##### Table of Contents

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q

(Mark one)

|x |  | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- |  | ---------------------------------------------------------------------------------------



FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2004



OR



| ̈ |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- |  | ----------------------------------------------------------------------------------------



Commission File Number: 000-30347



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CURIS, INC.

(Exact Name of Registrant as Specified in Its Charter)



|                                                                                    |  |                                                
|----------------------------------------------------------------------------------- |  | -----------------------------------------------
|Delaware (State or Other Jurisdiction of Incorporation or Organization)             |  | 04-3505116 (I.R.S. Employer Identification No.)
|                                                                                    | 
|61 Moulton Street Cambridge, Massachusetts (Address of Principal Executive Offices) |  | 02138 (Zip Code)                               



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



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



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



As of October 21, 2004, there were
47,290,071 shares of the Registrants common stock outstanding.





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##### Table of Contents

CURIS, INC. AND SUBSIDIARIES

QUARTERLY REPORT ON FORM 10-Q



INDEX



|          |  |                                                                                                                              |  |           
|--------- |  | ---------------------------------------------------------------------------------------------------------------------------- |  | ----------
|PART I.   |  | FINANCIAL INFORMATION                                                                                                        |  | PageNumber
|          |  |                                                                                                                             
|Item 1.   |  | Financial Statements (unaudited)                                                                                             |  |           
|          |  |                                                                                                                             
|          |  | Condensed Consolidated Balance Sheets as of September 30, 2004 and December 31, 2003                                         |  | 3         
|          |  |                                                                                                                             
|          |  | Consolidated Statements of Operations and Comprehensive Loss for the three and nine months ended September 30, 2004 and 2003 |  | 4         
|          |  |                                                                                                                             
|          |  | Consolidated Statements of Cash Flows for the nine months ended September 30, 2004 and 2003                                  |  | 5         
|          |  |                                                                                                                             
|          |  | Notes to Unaudited Condensed Consolidated Financial Statements                                                               |  | 6         
|          |  |                                                                                                                             
|Item 2.   |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                                        |  | 11        
|          |  |                                                                                                                             
|Item 3.   |  | Quantitative and Qualitative Disclosures About Market Risk                                                                   |  | 35        
|          |  |                                                                                                                             
|Item 4.   |  | Controls and Procedures                                                                                                      |  | 35        
|          |  |                                                                                                                             
|PART II.  |  | OTHER INFORMATION                                                                                                            |  |           
|          |  |                                                                                                                             
|Item 6.   |  | Exhibits                                                                                                                     |  | 36        
|          | 
|SIGNATURE |  | 37                                                                                                                          



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##### Table of Contents

Item 1.    FINANCIAL STATEMENTS



CURIS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited)



|                                                                                                                                                                                                                                                                                                      |  |                   |              |   |                   |   |              |  
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------- | ------------ | - | ----------------- | - | ------------ | -
|                                                                                                                                                                                                                                                                                                      |  | September 30,2004 |              |   | December 31, 2003 |  
|ASSETS                                                                                                                                                                                                                                                                                                |  |                   |              |   |                   |   |              |  
|Current Assets:                                                                                                                                                                                                                                                                                       |  |                   |              |   |                   |   |              |  
|Cash and cash equivalents                                                                                                                                                                                                                                                                             |  | $                 | 16,575,489   |   |                   | $ | 27,734,548   |  
|Cash equivalentsrestricted                                                                                                                                                                                                                                                                           |  |                   | 193,166      |   |                   |   | 190,661      |  
|Marketable securities                                                                                                                                                                                                                                                                                 |  |                   | 14,358,075   |   |                   |   | 7,413,703    |  
|Accounts receivable                                                                                                                                                                                                                                                                                   |  |                   | 2,581,341    |   |                   |   | 2,184,973    |  
|Prepaid expenses and other current assets                                                                                                                                                                                                                                                             |  |                   | 1,248,295    |   |                   |   | 1,202,993    |  
|                                                                                                                                                                                                                                                                                                      |  |                   |              |   |                   |   |              |  
|Total current assets                                                                                                                                                                                                                                                                                  |  |                   | 34,956,366   |   |                   |   | 38,726,878   |  
|                                                                                                                                                                                                                                                                                                      |  |                   |              |   |                   |   |              |  
|Property and equipment, net                                                                                                                                                                                                                                                                           |  |                   | 2,710,459    |   |                   |   | 2,500,703    |  
|                                                                                                                                                                                                                                                                                                      |  |                   |              |   |                   |   |              |  
|Other Assets:                                                                                                                                                                                                                                                                                         |  |                   |              |   |                   |   |              |  
|Long-term investments                                                                                                                                                                                                                                                                                 |  |                   | 1,607,682    |   |                   |   | 2,389,742    |  
|Goodwill, net                                                                                                                                                                                                                                                                                         |  |                   | 8,982,000    |   |                   |   | 8,982,000    |  
|Other intangible assets, net                                                                                                                                                                                                                                                                          |  |                   | 120,890      |   |                   |   | 177,193      |  
|Long-term receivables                                                                                                                                                                                                                                                                                 |  |                   |             |   |                   |   | 2,000,000    |  
|Deposits and other assets                                                                                                                                                                                                                                                                             |  |                   | 1,148,695    |   |                   |   | 959,974      |  
|                                                                                                                                                                                                                                                                                                      |  |                   |              |   |                   |   |              |  
|Total other assets                                                                                                                                                                                                                                                                                    |  |                   | 11,859,267   |   |                   |   | 14,508,909   |  
|                                                                                                                                                                                                                                                                                                      |  |                   |              |   |                   |   |              |  
|                                                                                                                                                                                                                                                                                                      |  | $                 | 49,526,092   |   |                   | $ | 55,736,490   |  
|                                                                                                                                                                                                                                                                                                      |  |                   |              |   |                   |   |              |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                                                                                                                                                                  |  |                   |              |   |                   |   |              |  
|Current Liabilities:                                                                                                                                                                                                                                                                                  |  |                   |              |   |                   |   |              |  
|Debt and lease obligations, current portion (Note 4)                                                                                                                                                                                                                                                  |  | $                 | 594,354      |   |                   | $ | 322,884      |  
|Accounts payable                                                                                                                                                                                                                                                                                      |  |                   | 1,498,085    |   |                   |   | 456,860      |  
|Accrued liabilities                                                                                                                                                                                                                                                                                   |  |                   | 1,837,564    |   |                   |   | 2,427,783    |  
|Deferred revenue, current portion                                                                                                                                                                                                                                                                     |  |                   | 1,900,092    |   |                   |   | 1,241,379    |  
|                                                                                                                                                                                                                                                                                                      |  |                   |              |   |                   |   |              |  
|Total current liabilities                                                                                                                                                                                                                                                                             |  |                   | 5,830,095    |   |                   |   | 4,448,906    |  
|Convertible notes payable (Note 4)                                                                                                                                                                                                                                                                    |  |                   | 5,615,688    |   |                   |   | 5,333,733    |  
|Deferred revenue, net of current portion                                                                                                                                                                                                                                                              |  |                   | 7,165,571    |   |                   |   | 7,088,638    |  
|                                                                                                                                                                                                                                                                                                      |  |                   |              |   |                   |   |              |  
|Total liabilities                                                                                                                                                                                                                                                                                     |  |                   | 18,611,354   |   |                   |   | 16,871,277   |  
|                                                                                                                                                                                                                                                                                                      |  |                   |              |   |                   |   |              |  
|Commitments (Note 5)                                                                                                                                                                                                                                                                                  |  |                   |              |   |                   |   |              |  
|Stockholders Equity:                                                                                                                                                                                                                                                                                 |  |                   |              |   |                   |   |              |  
|Common stock, $0.01 par value125,000,000 shares authorized at September 30, 2004 and December 31, 2003; 42,861,219 and 41,813,512
shares issued and outstanding, respectively, at September 30, 2004 and 41,608,698 and 40,560,991 shares issued and outstanding, respectively, at December 31, 2003 |  |                   | 428,613      |   |                   |   | 416,088      |  
|Additional paid-in capital                                                                                                                                                                                                                                                                            |  |                   | 693,784,484  |   |                   |   | 689,489,382  |  
|Notes receivable                                                                                                                                                                                                                                                                                      |  |                   | (110,368     | ) |                   |   | (110,368     | )
|Treasury stock (at cost, 1,047,707 shares at September 30, 2004 and December 31, 2003)                                                                                                                                                                                                                |  |                   | (891,274     | ) |                   |   | (891,274     | )
|Deferred compensation                                                                                                                                                                                                                                                                                 |  |                   | (941,320     | ) |                   |   | (963,931     | )
|Accumulated deficit                                                                                                                                                                                                                                                                                   |  |                   | (661,313,320 | ) |                   |   | (649,068,435 | )
|Accumulated other comprehensive income                                                                                                                                                                                                                                                                |  |                   | (42,077      | ) |                   |   | (6,249       | )
|                                                                                                                                                                                                                                                                                                      |  |                   |              |   |                   |   |              |  
|Total stockholders equity                                                                                                                                                                                                                                                                            |  |                   | 30,914,738   |   |                   |   | 38,865,213   |  
|                                                                                                                                                                                                                                                                                                      |  |                   |              |   |                   |   |              |  
|                                                                                                                                                                                                                                                                                                      |  | $                 | 49,526,092   |   |                   | $ | 55,736,490   |  
|                                                                                                                                                                                                                                                                                                      |  |                   |              |   |                   |   |              |  



See accompanying notes
to unaudited consolidated financial statements.



3



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##### Table of Contents

CURIS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS (unaudited)



|                                                                                                   |  |                                 |            |   |                                 |   |            |      |  |   |             |   |  |   |            |  
|-------------------------------------------------------------------------------------------------- |  | ------------------------------- | ---------- | - | ------------------------------- | - | ---------- | ---- |  | - | ----------- | - |  | - | ---------- | -
|                                                                                                   |  | Three Months EndedSeptember 30, |            |   | Nine Months Ended September 30, |  
|                                                                                                   |  | 2004                            |            |   | 2003                            |   |            | 2004 |  |   | 2003        |  
|REVENUES:                                                                                          |  |                                 |            |   |                                 |   |            |      |  |   |             |   |  |   |            |  
|Collaboration revenues                                                                             |  | $                               | 1,486,226  |   |                                 | $ | 9,308,838  |      |  | $ | 3,462,100   |   |  | $ | 10,293,138 |  
|                                                                                                   |  |                                 |            |   |                                 |   |            |      |  |   |             |   |  |   |            |  
|Total revenues                                                                                     |  |                                 | 1,486,226  |   |                                 |   | 9,308,838  |      |  |   | 3,462,100   |   |  |   | 10,293,138 |  
|                                                                                                   |  |                                 |            |   |                                 |   |            |      |  |   |             |   |  |   |            |  
|COSTS AND EXPENSES:                                                                                |  |                                 |            |   |                                 |   |            |      |  |   |             |   |  |   |            |  
|Research and development                                                                           |  |                                 | 2,946,962  |   |                                 |   | 2,822,855  |      |  |   | 8,584,658   |   |  |   | 9,009,957  |  
|General and administrative                                                                         |  |                                 | 2,111,520  |   |                                 |   | 1,650,647  |      |  |   | 6,265,967   |   |  |   | 4,996,517  |  
|Stock-based compensation (A)                                                                       |  |                                 | 368,060    |   |                                 |   | 291,241    |      |  |   | 1,058,678   |   |  |   | 1,210,435  |  
|Amortization of intangible assets                                                                  |  |                                 | 18,768     |   |                                 |   | 18,769     |      |  |   | 56,304      |   |  |   | 56,311     |  
|                                                                                                   |  |                                 |            |   |                                 |   |            |      |  |   |             |   |  |   |            |  
|Total costs and expenses                                                                           |  |                                 | 5,445,310  |   |                                 |   | 4,783,512  |      |  |   | 15,965,607  |   |  |   | 15,273,220 |  
|                                                                                                   |  |                                 |            |   |                                 |   |            |      |  |   |             |   |  |   |            |  
|Income (loss) from operations                                                                      |  |                                 | (3,959,084 | ) |                                 |   | 4,525,326  |      |  |   | (12,503,507 | ) |  |   | (4,980,082 | )
|                                                                                                   |  |                                 |            |   |                                 |   |            |      |  |   |             |   |  |   |            |  
|OTHER INCOME (EXPENSE):                                                                            |  |                                 |            |   |                                 |   |            |      |  |   |             |   |  |   |            |  
|Interest income                                                                                    |  |                                 | 116,358    |   |                                 |   | 115,228    |      |  |   | 332,530     |   |  |   | 312,996    |  
|Other income                                                                                       |  |                                 | 39,500     |   |                                 |   | 65,258     |      |  |   | 232,845     |   |  |   | 549,727    |  
|Interest expense                                                                                   |  |                                 | (102,474   | ) |                                 |   | (155,896   | )    |  |   | (306,753    | ) |  |   | (570,321   | )
|                                                                                                   |  |                                 |            |   |                                 |   |            |      |  |   |             |   |  |   |            |  
|Total other income                                                                                 |  |                                 | 53,384     |   |                                 |   | 24,590     |      |  |   | 258,622     |   |  |   | 292,402    |  
|                                                                                                   |  |                                 |            |   |                                 |   |            |      |  |   |             |   |  |   |            |  
|Net income (loss)                                                                                  |  | $                               | (3,905,700 | ) |                                 | $ | 4,549,916  |      |  | $ | (12,244,885 | ) |  | $ | (4,687,680 | )
|Accretion of preferred stock dividend                                                              |  |                                 |           |   |                                 |   |           |      |  |   |            |   |  |   | (271,306   | )
|                                                                                                   |  |                                 |            |   |                                 |   |            |      |  |   |             |   |  |   |            |  
|Net income (loss) applicable to common stockholders                                                |  | $                               | (3,905,700 | ) |                                 | $ | 4,549,916  |      |  | $ | (12,244,885 | ) |  | $ | (4,958,986 | )
|                                                                                                   |  |                                 |            |   |                                 |   |            |      |  |   |             |   |  |   |            |  
|Basic net income (loss) per common share                                                           |  | $                               | (0.09      | ) |                                 | $ | 0.12       |      |  | $ | (0.30       | ) |  | $ | (0.14      | )
|                                                                                                   |  |                                 |            |   |                                 |   |            |      |  |   |             |   |  |   |            |  
|Weighted average common shares for basic net income (loss) computation                             |  |                                 | 41,620,123 |   |                                 |   | 38,282,799 |      |  |   | 41,398,656  |   |  |   | 34,529,106 |  
|                                                                                                   |  |                                 |            |   |                                 |   |            |      |  |   |             |   |  |   |            |  
|Diluted net income (loss) per common share                                                         |  | $                               | (0.09      | ) |                                 | $ | 0.11       |      |  | $ | (0.30       | ) |  | $ | (0.14      | )
|                                                                                                   |  |                                 |            |   |                                 |   |            |      |  |   |             |   |  |   |            |  
|Weighted average common shares for diluted net income (loss) computation                           |  |                                 | 41,620,123 |   |                                 |   | 42,031,957 |      |  |   | 41,398,656  |   |  |   | 34,529,106 |  
|                                                                                                   |  |                                 |            |   |                                 |   |            |      |  |   |             |   |  |   |            |  
|Net income (loss)                                                                                  |  | $                               | (3,905,700 | ) |                                 | $ | 4,549,916  |      |  | $ | (12,244,885 | ) |  | $ | (4,687,680 | )
|Unrealized gain (loss) on marketable securities                                                    |  |                                 | 23,330     |   |                                 |   | (3,443     | )    |  |   | (35,829     | ) |  |   | (27,091    | )
|                                                                                                   |  |                                 |            |   |                                 |   |            |      |  |   |             |   |  |   |            |  
|Comprehensive loss                                                                                 |  | $                               | (3,882,370 | ) |                                 | $ | 4,546,473  |      |  | $ | (12,280,714 | ) |  | $ | (4,714,771 | )
|                                                                                                   |  |                                 |            |   |                                 |   |            |      |  |   |             |   |  |   |            |  
|(A)   The following summarizes the departmental allocation of the stock-based compensation charge: |  |                                 |            |   |                                 |   |            |      |  |   |             |   |  |   |            |  
|Research and development                                                                           |  | $                               | 341,510    |   |                                 | $ | 204,127    |      |  | $ | 863,876     |   |  | $ | 933,354    |  
|General and administrative                                                                         |  |                                 | 26,550     |   |                                 |   | 87,114     |      |  |   | 194,802     |   |  |   | 277,081    |  
|                                                                                                   |  |                                 |            |   |                                 |   |            |      |  |   |             |   |  |   |            |  
|Total stock-based compensation                                                                     |  | $                               | 368,060    |   |                                 | $ | 291,241    |      |  | $ | 1,058,678   |   |  | $ | 1,210,435  |  
|                                                                                                   |  |                                 |            |   |                                 |   |            |      |  |   |             |   |  |   |            |  



See accompanying notes
to unaudited consolidated financial statements.



4



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##### Table of Contents

CURIS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)



|                                                                            |  |                                 |             |   |      |   |             |  
|--------------------------------------------------------------------------- |  | ------------------------------- | ----------- | - | ---- | - | ----------- | -
|                                                                            |  | Nine Months Ended September 30, |            
|                                                                            |  | 2004                            |             |   | 2003 |  
|CASH FLOWS FROM OPERATING ACTIVITIES:                                       |  |                                 |             |   |      |   |             |  
|Net loss                                                                    |  | $                               | (12,244,885 | ) |      | $ | (4,687,680  | )
|                                                                            |  |                                 |             |   |      |   |             |  
|Adjustments to reconcile net loss to net cash used in operating activities: |  |                                 |             |   |      |   |             |  
|Depreciation and amortization                                               |  |                                 | 833,045     |   |      |   | 1,115,366   |  
|Stock-based compensation expense                                            |  |                                 | 1,058,678   |   |      |   | 1,210,435   |  
|Non-cash interest on notes payable                                          |  |                                 | 293,549     |   |      |   | 368,381     |  
|Amortization of intangible assets                                           |  |                                 | 56,304      |   |      |   | 56,311      |  
|Impairment of property and equipment                                        |  |                                 |            |   |      |   | 280         |  
|Decrease/increase in long-term receivables                                  |  |                                 | 2,000,000   |   |      |   | (2,000,000  | )
|Changes in current assets and liabilities:                                  |  |                                 |             |   |      |   |             |  
|Accounts receivable                                                         |  |                                 | (396,368    | ) |      |   | (2,000,000  | )
|Prepaid expenses and other assets                                           |  |                                 | (234,023    | ) |      |   | 93,983      |  
|Due from joint venture                                                      |  |                                 |            |   |      |   | 210,207     |  
|Accounts payable and accrued liabilities                                    |  |                                 | 451,006     |   |      |   | (379,442    | )
|Deferred contract revenue                                                   |  |                                 | 735,646     |   |      |   | (63,594     | )
|                                                                            |  |                                 |             |   |      |   |             |  
|Total adjustments                                                           |  |                                 | 4,797,837   |   |      |   | (1,388,073  | )
|                                                                            |  |                                 |             |   |      |   |             |  
|Net cash used in operating activities                                       |  |                                 | (7,447,048  | ) |      |   | (6,075,753  | )
|                                                                            |  |                                 |             |   |      |   |             |  
|CASH FLOWS FROM INVESTING ACTIVITIES:                                       |  |                                 |             |   |      |   |             |  
|Purchase of marketable securities                                           |  |                                 | (17,383,387 | ) |      |   | (16,898,874 | )
|Sale of marketable securities                                               |  |                                 | 10,400,683  |   |      |   | 18,396,518  |  
|Decrease in restricted cash                                                 |  |                                 |            |   |      |   | 199,473     |  
|Purchase of long-term investments                                           |  |                                 | (4,568,290  | ) |      |   |            |  
|Sale of long-term investments                                               |  |                                 | 5,350,350   |   |      |   |            |  
|Increase in other assets                                                    |  |                                 |            |   |      |   | (236,691    | )
|Purchases and dispositions of property and equipment                        |  |                                 | (1,042,801  | ) |      |   | (33,464     | )
|                                                                            |  |                                 |             |   |      |   |             |  
|Net cash provided by (used in) investing activities                         |  |                                 | (7,243,445  | ) |      |   | 1,426,962   |  
|                                                                            |  |                                 |             |   |      |   |             |  
|CASH FLOWS FROM FINANCING ACTIVITIES:                                       |  |                                 |             |   |      |   |             |  
|Proceeds from issuance of common stock                                      |  |                                 | 3,271,560   |   |      |   | 14,366,637  |  
|Purchases of treasury stock                                                 |  |                                 |            |   |      |   | (21,890     | )
|Proceeds from issuance of debt                                              |  |                                 | 591,930     |   |      |   |            |  
|Repayments of notes payable and capital leases                              |  |                                 | (332,056    | ) |      |   | (1,007,556  | )
|Repayments of convertible notes payable                                     |  |                                 |            |   |      |   | (1,601,563  | )
|Cash from consolidation of Curis Newco, Ltd                                 |  |                                 |            |   |      |   | 139         |  
|                                                                            |  |                                 |             |   |      |   |             |  
|Net cash provided by financing activities                                   |  |                                 | 3,531,434   |   |      |   | 11,735,767  |  
|                                                                            |  |                                 |             |   |      |   |             |  
|Effect of exchange rates on cash and equivalents                            |  |                                 |            |   |      |   | (452,857    | )
|                                                                            |  |                                
|NET DECREASE IN CASH AND CASH EQUIVALENTS                                   |  |                                 | (11,159,059 | ) |      |   | 6,634,119   |  
|                                                                            |  |                                
|CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD                              |  |                                 | 27,734,548  |   |      |   | 26,920,605  |  
|                                                                            |  |                                 |             |   |      |   |             |  
|CASH AND CASH EQUIVALENTS, END OF PERIOD                                    |  | $                               | 16,575,489  |   |      | $ | 33,554,724  |  
|                                                                            |  |                                 |             |   |      |   |             |  



See accompanying notes
to unaudited consolidated financial statements.



5



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##### Table of Contents

CURIS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)



|1. | Nature of Business
|-- | ------------------



Curis, Inc. (Curis or the Company) is 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. The Companys product development approach involves using small molecules,
proteins or antibodies to modulate these regulatory signaling pathways. The Company has successfully developed several preclinical product candidates in the fields of cancer, kidney disease, neurological disorders, hair growth regulation and
cardiovascular disease.



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



|2. | Basis of Presentation
|-- | ---------------------



The accompanying consolidated financial statements of the Company have been prepared in accordance with the instructions to Form 10-Q and
Article 10 of Regulation S-X. These statements, however, are condensed and do not include all disclosures required by accounting principles generally accepted in the United States for complete financial statements and should be read in conjunction
with the Companys Annual Report on Form 10-K for the year ended December 31, 2003, as filed with the Securities and Exchange Commission on March 1, 2004.



In the opinion of the Company, the unaudited financial statements contain all adjustments (all of which were considered normal and
recurring) necessary to present fairly the Companys financial position at September 30, 2004 and the results of operations and cash flows for the three- and nine-month periods ended September 30, 2004 and 2003. The preparation of the
Companys consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts and disclosure of certain assets
and liabilities at the balance sheet date. Such estimates include the carrying value of property and equipment and intangible assets and the value of certain liabilities. Actual results may differ from such estimates.



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



|3. | Financial Statement Reclassifications
|-- | -------------------------------------



The Company has reclassified $213,000 and $532,000, respectively, for legal costs associated with its patents for the three- and
nine-month periods ended September 30, 2003 from Research and development expenses to General and administrative expenses in the Companys costs and expenses section of its consolidated statements of operations and
comprehensive loss to conform with the current year presentation.



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##### Table of Contents

CURIS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)(continued)



|4. | Long-Term Debt and Capital Lease Obligations
|-- | --------------------------------------------



Long-term debt and capital lease obligations consisted of the following at September 30, 2004 and December 31, 2003:



|                                                                       |  |                   |           |   |                  |   |           |  
|---------------------------------------------------------------------- |  | ----------------- | --------- | - | ---------------- | - | --------- | -
|                                                                       |  | September 30,2004 |           |   | December 31,2003 |  
|Obligations under capital leases                                       |  | $                 |          |   |                  | $ | 323,000   |  
|Note payable for capital purchases                                     |  |                   | 594,000   |   |                  |   |          |  
|Convertible subordinated note payable to Becton Dickinson              |  |                   | 2,364,000 |   |                  |   | 2,219,000 |  
|Convertible promissory note payable to Elan Pharma International, Ltd. |  |                   | 3,252,000 |   |                  |   | 3,115,000 |  
|                                                                       |  |                   |           |   |                  |   |           |  
|                                                                       |  |                   | 6,210,000 |   |                  |   | 5,657,000 |  
|Less current portion                                                   |  |                   | (594,000  | ) |                  |   | (323,000  | )
|                                                                       |  |                   |           |   |                  |   |           |  
|Total long-term debt                                                   |  | $                 | 5,616,000 |   |                  | $ | 5,334,000 |  
|                                                                       |  |                   |           |   |                  |   |           |  



Effective January 20, 2004, the Company entered into a loan agreement with the Boston Private Bank & Trust Company to finance up to $1,250,000 in purchases of equipment and facility leasehold improvements from December 1, 2003 until
January 20, 2005. Through September 30, 2004, the Company financed $592,000 for purchases of equipment that accrue interest at a variable rate of 5.75% as of September 30, 2004. Under the terms of the loan agreement, the Company can request periodic
financings for qualifying purchases of equipment and leaseholds through January 20, 2005. Until such time, the Company will pay interest only on any borrowings on a monthly basis in arrears. The Company then has the option to either repay the
outstanding balance in full or convert the then outstanding balance into a 36-month term note that bears interest at either a variable rate (5.75% as of September 30, 2004) or a fixed rate (6.46% as of September 30, 2004) for the repayment period.
As of September 30, 2004, this obligation is classified as short-term since the Company has not yet exercised the option to convert the balance to a term note.



Effective September 23, 2004, the Company amended the loan agreement with Boston Private Bank & Trust Company originally entered
into on January 20, 2004. The loan was amended to (i) increase the maximum facility amount from $1,250,000 to $2,250,000, (ii) extend the period under which the Company may finance purchases of equipment and leasehold improvements to February 28,
2005 from January 20, 2005, (iii) increase the allowable percentage of overall borrowings attributable to the purchase of leasehold improvements from 25% to 100%, and (iv) increase the security under the loan to all of the Companys property,
plant and equipment assets, except for those that are affixed to the property and those that are purchased after February 20, 2005 under purchase money arrangements with equipment lenders.



|5. | Commitments and Contingencies
|-- | -----------------------------



In June 2003, the Company licensed its small molecule and antibody antagonists of the Hedgehog signaling pathway to Genentech. In March
2004, Genentech announced that it had added a new small molecule antagonist of the Hedgehog signaling pathway covered under the collaboration to its product candidate pipeline. This small molecule is under development for the treatment of basal cell
carcinoma. The Company has retained a co-development option under its collaboration with Genentech for the development of a basal cell carcinoma product candidate.



Under the terms of the agreement, Genentech is required to present a co-development plan and budget to the
Company for the small molecule, at which point the Company will have 30 days to decide if it will



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##### Table of Contents

CURIS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)(continued)



participate in the co-development of the basal cell carcinoma product candidate. If the Company elects to participate, it will determine the applicable
cost-sharing percentage. Subject to receipt and review of a final co-development plan and budget from Genentech, the Company expects that it will elect to exercise its co-development option. The Company plans to decide whether to exercise the
co-development option by the first quarter of 2005. If the Company elects to co-develop a basal cell carcinoma product candidate under its collaboration with Genentech, the Company will forego development milestone and royalty payments on potential
future sales and the Company will share in development costs and any profits based on a percentage that is equal to its co-development cost-sharing contribution. The Companys research and development costs are expected to increase as a result
of its determination to exercise this co-development option. As of September 30, 2004, no costs related to this co-development option have been accrued in the condensed consolidated balance sheet.



|6. | Accounting for Stock-Based Compensation
|-- | ---------------------------------------



The Company has two stock option plans. The Company applies APB Opinion No. 25, Accounting for Stock Issued to Employees and
related interpretations, in accounting for qualifying options granted to its employees and directors under its plans and applies Statement of Financial Accounting Standards No. 123, Accounting for Stock Issued to Employees (SFAS
123), as amended by SFAS 148, for disclosure purposes only. The SFAS 123 disclosures include pro forma net loss and net loss per share as if the fair value method of accounting had been used. Stock issued to non-employees is accounted for in
accordance with SFAS 123 and related interpretations.



The following are the pro forma net loss and net loss per share, as if compensation expense for the option plans had been determined based on the fair value at the date of grant, consistent with SFAS 123:



|                                                                                                               |  |                                 |            |   |                                 |   |            |      |  |   |             |   |  |   |            |  
|-------------------------------------------------------------------------------------------------------------- |  | ------------------------------- | ---------- | - | ------------------------------- | - | ---------- | ---- |  | - | ----------- | - |  | - | ---------- | -
|                                                                                                               |  | Three months endedSeptember 30, |            |   | Nine months ended September 30, |  
|                                                                                                               |  | 2004                            |            |   | 2003                            |   |            | 2004 |  |   | 2003        |  
|Net loss applicable to common stockholders, as reported                                                        |  | $                               | (3,906,000 | ) |                                 | $ | 4,550,000  |      |  | $ | (12,245,000 | ) |  | $ | (4,959,000 | )
|Add back: stock-based compensation included in net loss applicable to common stockholders, as reported         |  |                                 | 368,000    |   |                                 |   | 291,000    |      |  |   | 1,059,000   |   |  |   | 1,210,000  |  
|Less: total stock-based employee compensation expense determined under fair value based methods for all awards |  |                                 | (1,874,000 | ) |                                 |   | (2,127,000 | )    |  |   | (6,234,000  | ) |  |   | (5,809,000 | )
|                                                                                                               |  |                                 |            |   |                                 |   |            |      |  |   |             |   |  |   |            |  
|Pro forma net loss                                                                                             |  | $                               | (5,412,000 | ) |                                 | $ | 2,714,000  |      |  | $ | (17,420,000 | ) |  | $ | (9,558,000 | )
|Basic net income (loss) per common share                                                                      |  |                                 |            |   |                                 |   |            |      |  |   |             |   |  |   |            |  
|As reported                                                                                                    |  | $                               | (0.09      | ) |                                 | $ | 0.12       |      |  | $ | (0.30       | ) |  | $ | (0.14      | )
|Pro forma                                                                                                      |  | $                               | (0.13      | ) |                                 | $ | 0.07       |      |  | $ | (0.42       | ) |  | $ | (0.28      | )
|Diluted net income (loss) per common share                                                                    |  |                                 |            |   |                                 |   |            |      |  |   |             |   |  |   |            |  
|As reported                                                                                                    |  | $                               | (0.09      | ) |                                 | $ | 0.11       |      |  | $ | (0.30       | ) |  | $ | (0.14      | )
|Pro forma                                                                                                      |  | $                               | (0.13      | ) |                                 | $ | 0.06       |      |  | $ | (0.42       | ) |  | $ | (0.28      | )



The
effects on three- and ninemonth periods ended September 30, 2004 and 2003 pro forma net loss and net loss per share of the estimated fair value of stock options are not necessarily representative of the



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CURIS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)(continued)



effects on the results of operations in the future. In addition, the estimates made utilize a pricing model developed for traded options with relatively
short lives; the Companys option grants typically have a life of up to ten years and are generally not transferable. Therefore, the actual fair value of a stock option grant may be different from these estimates. The Company believes that its
estimates incorporate all relevant information and represent a reasonable approximation in light of the difficulties involved in valuing non-traded stock options.



|7. | Subsequent Events
|-- | -----------------



(a) Registered Direct Offering:    On October 14, 2004, the Company completed a registered direct offering of
5,476,559 shares of newly issued common stock, together with warrants to purchase 0.10 shares of common stock for each share of common stock purchased, at a purchase price of $3.67 per share to institutional and accredited investors. The warrants to
purchase an aggregate of 547,656 shares of common stock expire on October 14, 2009 and are exercisable at $4.59 per share. The transaction provided approximately $18,868,000 in net proceeds to the Company (exclusive of any proceeds the Company may
receive upon exercise of the warrants).



The
shares of common stock and warrants to purchase common stock offered by the Company in this transaction were registered under the Companys existing shelf registration statement on Form S-3 which was declared effective by the Securities and
Exchange Commission on January 7, 2004.



(b)
Amendment of Micromet Note Receivable:    On November 9, 2001, the Company entered into a convertible note receivable with Micromet AG, a former collaborator. The original notes terms included a principal amount of EUR
4,068,348, interest at 7% and a maturity date of June 2005. In addition, the note was convertible into common stock of Micromet at the Companys option under certain conditions.



In the fourth quarter of 2003, the Company wrote off
the then-carrying value of the note of $5,115,000. The Company 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 co-development
partner. Micromet had stated that this dispute would result in a significant decrease in previously budgeted cash inflows in 2004.



On October 21, 2004, the Company amended this note and, under the amended note, Micromet is obligated to pay the Company an amount of EUR
4,500,000, subject to certain conditions discussed below. The amended note does not bear interest and includes both fixed payments and payments that are made only upon the occurrence of certain events, called exit events. Exit events
include any listing or trading of all or part of Micromets shares on a stock exchange, a trade sale of more than 50% of the shares or voting rights of Micromet, a merger or other reorganization where Micromet controls less than 51% of the
combined entity, a sale of substantially all of Micromets assets, or a liquidation of Micromet. The payment terms are summarized as follows:



| | (i) | EUR 1,250,000 on or before November 15, 2004.
| | --- | ---------------------------------------------



| | (ii) | EUR 1,250,000 on or before October 29, 2005 or the occurrence of the closing of an exit event;
| | ---- | ----------------------------------------------------------------------------------------------



| | (iii) | EUR 2,000,000 will be due an payable is due upon the closing of any exit event;
| | ----- | -------------------------------------------------------------------------------



In addition to amending its note with Curis, Micromet completed a financing transaction on October 19, 2004.
As a result of Micromets financing, the Company expects that it will receive the EUR 1,250,000



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CURIS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)(continued)



payment in the fourth quarter of 2004. Assuming that the initial EUR 1,250,000 payment is made in the fourth quarter of 2004, and based on the EURO-to-US
dollar foreign exchange rate as of October 21, 2004, the Company expects to record a gain within Other Income of its consolidated statement of operations of approximately $1,500,000. This gain will be offset by a write-down of the
carrying value of the Companys equity held in Micromet of approximately $300,000, so that the net gain to be recorded in the fourth quarter of 2004 resulting from Micromets financing and the note amendment will approximate $1,200,000.
The Company believes that the terms of Micromets financing adversely affects the value of the Companys holdings in Micromet and, therefore, a write-down of the carrying value of the investment will be recorded.



The future amounts due to the Company under the amended note
payable will be recorded in other income when and if such amounts are collected.



(c) Settlement of Former Officer Notes Receivable:    On October 22, 2004, the Company entered into settlement
agreements regarding notes receivables with two former executive officers of Creative BioMolecules, one of the three predecessor companies that merged to form Curis in 2000.



Under the terms of the settlement agreement, the notes were cancelled, the underlying 139,707 common shares
were delivered to a broker of the Companys choice and the shares will be sold with the resulting proceeds remitted to the Company. Using the Companys closing price on October 21, 2004 of $3.33, the gross proceeds to the Company would
approximate $465,000, but the amount the Company realizes from the sale will depend upon the trading price at the time of sale. Upon completion of the sale of the shares, the Company will record in the fourth quarter of 2004 the gross proceeds, less
any brokerage commissions and less the current book value of the notes of $110,000, as a gain in Other income of its consolidated statement of operations.



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##### Table of Contents

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



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



Overview



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



Since our inception, we have funded our operations primarily through license fees, research and development funding from our collaborative partners, the
private and public placement of our equity securities, debt financings and the monetization of certain royalty rights. We have never been profitable and have incurred an accumulated deficit of $661,313,000 as of September 30, 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 license and collaboration agreements with Genentech, Ortho Biotech (a subsidiary of Johnson & Johnson) and Wyeth Pharmaceuticals (a subsidiary of Wyeth). Our strategic collaborations generally provide for
certain of our research, development and commercialization programs to be either partially 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 and potential future clinical development milestones
in excess of $500,000,000 in the aggregate, assuming that all of the collaborations continue for their full terms and all milestone payments are received. 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 partners 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. For example, we currently expect to select at least one program that we will develop further on our ownmost likely the Hedgehog small molecule agonist candidate for hair loss.



On October 14, 2004, we completed a registered direct offering of
5,476,559 shares of newly issued common stock, together with warrants to purchase 0.10 shares of common stock for each share of common stock purchased, at a purchase price of $3.67 per share to institutional and accredited investors. The warrants to
purchase an aggregate of 547,656 shares of common stock expire on October 14, 2009 and are exercisable at $4.59 per share. The transaction provided us with approximately $18,868,000 in net proceeds (exclusive of any proceeds we may receive upon
exercise of the warrants). The shares of common stock and warrants to purchase common stock offered by us in this transaction were registered under our existing shelf registration statement on Form S-3 which was declared effective by the Securities
and Exchange Commission on January 7, 2004.



Financial Operations Overview



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



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##### Table of Contents

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 September 30, 2004, together with the $18,868,000 of
net proceeds we received upon the closing of our registered direct common stock and warrant offering on October 14, 2004, should enable us to maintain current and planned operations into the second half of 2007, including spending related to the
potential exercise of our co-development option with Genentech. Our ability to continue funding our planned operations 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 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 licensors and collaborators, including Genentech, Ortho Biotech, and Wyeth. 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. 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 expenses consist 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 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 discovery means that we are seeking to identify compounds that may have therapeutic activities, early preclinical means we, and/or our collaborators, have observed initial demonstrations of therapeutic
efficacy in a preclinical model of human disease, mid preclinical means we, and/or our collaborators, have achieved multiple demonstrations of efficacy in preclinical models of human disease, and late preclinical means we, and/or our collaborators,
have multiple demonstrations of efficacy in preclinical models of human disease, as applicable, and are now seeking relevant toxicology and safety data required for an investigational new drug application filing with the FDA seeking to commence a
phase I clinical trial to assess safety in humans. We have set forth below under Results of Operations the expenses incurred with respect to each product candidate for the three- and nine-month periods ended September 30, 2004 and 2003.



|                                         |  |                          |  |                                    |  |                  
|---------------------------------------- |  | ------------------------ |  | ---------------------------------- |  | -----------------
|Product Candidate                        |  | Primary Indication       |  | Partner/Licensee                   |  | Status           
|Hh small molecule antagonist             |  | Basal cell carcinoma     |  | Genentech                          |  | Late preclinical 
|Hh small molecule or antibody antagonist |  | Cancer                   |  | Genentech                          |  | Mid preclinical  
|BMP-7 protein                            |  | Kidney disease           |  | Ortho Biotech(1)                   |  | Late preclinical 
|Hh small molecule agonist                |  | Nervous system disorders |  | Wyeth                              |  | Mid preclinical  
|Hh small molecule agonist                |  | Hair loss                |  | Internal development(2)            |  | Late preclinical 
|Hh agonist/protein/gene                  |  | Cardiovascular disease   |  | Internal development(2),(3)        |  | Mid preclinical  
|Hh small molecule antagonist             |  | Hair growth inhibition   |  | Internal development(4)            |  | Early preclinical
|Discovery research                       |  | Spinal muscular atrophy  |  | Spinal Muscular Atrophy Foundation |  | Discovery        
|Discovery research                       |  | Various                  |  | Internal development               |  | Discovery        



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---

|(1) |  | This product candidate has been licensed to Ortho Biotech. Under the license arrangement, we expect to incur no future costs related to these programs, assuming the license
agreement remains in effect.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(2) |  | Our Hh small molecule agonists were licensed to Wyeth under our collaboration agreement, effective February 2004. Under the terms of our collaboration agreement with Wyeth, our
retained rights to use Hh small molecule agonists in our hair loss and cardiovascular disease programs are subject to the requirement that Wyeth must first determine that such compounds are less suitable for systemic use in the Wyeth neurological
disorders program and thus available for further development in our hair loss and cardiovascular disease programs. We are currently working with Wyeth to identify Hh small molecule agonist candidates for our further development.
|--- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(3) |  | We have not incurred expenses related to our cardiovascular discovery program for either the three- or nine-month period ended September 30, 2004. Our preclinical data relating to
this program has been derived from studies conducted at St. Elizabeths Medical Center in Boston. We are currently in negotiations with additional third-party collaborators seeking to enter into sponsored research agreements under which these
additional third-party collaborators would attempt to replicate this preclinical data. Accordingly, we expect to incur costs on our cardiovascular discover program in the coming months.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(4) |  | Genentech has a co-development option on our hair growth inhibition program. If Genentech exercises this option, we will share development costs and net profits, if any, on future
product sales. If Genentech does not exercise this option, we may develop the program through phase II clinical trials at which point Genentech may (i) pay us a fee, future development milestones and royalties on product sales, if any, and elect to
assume all future development and commercialization of the hair growth inhibition compound, (ii) pay us a fee and require that we cease future development of the hair growth inhibition compound, or (iii) allow us to continue future development and
commercialization, with no further development or commercialization rights from Genentech. We are not currently incurring costs related to this program.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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 collaborative partners may not be able to successfully develop and commercialize any of the
product candidates included in the table above.



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



| |  |  | the timing of when collaborative partners may make compounds, that are subject to our retained rights, available for our development, either alone, or as part of a co-development
program;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the scope, quality of data, rate of progress and cost of clinical trials and other research and development activities undertaken by us or our collaborative partners;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | future clinical trials results;
| | - |  | -------------------------------



| |  |  | the terms and timing of any collaborative, licensing and other arrangements that we may establish;
| | - |  | --------------------------------------------------------------------------------------------------



| |  |  | the cost and timing of regulatory approvals;
| | - |  | --------------------------------------------



| |  |  | the cost and timing of establishing sales, marketing and distribution capabilities;
| | - |  | -----------------------------------------------------------------------------------



| |  |  | the cost of establishing clinical and commercial supplies of our product candidates and any products that we may develop;
| | - |  | -------------------------------------------------------------------------------------------------------------------------



| |  |  | the effect of competing technological and market developments; and
| | - |  | ------------------------------------------------------------------



| |  |  | the cost of filing, prosecuting, defending and enforcing any patent claims and other intellectual property rights.
| | - |  | ------------------------------------------------------------------------------------------------------------------



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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.



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 Alliances and License
Agreements.    Since inception, substantially all of our revenue has been derived from collaborations and other research and development arrangements with third parties. Our current strategic alliances and key license
agreements are with Genentech, Ortho Biotech and Wyeth Pharmaceuticals. These strategic license and collaboration agreements included $15,000,000 in up-front payments and potential future clinical development milestones in excess of $500,000,000 in
the aggregate, assuming that all of the collaborations continue for their full terms and all milestone payments are received. 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 small molecule and antibody antagonists of the Hedgehog signaling pathway to Genentech on an exclusive, worldwide royalty-bearing basis with the primary focus of the research plan to develop applications in cancer therapy. Under the
terms of the agreement, in June 2003 Genentech paid us an up-front license fee of $5,000,000 and purchased 1,323,835 shares of our common stock at a price of $2.644 per share for aggregate proceeds of $3,500,000. In addition, Genentech paid us a
$2,000,000 maintenance fee in July 2004, and is obligated to pay us an additional $2,000,000 maintenance fee by July 2005. Genentech is also obligated to make cash payments to us upon the successful achievement of certain 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.



In March 2004, Genentech announced that it had added a new small molecule antagonist of the Hedgehog signaling pathway covered under our collaboration to
its product candidate pipeline. This small molecule is under development for the treatment of basal cell carcinoma. We have retained the right to co-develop products in the field of basal cell carcinoma. If we elect to co-develop a basal cell
carcinoma product candidate, we will forego development milestones and royalty payments on potential future sales and we will share in any costs and profits related to the basal cell carcinoma program based on the percentage that is equal to our
co-development cost-sharing contribution. Genentech has publicly stated that it expects to file an investigational new drug application on this small molecule later this year or early in 2005. Under the terms of our agreement, Genentech is required
to present a co-development plan and budget to us for the small molecule, at which point we will have 30 days to decide if we will participate in the co-development of the basal cell carcinoma product candidate. If we elect to participate, we will
determine the applicable cost-sharing percentage. In the event that we elect not to participate in the co-development of the basal cell carcinoma product candidate, we will receive milestones and royalties on future sales, if any. We expect to
receive the co-development plan and budget in late 2004 and to make a decision by the first quarter of 2005. We currently expect that we will exercise the co-development option.



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 $510,000 for the $5,000,000 up-front license fee and the $4,000,000 maintenance fees. As of September 30, 2004, $310,000 has been paid to the university licensors.
Of the remaining $200,000 obligation, $100,000 relates to a $2,000,000 license fee payment due in July 2005. The unpaid obligations are included in Accrued liabilities in our condensed consolidated balance sheet as of September 30, 2004.



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Ortho Biotech License.    In November 2002, we licensed our broad BMP
technology portfolio to Ortho Biotech on an exclusive, worldwide royalty-bearing basis, for all non-orthopedic and non-dental therapeutic applications in exchange for a $3,500,000 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 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 Pharmaceuticals Collaboration.    Effective
February 2004, we licensed our Hedgehog proteins and small molecule Hedgehog pathway agonists to Wyeth Pharmaceuticals 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.



We are obligated to make payments to various
university licensors when certain payments are received from Wyeth. These obligations total $125,000 for the $3,000,000 up-front license fee. As of September 30, 2004, the entire $125,000 had been paid to the university licensors.



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.



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 privately held
companies, capitalized patent costs, long-term deposits, and other long-term assets. We assess the impairment of identifiable intangibles and long-lived assets whenever events or changes in circumstances indicate that the carrying value may not be
recoverable. If it were determined that the carrying value of intangible or long-lived assets may 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.



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 test in December 2003, and determined that as of that date our fair value exceeded the
carrying value of our net assets. Accordingly, no goodwill impairment was recognized in 2003. We plan to complete our next annual goodwill impairment test in December 2004. If, in connection with such impairment test, we determine that an impairment
indicator exists it could result in a material impairment charge to our statement of operations.



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



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Recognition, and EITF 00-21, Accounting for Revenue Arrangements with Multiple Deliverables. In accordance with SAB No. 104, we recognize
revenue related to research activities as they are performed, so long as there is persuasive evidence of an arrangement, the fee is fixed or determinable and collection of the related receivable is probable.



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.



Based
upon the application of our revenue recognition policies and our related estimates and judgments, we recognized $611,000 and $1,556,000 in revenue related to our collaboration with Genentech for the three- and nine-month periods ended September 30,
2004. For the three- and nine-month periods ended September 30, 2004, of these amounts, $310,000 and $931,000, respectively, were recognized under the amortization of $7,000,000 in license and maintenance fees received from Genentech and future
maintenance fees of $2,000,000 that Genentech is obligated to pay us by July 2005. We expect that the remainder of the license fees will be recognized proportionately through October 2010 as the remaining services are performed. We recognized
expenses of $68,000 for the nine-month period ended September 30, 2004, for the amortization of obligations related to these license fees. In addition, we recognized revenues of $301,000 and $625,000, respectively, relating to research and
development services performed under the collaboration agreement with Genentech for the three- and nine-month periods ended September 30, 2004. We recognized $346,000 in revenue related to the amortization of the Genentech license fee in the third
quarter of 2003.



Based upon the application of our revenue
recognition policies and our related estimates and judgments, we recognized $736,000 and $1,717,000, respectively, in revenue related to our collaboration with Wyeth for the three- and nine-month periods ended September 30, 2004. These amounts
consist of revenue of $75,000 and $192,000, respectively, for the three- and nine- month periods ended September 30, 2004, recognized under 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 proportionately through February 2009 as the remaining services are performed. We recognized expenses of $6,250 and $16,000, respectively, for the three- and nine-month periods ended September 30,
2004, for the amortization of obligations related to the license fee. In addition, we recognized $661,000 and $1,525,000, respectively, relating to research and development services performed under the collaboration agreement with Wyeth for the
three- and nine-month periods ended September 30, 2004. Since our collaboration with Wyeth was not effective until February 2004, no revenue related to Wyeth was recognized in 2003.



Although we follow detailed guidelines in measuring revenue, certain judgments affect the application of our revenue policy.
For example, in connection with our collaboration agreements with Genentech and Wyeth, 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 $1,900,000 and long-term deferred revenue of $7,166,000 as of September 30, 2004. Short-term deferred revenue consists of amounts that are expected to be recognized as revenue by September 30, 2005. Amounts that we
expect will not be recognized



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prior to September 30, 2005 are classified as long-term deferred revenue. However, this estimate is based on our current operating plan as of September 30,
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 October 1, 2004, through September 30, 2005.



The estimate of deferred revenue reflects managements estimate of the
period of our involvement in the collaboration. Our period of involvement is largely determined by the time to commercialize clinical candidates that we may co-develop 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.



Valuation of investments in privately held companies.    We have investments in Aegera, Micromet
and ES Cell International with carrying values of $167,000, $400,000 and $150,000, respectively. These investments are included in the Deposits and other assets category of our consolidated balance sheets. At each balance sheet date, we
review these investments to determine whether the fair value of these investments is less than the carrying value and, if so, whether we should write-down the investment. These companies are not publicly traded and, therefore, determining the fair
value of our investments in these companies involves significant judgment. We consider available information in estimating the fair value of these investments and, as of September 30, 2004, believe that the fair value of our investments is not less
than their carrying value.



In January 2004, Micromet announced
that it terminated one-third of its workforce as the result of a contract dispute with a co-development partner that resulted in a significant decrease of previously budgeted cash inflows in 2004. Accordingly, we concluded that the carrying value of
our investment in Micromet common stock had been impaired as of December 31, 2003, and we reduced the carrying value to the estimated fair value of $400,000. As of September 30, 2004, we believe our investment in Micromet has not been further
impaired. 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.



Results of Operations



Three-Month Periods Ended September 30, 2004 and September 30, 2003



Revenues.    Revenues decreased $7,823,000, or 84%, to $1,486,000 for the three-month period ended September 30, 2004 as compared to $9,309,000 for the three-month period ended September 30,
2003. Revenues for the three-month period ended September 30, 2004 were derived primarily from revenue recognized under our collaborations with Genentech and Wyeth of $611,000 and $736,000, respectively. In addition, we recognized revenue of
$139,000 for the three-month period ended September 30, 2004 under our sponsored research agreement with the Spinal Muscular Atrophy Foundation.



Revenues for the three-month period ended September 30, 2003 were derived primarily from $8,555,000 in previously deferred revenue that we recognized upon
the termination of our product development and target research agreements with Micromet during the quarter. In addition, we recognized $346,000 related to our collaboration with Genentech.



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



|                                          |                    |                          |      |                                         |           |                               |   |           |  |      |   
|----------------------------------------- | ------------------ | ------------------------ | ---- | --------------------------------------- | --------- | ----------------------------- | - | --------- |  | ---- | --
|Research and Development Program          |                    |                          |      | For the Three Months EndedSeptember 30, |           | PercentageIncrease/(Decrease) |  
|                                          | Primary Indication |                          | 2004 |                                         | 2003      |                              
|Hh small molecule antagonist              |                    | Basal cell carcinoma     |      | $                                       | 2,000     |                               | $ | 3,000     |  | (33  | %)
|Hh small molecule and antibody antagonist |                    | Cancer                   |      |                                         | 1,072,000 |                               |   | 1,008,000 |  | 6    | % 
|Hh small molecule agonist                 |                    | Nervous system disorders |      |                                         | 577,000   |                               |   | 1,183,000 |  | (51  | %)
|Hh small molecule agonist                 |                    | Hair loss                |      |                                         | 225,000   |                               |   | 177,000   |  | 27   | % 
|Discovery research                        |                    | Spinal muscular atrophy  |      |                                         | 139,000   |                               |   |          |  | NA   |   
|Discovery research                        |                    | Various                  |      |                                         | 932,000   |                               |   |          |  | NA   |   
|Other programs                            |                    |                          |      |                                         |          |                               |   | 452,000   |  | (100 | %)
|                                          |                    |                          |      |                                         |           |                               |   |           |  |      |   
|Total research and development expense    |                    |                          |      | $                                       | 2,947,000 |                               | $ | 2,823,000 |  | 4    | % 
|                                          |                    |                          |      |                                         |           |                               |   |           |  |      |   



The increase of
$124,000 in research and development expenses for the three-month period ended September 30, 2004 was primarily due to the net effect of changes in spending in our research programs. First, we decreased spending by $452,000, 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 partnered 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 reduced as compared to 2003. This reduction in costs was
primarily attributable to significant cost reductions related to personnel, chemistry and supplies. These decreases were partially offset by increases in spending under our new discovery research programs initiated in 2004. We incurred costs of
$139,000 for our spinal muscular atrophy program, which is under collaboration with Spinal Muscular Atrophy Foundation. We incurred $932,000 in expenses related to our other discovery research programs during the three-month period ended September
30, 2004. We incurred no expenses for either of these programs during the same period in 2003.



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



|                                          |  |                                         |           |                               |   |           |  |     |   
|----------------------------------------- |  | --------------------------------------- | --------- | ----------------------------- | - | --------- |  | --- | --
|                                          |  | For the Three Months EndedSeptember 30, |           | PercentageIncrease/(Decrease) |  
|                                          |  | 2004                                    |           | 2003                          |  
|Personnel                                 |  | $                                       | 749,000   |                               | $ | 673,000   |  | 11  | % 
|Occupancy and depreciation                |  |                                         | 136,000   |                               |   | 148,000   |  | (8  | %)
|Legal and professional services           |  |                                         | 716,000   |                               |   | 386,000   |  | 85  | % 
|Consulting services                       |  |                                         | 333,000   |                               |   | 87,000    |  | 283 | % 
|Insurance costs                           |  |                                         | 114,000   |                               |   | 134,000   |  | (15 | %)
|Other general and administrative expenses |  |                                         | 64,000    |                               |   | 223,000   |  | (71 | %)
|                                          |  |                                         |           |                               |   |           |  |     |   
|Total general and administrative expenses |  | $                                       | 2,112,000 |                               | $ | 1,651,000 |  | 28  | % 
|                                          |  |                                         |           |                               |   |           |  |     |   



The increase of
$461,000 in general and administrative expenses for the three-month period ended September 30, 2004 was primarily due to increases in personnel costs of $76,000, consulting services of $246,000, and professional service fees of $330,000. The
increase principally resulted from an increase in patent-related legal expenses, costs associated with various technology acquisition evaluations and an increase in personnel. These increases were offset by a decrease in other spending of $159,000,
principally from temporary help and bank-related expenses.



Stock-based Compensation.    Stock-based compensation for the three-month period ended September 30, 2004 was $368,000 as compared to $291,000 for the three-month period ended September 30, 2003, an increase



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of $77,000, or 26%. The increase was primarily attributable to an increase of compensation expense recorded on options held by non-employees.



Amortization of Intangibles.    Amortization of
intangible assets was $19,000 for each of the three-month periods ended September 30, 2004 and 2003.



Interest Income.    Interest income was comparable for the three-month periods ended September 30, 2004 and 2003 at $116,000
and $115,000, respectively.



Other
Income.    Other income was $40,000 for the three-month period ended September 30, 2004 as compared to $65,000 for the three-month period ended September 30, 2003. For the three-month period ended September 30, 2004, other
income consisted of an adjustment to an estimate of an amount payable to a former collaborator. Other income for the third quarter of 2003 consisted of a gain recognized on currency rate fluctuations on a euro-denominated note receivable from a
former collaborator.



Interest
Expense.    Interest expense for the three-month period ended September 30, 2004 was $102,000 as compared to $156,000 for the three-month period ended September 30, 2003, a decrease of $54,000, or 35%. The decrease in
interest expense was attributable to a decrease in interest expense accrued under our capital lease and debt obligations. We recorded $62,000, for the three-month period ended September 30, 2003 under our capital lease and debt obligations. We
recorded $8,000 in interest expense under such agreements during the three-month period ended September 30, 2004.



Accretion on Series A Convertible Exchangeable Preferred Stock.    We recorded no accretion of preferred stock dividend for
either of the three-month periods ended September 30, 2004 and September 30, 2003.



Net Income/Loss Applicable to Common Stockholders.    As a result of the foregoing, we incurred a net loss applicable to common stockholders of $3,906,000 for the three-month period ended
September 30, 2004 as compared to net income applicable to common stockholders of $4,550,000 for the three-month period ended September 30, 2003.



Nine-Month Periods Ended September 30, 2004 and September 30, 2003



Revenues.    Total revenues for the nine-month period ended September 30, 2004 were $3,462,000 as
compared to $10,293,000 for the nine-month period ended September 30, 2003, a decrease of $6,831,000, or 66%. Revenues for the nine-month period ended September 30, 2004 were primarily derived from revenue recognized under our collaborations with
Genentech and Wyeth of $1,556,000 and $1,717,000, respectively. In addition, we recognized revenue of $139,000 for the nine-month period ended September 30, 2004 under our sponsored research agreement with the Spinal Muscular Atrophy Foundation.



Revenues for the nine-month period ended September 30, 2003
were derived primarily from $8,555,000 in previously deferred revenue that we recognized upon the termination of our product development and target research agreements with Micromet AG during the quarter. In addition, we recognized $1,277,000 in
revenue under a former collaboration with ES Cell and $360,000 related to our collaboration with Genentech.



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



|                                          |  |                          |  |                                        |           |                               |   |           |  |       |   
|----------------------------------------- |  | ------------------------ |  | -------------------------------------- | --------- | ----------------------------- | - | --------- |  | ----- | --
|Research and Development Program          |  | Primary Indication       |  | For the Nine Months EndedSeptember 30, |           | PercentageIncrease/(Decrease) |  
|                                          |  | 2004                     |  | 2003                                   |          
|Hh small molecule antagonist              |  | Basal cell carcinoma     |  | $                                      | 73,000    |                               | $ | 6,000     |  | 1,117 | % 
|Hh small molecule and antibody antagonist |  | Cancer                   |  |                                        | 3,226,000 |                               |   | 2,186,000 |  | 48    | % 
|Hh small molecule agonist                 |  | Nervous system disorders |  |                                        | 2,243,000 |                               |   | 4,612,000 |  | (51   | %)
|Hh small molecule agonist                 |  | Hair loss                |  |                                        | 603,000   |                               |   | 584,000   |  | 3     | % 
|Discovery research                        |  | Spinal muscular atrophy  |  |                                        | 139,000   |                               |   |          |  | N/A   |   
|Discovery research                        |  | Various                  |  |                                        | 2,301,000 |                               |   |          |  | N/A   |   
|Other programs                            |  |                          |  |                                        |          |                               |   | 1,622,000 |  | (100  | %)
|                                          |  |                          |  |                                        |           |                               |   |           |  |       |   
|Total research and development expense    |  |                          |  | $                                      | 8,585,000 |                               | $ | 9,010,000 |  | (5    | %)
|                                          |  |                          |  |                                        |           |                               |   |           |  |       |   



The decrease of
$425,000 in research and development expenses for the nine-month period ended September 30, 2004 was primarily due to the net effect of changes in spending in our research programs. First, we decreased spending by $1,622,000, 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 partnered 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 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 $586,000 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 is obligated to reimburse 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 $139,000 for our spinal muscular atrophy program, which is under collaboration with Spinal Muscular Atrophy Foundation. We incurred $2,301,000 in expenses related
to our other discovery research programs during the nine-month period ended September 30, 2004. We incurred no expenses for these programs during the same period in 2003.



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



|                                          |  |                                        |           |                               |   |           |  |     |   
|----------------------------------------- |  | -------------------------------------- | --------- | ----------------------------- | - | --------- |  | --- | --
|                                          |  | For the Nine Months EndedSeptember 30, |           | PercentageIncrease/(Decrease) |  
|                                          |  | 2004                                   |           | 2003                          |  
|Personnel                                 |  | $                                      | 2,273,000 |                               | $ | 1,946,000 |  | 17  | % 
|Occupancy and depreciation                |  |                                        | 500,000   |                               |   | 465,000   |  | 8   | % 
|Legal and professional services           |  |                                        | 1,834,000 |                               |   | 1,141,000 |  | 61  | % 
|Consulting services                       |  |                                        | 746,000   |                               |   | 231,000   |  | 223 | % 
|Insurance costs                           |  |                                        | 378,000   |                               |   | 409,000   |  | (8  | %)
|Other general and administrative expenses |  |                                        | 535,000   |                               |   | 805,000   |  | (34 | %)
|                                          |  |                                        |           |                               |   |           |  |     |   
|Total general and administrative expenses |  | $                                      | 6,266,000 |                               | $ | 4,997,000 |  | 25  | % 
|                                          |  |                                        |           |                               |   |           |  |     |   



The increase of
$1,269,000 in general and administrative expenses for the nine-month period ended September 30, 2004 was primarily due to an increase in personnel costs of $327,000, consulting services of $515,000 and professional services of $693,000. The increase
principally resulted from expenses associated with a planned equity financing that was not completed during the first half of 2004, costs associated with various technology acquisition evaluations, an increase in legal patent expenses and an
increase in personnel.



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Stock-based Compensation.    Stock-based compensation for the nine-month
period ended September 30, 2004 was $1,059,000 as compared to $1,210,000 for the nine-month period ended September 30, 2003, a decrease of $151,000, or 12%. 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 will be recognized.



Amortization of Intangibles.    Amortization of
intangible assets was $56,000 for each of the nine-month periods ended September 30, 2004 and 2003.



Interest Income.    Interest income was comparable for the nine-month periods ended September 30, 2004 and 2003 at $333,000 and
$313,000, respectively.



Other
Income.    Other income for the nine-month period ended September 30, 2004 was $233,000 as compared to $550,000 for the nine-month period ended September 30, 2003. For the nine-month period ended September 30, 2004, other
income primarily consisted of an adjustment to an estimate of an amount payable to a former collaborator. For the nine-month period ended September 30, 2003, other income consisted primarily of a gain recognized on currency rate fluctuations on a
euro-denominated note receivable from a former collaborator.



Interest Expense.    Interest expense for the nine-month period ended September 30, 2004 was $307,000 as compared to $570,000 for the nine-month period ended September 30, 2003, a decrease of $263,000, or 46%. The
decrease in interest expense was attributable to a decrease in interest expense accrued under our convertible note payable to Elan Pharma International Limited, or EPIL, an affiliate of Elan Corporation, and lower interest expense on capital lease
and debt obligations. We recorded $137,000 and $211,000, respectively, for the nine-month periods ended September 30, 2004 and 2003 under the convertible note payable to EPIL. The decrease in interest expense under this note was due to a decrease in
the average outstanding balance of this note payable for the nine-month period ended September 30, 2004 as compared to the nine-month period ended September 30, 2003. We recorded interest expense of $112,000 for the nine-month period ended September
30, 2003 under our debt obligations. We recorded $8,000 in interest expense under an outstanding letter of credit during the three-month period ended September 30, 2004. The decrease in interest expense was partially attributable to the full
repayment in December 2003 of a note payable to the Boston Private Bank & Trust Company. In addition, interest expense recorded under our capital lease obligations decreased to $16,000 for the nine-month period ended September 30, 2004 from
$102,000 for the nine-month period ended September 30, 2003.



Accretion on Series A Convertible Exchangeable Preferred Stock.    We recorded no accretion of preferred stock dividend for the nine-month period ended September 30, 2004 as compared to $271,000 for the nine-month
period ended September 30, 2003. This charge relates to the accretion of a mandatory 6% dividend on shares of convertible exchangeable preferred stock issued to an affiliate of Elan Corporation. As part of our termination agreement with Elan
Corporation, the preferred stock was cancelled on May 16, 2003. The accretion of preferred stock is included in the net loss applicable to common stockholders for nine-month period ended September 30, 2003.



Net Loss Applicable to Common Stockholders.    As
a result of the foregoing, we incurred a net loss applicable to common stockholders of $12,245,000 for the nine-month period ended September 30, 2004 as compared to net loss applicable to common stockholders of $4,959,000 for the nine-month period
ended September 30, 2003.



Liquidity and Capital Resources



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



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At September 30, 2004, our principal sources of liquidity consisted of cash, cash equivalents and
marketable securities of $30,934,000. 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.
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 collaborative partners. 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.



Net cash used in operating activities was $7,447,000
for the nine-month period ended September 30, 2004 as compared to $6,076,000 for the nine-month period ended September 30, 2003. Cash used in operating activities during the nine-month period ended September 30, 2004 was primarily the result of our
net loss for the period partially offset by non-cash charges including stock-based compensation, depreciation and non-cash interest expense. In addition, increases in operating cash as a result of changes in certain current assets and liabilities
during the nine-month period ended September 30, 2004, including 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 net loss. We expect
that our cash used in operations will continue to increase as we continue to seek to develop our products toward clinical trials and advance new products into preclinical development. We also expect that the increase in cash used will be 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 nine-month period ended September 30, 2003 was primarily the result of our
net loss for the period and an increase in long-term receivables related to Genentech, which were partially offset by non-cash charges including stock-based compensation, depreciation and non-cash interest expense.



Investing activities used cash of $7,243,000 for the nine-month period ended
September 30, 2004 as compared to $1,427,000 provided in the nine-month period ended September 30, 2003. Cash used in investing activities resulted principally from $6,201,000 in net investment purchases and $1,043,000 in fixed asset purchases for
the nine-month period ended September 30, 2004. We expect we will continue to use cash in our investing activities as we expand our infrastructure. For the nine-month period ended September 30, 2003, cash provided from investing activities resulted
principally from $1,498,000 in net investment sales.



Financing
activities provided approximately $3,531,000 of cash for the nine-month period ended September 30, 2004, resulting primarily from the sale of $3,272,000 of our common stock, including $1,500,000 from the sale of 315,524 shares to Wyeth and
$1,567,000 in proceeds received upon stock option exercises. In addition, proceeds from the issuance of debt for the purchase of fixed assets provided $592,000 for the nine-month period ended September 30, 2004. These increases were offset by
$332,000 in repayments of obligations under capital leases. We expect our cash flows provided by financing activities to increase for the remainder of 2004, as we continue to borrow against our loan agreement.



Financing activities provided approximately $11,736,000 of cash for the
nine-month period ended September 30, 2003, resulting primarily from $14,367,000 received in issuances of common stock, including



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$9,829,000 in net proceeds from our August 2003 private placement of common stock, $3,500,000 in common stock purchased by Genentech as part of our
collaboration and $1,006,000 received by the exercise of stock options. These cash inflows were partially offset by repayments of obligations under capital lease and debt arrangements of $2,609,000.



On October 14, 2004, we completed a registered direct offering of 5,476,559
shares of newly issued common stock, together with warrants to purchase 0.10 shares of common stock for each share of common stock purchased, at a purchase price of $3.67 per share to institutional and accredited investors. The warrants to purchase
an aggregate of 547,656 shares of common stock expire on October 14, 2009 and are exercisable at $4.59 per share. The transaction provided us approximately $18,868,000 in net proceeds (exclusive of any proceeds we may receive upon exercise of the
warrants). The shares of common stock and warrants to purchase common stock offered by us in this transaction were registered under our existing shelf registration statement on Form S-3 which was declared effective by the Securities and Exchange
Commission on January 7, 2004.



Effective January 20, 2004, we
entered into a loan agreement with the Boston Private Bank & Trust Company to finance up to $1,250,000 in purchases of equipment and facility leasehold improvements from December 1, 2003 until January 20, 2005. In June 2004, we financed $592,000
for purchases of equipment that accrue interest at a variable rate of 5.75% as of September 30, 2004. Under the terms of the loan agreement, we can request periodic financings for qualifying purchases of equipment and leaseholds through January 20,
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 (5.75% as of September 30, 2004) or a fixed rate (6.46% as of September 30, 2004) for the repayment period. As of September 30, 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 secured by any equipment and leaseholds purchased with the proceeds of the loan.



Effective September 23, 2004, we amended the loan agreement originally entered into with Boston Private Bank & Trust Company on January 20, 2004. The
loan was amended to (i) increase the maximum facility amount from $1,250,000 to $2,250,000, (ii) extend the period under which we may finance purchases of equipment and leasehold improvements to February 28, 2005 from January 20, 2005, (iii)
increase the allowable percentage of overall borrowings attributable to the purchase of leasehold improvements from 25% to 100%, and (iv) increase the security under the loan to all of our property, plant and equipment assets, except for those that
are affixed to the property and those that are purchased after February 20, 2005 under purchase money arrangements with equipment lenders.



Effective September 7, 2004, we entered into a sponsored research agreement with the Spinal Muscular Atrophy Foundation. Under the agreement, the
Foundation will grant to us up to $5,364,000 over a three-year period for identification of therapeutic compounds to treat spinal muscular atrophy. As of September 30, 2004, we had received $498,000 from the Foundation.



Effective February 2004, we licensed our Hedgehog proteins and small molecule
Hedgehog pathway agonists to Wyeth 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 and other disorders pursuant to the terms of a
collaboration, research, and license agreement. The collaboration agreement provides for cash payments from Wyeth, including a license fee of $1,500,000 which was received in February 2004, and milestone payments at various intervals during the
regulatory approval process of Hedgehog proteins and small molecule Hedgehog pathway agonist candidates, assuming specified research objectives are met. Wyeth is also obligated to pay us a royalty on potential future product sales. We are
recognizing revenue related to the $1,500,000 license fee over our estimated period of involvement related to the collaboration of five years. Under our current operating plan, we expect to recognize approximately $150,000 for the remainder of 2004
related to the license fee payment. Under the terms of the collaboration agreement, Wyeth is obligated to provide financial support of our research under the collaboration for a minimum of two years. For the nine-month period ended September 30,
2004, Wyeth has paid us $1,280,000 for research and development services.



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In June 2003, we licensed our small molecule and antibody Hedgehog pathway antagonists to Genentech for
human therapeutic use with the primary focus of the research plan to develop applications in cancer therapy. The collaborative research, development and license agreement provides for cash payments from Genentech, including an up-front payment of
$5,000,000, maintenance fee payments totaling $4,000,000 over the first two years of the collaboration and milestone payments at various intervals during the regulatory approval process of small molecule and antibody product candidates, assuming
specified clinical development objectives are met. In July 2004, we received the first of two maintenance payments in the amount of $2,000,000. Genentech is also obligated to pay us a royalty on potential future product sales, if any. Under the
terms of the collaboration agreement, we are required to commit eight employees to the small molecule and/or antibody Hedgehog pathway antagonist programs for a period of two years. We are recognizing revenue related to the $5,000,000 up-front
payment and the $4,000,000 maintenance fee payments receivable over our estimated period of involvement related to the collaboration of seven and a quarter years. Under our current operating plan, we expect to recognize approximately $310,000 for
the remainder of 2004 related to these payments.



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 September 30, 2004, there was approximately $3,252,000, including approximately $252,000 in accrued interest, outstanding 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 September 30, 2004, there was approximately $2,457,000, including approximately $457,000 in accrued interest, outstanding under the note agreement.



In addition to our loan agreement, 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 at September 30, 2004 and the effects such obligations are expected to have on our
liquidity and cash flows for the remainder of 2004 and future periods:



|                                           |  |                                           |        |                  |   |       |  |      |       |      |   |       |  |      |       |            |   |     |  |   |     |  |   |    
|------------------------------------------ |  | ----------------------------------------- | ------ | ---------------- | - | ----- |  | ---- | ----- | ---- | - | ----- |  | ---- | ----- | ---------- | - | --- |  | - | --- |  | - | ---
|                                           |  | Payments Due by Period (amounts in 000s)
|                                           |  | Total                                     |        | Remainderof 2004 |   | 2005  |  | 2006 |       | 2007 |   | 2008  |  | 2009 |       | Thereafter
|Contractual Obligations                    |  |                                           |        |                  |   |       |  |      |       |      |   |       |  |      |       |            |   |     |  |   |     |  |   |    
|Convertible subordinated long-term debt(1) |  | $                                         | 6,618  |                  | $ |      |  | $    |      |      | $ | 2,805 |  | $    | 3,813 |            | $ |    |  | $ |    |  | $ |   
|Short-term debt obligations                |  |                                           | 592    |                  |   |      |  |      | 592   |      |   |      |  |      |      |            |   |    |  |   |    |  |   |   
|Operating lease obligations                |  |                                           | 6,454  |                  |   | 205   |  |      | 822   |      |   | 1,433 |  |      | 1,150 |            |   | 948 |  |   | 948 |  |   | 948
|Outside service obligations                |  |                                           | 1,455  |                  |   | 955   |  |      | 500   |      |   |      |  |      |      |            |   |    |  |   |    |  |   |   
|Licensing obligations                      |  |                                           | 337    |                  |   | 62    |  |      | 275   |      |   |      |  |      |      |            |   |    |  |   |    |  |   |   
|                                           |  |                                           |        |                  |   |       |  |      |       |      |   |       |  |      |       |            |   |     |  |   |     |  |   |    
|Total future obligations                   |  | $                                         | 15,456 |                  | $ | 1,222 |  | $    | 2,189 |      | $ | 4,238 |  | $    | 4,963 |            | $ | 948 |  | $ | 948 |  | $ | 948
|                                           |  |                                           |        |                  |   |       |  |      |       |      |   |       |  |      |       |            |   |     |  |   |     |  |   |    

---

|(1) |  | Convertible subordinated debt is convertible into either shares of our common stock or cash at our option.
|--- |  | ----------------------------------------------------------------------------------------------------------



We anticipate that existing capital resources at September 30, 2004, together
with the proceeds of our registered direct offering which was completed in October 2004, should enable us to maintain current and planned operations into the second half of 2007, including spending related to the potential exercise of our
co-development option with Genentech. We expect to incur substantial additional research and development and other costs, including costs related to preclinical studies and clinical trials for the foreseeable future. Our ability



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to continue funding planned operations beyond the second half of 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 or debt financings, or from other sources of financing. Our ability to generate sufficient cash flows depends on a number of factors, including the ability of either us, or
our collaborators, to obtain regulatory approval to market and commercialize products to treat indications in major commercial markets. We are seeking additional collaborative arrangements and also expect to raise funds through one or more financing
transactions, if conditions permit. Due to our significant long-term capital requirements, we intend to seek to raise funds through the sale of debt or equity securities when conditions are favorable, even if we do not have an immediate need for
additional capital at such time. Additional financing may not be available or, if available, it may not be available on favorable terms. In addition, the sale of additional debt or equity securities could result in dilution to our stockholders. If
substantial additional funding is not available, our ability to fund research and development and other operations will be significantly affected and, accordingly, our business will be materially and adversely affected.



Off-Balance Sheet Arrangements



We have no off-balance sheet arrangements as of September 30, 2004.



Risk Factors That May Affect Results



This Quarterly Report on Form 10-Q and certain other communications made by
us contain forward-looking statements, including statements about our future operating results, discovery and development of products and current and potential strategic alliances. For this purpose, any statement that is not a statement of
historical fact should be considered a forward-looking statement. We often use the words believe, anticipate, plan, expect, intend and similar expressions to help identify forward-looking
statements.



There are a number of important factors that could
cause our actual results to differ materially from those indicated or implied by forward-looking statements. Factors that could cause or contribute to such differences include those discussed below, as well as those discussed elsewhere in this Form
10-Q. We disclaim any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.



RISKS RELATING TO OUR FINANCIAL RESULTS AND NEED FOR FINANCING



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



We expect to incur
substantial operating losses for the foreseeable future, and we have no current sources of material ongoing revenue. As of September 30, 2004, we had an accumulated deficit of approximately $661,313,000. Other than OP-1, which we and Stryker
commercialized under a former collaboration, we have not commercialized any products to date, either alone or with a third party collaborator. If we are not able to commercialize any products, whether alone or with a collaborator, we will not
achieve profitability. Even if our collaboration agreements provide funding for a portion of our research and development expenses for some of our programs, we expect to spend significant capital to fund our internal research and development
programs for the foreseeable future. As a result, we will need to generate significant revenues in order to achieve profitability. We cannot be certain whether or when this will occur because of the significant uncertainties that affect our
business. Our failure to become and remain profitable may depress the market price of our common stock and could impair our ability to raise capital, expand our business, diversify our product offerings or continue our operations.



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



We will require substantial funds to continue our
research and development programs. We believe that our existing cash and working capital, together with the proceeds of our registered direct offering which closed October 2004, should be sufficient to fund our operations until the second half of
2007, however, our future capital requirements may vary from what we expect. There are factors that may affect our future capital requirements and accelerate our need for additional financing. Many of these factors are outside our control, including
the following:



| |  |  | continued progress in our research and development programs, as well as the magnitude of these programs;
| | - |  | --------------------------------------------------------------------------------------------------------



| |  |  | the cost of additional facilities requirements including the current expansion of the animal facility and such others as may be required;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------



| |  |  | our ability to establish and maintain collaborative arrangements;
| | - |  | -----------------------------------------------------------------



| |  |  | the timing, receipt and amount of research funding and milestone, license, royalty and other payments, if any, from collaborative partners;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the timing, payment and amount of research funding and milestone, license, royalty and other payments due to licensors of patent rights and technology used to make, use and sell our
product candidates;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the timing, receipt and amount of sales revenues and associated royalties to us, if any, from our product candidates in the market; and
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the costs of preparing, filing, prosecuting, maintaining and enforcing patent claims and other patent-related costs, including litigation costs and technology license fees.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------



We expect to seek additional funding through
public or private financings and may seek additional funding for programs that are not currently licensed to collaborators, from new strategic collaborators. However, the biotechnology market in general, and the market for our common stock, in
particular, is highly volatile. Due to market conditions and the status of our development pipeline, additional funding may not be available to us on acceptable terms, if at all. If we fail to obtain such additional financing on a timely basis, our
ability to continue all of our research and development, activities will be adversely affected.



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



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



Our financial statements have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments
that affect the reported amounts of our assets, liabilities, revenues and expenses, the amounts of charges taken by us and related disclosure. We base our estimates on historical experience and on various other assumptions that we believe to be
reasonable under the circumstances. We cannot assure you that our estimates, or the assumptions underlying them, will be correct. Accordingly, our actual financial results may vary significantly from the estimates contained in our financial
statements.



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RISKS RELATING TO OUR COLLABORATIONS



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



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



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



| |  |  | Each of our collaborators has significant discretion in determining the efforts and resources that they will apply to the collaboration. The timing and amount of any future royalty
and milestone revenue that we may receive under such collaborative arrangements will depend on, among other things, such collaborators efforts and allocation of resources.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | All of our strategic alliance agreements are for fixed terms and are subject to termination under various circumstances, including in some cases, on short notice without cause. If
any collaborative partner were to terminate an agreement, we may be required to undertake product development, manufacturing and commercialization and we may not have the funds or capability to do this, which could result in a discontinuation of
such program.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Our collaborators may develop and commercialize, either alone or with others, products and services that are similar to or competitive with the products and services that are the
subject of the alliance with us.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Our collaborators may change the focus of their development and commercialization efforts. Pharmaceutical and biotechnology companies historically have re-evaluated their priorities
following mergers and consolidations, which have been common in recent years in these industries. The ability of certain of our product candidates to reach their potential could be limited if our collaborators decrease or fail to increase spending
related to such product candidates.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



As an integral part of our ongoing research and development efforts, we periodically review opportunities to establish new collaborations, joint ventures
and strategic alliances for the development and commercialization of products in our development pipeline. We face significant competition in seeking appropriate collaborators and the negotiation process is time-consuming and complex. We may not be
successful in our efforts to establish additional strategic alliances or other alternative arrangements. Even if we are successful in our efforts to establish an alliance or agreement, the terms that we establish may not be favorable to us. Finally,
such strategic alliances or other arrangements may not result in successful products and associated revenue.



RISKS RELATED TO OUR BUSINESS, INDUSTRY, STRATEGY AND OPERATIONS



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



Our product candidates face competition with existing and
new products being developed by biotechnology, medical device and pharmaceutical companies, as well as universities and other research institutions. For example, research in the fields of regulatory signaling pathways and functional genomics, which
includes our work with Genentech in the field of cancer and with Ortho Biotech in the field of renal disease, is highly competitive. A number of entities are seeking to identify and patent randomly sequenced genes and gene



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fragments, typically without specific knowledge of the function that such genes or gene fragments perform. Our competitors may discover, characterize and
develop important inducing molecules or genes in advance of us. We also face competition from these and other entities in gaining access to DNA samples used in our research and development projects. Many of our competitors have substantially greater
capital resources, research and development staffs and facilities than we have. Efforts by other biotechnology, medical device and pharmaceutical companies could render our programs or products uneconomical or result in therapies superior to those
that we develop alone or with a collaboration partner. For those programs that we have selected for further internal development, we face competition from companies that are more experienced in product development and commercialization, obtaining
regulatory approvals and product manufacturing. As a result, they may develop competing products more rapidly and at a lower cost. For those programs that are subject to a collaboration agreement, competitors may discover, develop and commercialize
products which render our products non-competitive or obsolete. We expect competition to intensify in genomics research and regulatory signaling pathways as technical advances in the field are made and become more widely known.



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



We have limited financial and managerial resources. These limitations require us to focus on a select group of product candidates in specific therapeutic
areas and to forego the exploration of other product opportunities. While our technologies may permit us to work in multiple areas, resource commitments may require trade-offs resulting in delays in the development of certain programs or research
areas, which may place us at a competitive disadvantage. Our decisions as to resource allocation may not lead to the development of viable commercial products and may divert resources away from other market opportunities which ultimately prove to be
more profitable.



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



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



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



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



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



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



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Any growth and expansion into areas and activities that may require additional human resources or
expertise, such as regulatory affairs and compliance, would require us to either hire new key personnel or obtain such services via an outsourcing arrangement. The pool of personnel with the skills that we require is limited. We may not be able to
hire or contract such additional personnel.



RISKS RELATING
TO INTELLECTUAL PROPERTY



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



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



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



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



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



| |  |  | obtain patents to protect our discoveries;
| | - |  | ------------------------------------------



| |  |  | protect trade secrets from disclosure to third-party competitors;
| | - |  | -----------------------------------------------------------------



| |  |  | operate without infringing upon the proprietary rights of others; and
| | - |  | ---------------------------------------------------------------------



| |  |  | prevent others from infringing on our proprietary rights.
| | - |  | ---------------------------------------------------------



Patents may not issue from any of the patent applications that we own or license. If patents do issue, the allowed claims may not be sufficiently broad to
protect our technology from exploitation by our competitors. In addition, issued patents that we own or license may be challenged, invalidated or circumvented. Our patents also may not afford us protection against competitors with similar
technology. Because patent applications in the United States are maintained in secrecy until 18 months after filing, it is possible that third parties have filed or maintained patent applications for technology used by us or covered by our pending
patent applications without our knowledge.



We may not have
rights under patents which may cover one or more of our product candidates. In some cases, these patents may be owned or controlled by third party competitors and may impair our ability to exploit our technology. As a result, we or our collaborative
partners may be required to obtain licenses under third-party patents to develop and commercialize some of our product candidates. If we are unable to secure licenses to such patented technology on acceptable terms, we or our collaborative partners
will not be able to develop and commercialize the affected product candidate or candidates.



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



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



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



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



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



| |  |  | initiation of litigation or other proceedings against third parties to enforce our patent rights;
| | - |  | -------------------------------------------------------------------------------------------------



| |  |  | initiation of litigation or other proceedings against third parties to seek to invalidate the patents held by these third parties or to obtain a judgment that our product candidates
do not infringe the third parties patents;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | participation in interference or opposition proceedings to determine the priority of invention if our competitors file patent applications that claim technology also claimed by us;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | initiation of litigation by third parties claiming that our processes or product candidates or the intended use of our product candidates infringe their patent or other intellectual
property rights; and
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | initiation of litigation by us or third parties seeking to enforce contract rights relating to intellectual property which may be important to our business.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------



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



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



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



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



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RISKS RELATING TO CLINICAL AND REGULATORY MATTERS



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



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



Clinical development, including preclinical testing, is a
long, expensive and uncertain process. Accordingly, clinical trials, if any, of our product candidates under development may not be successful. We and our collaborators could experience delays in preclinical or clinical trials of any of our product
candidates, obtain unfavorable results in a development program, or fail to obtain regulatory approval for the commercialization of a product. Furthermore, the timing and completion of clinical trials, if any, of our product candidates depend on,
among other factors, the number of patients we will be required to enroll in the clinical trials and the rate at which those patients are enrolled. Any increase in the required number of patients or decrease in recruitment rates may result in
increased costs, program delays or both. Also, our products under development may not be effective in treating any of our targeted disorders or may prove to have undesirable or unintended side effects, toxicities or other characteristics that may
prevent or limit their commercial use. Any of these events would adversely affect our ability to market a product candidate.



The development process necessary to obtain regulatory approval is lengthy, complex and expensive. If we and our collaborative partners do not obtain necessary
regulatory approvals, then our business will be unsuccessful and the market price of our common stock will substantially decline.



To the extent that we, or our collaborative partners, are able to successfully advance a product candidate through the clinic, we, or such partner, will
be required to obtain regulatory approval prior to marketing and selling such product.



The process of obtaining FDA and other required regulatory approvals is expensive. The time required for FDA and other approvals is uncertain and typically takes a number of years, depending on the complexity and
novelty of the product. The process of obtaining FDA and other required regulatory approvals for many of our products under development is further complicated because some of these products use non-traditional or novel materials in non-traditional
or novel ways, and the regulatory officials have little precedent to follow. With respect to internal programs to date, we have limited experience in filing and prosecuting applications to obtain marketing approval.



Any regulatory approval to market a product may be subject to limitations on
the indicated uses for which we, or our collaborative partners, may market the product. These limitations may restrict the size of the market for the product and affect reimbursement by third-party payors. In addition, regulatory agencies may not
grant approvals on a timely basis or may revoke or significantly modify previously granted approvals.



We, or our collaborative partners, also are subject to numerous foreign regulatory requirements governing the manufacturing and marketing of our potential
future products outside of the United States. The approval procedure varies among countries, and the time required to obtain foreign approvals often differs from that required to obtain FDA approvals. Moreover, approval by the FDA does not ensure
approval by regulatory authorities in other countries, and vice versa.



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



Even if marketing approval is obtained,
any products we or our collaborators develop will be subject to ongoing regulatory oversight which may affect the successful commercialization of such products.



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



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



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



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



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



RISKS RELATING TO PRODUCT MANUFACTURING AND SALES



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



We have no manufacturing experience or manufacturing capabilities. In order to continue to develop products, apply for regulatory approvals, and
commercialize our products, we or our collaborators must be able to manufacture products in commercial quantities, in compliance with regulatory requirements, at acceptable costs and in a timely manner. The manufacture of our product candidates may
be complex, difficult to accomplish and difficult to scale-up when large-scale production is required. Manufacture may be subject to delays, inefficiencies and poor or low yields of quality products. The cost of manufacturing some of our products
may make them prohibitively expensive. If supplies of any of our product candidates or related materials become



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unavailable on a timely basis or at all or are contaminated or otherwise lost, clinical trials by us and our collaborators could be seriously delayed. This
is due to the fact that such materials are time-consuming to manufacture and cannot be readily obtained from third-party sources.



To the extent that we, or our collaborators, seek to enter into manufacturing arrangements with third parties, we and such collaborators will depend upon
these third parties to perform their obligations in a timely and effective manner and in accordance with government regulations. If third-party manufacturers fail to perform their obligations, our competitive position and ability to generate revenue
may be adversely affected in a number of ways, including;



| |  |  | we and our collaborators may not be able to initiate or continue clinical trials of products that are under development;
| | - |  | ------------------------------------------------------------------------------------------------------------------------



| |  |  | we and our collaborators may be delayed in submitting applications for regulatory approvals for our product candidates; and
| | - |  | ---------------------------------------------------------------------------------------------------------------------------



| |  |  | we and our collaborators may not be able to meet commercial demands for any approved products.
| | - |  | ----------------------------------------------------------------------------------------------



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



We have no sales, marketing or product
distribution experience. If we receive required regulatory approvals, we plan to rely primarily on sales, marketing and distribution arrangements with third parties, including our collaborative partners. For example, as part of our agreements with
Genentech, Ortho Biotech and Wyeth, we have granted our collaborators exclusive rights to distribute certain products resulting from such collaborations, if any are ever successfully developed. We may have to enter into additional marketing
arrangements in the future and we may not be able to enter into these additional arrangements on terms which are favorable to us, if at all. In addition, we may have limited or no control over the sales, marketing and distribution activities of
these third parties and sales through these third parties could be less profitable to us than direct sales. These third parties could sell competing products and may devote insufficient sales efforts to our products. Our future revenues will be
materially dependent upon the success of the efforts of these third parties.



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



| |  |  | we may not be able to attract and build a significant and skilled marketing staff or sales force;
| | - |  | -------------------------------------------------------------------------------------------------



| |  |  | the cost of establishing a marketing staff or sales force may not be justifiable in light of the revenues generated by any particular product; and
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | our direct sales and marketing efforts may not be successful.
| | - |  | -------------------------------------------------------------



RISKS RELATED TO OUR COMMON STOCK



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



The trading price of our common stock has been volatile and may continue to
be volatile in the future. For example, our stock has traded as high as $6.59 and as low as $0.65 per share for the period January 1, 2003 through September 30, 2004. The stock market, particularly in recent years, has experienced significant
volatility with respect to biopharmaceutical- and biotechnology-based company stocks. The volatility of biopharmaceutical- and biotechnology-based company stocks often does not relate to the operating performance



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of the companies represented by the stock. Prices for our stock will be determined in the market place and may be influenced by many factors, including:



| |  |  | announcements regarding new technologies by us or our competitors;
| | - |  | ------------------------------------------------------------------



| |  |  | market conditions in the biotechnology and pharmaceutical sectors;
| | - |  | ------------------------------------------------------------------



| |  |  | rumors relating to us or our competitors;
| | - |  | -----------------------------------------



| |  |  | litigation or public concern about the safety of our potential products;
| | - |  | ------------------------------------------------------------------------



| |  |  | actual or anticipated variations in our quarterly operating results;
| | - |  | --------------------------------------------------------------------



| |  |  | deviations in our operating results from the estimates of securities analysts;
| | - |  | ------------------------------------------------------------------------------



| |  |  | adverse results or delays in clinical trials being conducted by us or our collaborators;
| | - |  | ----------------------------------------------------------------------------------------



| |  |  | any intellectual property lawsuits involving us;
| | - |  | ------------------------------------------------



| |  |  | sales of large blocks of our common stock;
| | - |  | ------------------------------------------



| |  |  | sales of our common stock by our executive officers, directors or significant stockholders;
| | - |  | -------------------------------------------------------------------------------------------



| |  |  | the loss of any of our key scientific or management personnel;
| | - |  | --------------------------------------------------------------



| |  |  | FDA or international regulatory actions; and
| | - |  | --------------------------------------------



| |  |  | general market conditions.
| | - |  | --------------------------



While we cannot predict the individual effect that these factors may have on the price of our common stock, these factors, either individually or in the
aggregate, could result in significant variations in price during any given period of time. Moreover, in the past, securities class action litigation has often been instituted against companies following periods of volatility in their stock price.
This type of litigation could result in substantial costs and divert our managements attention and resources.



Substantially all of our outstanding common stock may be sold into the market at any time. This could cause the market price of our common stock to drop significantly.



Sales of a substantial number of shares of our common
stock in the public market could occur at any time. These sales, or the perception in the market that the holders of a large number of shares intend to sell shares, could reduce the market price of our common stock. As of September 30, 2004, we had
outstanding approximately 41.8 million shares of common stock. Substantially all of these shares may also be resold in the public market at any time. In addition, we have a significant number of shares that are subject to outstanding options. The
exercise of these options and the subsequent sale of the underlying common stock could cause a further decline in our stock price. These sales also might make it difficult for us to sell equity securities in the future at a time and at a price that
we deem appropriate.



We have anti-takeover defenses that could delay or
prevent an acquisition that our stockholders may consider favorable and the market price of our common stock may be lower as a result.



Provisions of our certificate of incorporation, our bylaws and Delaware law may have the effect of deterring unsolicited takeovers or delaying or
preventing changes in control of our management, including transactions in which our stockholders might otherwise receive a premium for their shares over then current market prices. In addition, these provisions may limit the ability of stockholders
to approve transactions that they may deem to be in their best interest. For example, we have divided our board of directors into three classes that serve staggered three-year terms, we may issue shares of our authorized blank check
preferred stock and our stockholders are limited in their ability to call special stockholder meetings.



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In addition, we are subject to the anti-takeover provisions of Section 203 of the Delaware General
Corporation Law, which prohibits a publicly-held Delaware corporation from engaging in a business combination with an interested stockholder, generally a person which together with its affiliates owns, or within the last three years has owned, 15%
of our voting stock, for a period of three years after the date of the transaction in which the person became an interested stockholder, unless the business combination is approved in a prescribed manner. These provisions could discourage, delay or
prevent a change in control transaction.



Item 3.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK



We invest our cash balances in excess of operating requirements in cash equivalents and short-term marketable securities, generally money market funds,
corporate debt and government securities with an average maturity of less than one year. All marketable securities are considered available for sale. The primary objective of our cash investment activities is to preserve principal while at the same
time maximizing the income we receive from our invested cash without significantly increasing risk of loss. Our marketable securities are subject to interest rate risk and will fall in value if market interest rates increase. However, because of the
short-term nature of the marketable securities, we do not believe that interest rate fluctuations would materially impair the principal amount of our investments. Our investments are investment grade securities, and deposits are with investment
grade financial institutions. We believe that the realization of losses due to changes in credit spreads is unlikely as we expect to hold our investments to maturity. We do not use derivative financial instruments in our investment portfolio. We
have operated primarily in the United States. Accordingly, we do not have any material exposure to foreign currency rate fluctuations.



Item 4.    CONTROLS AND PROCEDURES



| | (a) |  | Evaluation of disclosure controls and procedures.    Our management, with the participation of our chief executive officer and chief financial officer,
evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of September 30, 2004. Based on this evaluation, our chief executive officer and chief financial officer
concluded that, as of September 30, 2004, our disclosure controls and procedures were (1) designed to ensure that material information relating to us, including our consolidated subsidiaries, is made known to our chief executive officer and chief
financial officer by others within those entities, particularly during the period in which this report was being prepared and (2) effective, in that they provide reasonable assurance that information required to be disclosed by us in the reports
that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SECs rules and forms.
| | --- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | (b) |  | Changes in internal controls.    No change in our internal control over financial reporting (as defined in the Securities Exchange Act of 1934, Rules
13a-15(f) and 15d-15(f)) occurred during the fiscal quarter ended September 30, 2004 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
| | --- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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PART IIOTHER INFORMATION



Item 6.    EXHIBITS



(a)  Exhibits.



See exhibit
index.



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SIGNATURE



Pursuant to the
requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.



|                        |  |  |  |             |  |                        |  |                                                                                                                   
|----------------------- |  |  |  | ----------- |  | ---------------------- |  | ------------------------------------------------------------------------------------------------------------------
|                        |  |  |  | CURIS, INC.
|                        |  |  | 
|Dated: October 26, 2004 |  |  |  | By:         |  | /s/    MICHAEL P. GRAY
|                        |  |  |  |             |  |                        |  | Michael P. Gray Vice President of Finance and Chief Financial Officer (Principal Financial and Accounting
Officer)



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EXHIBIT INDEX



|               |  |                                                                                                                                                                                 
|-------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit Number |  | Description                                                                                                                                                                     
|               | 
|10.1           |  | Second Amendment to Leases, dated August 17, 2004, between Curis and FPRP Moulton LLC relating to the premises at 25, 27, 33, 45 and 61
Moulton Street, Cambridge, Massachusetts
|               | 
|10.2           |  | Form of Incentive Stock Option Agreement granted to directors and named executive officers under Curis 2000 Stock Incentive
Plan                                               
|               | 
|10.3           |  | Form of Non-statutory Stock Option Agreement granted to directors and named executive officers under Curis 2000 Stock Incentive
Plan                                           
|               | 
|10.4           |  | Form of Non-statutory Stock Option Agreement granted to non-employee directors under Curis Director Stock Option
Plan                                                          
|               | 
|31.1           |  | Certification of the Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Exchange Act                                                                           
|               | 
|31.2           |  | Certification of the Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Exchange Act                                                                           
|               | 
|32.1           |  | Certification of the Chief Executive Officer pursuant to Rule 13a-14(b)/15d-14(b) of the Exchange Act and 18 U.S.C. Section
1350                                                
|               | 
|32.2           |  | Certification of the Chief Financial Officer pursuant to Rule 13a-14(b)/15d-14(b) of the Exchange Act and 18 U.S.C. Section
1350                                                



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