.

Hedgehog Pathway.    We have 43 issued U.S. patents and 8 allowed U.S. applications expiring on various dates between 2013 and 2022, which relate to the Hedgehog pathway. These patents and patent applications cover proteins, nucleic acids, antibodies, and certain small molecule agonists and antagonists of the Hedgehog pathway, drug screening and discovery methods, methods of protein manufacturing, as well as methods of using the aforementioned proteins, nucleic acids, antibodies or small molecules to activate or inhibit the Hedgehog pathway for a variety of therapeutic indications or diagnostic uses. In addition, we have filed foreign patent applications corresponding to many of the aforementioned U.S. filings that could provide additional patent protection for products that activate or inhibit the Hedgehog pathway.

Bone Morphogenetic Pathway.    We have 155 issued U.S. patents expiring on various dates between 2006 and 2022, which relate to the BMP pathway. These patents and patent applications cover certain BMP proteins, nucleic acids, antibodies, drug screening and discovery methods, methods of protein manufacturing, as well as methods of using these BMP proteins, nucleic acids or antibodies for a variety of therapeutic indications or diagnostic uses. In addition, we have filed foreign patent applications corresponding to many of the aforementioned U.S. filings that could provide additional patent protection for BMP-related products.

Our academic and research institution collaborators have certain rights to publish data and information regarding their discoveries to which we have rights. While we believe that the prepublication access to the data developed by our collaborators pursuant to our collaboration agreements will be sufficient to permit us to apply for patent protection in the areas in which we are interested in pursuing further research, there is considerable pressure on such institutions to rapidly publish discoveries arising from their efforts. This may affect our ability to obtain patent protection in the areas in which we may have an interest. In addition, these collaboration agreements typically contain provisions that provide us with, at a minimum, an option to license the institution’s rights to intellectual property arising from the collaboration.

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

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

Research Program

We have a research group that seeks to identify and develop new therapeutic applications for our existing patent portfolio and seeks to identify new signaling pathways that may have therapeutic potential. Our research

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group, working closely with our business development group, also strives to identify external technologies that might provide in-licensing opportunities, consistent with our broad interest in regulatory signaling pathways. As of December 31, 2004, our research group consists of 40 employees, consisting of molecular biologists, cell biologists, pharmacologists and other scientific disciplines.

During the years ended December 31, 2004, 2003 and 2002, we estimate that our total company-sponsored research and development expenses were approximately $6,700,000, $10,100,000 and $6,700,000, respectively, and that our collaborator-sponsored research and development expenses were approximately $4,900,000, $2,600,000 and $5,300,000, respectively.

Regulatory Matters

FDA Requirements for New Drug Compounds

Numerous governmental authorities in the United States and other countries extensively regulate the research, testing, manufacture, import and export and marketing of drug products. In the United States, drugs are subject to rigorous regulation by the FDA. The Federal Food, Drug, and Cosmetic Act, and other federal and state statutes and regulations, govern, among other things, the research, development, testing, manufacture, storage, recordkeeping, labeling, promotion, sampling and marketing and distribution of pharmaceutical products. Failure to comply with applicable regulatory requirements may subject a company to a variety of administrative or judicially-imposed sanctions. These sanctions could include the FDA’s refusal to approve pending applications, withdrawal of approvals, clinical holds, warning letters, product recalls, product seizures, total or partial suspension of our operations, injunctions, fines, civil penalties or criminal prosecution.

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

Preclinical tests include laboratory evaluation of product chemistry and formulation, as well as animal trials to assess the potential safety and efficacy of the product. The conduct of the preclinical tests and formulation of compounds for testing must comply with federal regulations and requirements including the FDA’s good laboratory practice regulations. Preclinical testing may not be completed successfully within any specified time period, if at all, and may not assure success in clinical trials. The results of preclinical testing are submitted to the FDA as part of an investigational new drug application, together with manufacturing information and analytical and stability data. The investigational new drug application must become effective before clinical trials can begin in the United States. An investigational new drug application becomes effective 30 days after receipt by the FDA unless before that time the FDA raises concerns or questions about issues such as the proposed clinical trials outlined in the investigational new drug application. In that case, the investigational new drug application sponsor and the FDA must resolve any outstanding FDA concerns or questions before clinical trials can proceed. If these concerns or questions are unresolved, the FDA may not allow the clinical trials to commence.

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

Clinical trials to support new drug applications for marketing approval are typically conducted in three sequential phases, but the phases may overlap. In phase I, the initial introduction of the drug into healthy human subjects or patients, the drug is tested to assess metabolism, pharmacokinetics and pharmacological actions and safety, including side effects associated with increasing doses. Phase II usually involves trials in a limited patient population, to determine dosage tolerance and optimum dosage, identify possible adverse effects and safety risks, and provide preliminary support for the efficacy of the drug in the indication being studied. If a compound demonstrates evidence of effectiveness and an acceptable safety profile in phase II evaluations, phase III trials are undertaken to further evaluate clinical efficacy and to further test for safety within an expanded patient population, typically at geographically dispersed clinical trial sites. Phase I, phase II or phase III testing of any product candidates may not be completed successfully within any specified time period, if at all. The FDA closely monitors the progress of each of the three phases of clinical trials that are conducted in the United States and may, at its discretion, reevaluate, alter, suspend or terminate the testing based upon the data accumulated to that point and the FDA’s assessment of the risk/benefit ratio to the patient. The FDA, an institutional review board, or a clinical trial sponsor may suspend or terminate clinical trials at any time for various reasons, including a finding that the subjects or patients are being exposed to an unacceptable health risk. The FDA can also request additional clinical trials be conducted as a condition to product approval.

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

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

Once the new drug application is approved, a product will be subject to certain post-approval requirements, including requirements for adverse event reporting and submission of periodic reports and drug sampling and distribution requirements. Additionally, the FDA also strictly regulates the promotional claims that may be made about prescription drug products. In particular, the FDA requires substantiation of any claims of superiority of one product over another including, in many cases, requirements that such claims be proven by adequate and well-controlled head-to-head clinical trials. After approval, some types of changes to the approved product, such as adding new indications, manufacturing changes and additional labeling claims, are subject to FDA review and approval. Quality control and manufacturing procedures must continue to conform to cGMPs after approval. Drug manufacturers and their subcontractors are required to register their facilities with the FDA and are subject to periodic unannounced inspections by the FDA to assess compliance with cGMPs. Accordingly, manufacturers must continue to expend time, money and effort in the area of production and quality control to maintain compliance with cGMPs and other aspects of regulatory compliance.

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

Foreign Regulation of New Drug Compounds

Approval of a product by comparable regulatory authorities will be necessary in foreign countries prior to the commencement of marketing of the product in those countries, whether or not FDA approval has been obtained. The approval procedure varies among countries and can involve requirements for additional testing. The time required may differ from that required for FDA approval. There can be substantial delays in obtaining required approvals from foreign regulatory authorities after the relevant applications are filed.

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

Hazardous Materials

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

Competition

Our product candidates will compete with existing and new products being developed by others for treatment of the same indications. Competition in the development of human therapeutics and, in particular, human therapeutics based upon signaling pathways, is intense. Our competitors will include many large pharmaceutical and biopharmaceutical companies, as well as specialized biotechnology and medical device firms. For example, we have identified two biotechnology companies that claim to have intellectual property rights relating to compounds that modulate the Hedgehog pathway.

Many of the companies competing against us have financial, marketing and human resource capacities that are substantially greater than our own, which may provide these competitors significant competitive advantages over us. Others have extensive experience in undertaking clinical trials, in obtaining regulatory approval to market products and in manufacturing products on a large scale, which may enhance their competitive position relative to ours. In addition to competing with pharmaceutical, biotechnology and medical device companies, the products we are developing would also compete with those being developed by academic and research institutions, government agencies and other public organizations. Any of these organizations may discover new therapies, seek patent protection or establish collaborative arrangements for products and technologies that are competitive with our products and technologies.

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

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

We rely on or will rely on our strategic collaborators for support in our disease research programs and for preclinical evaluation and clinical development of our potential products and manufacturing and marketing of any products. Some of our strategic collaborators are conducting multiple product development efforts within each disease area that is the subject of our strategic collaboration with them. Our strategic collaboration agreements may not restrict the strategic collaborator from pursuing competing internal development efforts. Any of our product candidates, therefore, may be subject to competition with a product candidate under development by a strategic collaborator.

Our lead product candidate, a topical therapy for the treatment of basal cell carcinoma under co-development with Genentech, will face competition from both surgical and medical alternatives. Surgery is currently the standard of care, is typically performed by dermatologists and has an efficacy rate of approximately 90%. The American Cancer Society describes the four main surgical treatment alternatives and their drawbacks as follows:

In addition to surgery, certain types of basal cell carcinomas can be treated using at least two FDA-approved topical treatments, including 3M’s Aldara^® (Immiquimod) and ICN’s Efudex^® (Flouruoracil). These FDA-approved topical treatments are limited to a subset of basal cell carcinomas, called superficial basal cell carcinoma, which is the least severe form of basal cell carcinoma and is not as prevelant as the more serious form of the disease, nodular basal cell carcinoma. A market assessment that we completed during 2004 estimates that approximately 35% of basal cell carcinomas are superficial basal cell carcinomas, 55% are nodular basal cell carcinomas, and 10% are associated with other types of basal cell carcinomas. Aldara is an immune response modulator that was approved in July 2004 for the treatment of a subset of superficial basal cell carcinoma lesions. Its mechanism of curing superficial basal cell carcinoma will generally result in skin irritation including possible scabbing, flaking, burning or itching of the skin. Efudex’s active ingredient, Flouruoracil, or 5FU, is chemotherapy that is given as a treatment for some types of cancer including bowel, breast and stomach cancer. Because Efudex is a chemotherapeutic agent, we expect that there will be side effects which are greater than our basal cell carcinoma product candidate.

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We believe that our basal cell carcinoma product candidate directly targets the known mechanism of action underlying the formation of basal cell carcinomas and that our product may be superior because it induces selective death of tumor cells while sparing adjacent normal cells and maintaining the typical architecture of the skin at the treatment site. Because of this, we believe that our product may produce minimal scarring when compared to the treatments described above and may be more effective than any of the topical treatments listed above. However, we acknowledge that our basal cell carcinoma product candidate, if approved by FDA, will face the challenge of displacing entrenched competition from at least the surgical and topical treatments listed above.

Manufacturing

We have no experience or capabilities in manufacturing. We have no current plans to develop manufacturing capability and instead plan to rely on our corporate collaborators or subcontractors to manufacture products.

Sales and Marketing

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

Scientific Advisory Board

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

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

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Employees

As of December 31, 2004, we had 64 full-time employees, of whom 34 hold Ph.D. or other advanced degrees. Of these employees, 40 are currently involved in research and development. None of our employees is a party to a collective bargaining agreement, and we consider our relations with our employees to be good.

We have three facilities which are located at 25, 45 and 61 Moulton Street in Cambridge, Massachusetts and which consist of 1,526, 35,095, and 17,800 square feet, respectively. The facilities at 25 and 61 Moulton Street are leased until April 2006 and April 2007, respectively. In August 2004, we extended the lease for the 45 Moulton Street location until December 2010. Except for 11,980 square feet at our 61 Moulton Street facility that we have sublet until April 2007, we currently use our space to conduct research and development initiatives and to manage the administrative aspects of our business. We believe that our existing facilities will be suitable and adequate to meet our needs for the foreseeable future.

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

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

EXECUTIVE OFFICERS OF THE REGISTRANT

Our executive officers are as follows:

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PART II

(a) Market Information.    Our common stock is traded on the Nasdaq National Market under the trading symbol “CRIS.” The following table sets forth, for the fiscal periods indicated, the high and low sales prices per share of our common stock as reported on the Nasdaq National Market:

(b) Holders of Record.    On March 8, 2005, the last reported sale price of our common stock on the Nasdaq National Market was $3.57 and there were 311 holders of record of our common stock. The number of record holders may not be representative of the number of beneficial owners because many of the shares of our common stock are held by depositories, brokers or other nominees.

(c) Dividends.    We have never declared or paid any cash dividends on our common stock. We currently intend to retain earnings, if any, to support our business strategy and do not anticipate paying cash dividends in the foreseeable future. Payment of future dividends, if any, will be at the sole discretion of our board of directors after taking into account various factors, including our financial condition, operating results, capital requirements and any plans for expansion.

(d) Changes in Securities and Use of Proceeds.    None.

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

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

Overview

We are a therapeutic drug development company principally focused on the discovery, development and future commercialization of products that modulate key regulatory signaling pathways controlling the repair and regeneration of human tissues and organs. Our product development approach involves using small molecules, proteins or antibodies to modulate these regulatory signaling pathways, for example, to increase the pathway signals when they are insufficient or to decrease them when they are excessive. We have successfully used our product development approach to produce multiple compounds with potential use for several different disease indications. For example, we have developed a clinical-stage product candidate for the topical treatment of basal cell carcinoma and several promising preclinical product candidates in the fields of cancer, kidney disease, neurological disorders, cardiovascular disease and hair growth regulation. 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.

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 $662,973,000 as of December 31, 2004. We expect to incur significant operating losses for the next several years as we devote substantially all of our resources to research and development of our product candidates. We will need to generate significant revenues to achieve profitability and do not expect to achieve profitability in the foreseeable future, if at all.

We currently have strategic collaborations with Genentech and Wyeth Pharmaceuticals, or Wyeth, to develop therapeutics which modulate the signaling of the Hedgehog pathway. We have also licensed our BMP pathway portfolio to Ortho Biotech Products, for systemic administration for all non-orthopedic and dental therapeutic applications. Our strategic collaborations and license agreements generally provide for our research, development and commercialization programs to be either majority or wholly funded by our collaborators and provide us with the opportunity to receive additional payments if specified milestones are achieved, as well as royalty payments upon the successful commercialization of any products based upon the collaboration. These strategic license and collaboration agreements included $15,000,000 in up-front payments, including $5,000,000 received from the sale of shares of our common stock, and potential future clinical development milestones of approximately $500,000,000 in the aggregate, assuming that all of the collaborations continue for their full terms and all milestone payments are received upon successful completion of specified research and development objectives. These collaborations also include royalty rates on potential future product sales ranging from 6% to 10%.

In the future, we plan to continue to seek corporate collaborators for the further development and commercialization of some of our technologies. In some cases, we have retained development and commercialization rights in areas where we believe we can attain the greatest potential long-term value through the application of our own internal resources.

Pursuant to the terms of our collaboration agreement with Genentech, on January 28, 2005 we elected to exercise a co-development option with Genentech pursuant to which we will now 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

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candidate for the topical treatment of basal cell carcinoma. We expect that by exercising this co-development and equal cost-sharing option we will incur approximately $20,000,000 in development expenses through the phase II clinical trials, a portion of which will be recorded in the first quarter of 2005. We plan to assist Genentech in filing an investigational new drug application with the FDA in order to initiate human clinical investigation of the basal cell carcinoma product candidate. Assuming the acceptance of the investigational new drug application by the FDA and the successful advancement of the basal cell carcinoma product candidate through phase I and phase II clinical trials, we expect that the phase II clinical trial will be completed in mid-2007. We expect to incur additional costs to complete phase III clinical trials and complete the regulatory approval process, assuming that we and Genentech successfully complete phase II clinical trials.

Financial Operations Overview

General.    Our future operating results will depend largely 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 clinical trials. We believe that our existing capital resources at December 31, 2004 should enable us to maintain current and planned operations into mid- 2007, including expected spending related to our co-development of our lead product candidate for the treatment of basal cell carcinoma, under development with Genentech. Our ability to continue funding our planned operations beyond mid-2007 is dependent upon the success of our collaborations, our ability to maintain or reduce our cash burn rate and our ability to raise additional funds through equity, 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 under the heading “Risk Factors that May Affect Results.”

Revenue.    We do not expect to generate any revenue from the sale of products for several years, if ever. Substantially all of our revenue to date has been derived from license fees, research and development payments, and other amounts that we have received from our strategic collaborators and licensees, including Genentech, Ortho Biotech Products, Wyeth and Stryker. In the future, we will seek to generate revenue from a combination of license fees, research and development funding and milestone payments in connection with strategic licenses and collaborations, and royalties resulting from the sale of products which incorporate our intellectual property and from sales of any products we successfully develop and commercialize, either alone or in partnership with third parties. We expect that any revenue we generate will fluctuate from quarter to quarter as a result of the timing and amount of payments received under our strategic collaborations, and the amount and timing of payments we receive upon the sale of our products, to the extent that any are successfully commercialized.

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

The following table summarizes our primary research and development programs, including the current development status of each program. In the table below, the term early preclinical means we are seeking to obtain initial demonstrations of therapeutic efficacy in preclinical models of human disease, mid preclinical means we are seeking to obtain multiple demonstrations of efficacy in preclinical models of human disease, and late preclinical means we are seeking to obtain both multiple demonstrations of efficacy in preclinical models of human disease and relevant toxicology and safety data required for an investigation new drug application filing with the FDA, referred to as an IND in the table below, seeking to commence a phase I clinical trial to assess safety in humans.

Except for the public disclosures of Genentech, 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 plans of our corporate collaborators or licensors, if applicable. Moreover, because

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of the early stage of development of these programs, our, and our collaborators and licensors’ ability to successfully complete preclinical studies of these product candidates, and the timing of completion of such programs, is highly uncertain. Accordingly, the estimated period in which we or our collaborators or licensors may file an investigational new drug application for any of these product candidates may vary materially from the estimates set forth below:

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

All of our product development initiatives are in various stages of preclinical testing. Because of the early stage of these programs, the successful development of our preclinical product candidates is highly uncertain. We cannot reasonably estimate or know the nature, timing and estimated costs of the efforts necessary to complete the development of, or the period in which material net cash inflows are expected to commence from any of our product candidates due to the numerous risks and uncertainties associated with developing drugs, including the uncertainty of:

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

We have received a development plan and budget from Genentech relating to the clinical development of a small molecule formulated for topical treatment for basal cell carcinoma. Based on this budget, we expect that by exercising this co-development and equal cost-sharing option we will incur approximately $20,000,000 in development expenses through phase II clinical trials, a portion of which will be recorded in the first quarter of 2005. Assuming the acceptance of the investigational new drug application by the FDA and the successful advancement of the basal cell carcinoma product candidate through phase I and phase II clinical trials, we expect that the phase II clinical trial will be completed in mid-2007. We expect to incur additional costs to complete phase III clinical trials and complete the regulatory approval process, assuming that we and Genentech successfully complete phase II clinical trials.

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

Strategic Collaborations and License Agreements.    Since inception, substantially all of our revenue has been derived from collaborations and other research and development arrangements with third parties. Our current strategic collaborations and key license agreements are with Genentech, Ortho Biotech Products and Wyeth. Pursuant to these strategic license and collaboration agreements we have received $15,000,000 in up-front payments, including $5,000,000 received from the sale of shares of our common stock, and may receive potential future clinical development milestones of approximately $500,000,000 in the aggregate, assuming that all of the collaborations continue for their full terms and all milestone payments are received upon successful completion of specified research and development objectives. These collaborations also include royalty rates on potential future product sales ranging from 6% to 10%.

The collaborations and licenses are summarized as follows:

Genentech Collaboration.    In June 2003, we licensed our proprietary Hedgehog pathway antagonists to Genentech for human therapeutic use. The primary focus of our collaborative research plan has been to develop these molecules for cancer indications. The collaboration consists of two main programs: the development of a small molecule formulated for topical treatment of basal cell carcinoma, and the development of systemically administered small molecule and antibody Hedgehog antagonists for the treatment of certain other solid tumor cancers. The development of the topical Hedgehog antagonist is subject to a co-development arrangement with Genentech. Pursuant to the collaborative research, development and license agreement entered into in June 2003, as amended in December 2004, Genentech paid us an up-front payment of $5,000,000, purchased 1,323,835 shares of our common stock at a price of

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$2.644 per share for aggregate proceeds of $3,500,000, and made a maintenance payment of $2,000,000. During the initial two-year term of the research program, Genentech has also agreed to make research and development funding payments totaling $4,000,000, of which $2,000,000 has been paid to date.

In March 2004, Genentech added one of our small molecule antagonists of the Hedgehog signaling pathway covered under our collaboration to its product candidate pipeline. This small molecule is under development for the topical treatment of basal cell carcinoma. Under the terms of our collaboration with Genentech, we retained the right to co-develop products in the field of basal cell carcinoma in the U.S. On January 28, 2005, we elected to exercise this co-development option and will now share equally in both the U.S. development costs and any future U.S. net profits and/or losses of our basal cell carcinoma product candidate. This co-development right includes basal cell carcinoma and any additional indications for which this product candidate may be developed in the U.S. Genentech has stated that it expects to file an investigational new drug application with the FDA in the first quarter of 2005. Pending FDA approval of this investigational new drug filing, Genentech will begin enrollment of a phase I clinical trial for a basal cell carcinoma product candidate. We currently estimate that our share of development costs for the basal cell carcinoma indication will approximate $20,000,000 through the phase II clinical trials. We expect that this endpoint will be achieved, if at all, in mid-2007. In addition, in certain major international markets, we will receive milestones if specific clinical development objectives are achieved and a royalty on any international sales of the topical Hedgehog antagonist.

Under the systemic Hedgehog antagonist portion of the collaboration, Genentech is also obligated to make cash payments to us upon the successful achievement of clinical development and drug approval milestones. In addition, Genentech will pay a royalty on potential future net product sales, which increases with increasing sales volume.

As a result of our licensing agreements with various universities, we are obligated to make payments to these university licensors when certain payments are received from Genentech. These obligations total $410,000 for the $5,000,000 up-front license fee and the $2,000,000 maintenance fee for the period June 11, 2003 through June 11, 2004. As of December 31, 2004, $310,000 has been paid to the university licensors. The unpaid obligations are included in “Accrued liabilities” in our consolidated balance sheet as of December 31, 2004.

Ortho Biotech Products License.    In November 2002, we licensed our broad BMP technology portfolio to Ortho Biotech Products on an exclusive, worldwide royalty-bearing basis, for all non-orthopedic and non-dental therapeutic applications in exchange for a $3,500,000 fee, a series of cash milestones if specified clinical research objectives and regulatory approvals are achieved, including a $30,000,000 milestone payment upon U.S. regulatory approval of a product for the treatment of kidney disease, and a royalty on potential future product sales. Ortho Biotech Products has assumed all future costs and responsibility for BMP-based product development and has sole responsibility for deciding if and when human clinical trials of BMP-based product candidates will begin.

Wyeth Collaboration.    Effective February 2004, we licensed our Hedgehog proteins and small molecule Hedgehog pathway agonists to Wyeth on an exclusive worldwide, royalty-bearing basis for the development and commercialization of pharmaceutical products for therapeutic applications in the treatment of diseases and disorders in humans with the primary focus of the research program on the treatment of neurological disorders, including neurodegenerative diseases and neuropathies. Under the terms of the agreement, Wyeth paid us a license fee of $1,500,000 and purchased 315,524 shares of our common stock at a price of $4.754 per share for an aggregate purchase price of $1,500,000. Wyeth will also provide us with research funding for a minimum of two years. In addition, Wyeth is obligated to make cash payments to us upon the successful achievement of development and drug approval milestones and is obligated to pay a royalty on net product sales, if any, that escalates with increasing sales volume.

As part of our collaboration with Wyeth, we have retained development and licensing options for certain therapeutic applications of the Hedgehog agonist technologies, including those applications that qualify as orphan drug indications, topical applications for hair growth and local delivery applications for

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treatment of cardiovascular disease. Wyeth has a right of first negotiation to obtain an exclusive license to the cardiovascular applications. If Wyeth declines to exercise its option, or if we are unable to reach an agreement with Wyeth on terms within the contractually specified period, we are free to seek another collaborator for this program.

We are obligated to make payments to various university licensors when certain payments are received from Wyeth. We have paid to such university licensors a total of $125,000 upon receipt of the $1,500,000 up-front license fee from Wyeth. In addition, as part of a termination agreement entered into with Elan, we will pay Elan royalty payments related to any revenues, other than revenues received as direct reimbursement for research, development and other expenses, that we receive in the field of neurological disease.

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 liabilities. We base our estimates on historical experience and on various other factors that are believed 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.

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

Long-Lived Assets.    Long-lived assets consist of goodwill, long-term receivables, equity securities held in Micromet, ES Cell International and Aegera Therapeutics, capitalized patent costs and long-term deposits. We assess the impairment of identifiable intangibles and long-lived assets whenever events or changes in circumstances indicate that the carrying value may not be recoverable. In addition, we perform a goodwill impairment test annually. If it were determined that the carrying value of intangible or long-lived assets might not be recoverable based upon the existence of one or more indicators of impairment, we would measure any impairment based on a projected cash flow method.

Goodwill.    At December 31, 2004, we have recorded $8,982,000 in goodwill. As a result of the adoption of SFAS No. 142, effective January 1, 2002, we ceased amortization of goodwill and have since performed at least annual assessments of goodwill impairment by comparing our fair value to our net assets. SFAS No. 142 requires us to perform an impairment assessment annually or whenever events or changes in circumstances indicate that our goodwill may be impaired. We completed our annual goodwill impairment tests in December 2004 and 2003, and determined that as of those dates our fair value exceeded the carrying value of our net assets. Accordingly, no goodwill impairment was recognized in 2004 or 2003.

During the three-month period ended June 30, 2002, we concluded that the decline in our market capitalization indicated that the carrying value of goodwill might be impaired. As a result, we conducted an impairment assessment as required under SFAS No. 142 by comparing our fair value to our net assets, including goodwill, as of June 30, 2002. Because the carrying value of our net assets exceeded our fair value at June 30, 2002, we determined that our goodwill had been impaired. To determine the amount of the impairment charge, we calculated our implied goodwill as the difference between our fair value and the fair value of our assets and liabilities. The fair value of our intangible assets, principally consisting of completed and in-process technology, was estimated using a discounted cash flow methodology. Based on this valuation, we determined that our implied goodwill was $8,982,000, and we recorded a non-cash charge in the quarter ended June 30, 2002, of $64,098,000 to write-down our existing goodwill.

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The goodwill impairment analysis as of June 30, 2002 involved considerable judgment and the use of several estimates including: control premium, discount rates, projected cash flows of OP-1, a bone regeneration product that we had developed under agreements with Stryker Corporation, and projected cash flows of our in-process research and development programs. The control premium used in determining our fair value was based on an analysis of control premiums involved in other biotechnology and medical products acquisitions. Most of our research and development programs will not be completed for several years, if ever, and therefore estimating the costs to complete these programs and the revenue to be derived through collaborations and commercialization of the products involves substantial judgment. The discount rates used to determine the net present value of these cash flows were based on a consideration of the risks associated with achieving these cash flow projections, including the risk of successfully completing our in-process technology. All of these estimates involve a significant amount of judgment by our management. Although the estimates used reflect management’s best estimates based upon all available evidence, the use of different estimates could have yielded different results in our transitional impairment assessment conducted as of January 1, 2002, and in our impairment assessment conducted in the second quarter of 2002. Had we used a significantly lower control premium in determining our fair value, our transitional impairment analysis could have indicated that goodwill was impaired at January 1, 2002. In addition, using different estimated cash flows or discount rates in determining our implied goodwill in the second quarter of 2002 could have resulted in a higher or lower goodwill impairment charge.

Long-term receivables.    During the year ended December 31, 2003, we recorded, in other expense, charges of $1,708,000 related to the write-off of a euro-denominated note receivable that was originally due in June 2005 from Micromet, a former collaborator, and $286,000 related to a reduction in the carrying value of Micromet equity securities held by us. We determined that this charge was necessary due to Micromet’s announcement that it was terminating one-third of its workforce as the result of a contract dispute with a collaborator. Micromet had stated that this dispute would result in a significant decrease in previously budgeted cash inflows in 2004.

On October 21, 2004, we amended our note receivable with Micromet, and, under the amended note, Micromet is obligated to pay us a total amount of EUR 4,500,000, subject to certain conditions. As a result of Micromet’s financing in October 2004, we received a EUR 1,250,000 payment in November 2004, resulting in a gain of $1,604,000 based on the EURO-to-US dollar foreign exchange rate. The terms of Micromet’s financing adversely affect the carrying value of the equity we hold in Micromet and, therefore, we recorded a $300,000 write-down of the carrying value from $400,000 to our estimated fair value of the investment of $100,000. The $1,304,000 net gain was recorded in other income for the year ended December 31, 2004. The future amounts due to us under the amended note payable will be recorded in other income when and if such amounts are collected.

Valuation of investments in privately held companies.    We have investments in Aegera, Micromet and ES Cell International with carrying values of $167,000, $100,000 and $150,000, respectively. These investments are included in the “Deposits and other assets” category of our consolidated balance sheets. At each balance sheet date, we review these investments to determine whether the fair value of these investments is less than the carrying value and, if so, whether we should write-down the investment. These companies are not publicly traded and, therefore, determining the fair value of our investments in these companies involves significant judgment. We consider available information in estimating the fair value of these investments and, as of December 31, 2004, believe that the fair value of our investments is not less than their carrying value after taking into effect the write-down of the Micromet investment.

If the financial condition or results of Aegera or ES Cell decline significantly or if Micromet’s financial condition continues to decline, the fair value of these investments would likely decline and, as a result, we may have to record an impairment charge to the extent such impairment is deemed other than temporary.

Revenue recognition.    Revenue is a key component of our results of operations. We follow the provisions of the Securities and Exchange Commission’s Staff Accounting Bulletin No. 104 (SAB No. 104), Revenue Recognition, and EITF 00-21, Accounting for Revenue Arrangements with Multiple Deliverables. In accordance

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with SAB No. 104, we recognize revenue related to research activities as they are performed, so long as there is persuasive evidence of an arrangement, the fee is fixed or determinable and collection of the related receivable is probable.

We analyze our multiple-element arrangements entered into since July 2003 to determine whether the elements can be separated and accounted for individually as separate units of accounting in accordance with EITF No. 00-21. We recognize license payments as revenue when received if the license has stand-alone value and the fair value of the undelivered items can be determined. If the license is considered to have stand-alone value but the fair value on any of the undelivered items cannot be determined, the license payments are recognized as revenue over the period of performance for such undelivered items or services.

Amounts received for license fees are deferred and recognized as services are performed over the performance period of the contract. Any obligations related directly to the receipt of a license fee are also deferred and recognized as services are performed over the performance period of the contract. Amounts received for milestones are recognized upon achievement of the milestone, as long as the milestone is deemed to be substantive and we have no other performance obligations with respect to that milestone. In the event that we have remaining performance obligations, the portion of the milestone payment equal to the lesser of the non-refundable cash received or the percentage of the services performed through that date multiplied by the total milestone payment would be recognized as revenue. Revenue received under grants is being recognized as the services are provided and payment is assured under the terms of the grant. Based upon the application of our revenue recognition policies, and our related estimates and judgments, we have recognized revenue under our key collaborations, license agreements and grant as follows:

Genentech Collaboration.    On December 10, 2004, we entered into an amendment to our collaboration agreement with Genentech. The amendment, effective from June 12, 2004 to June 11, 2005, increases Genentech’s funding commitment from $2,000,000 to $4,000,000 for this period. Under the terms of the amended collaboration agreement, Genentech committed to pay an incremental payment of $2,000,000 for support of full-time equivalents in our collaboration with Genentech. We are required to commit up to sixteen employees to the systemic Hedgehog antagonist program through June 11, 2005. We are recognizing this reimbursement of research and development services as revenue over the six-month period through June 11, 2005 as services are performed based on the actual staffing level.

In December 2004, we determined that the performance period covered by the Genentech license fee should be extended through June 2011, from our previous estimate of October 2010. The change in estimate related to a change in our estimate of the period during which we will provide services under the collaboration, defined as the time to market of our basal cell carcinoma product under co-development with Genentech. This change will be applied prospectively and therefore did not have an effect on previously recognized revenue.

We recognized $1,829,000 in revenue related to our collaboration with Genentech for the year ended December 31, 2004. Of this amount, $1,229,000 was from the amortization of the $9,000,000 in license and up-front payments received from Genentech. We expect that the remainder of the license fees will be recognized on a straight-line basis through June 2011 as the remaining services are performed. We recognized expenses of $83,000 for the year ended December 31, 2004, for the amortization of obligations related to these license fees. In addition, we recognized revenues of $600,000 relating to other research and development services performed under the collaboration agreement with Genentech for the year ended December 31, 2004. We recognized $728,000 in revenue for the year ended December 31, 2003, related solely to the amortization of the Genentech license fee.

Wyeth Collaboration.    We recognized $2,523,000 in revenue related to our collaboration with Wyeth for the year ended December 31, 2004. This amount consists of revenue of $267,000 from the amortization of a $1,500,000 license fee payment received from Wyeth in February 2004. We expect that the remainder of the license fee will be recognized on a straight-line basis through February 2009, our remaining service period. We recognized expenses of $22,000 for the year ended December 31, 2004, for the amortization of

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obligations related to the license fee. In addition, we recognized $2,256,000 relating to research and development services performed under the collaboration agreement with Wyeth for the year ended December 31, 2004. As of December 31, 2004, we were meeting the staffing requirements under the collaboration and expect to continue to meet staffing, as determined by Wyeth, through the remainder of the performance period. Since our collaboration with Wyeth was not effective until February 2004, no revenue related to Wyeth was recognized in 2003.

Spinal Muscular Atrophy Foundation.    We recognized $551,000 relating to research and development services performed under the $5,364,000, three-year grant from the Spinal Muscular Atrophy Foundation for the year ended December 31, 2004. Future revenues received under this grant will be recognized as the services are provided and payment is assured under the terms of the grant. Since this grant was not received until September 2004, no revenue related to the Spinal Muscular Atrophy Foundation was recognized in 2003.

ES Cell International Collaboration.    Our collaboration with ES Cell International was terminated in December 2003. Accordingly, we recognized no revenue related to this collaboration during 2004. For the year ended December 31, 2003, we recognized $1,470,000 of revenues relating to research and development services performed under this collaboration.

Although we follow detailed guidelines in measuring revenue, certain judgments affect the application of our revenue policy. For example, in connection with our existing collaboration agreements, we have recorded on our balance sheet short- and long-term deferred revenue based on our best estimate of when such revenue will be recognized. We have recorded short-term deferred revenue of $1,940,000 and long-term deferred revenue of $6,942,000 as of December 31, 2004. Short-term deferred revenue consists of amounts that are expected to be recognized as revenue by December 31, 2005. Amounts that we expect will not be recognized prior to December 31, 2005 are classified as long-term deferred revenue. However, this estimate is based on our current operating plan as of December 31, 2004. If our operating plan should change in the future, we may recognize a different amount of deferred revenue over the twelve-month period from January 1, 2005, through December 31, 2005.

The estimate of deferred revenue reflects management’s estimate of the periods of our involvement in certain of our collaborations. Our performance obligations under these collaborations consist of participation on steering committees and the performance of other research and development services. Our period of involvement is largely determined by the time to commercialize our basal cell carcinoma clinical candidate that we are co-developing with Genentech and our estimate of time to reach clinical development for candidates under our collaboration with Wyeth. Since the timing of clinical development is difficult to estimate, our estimates may change in the future. Such changes to estimates would result in a change in revenue recognition amounts. If these estimates and judgments change over the course of these agreements, it may affect the timing and amount of revenue that we recognize and record in future periods.

Stock-based compensation.    We issue stock options to employees under our stock option and employee stock purchase plans. These options are accounted for under APB Opinion No. 25, Accounting for Stock Issued to Employees and related interpretations, including FASB Interpretation No. 44. All stock-based awards to non-employees are accounted for at their fair value in accordance with SFAS No. 123, Accounting for Stock-Based Compensation, as amended by FASB No. 148, and Emerging Issues Task Force Issue No. 96-18, Accounting for Equity Instruments that are Issued to Other than Employees.

SFAS 123 requires that companies either recognize compensation expense for grants of stock options and other equity instruments based on fair value, or provide pro forma disclosure of net loss and net loss per share in the notes to the financial statements. At December 31, 2004, we had two stock-based compensation plans. We account for these plans under the recognition and measurement principles of APB Opinion No. 25 and related interpretations. Accordingly, no compensation cost has been recognized under SFAS 123 for the our employee stock option plans.

Under SFAS No. 123, the fair value of stock-based awards to employees is calculated through the use of option pricing models, even though such models were developed to estimate the fair value of freely tradable,

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fully transferable options without vesting restrictions, which significantly differ from our stock option awards. These models also require subjective assumptions, including risk-free interest rates, future stock price volatility and expected time to exercise, which greatly affect the calculated values. We calculate compensation cost with the Black-Scholes option-pricing model.

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.

Results of Operations

Years Ended December 31, 2004 and 2003

Revenues

Total revenues are summarized as follows:

Revenues from research and development contracts increased by $1,828,000 for the year ended December 31, 2004, as compared to the year ended December 31, 2003. Research and development contract revenues for the year ended December 31, 2004 were primarily derived from revenue recognized under our collaborations with Genentech and Wyeth of $600,000 and $2,256,000, respectively. In addition, we recognized revenue of $551,000 for the year ended December 31, 2004 under our sponsored research agreement with the Spinal Muscular Atrophy Foundation.

For the year ended December 31, 2003, research and development contract revenues primarily consisted of $1,470,000 recognized under a licensing agreement with ES Cell International. Effective December 2003, and consistent with the terms of this agreement, we are no longer providing research and development services for ES Cell International and will therefore not recognize future revenues related to this collaboration.

The decrease in revenue from license fees and royalties of $7,923,000 for the year ended December 31, 2004, as compared to the year ended December 31, 2003, primarily consisted of $8,555,000 in previously deferred revenue which was recognized upon the termination of our collaboration with Micromet during the third quarter of 2003. License fee revenues for the year ended December 31, 2004 were derived from revenue recognized under our collaborations with Genentech and Wyeth of $1,229,000 and $267,000, respectively.

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Operating Expenses

Research and development expenses are summarized as follows:

The decrease of $1,165,000 in research and development expenses for the year ended December 31, 2004 was primarily due to the net effect of changes in spending in our research programs. First, we decreased spending by $2,125,000, or 100%, on other programs. Included in other programs were expenses incurred for contract research and development services performed under our diabetes cell therapy program that was under collaboration with ES Cell International. The contract research component of this collaboration ended in December 2003 and, accordingly, we are no longer incurring costs related to this program. In addition, costs related to our nervous system disorders program were significantly reduced as compared to 2003. These decreases were partially offset by increases in spending under our cancer program, which is under collaboration with Genentech. The increase in expenses was primarily attributable to a $698,000 increase in chemistry expenses related to potential small molecule antagonist product candidates for the treatment of various cancers as well as increases in license fees, personnel costs and related lab supplies. Genentech reimbursed us for all chemistry costs incurred under our collaboration for 2004. In addition, we initiated new discovery research programs in 2004. We incurred costs of $602,000 for our spinal muscular atrophy program, which is under collaboration with the Spinal Muscular Atrophy Foundation, and $2,872,000 in expenses related to our other discovery research programs during the year ended December 31, 2004. We incurred no expenses for these programs during the same period in 2003.

General and administrative expenses are summarized as follows:

The increase of $1,041,000 in total general and administrative expenses for the year ended December 31, 2004 was primarily due to an increase in personnel costs of $375,000, legal fees of $626,000 and professional and consulting services of $669,000. The increases principally resulted from costs associated with various technology acquisition evaluations, expenses associated with financing-related activities during the first half of 2004, an increase in legal patent expenses, an increase in personnel, and costs associated with compliance with

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the Sarbanes-Oxley Act. To offset these increases, we received $558,000 during the fourth quarter of 2004 from the settlement of notes receivable from former officers of a predecessor company that had a carrying value of $110,000, resulting in a net gain of $448,000. The amount charged to reserve for the possible non-collection of these notes receivable was $34,000 for the year ended December 31, 2003.

Stock-based compensation decreased by $259,000, or 16%, to $1,372,000 for the year ended December 31, 2004, as compared to $1,631,000 for the year ended December 31, 2003. The decrease was primarily attributable to a decrease of compensation expense recorded on options to purchase common stock that were issued to employees below fair market value on August 18, 2000. As of August 18, 2004, all of these options became fully vested; therefore, no related additional expense was recognized beyond August 2004. We recorded $599,000 and $1,100,000 in stock-based compensation related to these options for the years ended December 31, 2004 and 2003, respectively. This decrease was offset by an increase in compensation expense recognized on options issued to non-employees. We recorded $773,000 and $483,000 in stock-based compensation related to non-employee options for the years ended December 31, 2004 and 2003, respectively.

Amortization of intangible assets was $75,000 for each of the years ended December 31, 2004 and 2003.

Other Income (Expense)

For the year ended December 31, 2004, interest income was $540,000 as compared to $428,000 for the year ended December 31, 2003, an increase of $112,000, or 26%. The increase in interest income resulted from a higher available investment balance for the year ended December 31, 2004, as compared to the year ended December 31, 2003.

For the year ended December 31, 2004, other income was $1,592,000 as compared to other expense of $1,445,000 for the year ended December 31, 2003, an increase of $3,037,000. The increase was principally due to the receipt of $1,604,000 on a note receivable from Micromet, a former collaborator, offset by a $300,000 write-down of our investment in Micromet resulting in a net gain of $1,304,000 in the fourth quarter of 2004. The note had been written off during the fourth quarter of 2003 resulting in an impairment charge of $1,708,000 for year ended December 31, 2003.

For the year ended December 31, 2004, interest expense was $411,000, as compared to $694,000 for the year ended December 31, 2003, a decrease of $283,000, or 41%. The decrease in interest expense resulted from a decrease in the amount of interest expense that we paid under capital lease and debt obligations in 2004 as compared to 2003. We recorded interest expense under these obligations of $35,000 for the year ended December 31, 2004 compared to $244,000 for the year ended December 31, 2003.

Accretion on Series A Convertible Exchangeable Preferred Stock

We recorded no accretion of preferred stock dividend for the year ended December 31, 2004 as compared to $271,000 for the year ended December 31, 2003. The charge for the year ended December 31, 2003 relates to the accretion of a mandatory 6% dividend on shares of convertible exchangeable preferred stock issued to an affiliate of Elan as part of a joint venture with Elan. The joint venture was terminated on May 16, 2003 and the convertible exchangeable preferred stock was cancelled as part of the termination. The amount is included in the net loss applicable to common stockholders for the year ended December 31, 2003.

Net Loss Applicable to Common Stockholders

As a result of the foregoing, we incurred a net loss applicable to common stockholders of $13,904,000 for the year ended December 31, 2004, as compared to $11,895,000 for the year ended December 31, 2003.

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Years Ended December 31, 2003 and 2002

Revenues

Total revenues are summarized as follows:

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

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

Operating Expenses

Research and development expenses are summarized as follows:

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In the foregoing table, “Other programs” includes research and development expenses relating to adult stem cell and cell therapy programs. For the years ended December 31, 2003 and 2002, $1,892,000 and $5,255,000, respectively, related to our adult stem cell and cell therapy programs. As further described below, we reduced expenses incurred under our adult stem cell and cell therapy programs in connection with our business realignment in 2002. Costs allocated to the Curis Newco joint venture relate to research expenses incurred by us and charged to Curis Newco, a joint venture that, until May 16, 2003, was operated by us and affiliates of Elan Corporation. These amounts related to our nervous system disorders program.

The increase in research and development expenses for the year ended December 31, 2003, as compared to the year ended December 31, 2002, was primarily due to the termination of our collaboration with Elan, offset by a reduction in ongoing operating costs as a result of our business realignment in the first quarter of 2002, including reductions in amounts spent on stem cell and cell therapy programs. As a result of this realignment, our research and development expenses were focused principally on regulatory signaling pathways, particularly the Hedgehog Pathway, for the year ended December 31, 2003, and spending on our stem cell, cell therapy and other programs decreased by an aggregate of $3,717,000, to $2,125,000 for the year ended December 31, 2003, as compared to $5,842,000 for the year ended December 31, 2002. Reductions in spending on our stem cell, cell therapy and other programs were offset by the termination of our collaboration with Elan, which resulted in no research and development expense being charged to Curis Newco in 2003 as compared to $5,263,000 in 2002. In 2002, our research and development expenses were presented net of these expenses charged to Curis Newco.

General and administrative expenses are summarized as follows:

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

Stock-based compensation decreased by $529,000, or 24%, to $1,631,000 for the year ended December 31, 2003, as compared to $2,160,000 for the year ended December 31, 2002. The decrease was primarily attributable to a decrease in the amount of stock-based compensation expense related to our issuance on August 18, 2000 of stock options with exercise prices below fair market value. We recorded $1,100,000 and $1,893,000 in stock-based compensation related to these options for the years ended December 31, 2003 and 2002, respectively. Because these options were issued with exercise prices below fair market value, we recorded deferred compensation and have been amortizing the deferred compensation over the four-year vesting period of the options. When an option holder’s employment with us is terminated, we treated any unvested portion of their options and related deferred compensation as charged to additional paid-in capital rather than stock-based compensation. Accordingly, the departure of four officers and 55 additional employees as a result of the

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realignment of our business and a subsequent staff reduction in December 2002 has resulted in a decrease in stock-based compensation expense, as the remaining deferred compensation balance associated with each terminated employees’ August 18, 2000 stock options was immediately charged to additional paid-in capital.

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

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

Impairment of goodwill for the year ended December 31, 2002 was $64,098,000. In accordance with SFAS No. 142, we concluded that the decline in our market capitalization during the three-month period ended June 30, 2002 indicated that the carrying value of our goodwill might be impaired. Accordingly, we conducted an impairment review as required under SFAS No. 142 as of June 30, 2002, and determined that goodwill impairment had occurred as of June 30, 2002. Our value, as a single reporting unit, was calculated using quoted market prices adjusted to provide for a control premium. In calculating the impairment charge, the fair value of our intangible assets, principally consisting of completed and in-process technology, was estimated using a discounted cash flow methodology.

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

Equity in Loss from Joint Venture

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

Other Income (Expense)

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

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For the year ended December 31, 2003, other expense was $1,445,000 as compared to other income of $1,262,000 for the year ended December 31, 2002, a decrease of $2,707,000. This decrease was principally due to an impairment charge of $1,708,000 for the write-off of a euro-denominated note receivable from Micromet, a former collaborator, during the fourth quarter of the year ended December 31, 2003, as well as a decrease in the gain recognized on currency rate fluctuations on the Micromet note receivable of $207,000. In addition, the amount of gain recognized on sales of securities decreased by $504,000 in the year ended December 31, 2003, as compared to the year ended December 31, 2002. We recognized gains on sales of securities of $97,000 for the year ended December 31, 2003, as compared to $601,000 for the year ended December 31, 2002.

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

Accretion on Series A Convertible Exchangeable Preferred Stock

Accretion of preferred stock dividend for the year ended December 31, 2003 was $271,000, as compared to $723,000 for the year ended December 31, 2002, a decrease of $452,000, or 63%. This charge relates to the accretion of a mandatory 6% dividend on shares of convertible exchangeable preferred stock issued to an affiliate of Elan as part of a joint venture with Elan. The decrease is attributed to the termination of the joint venture on May 16, 2003, in which the convertible exchangeable preferred stock was cancelled as part of the termination. The amounts are included in the net loss applicable to common stockholders for the years ended December 31, 2003 and 2002.

Net Loss Applicable to Common Stockholders

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

Liquidity and Capital Resources

We have financed our operations primarily through license fees, research and development funding from our collaborators, the private and public placement of our equity securities, debt financings and the monetization of certain royalty rights.

At December 31, 2004, our principal sources of liquidity consisted of cash, cash equivalents, and marketable securities of $49,514,000, excluding restricted long-term investments of $193,000. Our cash and cash equivalents are highly liquid investments with a maturity of three months or less at date of purchase and 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. However, 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 original 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. To date, the source of our cash flows from operations has been payments received from our collaborators. In general, our only source of cash flows from operations for the foreseeable future will be the up-front license payments, payments for the achievement of milestones, and funded research and development that we may receive under collaboration agreements. The timing of any new collaboration agreements and any payments under collaboration agreements cannot be easily predicted and may vary significantly from quarter to quarter.

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Net cash used in operating activities was $7,329,000 for the year ended December 31, 2004, as compared to $9,761,000 for the year ended December 31, 2003. Cash used in operating activities during the year ended December 31, 2004 was primarily to fund our net loss of $13,904,000, partially offset by $2,688,000 in non-cash charges including stock-based compensation expense, depreciation and amortization, non-cash interest expense on notes payable, amortization of intangible assets, a gain on recovery of officers’ notes receivable relating to prior officers of a predecessor company and an impairment of an investment in Micromet, a former collaborator of ours. In addition, a $1,500,000 up-front payment received for a licensing agreement with Wyeth and a $2,000,000 maintenance fee payment received from Genentech further offset our use of cash. We expect that our cash used in operations will increase as we begin to incur costs under the equal co-development and cost-sharing arrangement for our basal cell carcinoma product candidate under development with Genentech. In addition, our cash used in operations could further increase if we seek to develop additional products toward clinical trials and as we advance new products into preclinical development. We also expect that the increase in cash used will be partially offset by anticipated payments made under our collaborations with Genentech, Wyeth and the Spinal Muscular Atrophy Foundation, assuming these collaborations continue in accordance with their terms.

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

Investing activities used cash of $21,631,000 for the year ended December 31, 2004 as compared to $1,645,000 in cash generated for the year ended December 31, 2003. Cash used in investing activities resulted principally from $19,714,000 in net investment purchases and $1,917,000 in fixed asset purchases for the year ended December 31, 2004. We expect that we will continue to use cash in our investing activities as we expand our infrastructure. We expect that our cash spent on fixed asset purchases will decline in 2005. The $1,917,000 spent on fixed assets in 2004 related to equipment associated with a new screening program and to the partial completion of a laboratory build out that will be used to improve our capacity to conduct preclinical disease models. We expect that we will complete the laboratory build out during the first quarter of 2005. Net cash generated for the year ended December 31, 2003, was driven by a reduction in restricted cash balances of $4,213,000, resulting from the full repayment of our loan agreement with the Boston Private Bank & Trust Company.

Financing activities generated $23,906,000 of net cash for the year ended December 31, 2004, as compared to net cash generated by financing activities of $8,930,000 for the year ended December 31, 2003. The cash generated by financing activities during 2004 was principally the result of the sale of $22,540,000 of our common stock, including $18,837,000 in net proceeds from a registered direct offering of 5,476,559 shares of newly issued common stock, and warrants to purchase an aggregate of 547,656 shares of common stock, in October 2004, $1,500,000 from the sale of 315,524 shares of common stock to Wyeth and $1,919,000 in proceeds received upon stock option exercises. In addition, proceeds from the issuance of debt for the purchase of fixed assets provided $1,137,000 for the year ended December 31, 2004. These increases were offset by $332,000 in repayments of obligations under capital leases. During 2005, we expect to borrow the remaining $1,113,000 against our Boston Private Bank & Trust Company loan agreement as we will complete construction on our laboratory build out in the first quarter of 2005.

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

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Pursuant to the terms of our collaboration agreement with Genentech, on January 28, 2005 we elected to exercise a co-development option with Genentech pursuant to which we will now 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 expect that by exercising this co-development and equal cost-sharing option we will incur approximately $20,000,000 in development expenses through phase II clinical trials, a portion of which will be booked in the first quarter of 2005. We plan to assist Genentech in filing an investigational new drug application with the FDA in order to initiate human clinical investigation of the basal cell carcinoma product candidate. Assuming the acceptance of the investigational new drug application by the FDA and the successful advancement of the basal cell carcinoma product candidate through phase I and phase II clinical trials, we expect that the phase II clinical trial will be completed in mid-2007. We expect to incur additional costs to complete phase III clinical trials and complete the regulatory approval process, assuming that we and Genentech successfully complete phase II clinical trials.

Effective September 23, 2004, we cancelled an existing loan agreement with the Boston Private Bank & Trust Company and entered into a new loan agreement to finance up to $2,250,000 in purchases of equipment and facility leasehold improvements through February 28, 2005. We have financed $1,137,000 for purchases of equipment and leasehold improvements that accrue interest at a variable rate of 6.25% as of December 31, 2004. On January 7, 2005, we entered into an amendment to extend the drawdown date in which we can request periodic financings for qualifying purchases of equipment and leaseholds under the loan agreement through April 30, 2005. Until such time, we will pay interest only on any borrowings on a monthly basis in arrears. We then have the option to either repay the then outstanding balance in full or convert the then outstanding balance into a 36-month term note that bears interest at either a variable rate (6.25% as of December 31, 2004) or a fixed rate (6.91% as of December 31, 2004) for the repayment period. As of December 31, 2004, we consider this obligation to be short-term since we have not yet exercised the option to convert the balance to a term note. The loan is collateralized by all of our property, plant and equipment assets, except for those that are affixed to the property and those that are purchased after April 30, 2005 under purchase money arrangements with equipment lenders.

On May 16, 2003, we and affiliates of Elan Corporation entered into a termination agreement to conclude the joint venture that was originally formed in July 2001. As part of the termination, we entered into an amended and restated convertible note payable with EPIL with the principal amount of $3,000,000. The terms of the amended and restated note were substantially the same as those under the original note, except that the interest rate was reduced from 8% to 6% and the conversion rate was increased from $8.63 to $10.00. As of December 31, 2004, there was approximately $3,298,000, including approximately $298,000 in accrued interest, outstanding under this convertible note payable. On January 7, 2005, Elan elected to convert the then-outstanding balance of $3,305,523 into 330,552 shares of our common stock, based on a conversion price of $10.00 per share. We have no further obligations under this convertible note payable.

On June 26, 2001, we received $2,000,000 from Becton Dickinson under a convertible subordinated note payable in connection with the exercise by Becton Dickinson of an option to negotiate a collaboration agreement. The note is repayable at any time up to its maturity date of June 26, 2006 by us, at our discretion, in either cash or upon issuance to Becton Dickinson of shares of our common stock. The note bears interest at 7%. As of December 31, 2004, there was approximately $2,492,000, including approximately $492,000 in accrued interest, outstanding under the note agreement.

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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 December 31, 2004: