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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q



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

For the quarterly period ended September 30, 2006

OR



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

For the transition period from  to

Commission File Number 000-23223



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CURAGEN CORPORATION

(Exact name of registrant as specified in its charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Delaware                                                       |  | 06-1331400                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)
|                                                               | 
|322 East Main Street, Branford, Connecticut                    |  | 06405                               
|(Address of principal executive offices)                       |  | (Zip Code)                          

Registrants telephone number, including area code: (203) 481-1104



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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.    Yes  x    No ̈

Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):



|                         |  |                      |  |                       
|------------------------ |  | -------------------- |  | ----------------------
|Large accelerated filer ̈ |  | Accelerated filer  x |  | Non-accelerated filer ̈

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

The number of shares outstanding of the registrants common stock as of October 27, 2006 was 56,371,176.



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##### Table of Contents

CURAGEN CORPORATION AND SUBSIDIARY

FORM 10-Q

INDEX



|                              |  |                                                                                                                             |  |       
|----------------------------- |  | --------------------------------------------------------------------------------------------------------------------------- |  | ------
|                              |  |                                                                                                                             |  | Page  
|                              | 
|PART I. Financial Information |  |                                                                                                                            
|                              |  |                                                                                                                            
|Item 1.                       |  | Financial Statements                                                                                                        |  |       
|                              |  |                                                                                                                            
|                              |  | Condensed Consolidated Balance Sheets as of September 30, 2006 and December 31, 2005 (unaudited)                            |  | 3     
|                              |  |                                                                                                                            
|                              |  | Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2006 and 2005 (unaudited) |  | 4     
|                              |  |                                                                                                                            
|                              |  | Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2006 and 2005 (unaudited)           |  | 5     
|                              |  |                                                                                                                            
|                              |  | Notes to Condensed Consolidated Financial Statements (unaudited)                                                            |  | 6 - 14
|                              |  |                                                                                                                            
|Item 2.                       |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                                       |  | 15 -29
|                              |  |                                                                                                                            
|Item 3.                       |  | Quantitative and Qualitative Disclosures About Market Risk                                                                  |  | 30    
|                              |  |                                                                                                                            
|Item 4.                       |  | Controls and Procedures                                                                                                     |  | 30    
|                              | 
|PART II. Other Information    |  |                                                                                                                            
|                              |  |                                                                                                                            
|Item 1A.                      |  | Risk Factors                                                                                                                |  | 31 -32
|                              |  |                                                                                                                            
|Item 6.                       |  | Exhibits                                                                                                                    |  | 33    
|                              | 
|Signatures                    |  | 34                                                                                                                         
|                              | 
|Exhibit Index                 |  | 35                                                                                                                         



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##### Table of Contents

CURAGEN CORPORATION AND SUBSIDIARY

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except par value and share data)

(unaudited)



|                                                                                                                                         |  |                   |          |   |                  |   |          |  
|---------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------- | -------- | - | ---------------- | - | -------- | -
|                                                                                                                                         |  | September 30,2006 |          |   | December 31,2005 |  
|ASSETS                                                                                                                                   |  |                   |          |   |                  |   |          |  
|Current assets:                                                                                                                          |  |                   |          |   |                  |   |          |  
|Cash and cash equivalents                                                                                                                |  | $                 | 38,129   |   |                  | $ | 20,757   |  
|Short-term investments                                                                                                                   |  |                   | 32,293   |   |                  |   | 22,267   |  
|Marketable securities                                                                                                                    |  |                   | 110,750  |   |                  |   | 183,504  |  
|                                                                                                                                         |  |                   |          |   |                  |   |          |  
|Cash and investments                                                                                                                     |  |                   | 181,172  |   |                  |   | 226,528  |  
|Income taxes receivable                                                                                                                  |  |                   | 470      |   |                  |   | 709      |  
|Inventory                                                                                                                                |  |                   | 8,918    |   |                  |   | 4,103    |  
|Accounts receivable                                                                                                                      |  |                   | 3,991    |   |                  |   | 3,491    |  
|Prepaid expenses                                                                                                                         |  |                   | 2,221    |   |                  |   | 1,522    |  
|                                                                                                                                         |  |                   |          |   |                  |   |          |  
|Total current assets                                                                                                                     |  |                   | 196,772  |   |                  |   | 236,353  |  
|Property and equipment, net                                                                                                              |  |                   | 16,966   |   |                  |   | 21,705   |  
|Intangible and other assets, net                                                                                                         |  |                   | 14,316   |   |                  |   | 12,399   |  
|                                                                                                                                         |  |                   |          |   |                  |   |          |  
|Total assets                                                                                                                             |  | $                 | 228,054  |   |                  | $ | 270,457  |  
|                                                                                                                                         |  |                   |          |   |                  |   |          |  
|                                                                                                                                         |  |                  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                     |  |                   |          |   |                  |   |          |  
|Current liabilities:                                                                                                                     |  |                   |          |   |                  |   |          |  
|Accounts payable                                                                                                                         |  | $                 | 3,241    |   |                  | $ | 2,943    |  
|Accrued expenses                                                                                                                         |  |                   | 4,837    |   |                  |   | 3,864    |  
|Accrued payroll and related items                                                                                                        |  |                   | 2,512    |   |                  |   | 1,775    |  
|Interest payable                                                                                                                         |  |                   | 1,212    |   |                  |   | 3,305    |  
|Current portion of deferred revenue                                                                                                      |  |                   | 5,199    |   |                  |   | 7,766    |  
|Other current liabilities                                                                                                                |  |                   | 2,040    |   |                  |   | 2,887    |  
|Current portion of convertible subordinated debt                                                                                         |  |                   | 66,228   |   |                  |   |         |  
|                                                                                                                                         |  |                   |          |   |                  |   |          |  
|Total current liabilities                                                                                                                |  |                   | 85,269   |   |                  |   | 22,540   |  
|                                                                                                                                         |  |                   |          |   |                  |   |          |  
|Long-term liabilities:                                                                                                                   |  |                   |          |   |                  |   |          |  
|Convertible subordinated debt, net of current portion                                                                                    |  |                   | 110,000  |   |                  |   | 176,228  |  
|Long-term liabilities                                                                                                                    |  |                   | 81       |   |                  |   | 518      |  
|Deferred revenue, net of current portion                                                                                                 |  |                   | 11,400   |   |                  |   | 14,250   |  
|                                                                                                                                         |  |                   |          |   |                  |   |          |  
|Total long-term liabilities                                                                                                              |  |                   | 121,481  |   |                  |   | 190,996  |  
|                                                                                                                                         |  |                   |          |   |                  |   |          |  
|Commitments and contingencies                                                                                                            |  |                   |          |   |                  |   |          |  
|                                                                                                                                         |  |                  
|Minority interest in subsidiary                                                                                                          |  |                   |         |   |                  |   | 485      |  
|                                                                                                                                         |  |                   |          |   |                  |   |          |  
|                                                                                                                                         |  |                  
|Stockholders equity:                                                                                                                    |  |                   |          |   |                  |   |          |  
|Common Stock; $.01 par value, issued and outstanding 56,314,832 shares at September 30, 2006, and 55,642,080 shares at December 31,
2005 |  |                   | 563      |   |                  |   | 556      |  
|Additional paid-in capital                                                                                                               |  |                   | 517,106  |   |                  |   | 514,862  |  
|Accumulated other comprehensive income (loss)                                                                                            |  |                   | 811      |   |                  |   | (2,833   | )
|Accumulated deficit                                                                                                                      |  |                   | (497,176 | ) |                  |   | (453,133 | )
|Unamortized stock-based compensation                                                                                                     |  |                   |         |   |                  |   | (3,016   | )
|                                                                                                                                         |  |                   |          |   |                  |   |          |  
|Total stockholders equity                                                                                                               |  |                   | 21,304   |   |                  |   | 56,436   |  
|                                                                                                                                         |  |                   |          |   |                  |   |          |  
|Total liabilities and stockholders equity                                                                                               |  | $                 | 228,054  |   |                  | $ | 270,457  |  
|                                                                                                                                         |  |                   |          |   |                  |   |          |  

See accompanying notes to condensed consolidated financial statements



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##### Table of Contents

CURAGEN CORPORATION AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(unaudited)



|                                                                                         |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|---------------------------------------------------------------------------------------- |  | ------------------------------- | ------- | - | ------------------------------ | - | ------- | ---- |  | - | ------- | - |  | - | ------- | -
|                                                                                         |  | Three Months EndedSeptember 30, |         |   | Nine Months EndedSeptember 30, |  
|                                                                                         |  | 2006                            |         |   | 2005                           |   |         | 2006 |  |   | 2005    |  
|Revenue:                                                                                 |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Product revenue                                                                          |  | $                               | 4,806   |   |                                | $ | 3,029   |      |  | $ | 14,653  |   |  | $ | 6,239   |  
|Sequencing service revenue                                                               |  |                                 | 2,777   |   |                                |   | 663     |      |  |   | 7,479   |   |  |   | 1,402   |  
|Collaboration revenue                                                                    |  |                                 | 375     |   |                                |   | 911     |      |  |   | 3,409   |   |  |   | 3,315   |  
|Grant revenue                                                                            |  |                                 | 949     |   |                                |   | 639     |      |  |   | 2,297   |   |  |   | 1,975   |  
|Milestone revenue                                                                        |  |                                 | 950     |   |                                |   |        |      |  |   | 2,850   |   |  |   | 31      |  
|                                                                                         |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Total revenue                                                                            |  |                                 | 9,857   |   |                                |   | 5,242   |      |  |   | 30,688  |   |  |   | 12,962  |  
|                                                                                         |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Operating expenses:                                                                      |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Cost of product revenue                                                                  |  |                                 | 2,949   |   |                                |   | 958     |      |  |   | 8,890   |   |  |   | 1,636   |  
|Cost of sequencing service revenue                                                       |  |                                 | 1,062   |   |                                |   | 228     |      |  |   | 3,101   |   |  |   | 535     |  
|Grant research expenses                                                                  |  |                                 | 898     |   |                                |   | 534     |      |  |   | 2,095   |   |  |   | 1,479   |  
|Research and development expenses                                                        |  |                                 | 14,164  |   |                                |   | 20,191  |      |  |   | 43,361  |   |  |   | 52,921  |  
|General and administrative expenses                                                      |  |                                 | 6,644   |   |                                |   | 5,003   |      |  |   | 16,968  |   |  |   | 13,957  |  
|Restructuring and related charges                                                        |  |                                 |        |   |                                |   | 1,280   |      |  |   |        |   |  |   | 1,280   |  
|                                                                                         |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Total operating expenses                                                                 |  |                                 | 25,717  |   |                                |   | 28,194  |      |  |   | 74,415  |   |  |   | 71,808  |  
|                                                                                         |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Loss from operations                                                                     |  |                                 | (15,860 | ) |                                |   | (22,952 | )    |  |   | (43,727 | ) |  |   | (58,846 | )
|Interest income                                                                          |  |                                 | 1,777   |   |                                |   | 2,081   |      |  |   | 5,718   |   |  |   | 6,395   |  
|Interest expense                                                                         |  |                                 | (2,334  | ) |                                |   | (2,775  | )    |  |   | (7,019  | ) |  |   | (9,370  | )
|Gain on extinguishment of debt                                                           |  |                                 |        |   |                                |   | 358     |      |  |   |        |   |  |   | 1,766   |  
|                                                                                         |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Loss before income tax benefit and minority interest in subsidiary loss                  |  |                                 | (16,417 | ) |                                |   | (23,288 | )    |  |   | (45,028 | ) |  |   | (60,055 | )
|Income tax benefit                                                                       |  |                                 | 52      |   |                                |   | 140     |      |  |   | 161     |   |  |   | 285     |  
|Minority interest in subsidiary loss                                                     |  |                                 | 485     |   |                                |   | 610     |      |  |   | 824     |   |  |   | 2,153   |  
|                                                                                         |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Net loss                                                                                 |  | $                               | (15,880 | ) |                                | $ | (22,538 | )    |  | $ | (44,043 | ) |  | $ | (57,617 | )
|                                                                                         |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Basic and diluted net loss per share                                                     |  | $                               | (0.29   | ) |                                | $ | (0.43   | )    |  | $ | (0.80   | ) |  | $ | (1.13   | )
|                                                                                         |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Weighted average number of shares used in computing basic and diluted net loss per share |  |                                 | 54,932  |   |                                |   | 52,731  |      |  |   | 54,784  |   |  |   | 51,120  |  
|                                                                                         |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  

See accompanying notes to condensed consolidated financial statements



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CURAGEN CORPORATION AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)



|                                                                            |  |                                |         |   |      |   |         |  
|--------------------------------------------------------------------------- |  | ------------------------------ | ------- | - | ---- | - | ------- | -
|                                                                            |  | Nine Months EndedSeptember 30, |        
|                                                                            |  | 2006                           |         |   | 2005 |  
|Cash flows from operating activities:                                       |  |                                |         |   |      |   |         |  
|Net loss                                                                    |  | $                              | (44,043 | ) |      | $ | (57,617 | )
|Adjustments to reconcile net loss to net cash used in operating activities: |  |                                |         |   |      |   |         |  
|Depreciation and amortization                                               |  |                                | 7,509   |   |      |   | 6,416   |  
|Stock-based compensation                                                    |  |                                | 4,599   |   |      |   | 1,511   |  
|Stock-based 401(k) plan employer match                                      |  |                                | 268     |   |      |   | 387     |  
|Non-cash interest income                                                    |  |                                | 894     |   |      |   | 1,692   |  
|Gain on extinguishment of debt                                              |  |                                |        |   |      |   | (1,766  | )
|Minority interest in subsidiary loss                                        |  |                                | (824    | ) |      |   | (2,153  | )
|Changes in assets and liabilities:                                          |  |                                |         |   |      |   |         |  
|Income taxes receivable                                                     |  |                                | 239     |   |      |   | 144     |  
|Inventory                                                                   |  |                                | (5,383  | ) |      |   | (3,837  | )
|Accounts receivable                                                         |  |                                | (500    | ) |      |   | (1,854  | )
|Prepaid expenses                                                            |  |                                | (699    | ) |      |   | 193     |  
|Intangible and other assets, net                                            |  |                                | (138    | ) |      |   | (135    | )
|Accounts payable                                                            |  |                                | 338     |   |      |   | 2,012   |  
|Accrued expenses                                                            |  |                                | 1,523   |   |      |   | 2,858   |  
|Accrued payroll and related items                                           |  |                                | 737     |   |      |   | (87     | )
|Interest payable                                                            |  |                                | (2,093  | ) |      |   | (3,688  | )
|Current portion of deferred revenue                                         |  |                                | (2,567  | ) |      |   | 2,831   |  
|Other current liabilities                                                   |  |                                | (822    | ) |      |   | 601     |  
|Long-term liabilities                                                       |  |                                | (437    | ) |      |   | 5       |  
|Deferred revenue, net of current portion                                    |  |                                | (2,850  | ) |      |   | 9,200   |  
|                                                                            |  |                                |         |   |      |   |         |  
|Net cash used in operating activities                                       |  |                                | (44,249 | ) |      |   | (43,287 | )
|                                                                            |  |                                |         |   |      |   |         |  
|Cash flows from investing activities:                                       |  |                                |         |   |      |   |         |  
|Acquisitions of property and equipment                                      |  |                                | (1,182  | ) |      |   | (8,741  | )
|Proceeds from sale of fixed assets                                          |  |                                | 112     |   |      |   | 411     |  
|Payments for intangible assets                                              |  |                                | (762    | ) |      |   | (770    | )
|Purchases of short-term investments                                         |  |                                | (31,357 | ) |      |   | (16,608 | )
|Proceeds from sales of short-term investments                               |  |                                | 6,055   |   |      |   | 10,510  |  
|Proceeds from maturities of short-term investments                          |  |                                | 15,222  |   |      |   | 73,362  |  
|Purchases of marketable securities                                          |  |                                | (11,710 | ) |      |   | (65,956 | )
|Proceeds from sales of marketable securities                                |  |                                | 38,887  |   |      |   | 43,486  |  
|Proceeds from maturities of marketable securities                           |  |                                | 45,643  |   |      |   | 57,192  |  
|                                                                            |  |                                |         |   |      |   |         |  
|Net cash provided by investing activities                                   |  |                                | 60,908  |   |      |   | 92,886  |  
|                                                                            |  |                                |         |   |      |   |         |  
|Cash flows from financing activities:                                       |  |                                |         |   |      |   |         |  
|Proceeds from exercise of stock options                                     |  |                                | 713     |   |      |   | 601     |  
|Payment for extinguishment of debt                                          |  |                                |        |   |      |   | (61,540 | )
|Proceeds from issuance of common stock                                      |  |                                |        |   |      |   | 22,000  |  
|Payments of stock issuance costs                                            |  |                                |        |   |      |   | (1,152  | )
|                                                                            |  |                                |         |   |      |   |         |  
|Net cash provided by (used in) financing activities                         |  |                                | 713     |   |      |   | (40,091 | )
|                                                                            |  |                                |         |   |      |   |         |  
|Net increase in cash and cash equivalents                                   |  |                                | 17,372  |   |      |   | 9,508   |  
|Cash and cash equivalents, beginning of period                              |  |                                | 20,757  |   |      |   | 23,849  |  
|                                                                            |  |                                |         |   |      |   |         |  
|Cash and cash equivalents, end of period                                    |  | $                              | 38,129  |   |      | $ | 33,357  |  
|                                                                            |  |                                |         |   |      |   |         |  
|Supplemental cash flow information:                                         |  |                                |         |   |      |   |         |  
|Interest paid                                                               |  | $                              | 8,463   |   |      | $ | 12,230  |  
|                                                                            |  |                                |         |   |      |   |         |  
|Income tax benefit payments received, net of payments made                  |  | $                              | 859     |   |      | $ | 524     |  
|                                                                            |  |                                |         |   |      |   |         |  
|Acquisition/construction of property and equipment, unpaid at end of period |  | $                              | 11      |   |      | $ | 74      |  
|                                                                            |  |                                |         |   |      |   |         |  
|Transfer of inventory to (from) property and equipment                      |  | $                              | 568     |   |      | $ | (556    | )
|                                                                            |  |                                |         |   |      |   |         |  

See accompanying notes to condensed consolidated financial statements



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##### Table of Contents

CURAGEN CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

1. Basis of Presentation and
Reclassifications

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes
required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of our management, the accompanying unaudited condensed consolidated financial statements include all adjustments,
consisting of only normal recurring accruals, necessary to present fairly our consolidated financial position, results of operations and cash flows. Interim results are not necessarily indicative of the results that may be expected for the entire
year. The condensed consolidated financial statements of CuraGen Corporation and subsidiary (collectively, the Company) include CuraGen Corporation (CuraGen) and its majority-owned subsidiary, 454 Life Sciences Corporation
(454), and accordingly, all material intercompany balances and transactions have been eliminated.

The Company has revised the
condensed consolidated statement of cash flows for the nine months ended September 30, 2005 to reflect non-cash interest income of $1.6 million in the cash flows used in operating activities. This revision had no effect on the Companys
net loss or the increase in cash and cash equivalents reported.

The accompanying condensed consolidated financial statements should be
read in conjunction with the audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2005. All dollar amounts herein are shown in thousands, except par value and per
share data.

2. Comprehensive Loss

The
accumulated balance of other comprehensive loss is disclosed as a separate component of stockholders equity and represents unrealized gains and losses on short-term investments and marketable securities. A summary of total comprehensive loss
is as follows:



|                                                            |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|----------------------------------------------------------- |  | ------------------------------- | ------- | - | ------------------------------ | - | ------- | ---- |  | - | ------- | - |  | - | ------- | -
|                                                            |  | Three Months EndedSeptember 30, |         |   | Nine Months EndedSeptember 30, |  
|                                                            |  | 2006                            |         |   | 2005                           |   |         | 2006 |  |   | 2005    |  
|Net loss                                                    |  | $                               | (15,880 | ) |                                | $ | (22,538 | )    |  | $ | (44,043 | ) |  | $ | (57,617 | )
|Other comprehensive loss:                                   |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Unrealized gains (losses) on securities:                    |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Unrealized holding gains (losses) arising during period     |  |                                 | 623     |   |                                |   | (638    | )    |  |   | 3,495   |   |  |   | (1,123  | )
|Reclassification adjustment for losses included in net loss |  |                                 | 136     |   |                                |   | 7       |      |  |   | 149     |   |  |   | 62      |  
|                                                            |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Net unrealized gains (losses) on securities                 |  |                                 | 759     |   |                                |   | (631    | )    |  |   | 3,644   |   |  |   | (1,061  | )
|                                                            |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Total comprehensive loss                                    |  | $                               | (15,121 | ) |                                | $ | (23,169 | )    |  | $ | (40,399 | ) |  | $ | (58,678 | )
|                                                            |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  

The Company periodically reviews its investment portfolios and its investment in TopoTarget A/S
(TopoTarget), a publicly-traded company on the Copenhagen Stock Exchange, to determine if there is an impairment that is other than temporary, and as of the balance sheet date, has not experienced any impairments in its investments that
were other than temporary. In evaluating whether the individual investments in the investment portfolio are other than temporarily impaired, the Company considers the credit rating of the individual securities, the cause of the impairment of the
individual securities which is generally related to interest rate increases, and the severity of the impairment of the individual securities and the Companys ability and intent to hold an impairment until recovery. In order for an individual
investment to be potentially impaired, the cause and severity of the impairment must be equal to or more than 5% of the book value of the investment.

The Company regularly adjusts the fair value of its investment in TopoTarget based on the market value of the stock of TopoTarget as reported on the Copenhagen Stock Exchange. This investment is classified as an
available-for-sale long-term marketable security and is included in Intangible and other assets, net, on the September 30, 2006 balance sheet at a fair value of $8,028 which includes an unrealized gain of $2,740.



6



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##### Table of Contents

3. Stock-Based Compensation

The Company adopted Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (SFAS 123R), effective January 1, 2006. SFAS 123R requires recognition of
the fair value of stock-based compensation in net earnings. Previously, Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (SFAS 123) required only expanded disclosures of
stock-based compensation arrangements with employees, and encouraged (but did not require) compensation cost to be measured based on the fair value of the equity instruments awarded. Companies were permitted to continue to apply Accounting
Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (APB 25) for equity instruments awarded to employees, which recognized compensation cost based on the intrinsic value of the equity instruments
awarded. The Company continued to apply APB 25 for purposes of its stock-based compensation awards to employees through December 31, 2005, and accordingly recorded no compensation expense for option grants unless the option grants had an
exercise price less than the fair market value of the underlying stock at the date of grant.

CuraGen has one active stock-based
compensation plan, the 1997 Employee, Director and Consultant Stock Plan (1997 Stock Plan) and one inactive stock-based compensation plan, the 1993 Stock Option and Incentive Award Plan (1993 Stock Plan), and 454 has one
active stock-based compensation plan, the 2006 Equity Incentive Plan (454 2006 Stock Plan) and one inactive stock-based compensation plan, the 2000 Employee, Director and Consultant Stock Plan (454 2000 Stock Plan). The 454
2006 Stock Plan was approved by the stockholders of 454 effective May 22, 2006. Under the active plans, restricted stock, stock options and other stock-related awards may be granted to directors, officers, employees and consultants or advisors
of CuraGen and 454, respectively. No future awards may be granted under the inactive plans subsequent to the adoption of the new active plans. To date, stock-based compensation issued under the plans has consisted of incentive and non-qualified
stock options and restricted stock. Generally, stock options are granted to employees at exercise prices equal to the respective fair market values of the common stock of CuraGen and 454, at the dates of grant, and have terms of 10 years. The
Company recognizes stock-based compensation expense for stock option grants over the requisite service period of the individual stock option grants, which equals the vesting period. Generally, stock option grants to employees fully vest between
three to five years from the grant date. Each of CuraGen and 454 issue new common shares upon the exercise of their respective stock options.

The Company has transitioned to fair-value-based accounting for stock-based compensation under SFAS 123R using a modified version of the prospective application method (modified prospective application method). Under the
modified prospective application method, restatement of prior financial statements is not required; however, SFAS 123R applies to new awards and to awards modified, repurchased, or cancelled on or after January 1, 2006. Additionally,
compensation cost for the portion of awards that are outstanding as of January 1, 2006, for which the requisite service has not been rendered (generally referring to unvested awards), is recognized as the remaining requisite service is rendered
after January 1, 2006.

The attribution of compensation cost for purposes of the pro forma disclosures required under SFAS 123 prior
to January 1, 2006, was calculated on a straight-line basis over the requisite service period for each separately vesting portion of an award as if the awards were in-substance, multiple awards, which resulted in an acceleration of compensation
cost. However, effective with the adoption of SFAS 123R, the Company is recording compensation cost for new awards on a straight-line basis over the requisite service period for the entire award.

In addition, the Company estimated forfeitures when calculating compensation expense for SFAS 123 pro forma disclosures, and adjusted the estimate of
forfeitures over the requisite service period based on the extent to which actual forfeitures differed from such estimates. Changes in estimated forfeitures were recognized through a cumulative true-up adjustment in the period of change and also
impacted the amount of compensation expense to be recognized in future periods. The Company will continue to use this methodology after the adoption of SFAS 123R. With respect to accounting for the compensation expense related to restricted stock
awards, the Company previously recognized forfeitures as they occurred. However, effective with the adoption of SFAS 123R, the Company now estimates forfeitures for purposes of calculating compensation expense related to restricted stock. The impact
on previously reported compensation expense related to restricted stock where forfeitures were recognized as incurred was not material.



7



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##### Table of Contents

Prior to the adoption of SFAS 123R, the Company used the Black-Scholes option valuation model to estimate
the fair value of stock options granted to employees for purposes of SFAS 123 disclosure. Upon the adoption of SFAS 123R, the Company continues to use the Black-Scholes option valuation model for purposes of valuing all new awards and awards
modified, repurchased or cancelled on or after January 1, 2006.

Historically, CuraGen has used the following methods to determine the
factors input into the Black-Scholes model: historical volatility is used to determine the expected stock price volatility factor; risk-free interest rates are based on the U.S. Treasury yield curve in effect at the time of grant, for the period
corresponding to the approximate expected term of the options; and the expected term of the options has been calculated using CuraGens historical exercise patterns to estimate future exercise patterns. Effective with the adoption of SFAS 123R,
CuraGen continues to utilize the same methodology for purposes of estimating the expected stock price volatility and the risk-free interest rates, however, for purposes of estimating the expected term, CuraGen uses the simplified approach as
outlined in Staff Accounting Bulletin No. 107 (Topic 14) (SAB 107), whereby the expected term is equal to the average of the vesting term and the contractual term.

Historically, 454 has used the following methods to determine the factors input into the Black-Scholes model: the volatilities of similar entities with
publicly-traded stock, adjusted for not being public, to determine the expected stock price volatility of 454s non-public stock; risk-free interest rates are based on the U.S. Treasury yield curve in effect at the time of grant, for the period
corresponding to the approximate expected term of the options; and the expected term of the options has been calculated using 454s historical exercise patterns to estimate future exercise patterns. Effective with the adoption of SFAS 123R, 454
continues to utilize the same methodology for purposes of estimating the expected stock price volatility and the risk-free interest rates, however, for purposes of estimating the expected term, 454 uses the simplified approach as outlined in SAB
107, whereby the expected term is equal to the average of the vesting term and the contractual term.

For purposes of restricted stock
grants, the grant date fair value is calculated as the fair market value of the stock on the date of grant less the purchase price of the restricted stock paid by the grantee, which is equal to the $.01 par value of the stock. CuraGen recognizes
stock-based compensation expense for restricted stock grants over the requisite service period of the individual grants, which equals the vesting period. Generally, restricted stock grants to employees fully vest between two to three years from the
grant date. CuraGen issues new shares to satisfy grants of restricted stock.

SFAS 123R requires the presentation of pro forma information
for periods prior to the adoption as if the Company had accounted for all stock-based compensation under the fair value method. For purposes of pro forma disclosure, the estimated fair value of the options at the date of grant is amortized to
expense over the requisite service period, which equals the vesting period. Employee stock-based compensation shown below includes the amortization of restricted stock compensation expense recorded in the statements of operations during the period
presented. The following table illustrates the effect on net loss and earnings per share as if the fair value recognition provisions had been applied to the Companys employee stock-based compensation.



|                                                                                                            |  |                                       |         |   |                                     |   |         |  
|----------------------------------------------------------------------------------------------------------- |  | ------------------------------------- | ------- | - | ----------------------------------- | - | ------- | -
|                                                                                                            |  | Three Months Ended September 30, 2005 |         |   | Nine Months EndedSeptember 30, 2005 |  
|Net loss, as reported                                                                                       |  | $                                     | (22,538 | ) |                                     | $ | (57,617 | )
|Employee stock-based compensation expense included in net loss                                              |  |                                       | 455     |   |                                     |   | 1,188   |  
|Total employee stock-based compensation expense determined under the fair-value based method for all awards |  |                                       | (1,160  | ) |                                     |   | (3,550  | )
|                                                                                                            |  |                                       |         |   |                                     |   |         |  
|Pro forma net loss                                                                                          |  | $                                     | (23,243 | ) |                                     | $ | (59,979 | )
|                                                                                                            |  |                                       |         |   |                                     |   |         |  
|Basic and diluted net loss per share:                                                                       |  |                                       |         |   |                                     |   |         |  
|As reported                                                                                                 |  | $                                     | (0.43   | ) |                                     | $ | (1.13   | )
|Pro forma                                                                                                   |  | $                                     | (0.44   | ) |                                     | $ | (1.17   | )



8



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##### Table of Contents

Upon adoption of SFAS 123R, the Company recognizes the compensation expense associated with stock options
granted to employees after December 31, 2005, and the unvested portion of previously granted employee stock option awards that were outstanding as of December 31, 2005, in the condensed consolidated statements of operations. During the
three and nine months ended September 30, 2006, the Company recognized compensation expense of $1,057 and $2,643 in the condensed consolidated statements of operations with respect to employee stock options. As of September 30, 2006, the
Company had capitalized compensation expense for employee stock options of $8 into inventory. During the three and nine months ended September 30, 2006, the Company also recognized compensation expense of $716 and $2,017 in the condensed
consolidated statements of operations with respect to restricted stock grants. Due to the CuraGen and 454 net loss positions, no tax benefit was recorded during the period. Upon the adoption of SFAS 123R on January 1, 2006, the Company reversed
the $3,016 balance in the unamortized stock-based compensation account to additional paid-in-capital in accordance with SFAS 123R. Compensation expense related to the shares of restricted stock is being recognized in the Companys statements of
operations over the vesting periods.

For the three and nine months ended September 30, 2006, the adoption of SFAS 123R had the
following effect on amounts that would have been reported using the intrinsic value method under APB 25:



|                                                                        |  |                                       |         |   |                      |   |        |             |  |   |         |  
|----------------------------------------------------------------------- |  | ------------------------------------- | ------- | - | -------------------- | - | ------ | ----------- |  | - | ------- | -
|                                                                        |  | Three Months Ended September 30, 2006 |        
|                                                                        |  | Using APB 25Accounting                |         |   | SFAS 123RAdjustments |   |        | As Reported | 
|Loss before income tax benefit and minority interest in subsidiary loss |  | $                                     | (15,360 | ) |                      | $ | (1,057 | )           |  | $ | (16,417 | )
|Net loss                                                                |  | $                                     | (14,873 | ) |                      | $ | (1,007 | )           |  | $ | (15,880 | )
|Basic and diluted net loss per share                                    |  | $                                     | (0.27   | ) |                      | $ | (0.02  | )           |  | $ | (0.29   | )



|                                                                        |  |                                      |         |   |                      |   |        |             |  |   |         |  
|----------------------------------------------------------------------- |  | ------------------------------------ | ------- | - | -------------------- | - | ------ | ----------- |  | - | ------- | -
|                                                                        |  | Nine Months Ended September 30, 2006 |        
|                                                                        |  | Using APB 25Accounting               |         |   | SFAS 123RAdjustments |   |        | As Reported | 
|Loss before income tax benefit and minority interest in subsidiary loss |  | $                                    | (42,385 | ) |                      | $ | (2,643 | )           |  | $ | (45,028 | )
|Net loss                                                                |  | $                                    | (41,567 | ) |                      | $ | (2,476 | )           |  | $ | (44,043 | )
|Basic and diluted net loss per share                                    |  | $                                    | (0.75   | ) |                      | $ | (0.05  | )           |  | $ | (0.80   | )

The fair value of options granted during the three months ended September 30, 2006 and 2005
were estimated as of the grant date using the Black-Scholes option valuation model with the following assumptions:



|                                          |  |                                  |   |  |      |  
|----------------------------------------- |  | -------------------------------- | - |  | ---- | -
|                                          |  | Three Months Ended September 30, |  
|                                          |  | 2006                             |   |  | 2005 |  
|Expected stock price volatility - CuraGen |  | 78                               | % |  | 81   | %
|Expected stock price volatility - 454     |  | 27                               | % |  | 33   | %
|                                          |  |                                 
|Risk-free interest rate - CuraGen         |  | 4.49                             | % |  | 3.93 | %
|Risk-free interest rate - 454             |  | 4.49                             | % |  | 4.06 | %
|                                          |  |                                 
|Expected option term in years - CuraGen   |  | 6.25                             |   |  | 4.39 |  
|Expected option term in years - 454       |  | 6.25                             |   |  | 7.82 |  
|                                          |  |                                 
|Expected dividend yield - CuraGen and 454 |  | 0                                | % |  | 0    | %

The approximate weighted-average grant date fair values using the Black-Scholes option valuation
model of all stock options granted during the three and nine months ended September 30, 2006 and 2005 were as follows:



|        |  |                                 |      |                                |   |      |  |      |      |  |   |     
|------- |  | ------------------------------- | ---- | ------------------------------ | - | ---- |  | ---- | ---- |  | - | ----
|        |  | Three Months EndedSeptember 30, |      | Nine Months EndedSeptember 30,
|        |  | 2006                            |      | 2005                           |   | 2006 |  | 2005
|CuraGen |  | $                               | 2.15 |                                | $ | 3.05 |  | $    | 2.78 |  | $ | 3.60
|454     |  | $                               | 1.40 |                                | $ | 1.38 |  | $    | 1.24 |  | $ | 1.24



9



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##### Table of Contents

A summary of the stock option activity under the 1993 Stock Plan as of September 30, 2006, and
changes during the three months ended September 30, 2006, are as follows:



|                                |  |                   |   |  |                              |      |                                                     |     |                          |   |  
|------------------------------- |  | ----------------- | - |  | ---------------------------- | ---- | --------------------------------------------------- | --- | ------------------------ | - | -
|                                |  | Number of Options |   |  | WeightedAverageExercisePrice |      | WeightedAverageRemainingContractual Life
(in years) |     | AggregateIntrinsic Value
|Outstanding, July 1, 2006       |  | 96,064            |   |  | $                            | 4.31 |                                                     |     |                          |   |  
|Granted                         |  |                  |   |  |                              |      |                                                     |     |                          |   |  
|Exercised                       |  | (800              | ) |  |                              | 1.50 |                                                     |     |                          |   |  
|Canceled or lapsed              |  |                  |   |  |                              |      |                                                     |     |                          |   |  
|                                |  |                   |   |  |                              |      |                                                     |     |                          |   |  
|Outstanding, September 30, 2006 |  | 95,264            |   |  |                              | 4.33 |                                                     | .89 |                          | $ | 3
|                                |  |                   |   |  |                              |      |                                                     |     |                          |   |  
|Exercisable, September 30, 2006 |  | 95,264            |   |  |                              | 4.33 |                                                     | .89 |                          | $ | 3
|                                |  |                   |   |  |                              |      |                                                     |     |                          |   |  

The total intrinsic value of options exercised under the 1993 Stock Plan during the three months
ended September 30, 2006 and 2005 was $2 and $135, respectively, and during the nine months ended September 30, 2006 and 2005 was $255 and $220, respectively.

The following table presents weighted average price information about significant option groups under the 1993 Stock Plan exercisable at September 30, 2006:



|                         |  |                             |  |                                |     
|------------------------ |  | --------------------------- |  | ------------------------------ | ----
|Range of Exercise Prices |  | Number ofOptionsExercisable |  | WeightedAverage Exercise Price
|$1.50                    |  | 1,600                       |  | $                              | 1.50
|3.75 - 5.00              |  | 93,664                      |  |                                | 4.38
|                         |  |                             |  |                                |     
|                         |  | 95,264                      |  |                                | 4.33
|                         |  |                             |  |                                |     

A summary of the stock option activity under the 1997 Stock Plan as of
September 30, 2006, and changes during the three months ended September 30, 2006, are as follows:



|                                |  |                   |   |  |                              |       |                                                     |      |                          |   |    
|------------------------------- |  | ----------------- | - |  | ---------------------------- | ----- | --------------------------------------------------- | ---- | ------------------------ | - | ---
|                                |  | Number of Options |   |  | WeightedAverageExercisePrice |       | WeightedAverageRemainingContractual Life
(in years) |      | AggregateIntrinsic Value
|Outstanding, July 1, 2006       |  | 6,337,195         |   |  | $                            | 9.93  |                                                     |      |                          |   |    
|Granted                         |  | 270,816           |   |  |                              | 3.00  |                                                     |      |                          |   |    
|Exercised                       |  | (8,992            | ) |  |                              | 3.07  |                                                     |      |                          |   |    
|Canceled or lapsed              |  | (48,796           | ) |  |                              | 7.81  |                                                     |      |                          |   |    
|                                |  |                   |   |  |                              |       |                                                     |      |                          |   |    
|Outstanding, September 30, 2006 |  | 6,550,223         |   |  |                              | 9.67  |                                                     | 6.38 |                          | $ | 211
|                                |  |                   |   |  |                              |       |                                                     |      |                          |   |    
|Exercisable, September 30, 2006 |  | 3,818,413         |   |  |                              | 12.89 |                                                     | 4.79 |                          | $ | 93 
|                                |  |                   |   |  |                              |       |                                                     |      |                          |   |    

The total intrinsic value of options exercised under the 1997 Stock Plan during the three months
ended September 30, 2006 and 2005 was $2 and $134, respectively, and during the nine months ended September 30, 2006 and 2005 was $24 and $165, respectively.



10



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##### Table of Contents

The following table presents weighted average price information about significant option groups under the
1997 Stock Plan exercisable at September 30, 2006:



|                         |  |                              |  |                                 |      
|------------------------ |  | ---------------------------- |  | ------------------------------- | -----
|Range of Exercise Prices |  | Number of OptionsExercisable |  | Weighted Average Exercise Price
|$2.565-3.780             |  | 485,858                      |  | $                               | 3.26 
|3.850-5.031              |  | 930,371                      |  |                                 | 4.25 
|5.090-5.970              |  | 854,139                      |  |                                 | 5.72 
|6.000-8.710              |  | 493,918                      |  |                                 | 8.08 
|15.830-22.500            |  | 340,375                      |  |                                 | 16.77
|24.938-31.660            |  | 327,385                      |  |                                 | 26.89
|41.125-58.334            |  | 386,367                      |  |                                 | 52.54
|                         |  |                              |  |                                 |      
|                         |  | 3,818,413                    |  |                                 | 12.89
|                         |  |                              |  |                                 |      

A summary of all stock option activity under the 454 2000 Stock Plan as of September 30,
2006, and changes during the three months ended September 30, 2006, are as follows:



|                                |  |                   |   |  |                              |      |                                                    |      |                         |   |      
|------------------------------- |  | ----------------- | - |  | ---------------------------- | ---- | -------------------------------------------------- | ---- | ----------------------- | - | -----
|                                |  | Number of Options |   |  | WeightedAverageExercisePrice |      | WeightedAverageRemainingContractual Life(in years) |      | AggregateIntrinsicValue
|Outstanding, July 1, 2006       |  | 4,691,351         |   |  | $                            | 2.69 |                                                    |      |                         |   |      
|Granted                         |  |                  |   |  |                              |     |                                                    |      |                         |   |      
|Exercised                       |  | (10,667           | ) |  |                              | 2.50 |                                                    |      |                         |   |      
|Canceled or lapsed              |  | (27,632           | ) |  |                              | 2.89 |                                                    |      |                         |   |      
|                                |  |                   |   |  |                              |      |                                                    |      |                         |   |      
|Outstanding, September 30, 2006 |  | 4,653,052         |   |  |                              | 2.69 |                                                    | 5.97 |                         | $ | 4,925
|                                |  |                   |   |  |                              |      |                                                    |      |                         |   |      
|Exercisable, September 30, 2006 |  | 2,938,889         |   |  |                              | 2.51 |                                                    | 4.58 |                         | $ | 3,659
|                                |  |                   |   |  |                              |      |                                                    |      |                         |   |      

The total intrinsic value of options exercised under the 454 2000 Stock Plan during the three
months ended September 30, 2006 and 2005 was $14 and $4, respectively, and during the nine months ended September 30, 2006 and 2005 was $132 and $5, respectively.

The following table presents weighted average price information about significant option groups under the 454 2000 Stock Plan exercisable at
September 30, 2006:



|                         |  |                              |  |                                |     
|------------------------ |  | ---------------------------- |  | ------------------------------ | ----
|Range of Exercise Prices |  | Number of OptionsExercisable |  | Weighted AverageExercise Price
|$1.25                    |  | 81,000                       |  | $                              | 1.25
|2.50                     |  | 2,652,614                    |  |                                | 2.50
|2.75                     |  | 35,400                       |  |                                | 2.75
|3.00                     |  | 139,875                      |  |                                | 3.00
|3.75                     |  | 30,000                       |  |                                | 3.75
|                         |  |                              |  |                                |     
|                         |  | 2,938,889                    |  |                                | 2.51
|                         |  |                              |  |                                |     

The 454 2006 Stock Plan was approved as of May 22, 2006, and a summary of all stock option
activity under the 454 2006 Stock Plan as of September 30, 2006, and changes during the three months ended September 30, 2006, are as follows:



|                                |  |                  |  |                              |      |                                                    |       |                         |  
|------------------------------- |  | ---------------- |  | ---------------------------- | ---- | -------------------------------------------------- | ----- | ----------------------- | -
|                                |  | Numberof Options |  | WeightedAverageExercisePrice |      | WeightedAverageRemainingContractual Life(in years) |       | AggregateIntrinsicValue
|Outstanding, July 1, 2006       |  |                 |  |                              |     |                                                    |       |                         |  
|Granted                         |  | 138,000          |  | $                            | 3.75 |                                                    |       |                         |  
|Exercised                       |  |                 |  |                              |     |                                                    |       |                         |  
|Canceled or lapsed              |  |                 |  |                              |     |                                                    |       |                         |  
|Outstanding, September 30, 2006 |  | 138,000          |  |                              | 3.75 |                                                    | 9.94  |                         | 
|                                |  |                  |  |                              |      |                                                    |       |                         |  
|Exercisable, September 30, 2006 |  | 10,000           |  |                              | 3.75 |                                                    | 10.00 |                         | 
|                                |  |                  |  |                              |      |                                                    |       |                         |  



11



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##### Table of Contents

There were no options exercised under the 454 2006 Stock Plan during either the three or nine months
ended September 30, 2006.

The following table presents weighted average price information about significant option groups under the
454 2006 Stock Plan exercisable at September 30, 2006:



|                         |  |                              |  |                                |     
|------------------------ |  | ---------------------------- |  | ------------------------------ | ----
|Range of Exercise Prices |  | Number of OptionsExercisable |  | Weighted AverageExercise Price
|$3.75                    |  | 10,000                       |  | $                              | 3.75
|                         |  |                              |  |                                |     

As of September 30, 2006 there was $4,611 of total unrecognized compensation expense related
to unvested stock option grants under the 1993 Stock Plan, 1997 Stock Plan, 454 2000 Stock Plan and 454 2006 Stock Plan. This expense is expected to be recognized over a weighted-average period of 1.86 years.

A summary of all restricted stock activity under the 1997 Stock Plan as of September 30, 2006, and changes during the three months ended
September 30, 2006, are as follows:



|                                      |  |                                      |   |  |                                       |     
|------------------------------------- |  | ------------------------------------ | - |  | ------------------------------------- | ----
|                                      |  | Number of Shares of Restricted Stock |   |  | Weighted AverageGrant Date Fair Value
|Outstanding, July 1, 2006             |  | 1,218,820                            |   |  | $                                     | 4.73
|Granted                               |  | 155,000                              |   |  |                                       | 2.85
|Restrictions lapsed                   |  | (88,375                              | ) |  |                                       | 4.75
|Repurchased upon employee termination |  | (3,000                               | ) |  |                                       | 6.22
|                                      |  |                                      |   |  |                                       |     
|Outstanding, September 30, 2006       |  | 1,282,445                            |   |  |                                       | 4.50
|                                      |  |                                      |   |  |                                       |     

The total fair value of restricted shares vested during the three months ended September 30,
2006 and 2005 was $292 and $458, respectively, and during the nine months ended September 30, 2006 and 2005 was $708 and $458, respectively.

As of September 30, 2006, there was $2,597 of total unrecognized compensation expense related to unvested restricted stock grants under the 1997 Stock Plan. This expense is expected to be recognized over a weighted-average period of
1.48 years.

4. Restructuring and Related Charges

In June 2003, CuraGen announced a restructuring plan intended to focus resources on continuing to advance its pipeline of protein, antibody, and small molecule therapeutics into preclinical and clinical development.
In connection with the June 2003 restructuring plan, a charge of $2,888 was recorded in the second quarter of 2003, including $1,742 related to employee separation costs, $1,046 of operating lease obligations and $100 of asset impairment costs. The
cash requirements under the June 2003 restructuring plan were $2,681, of which $2,439 was paid prior to September 30, 2006. The remaining cash requirements of $242 will be paid through 2008 and relate to remaining operating lease payments.

In November 2005, CuraGen underwent a corporate restructuring to focus on advancing its therapeutic pipeline through clinical development.
In connection with the November 2005 restructuring plan, a charge of $1,537 was recorded in the fourth quarter of 2005, including $1,396 of operating lease obligations and $141 of asset impairment costs. The cash requirements under the November 2005
restructuring plan were $1,396, of which $658 was paid prior to September 30, 2006. The remaining cash requirements of $738 will be paid through 2007 and relate to remaining operating lease payments.

5. Segment Reporting

The Company currently
operates in two business segments: CuraGen and 454. CuraGen is a biopharmaceutical development company dedicated to improving the lives of patients by developing novel protein, antibody and small molecule therapeutics in the areas of oncology,
inflammatory diseases, and diabetes. 454, CuraGens majority-owned subsidiary, has commercialized advanced technologies for high-throughput sequencing of DNA. The operations of 454 are run by a separate management team and governed by a
separate Board of Directors including members of CuraGens management team and Board of Directors.



12



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##### Table of Contents

The following table sets forth a comparison of balance sheet items at September 30, 2006 and
December 31, 2005:



|                          |  |                   |         |   |                  |   |         |  
|------------------------- |  | ----------------- | ------- | - | ---------------- | - | ------- | -
|                          |  | September 30,2006 |         |   | December 31,2005 |  
|Cash and investments:     |  |                   |         |   |                  |   |         |  
|CuraGen                   |  | $                 | 174,943 |   |                  | $ | 211,238 |  
|454                       |  |                   | 6,229   |   |                  |   | 15,290  |  
|                          |  |                   |         |   |                  |   |         |  
|Total                     |  | $                 | 181,172 |   |                  | $ | 226,528 |  
|                          |  |                   |         |   |                  |   |         |  
|Total assets:             |  |                   |         |   |                  |   |         |  
|CuraGen                   |  | $                 | 207,289 |   |                  | $ | 247,493 |  
|454                       |  |                   | 26,128  |   |                  |   | 30,119  |  
|Intercompany eliminations |  |                   | (5,363  | ) |                  |   | (7,155  | )
|                          |  |                   |         |   |                  |   |         |  
|Total                     |  | $                 | 228,054 |   |                  | $ | 270,457 |  
|                          |  |                   |         |   |                  |   |         |  

The following table sets forth a comparison of income statement items for the three and nine month
periods ended September 30, 2006 and 2005:



|                                     |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|------------------------------------ |  | ------------------------------- | ------ | - | ------------------------------ | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                     |  | Three Months EndedSeptember 30, |        |   | Nine Months EndedSeptember 30, |  
|                                     |  | 2006                            |        |   | 2005                           |   |        | 2006 |  |   | 2005   |  
|Revenues:                            |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|CuraGen                              |  | $                               | 137    |   |                                | $ | 944    |      |  | $ | 2,659  |   |  | $ | 3,395  |  
|454                                  |  |                                 | 9,857  |   |                                |   | 4,331  |      |  |   | 28,404 |   |  |   | 9,897  |  
|Intercompany eliminations            |  |                                 | (137   | ) |                                |   | (33    | )    |  |   | (375   | ) |  |   | (330   | )
|                                     |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Total                                |  | $                               | 9,857  |   |                                | $ | 5,242  |      |  | $ | 30,688 |   |  | $ | 12,962 |  
|                                     |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Operating expenses:                  |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|CuraGen                              |  | $                               | 14,248 |   |                                | $ | 22,061 |      |  | $ | 43,426 |   |  | $ | 55,853 |  
|454                                  |  |                                 | 11,606 |   |                                |   | 6,166  |      |  |   | 31,364 |   |  |   | 16,285 |  
|Intercompany eliminations            |  |                                 | (137   | ) |                                |   | (33    | )    |  |   | (375   | ) |  |   | (330   | )
|                                     |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Total                                |  | $                               | 25,717 |   |                                | $ | 28,194 |      |  | $ | 74,415 |   |  | $ | 71,808 |  
|                                     |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Net loss:                            |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|CuraGen                              |  | $                               | 14,652 |   |                                | $ | 21,367 |      |  | $ | 42,174 |   |  | $ | 53,488 |  
|454                                  |  |                                 | 1,712  |   |                                |   | 1,781  |      |  |   | 2,692  |   |  |   | 6,282  |  
|Minority interest in subsidiary loss |  |                                 | (484   | ) |                                |   | (610   | )    |  |   | (823   | ) |  |   | (2,153 | )
|                                     |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Total                                |  | $                               | 15,880 |   |                                | $ | 22,538 |      |  | $ | 44,043 |   |  | $ | 57,617 |  
|                                     |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Capital expenditures:                |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|CuraGen                              |  | $                               | 236    |   |                                | $ | 1,116  |      |  | $ | 381    |   |  | $ | 7,822  |  
|454                                  |  |                                 | 307    |   |                                |   | 700    |      |  |   | 824    |   |  |   | 1,101  |  
|Intercompany eliminations            |  |                                 |       |   |                                |   | (180   | )    |  |   | (23    | ) |  |   | (182   | )
|                                     |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Total                                |  | $                               | 543    |   |                                | $ | 1,636  |      |  | $ | 1,182  |   |  | $ | 8,741  |  
|                                     |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Depreciation and amortization:       |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|CuraGen                              |  | $                               | 1,963  |   |                                | $ | 1,917  |      |  | $ | 5,671  |   |  | $ | 4,635  |  
|454                                  |  |                                 | 586    |   |                                |   | 588    |      |  |   | 1,838  |   |  |   | 1,781  |  
|                                     |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Total                                |  | $                               | 2,549  |   |                                | $ | 2,505  |      |  | $ | 7,509  |   |  | $ | 6,416  |  
|                                     |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  

6. Inventory

A summary of inventory is as follows:



|                |  |                    |       |                  |   |      
|--------------- |  | ------------------ | ----- | ---------------- | - | -----
|                |  | September 30, 2006 |       | December 31,2005
|Raw material    |  | $                  | 5,395 |                  | $ | 2,098
|Work in process |  |                    | 1,358 |                  |   | 1,336
|Finished goods  |  |                    | 2,165 |                  |   | 669  
|                |  |                    |       |                  |   |      
|Total           |  | $                  | 8,918 |                  | $ | 4,103
|                |  |                    |       |                  |   |      

454s inventory consists of instrumentation, reagents and disposables. During the nine months
ended September 30, 2006, 454 transferred $568 of laboratory equipment from inventory to property and equipment. This equipment is to be used in the Companys research and development facility and fee for service facility. This equipment
has been placed in service and is being depreciated on a straight line basis, consistent with the Companys property and equipment policy. On February 1, 2005, the date on which 454 successfully completed the installation of its first
sequencing instrument at a customer site, 454 began to capitalize, in inventory the costs of manufacturing instruments,



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reagents and consumables for commercial sale. Included in inventory on February 1, 2005 was raw material, which was previously capitalized as a fixed
asset, valued at net book value on February 1, 2005 of $556.

7. Loss Per Share

Basic loss per share (LPS) is computed by dividing net loss by the weighted average number of shares of common stock outstanding for the
period, excluding unvested restricted stock. Diluted LPS reflects the potential dilution that could occur if options or other contracts to issue common stock were exercised or converted into common stock. Convertible subordinated debt, stock options
granted under CuraGens stock option plans but not yet exercised and unvested restricted stock are anti-dilutive and therefore not considered for the diluted LPS calculations. Anti-dilutive potential common shares, consisting of convertible
subordinated debt, outstanding stock options and unvested restricted stock are 21,599,705 and 20,404,932 as of September 30, 2006 and 2005, respectively.

8. Minority Interest in Subsidiary

454 was formed in 2000 as CuraGens majority-owned subsidiary, and as of
September 30, 2006, CuraGens majority ownership in 454 is approximately 66%. 454 has commercialized advanced technologies for whole genome, ultra-deep and ultra-broad sequencing.

Minority interest in subsidiary loss is the portion of 454s loss attributable to shareholders of 454 other than CuraGen. During the third quarter
2006, the cumulative losses applicable to the minority interest in subsidiary exceeded the minority interest in the equity capital of 454, therefore, going forward, all future losses applicable to the minority interest will be charged to CuraGen,
until such time as 454 has future income and/or financing from the minority interest. For the third quarter 2006, 28% of 454s net loss was allocated to the minority interest in subsidiary as compared to 34% in prior periods.

9. Recently Enacted Pronouncements

In July 2006, the
Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN No. 48). FIN No. 48 clarifies the accounting for uncertainty in income
taxes recognized in an enterprises financial statements in accordance with FASB Statement No. 109. Accounting for Income Taxes. This interpretation prescribes a recognition threshold and measurement attribute for the financial
statement recognition and measurement of a tax position taken or expected to be taken in a tax return. It also provides guidance on derecognition, classification, interest and penalties, accounting for taxes in interim periods and disclosure
requirements. For the Company, this interpretation will be effective beginning January 1, 2007. The Company is currently evaluating the impact this interpretation will have on its financial statements.

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157 Fair Value Measurements (SFAS 157).
SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. SFAS 157 is effective for the Company as of January 1, 2008. The
Company does not expect the adoption of SFAS 157 to have a material impact on its consolidated financial statements.



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CURAGEN CORPORATION AND SUBSIDIARY

Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations

This
Managements Discussion and Analysis of Financial Condition and Results of Operations as of September 30, 2006 and for the three and nine month periods ended September 30, 2006 and 2005 should be read in conjunction with the sections
of our audited consolidated financial statements and notes thereto as well as our Managements Discussion and Analysis of Financial Condition and Results of Operations that are included in our Annual Report on Form 10-K for the year
ended December 31, 2005.

This Quarterly Report on Form 10-Q contains forward-looking statements that involve risks and uncertainties.
Statements that are not purely historical are considered forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. We often use the words
may, will, should, could, expects, anticipates, plans, intends, believes, estimates, predicts, potential,
continue, target, or similar expressions, variations of such terms or the negative of those terms intended to identify forward-looking statements. We undertake no intention or obligation to update or revise any such
forward-looking statements. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of certain important factors, including those set forth below under Part ICertain Factors
That May Affect Results of Operations and Part II, Item 1A  Risk Factors and elsewhere in this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K for the year ended December 31, 2005.

Overview

We are a biopharmaceutical development
company dedicated to improving the lives of patients by developing novel protein, antibody and small molecule therapeutics in the areas of oncology, inflammatory diseases, and diabetes. We have taken a systematic approach to identifying and
validating the most promising therapeutic targets from our past research into the human genome and our efforts are now focused on developing and advancing potential therapeutics through preclinical and clinical development. As our pipeline has
matured over the past few years, we have decreased our early-stage target discovery efforts and focused our resources on the advancement of our oncology therapeutics in the areas of cancer supportive care and the treatment of cancer. Our
majority-owned subsidiary, 454 Life Sciences Corporation (454), has commercialized advanced technologies for high-throughput sequencing of DNA. 454s current products perform rapid and comprehensive whole genome
sequencing, or the determination of the nucleotide sequence of entire genomes, ultra-deep sequencing, or the accurate detection of mutations in target genes of interest, and ultra-broad sequencing, or the surveying and
characterization of large numbers of DNA molecules from a complex mixture. Currently 454s sequencing technology consists of 454s Genome Sequencer 20 Instrument (GS20), reagent kits, disposables and a suite of analysis
software.

Recent Developments

Preclinical and Clinical Therapeutics

We are currently focusing our resources on the development of our oncology
therapeutics in the areas of cancer supportive care and the treatment of cancer. We also maintain a portfolio of proteins, antibodies, small molecules, and targets in various stages of development in the areas of oncology, inflammatory diseases and
diabetes.



| |  |  | Velafermin is a protein therapeutic that we are investigating for the prevention of oral mucositis (OM), a debilitating side effect experienced by many cancer patients
receiving treatment with chemotherapy, radiotherapy, or a combination thereof. In December 2005, we completed a Phase II clinical trial on velafermin that randomized 212 patients undergoing high-dose chemotherapy, with or without total body
irradiation, prior to autologous bone marrow transplantation, to receive a single administration of either placebo or one of three doses of velafermin for the prevention of OM. Results from this trial were presented in February 2006 at the 2006 Bone
Marrow Transplantation Tandem Meetings. Data presented suggests that a single dose of 30 mcg/kg velafermin administered to patients one day after reinfusion of stem cells may reduce the incidence of severe Grade 3 or 4 OM, however the primary
analysis for a linear dose trend across increasing doses of velafermin did not achieve statistical significance. To confirm the activity of the 30 mcg/kg dose of velafermin, we are conducting a second Phase II trial, which began enrolling patients
in May 2006. This study will evaluate the efficacy of 30 mcg/kg velafermin compared to placebo for the prevention of OM, and also evaluate the activity of a single dose of 10 mcg/kg velafermin or 60 mcg/kg velafermin compared to placebo;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | PXD101 is a small molecule histone deacetylase inhibitor we in-licensed from TopoTarget A/S (TopoTarget) in June 2004 and it is currently being
investigated for the treatment of cancer, both as a
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| | single agent and in combination with other anti-cancer treatments. We are currently studying the activity of PXD101 in six proof-of-concept clinical trials:
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------



|                                   |  |       |  |                                                  |  |                                 |  |                                      
|---------------------------------- |  | ----- |  | ------------------------------------------------ |  | ------------------------------- |  | -------------------------------------
|Indication                         |  | Phase |  | Regimen                                          |  | Initiation of PatientEnrollment |  | Anticipated Milestone                
|Multiple myeloma (MM)            |  | II    |  | Monotherapy or in combination with dexamethasone |  | January 2005                    |  | Presenting results in December 2006  
|                                   |  |       |  |                                                 
|Solid tumors and colorectal cancer |  | Ib    |  | Combination with 5-fluorouracil (5-FU)         |  | September 2005                  |  | Presenting results in November 2006  
|                                   |  |       |  |                                                 
|Solid tumors and ovarian cancer    |  | Ib    |  | Combination with paclitaxel and/or carboplatin   |  | September 2005                  |  | Presenting results in November 2006  
|                                   |  |       |  |                                                 
|T-cell lymphoma                    |  | II    |  | Monotherapy                                      |  | January 2006                    |  | Preliminary results expected mid 2007
|                                   |  |       |  |                                                 
|Multiple myeloma                   |  | Ib    |  | Combination with Velcade®                        |  | March 2006                      |  | Preliminary results expected mid 2007
|                                   |  |       |  |                                                 
|Advanced solid tumors              |  | I     |  | Oral PXD101                                      |  | August 2006                     |  | Preliminary results expected end 2007

In October 2006, we provided an update on the intravenous PXD101 clinical development program and
reported preliminary results including data from the Phase Ib trial of PXD101 in combination with paclitaxel and carboplatin for advanced solid tumors, the Phase II trial of PXD101 monotherapy or in combination with dexamethasone for advanced MM,
and the Phase Ib trial of PXD101 in combination with 5-fluorouracil for advanced solid tumors.



| |  |  | The Phase II trial of PXD101 monotherapy or in combination with dexamethasone for MM was completed with a total of 25 patients enrolled in the study, of which 21 were eligible to be
evaluated for single agent clinical activity. Patients had previously received an average of greater than 5 prior lines of therapy before enrollment into the study. Preliminary results indicate that 9 patients (43%) receiving PXD101 monotherapy
achieved stable disease (SD), with no objective responses observed. Patients who progressed following treatment with PXD101 monotherapy were eligible to receive PXD101 in combination with dexamethasone. Of the 8 evaluable patients
treated with this combination, an objective response rate of 38% was achieved including 1 partial response and 2 minimal responses. The other 5 patients achieved SD, with two of these patients continuing to receive PXD101 and dexamethasone. PXD101,
both alone and in combination with dexamethasone, was well tolerated. Single agent activity did not meet the criteria necessary for expansion of enrollment into this trial, however, currently enrolled patients will continue to receive PXD101 in
combination with dexamethasone. Results from this trial will be presented in December 2006 at the American Society of Hematology Annual Meeting in Orlando, Florida. We are awaiting preliminary results from an ongoing program evaluating PXD101 in
combination with Velcade® (bortezomib) for
Injection, as well as data being generated from other ongoing trials with PXD101, before initiating additional investments in the MM indication.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The Phase Ib trial of PXD101 in combination with 5-FU for advanced solid tumors has generated initial results suggesting 250mg/m2/day 5-FU was well tolerated with 1000 mg/m2/d
PXD101, and have added additional cohorts to the trial to evaluate higher doses of 5-FU in combination with PXD101. A total of 17 patients have been enrolled in the study, with enrollment completed in four out of five cohorts. Preliminary results
will be presented in November 2006 at the 18th EORTC-NCI-AACR Symposium on Molecular Targets and Cancer Therapeutics (EORTC-AACR-NCI) in Prague, Czech Republic. We anticipate advancing this trial into Phase II during the first quarter
2007, where approximately 20 patients with advanced colorectal cancer will be enrolled to further evaluate the safety and activity of the regimen.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The Phase Ib trial of PXD101 in combination with paclitaxel and carboplatin for advanced solid tumors has been completed with a total of 23 patients treated.
Preliminary results indicate that PXD101 was safe and well tolerated when combined with standard doses of paclitaxel and carboplatin. Clinical activity was also reported including 2 partial objective responses for patients with advanced, refractory
cancer
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| | (confirmed response in a patient with pancreatic cancer and an ongoing confirmation in a patient with metastatic rectal cancer), and 3 patients who achieved
SD lasting greater than 10 cycles of treatment (one patient each with advanced Ewings sarcoma, malignant melanoma and bladder cancer). The results from this trial will be presented in November 2006 at the EORTC-AACR-NCI symposium. The Phase II
portion of the study has been initiated and will enroll 15 patients to further evaluate the safety and activity of PXD101 combined with carboplatin and paclitaxel in patients with advanced ovarian cancer.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Under the Clinical Trials Agreement we signed with the National Cancer Institute (NCI) in August 2005, the NCI will also initiate additional
clinical trials evaluating PXD101, both alone and in combination, for other cancer indications. There are currently seven NCI-sponsored trials that have begun treating patients at sites both in the United States of America and abroad:



|                                   |  |       |  |                                    |  |                                 
|---------------------------------- |  | ----- |  | ---------------------------------- |  | --------------------------------
|Indication                         |  | Phase |  | Regimen                            |  | Initiation of Patient Enrollment
|Advanced solid tumors or lymphomas |  | Ib    |  | Combination with Velcade ®         |  | March 2006                      
|                                   |  |       | 
|Acute Myelogenous Leukemia         |  | II    |  | Monotherapy                        |  | June 2006                       
|                                   |  |       | 
|Advanced solid tumors              |  | Ib    |  | Combination with cis-retinoic acid |  | June 2006                       
|                                   |  |       | 
|Mesothelioma                       |  | II    |  | Monotherapy                        |  | June 2006                       
|                                   |  |       | 
|Hepatocellular carcinoma           |  | I/II  |  | Monotherapy                        |  | July 2006                       
|                                   |  |       | 
|Advanced hematologic malignancies  |  | I     |  | Combination with azacitidine       |  | August 2006                     
|                                   |  |       | 
|B-cell lymphomas                   |  | II    |  | Monotherapy                        |  | August 2006                     



| |  |  | CR011 is a fully-human monoclonal antibody resulting from our collaboration with Amgen Fremont, Inc. (Amgen Fremont), formerly Abgenix, Inc. (Abgenix), and
utilizes antibody-drug conjugation (ADC) technology licensed from Seattle Genetics, Inc. (Seattle Genetics) to attach monomethyl auristatin E (MMAE) to yield CR011-vcMMAE. In June 2006, we announced that the
investigational new drug application (IND) for CR011-vcMMAE had been cleared by the U.S. Food and Drug Administration (FDA) and dosing of patients in a Phase I clinical trial had begun. The open-label, multi-center,
dose-escalation study will evaluate the safety, tolerability and pharmacokinetics of CR011-vcMMAE for patients with unresectable Stage III or Stage IV melanoma who have failed no more than one prior line of cytotoxic therapy. The first part of the
trial will evaluate cohorts of patients receiving increasing doses of CR011-vcMMAE to determine the maximum tolerated dose (MTD). After determination of the MTD, up to approximately 30 additional patients will be enrolled and treated at
the MTD to further define safety and efficacy in this Phase I trial;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | CR014 is a fully-human monoclonal ADC that targets TIM-1, also known as T-cell Immunoglobulin domain and Mucin domain 1, and is in preclinical studies to evaluate its role in the
treatment of ovarian cancer and renal cell carcinoma. In March 2006, we presented new preclinical data on CR014 at the 97th Annual Meeting of the American Association for Cancer Research (AACR) in Washington, D.C., that demonstrated significant
anti-proliferative activity on antigen positive renal and ovarian carcinoma cell lines both in vitro and in vivo;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | CR012 is a fully-human monoclonal antibody that targets SLPI, also known as secretory leukocyte protease inhibitor, a protein located on the surface of certain cancer cells, and is
in preclinical studies to evaluate its role in the treatment of colorectal and ovarian cancers. In March 2006, we presented new preclinical data on CR012 at the 97th Annual Meeting of the AACR in Washington, D.C., that demonstrated inhibition of
colon carcinoma cell lines growth in vitro and in vivo; and
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | CR002 is a fully-human monoclonal antibody drug candidate that targets platelet derived growth factor-D, also known as PDGF-D, an autocrine growth factor implicated
in kidney disease. In July 2005, we announced the completion of our Phase I clinical trial evaluating the safety and tolerability of CR002 on 40 healthy male volunteers with results supportive of developing CR002 as a treatment for kidney
inflammation, including IgA nephropathy, diabetic nephropathy, and lupus nephritis. In July 2005, we
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| | announced our intent to license CR002 to a partner with the necessary resources for developing and marketing a nephrology product.
| | ----------------------------------------------------------------------------------------------------------------------------------

In addition, we have identified several potential proteins, antibodies, and small molecules that have been or are being
prepared to be evaluated for potential therapeutic use in animal studies. We will continue to evaluate strategic opportunities and potential clinical use for these assets through partnerships, licensing, or the submission of INDs in the future.

454 Life Sciences Corporation

454 was formed in 2000 as our majority-owned subsidiary. 454 has commercialized advanced technologies for high-throughput sequencing of DNA, including whole genome, ultra-deep and ultra-broad sequencing. The GS20
sequences more than 20 million bases from over 200,000 independent DNA fragments per five hour run on a single instrument. We believe 454s affordable, high-throughput technology will expand the market for sequencing beyond genome centers,
where the majority of such sequencing is currently performed, to research centers, academic institutions and commercial entities.

In April
2006, 454 and F. Hoffman-LaRoche Ltd. (Roche), 454s distribution partner, announced enhancements to the GS20 including average single read accuracy of greater than or equal to 99%, two additional PicoTiterPlate gasket formats, new
software algorithms supporting additional applications, and a Laboratory Information Management System enabled mode that allows the system to be embedded into existing lab infrastructures.

In June 2006, in collaboration with scientists at the Dana-Farber Cancer Institute and the Broad Institute, 454 reported a new method for the detection
of cancer gene mutations present at extremely low levels. The research was published online (ahead of print) in the journal Nature Medicine in an article entitled, Sensitive mutation detection in heterogeneous cancer specimens by
massively parallel picoliter reactor sequencing, and describes how the 454 sequencing method can identify rare cancer-associated genetic variations at the molecular level, potentially enabling the personalization of targeted therapies.

In July 2006, 454 announced a collaboration with the Max Planck Institute for Evolutionary Anthropology to sequence the Neanderthal
genome, under a project which is estimated to take two years.

In October 2006, 454 provided details on the next-generation instrument
based on 454 Sequencing, the Genome Sequencer FLX, which is expected to be commercially available during the first half of 2007. The Genome Sequencer FLX is designed to accurately sequence more than 100 megabases (million bases) per 7 hour run and
achieve read lengths of 200 base pairs or greater.

Strategic Collaborations

Bayer Metabolic Disease Collaboration

We announced in July 2006, that we were informed by Bayer Pharmaceuticals Corporation (Bayer) that Bayer plans to license BAY 76-7171 (formerly CT052) to a third party. BAY 76-7171 was discovered under our metabolic disorder
collaboration with Bayer aimed at identifying and developing potential small molecule therapeutics for the management of diabetes. An IND application for BAY 76-7171 was cleared by the FDA in November 2005. In December of 2005, we announced we had
exercised our right to revert to a tiered royalty structure under which we would receive royalties on any BAY 76-7171 product sales and we would no longer contribute to the ongoing development costs for BAY 76-7171. We believe that Bayers
intention to license BAY 76-7171 will have no direct impact on our near term value generation or on our cash utilization.

Amgen Fremont

In December 1999, we entered into a strategic alliance with Abgenix to develop and commercialize antibody therapeutics using
Abgenix XenoMouse technology. We amended and restructured this alliance in November 2000 and again in April 2004. The initial phase of the agreement involving the identification of targets and initiation of monoclonal antibody generation
was completed in June 2005. We and Abgenix continue to jointly characterize antibody candidates under the research phase of the alliance, and have, to date, characterized ten antibodies as having commercial product potential. We have elected to
further develop nine of these antibodies and Abgenix has elected one. Under the agreement, antibodies resulting from the strategic alliance are available for characterization and allocation until December 2007.



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In April 2006, Amgen Inc. acquired Abgenix, and Abgenix now operates as a wholly-owned subsidiary known
as Amgen Fremont. In accordance with the terms of the agreement pertaining to change of control, Amgen Fremont automatically assumed all obligations of the agreement.

TopoTarget

In November 2006, we announced with TopoTarget the grant of exclusive worldwide rights to
LEO Pharma to develop, manufacture, and commercialize PXD118490, a preclinical HDAC inhibitor, for the treatment of psoriasis and other dermatological disorders. Under the terms of the agreement between TopoTarget and LEO Pharma, TopoTarget will
receive initial payments totaling 2,000,000 euros (approximately $2.6 million). In addition, TopoTarget is eligible to receive additional milestone payments of up to 32,000,000 euros (approximately $40.8 million), and tiered royalties on any future
product sales. Under the terms of an existing agreement between TopoTarget and us, we will receive 50% of all payments received by TopoTarget under the licensing agreement between TopoTarget and LEO Pharma.

Summary

We seek to generate value for our
shareholders by developing novel therapeutics and advanced technologies for the sequencing of DNA in the long term. We seek to become profitable by commercializing a subset of therapeutics stemming from our development pipeline, and establishing
partnerships with pharmaceutical and biotechnology companies for the development and commercialization of other therapeutics from our development pipeline. Our failure to successfully develop pharmaceutical products that we can commercialize would
materially adversely affect our business, financial condition and results of operations. Royalties or other revenue generated from commercial sales of therapeutic products developed through the application of our technologies and expertise are not
expected for several years, if at all. We expect that our revenue or income sources for at least the next several years may be limited to: 454 product, service, grant, and milestone revenue; and interest income. In July 2006, we also announced that
we engaged Goldman, Sachs & Co. to examine strategic options for CuraGens investment in 454. This strategic initiative is ongoing and focused on implementing a strategic option.

We expect to continue incurring substantial research and development expenses relating to: preclinical studies and clinical trials required for the
development of therapeutic protein, antibody and small molecule product candidates; external programs that we identify as being promising and synergistic with our products and expertise; and 454, as it continues to work on the development and
commercialization of its technology for whole genome analysis and other sequencing applications. Conducting clinical trials is a lengthy, time-consuming and expensive process. As a result, we expect to incur continued losses over the next several
years, unless we are able to realize significant revenues through 454s sales of DNA sequencing services and products. The timing and amounts of such revenues cannot be predicted with certainty and may fluctuate. Results of operations for any
period may be unrelated to the results of operations for any other period. In addition, historical results should not be viewed as indicative of future operating results.

While we will continue to explore alternative sources for financing our business activities, including the possibility of public securities offerings and/or private strategic-driven common stock offerings, we cannot
be certain that in the future these sources will be available when needed or that our actual cash requirements will not be greater than anticipated. In appropriate strategic situations, we may seek financial assistance from other sources, including
the sale of certain assets, contributions by others to joint ventures, other collaborative or licensing arrangements for the development and testing of products under development, and strategic options with respect to our investment in 454. However,
should we be unable to obtain future financing either through the methods described above or through other means, we may be unable to meet the critical objective of our long-term business plan, which is to successfully develop and market
pharmaceutical products, and may be unable to continue operations. This result could cause our shareholders to lose all or a substantial portion of their investment.

Critical Accounting Policies and Use of Estimates

The discussion and analysis of our financial
condition and results of operations are based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these
condensed consolidated financial statements requires us to make estimates and judgments that affect the reported amount of assets and liabilities, revenues and expenses and as such, actual results may differ from our estimates under different
assumptions or conditions. Our significant accounting policies are fully described in Note 1 to our consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2005.



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##### Table of Contents

Stock-Based Compensation

We utilized the modified prospective transition method to adopt SFAS 123R on January 1, 2006. Under this method, the provisions of SFAS 123R apply to
all awards granted or modified after the date of adoption. In addition, the unrecognized expense of awards not yet vested at the date of adoption, determined under the original provisions of SFAS 123, shall be recorded in net income in the periods
after the date of adoption. Prior to January 1, 2006, we accounted for stock options under the intrinsic value method described in APB 25, and related Interpretations as permitted by SFAS 123. When applying the intrinsic value method to stock
options, we did not record stock-based compensation cost in net loss because the exercise price of our stock options equaled the market price of the underlying stock on the date of grant. For additional information on stock-based compensation,
please see Note 3 to our condensed consolidated financial statements included in this Form 10-Q.

Results of Operations

The following table sets forth a comparison of the components of consolidated net loss for the three month periods ended September 30, 2006 and
2005 (in millions):



|                                     |  |                                  |      |      |   |          |  |   |          |   |  |      |   
|------------------------------------ |  | -------------------------------- | ---- | ---- | - | -------- |  | - | -------- | - |  | ---- | --
|                                     |  | Three months ended September 30, |     
|                                     |  | 2006                             |      | 2005 |   | $ Change |  |   | % Change |  
|Product revenue                      |  | $                                | 4.8  |      | $ | 3.0      |  | $ | 1.8      |   |  | 60   | % 
|Sequencing service revenue           |  |                                  | 2.8  |      |   | 0.7      |  |   | 2.1      |   |  | 300  | % 
|Collaboration revenue                |  |                                  | 0.4  |      |   | 0.9      |  |   | (0.5     | ) |  | (56  | )%
|Grant revenue                        |  |                                  | 0.9  |      |   | 0.6      |  |   | 0.3      |   |  | 50   | % 
|Milestone revenue                    |  |                                  | 1.0  |      |   |         |  |   | 1.0      |   |  | 100  | % 
|Cost of product revenue              |  |                                  | 2.9  |      |   | 0.9      |  |   | 2.0      |   |  | 222  | % 
|Cost of sequencing service revenue   |  |                                  | 1.1  |      |   | 0.3      |  |   | 0.8      |   |  | 267  | % 
|Grant research expenses              |  |                                  | 0.9  |      |   | 0.5      |  |   | 0.4      |   |  | 80   | % 
|Research and development expenses    |  |                                  | 14.2 |      |   | 20.1     |  |   | (5.9     | ) |  | (29  | )%
|General and administrative expenses  |  |                                  | 6.7  |      |   | 5.0      |  |   | 1.7      |   |  | 34   | % 
|Restructuring and related charges    |  |                                  |     |      |   | 1.3      |  |   | (1.3     | ) |  | (100 | )%
|Interest income                      |  |                                  | 1.8  |      |   | 2.1      |  |   | (0.3     | ) |  | (14  | )%
|Interest expense                     |  |                                  | 2.4  |      |   | 2.8      |  |   | (0.4     | ) |  | (14  | )%
|Gain on extinguishment of debt       |  |                                  |     |      |   | 0.4      |  |   | (0.4     | ) |  | (100 | )%
|Income tax benefit                   |  |                                  | 0.1  |      |   | 0.1      |  |   |         |   |  |     |   
|Minority interest in subsidiary loss |  |                                  | 0.5  |      |   | 0.6      |  |   | (0.1     | ) |  | (17  | )%
|                                     |  |                                  |      |      |   |          |  |   |          |   |  |      |   
|Net loss                             |  | $                                | 15.9 |      | $ | 22.5     |  |   |          |   |  |      |   
|                                     |  |                                  |      |      |   |          |  |   |          |   |  |      |   

The following table sets forth a comparison of the components of consolidated net loss for the
nine month periods ended September 30, 2006 and 2005 (in millions):



|                                     |  |                                 |      |      |   |          |  |   |          |   |  |      |   
|------------------------------------ |  | ------------------------------- | ---- | ---- | - | -------- |  | - | -------- | - |  | ---- | --
|                                     |  | Nine months ended September 30, |     
|                                     |  | 2006                            |      | 2005 |   | $ Change |  |   | % Change |  
|Product revenue                      |  | $                               | 14.7 |      | $ | 6.2      |  | $ | 8.5      |   |  | 137  | % 
|Sequencing service revenue           |  |                                 | 7.5  |      |   | 1.5      |  |   | 6.0      |   |  | 400  | % 
|Collaboration revenue                |  |                                 | 3.4  |      |   | 3.3      |  |   | 0.1      |   |  | 3    | % 
|Grant revenue                        |  |                                 | 2.3  |      |   | 2.0      |  |   | 0.3      |   |  | 15   | % 
|Milestone revenue                    |  |                                 | 2.9  |      |   |         |  |   | 2.9      |   |  | 100  | % 
|Cost of product revenue              |  |                                 | 8.9  |      |   | 1.6      |  |   | 7.3      |   |  | 456  | % 
|Cost of sequencing service revenue   |  |                                 | 3.1  |      |   | 0.6      |  |   | 2.5      |   |  | 417  | % 
|Grant research expenses              |  |                                 | 2.1  |      |   | 1.5      |  |   | 0.6      |   |  | 40   | % 
|Research and development expenses    |  |                                 | 43.4 |      |   | 52.9     |  |   | (9.5     | ) |  | (18  | )%
|General and administrative expenses  |  |                                 | 17.0 |      |   | 14.0     |  |   | 3.0      |   |  | 21   | % 
|Restructuring and related charges    |  |                                 |     |      |   | 1.3      |  |   | (1.3     | ) |  | (100 | )%
|Interest income                      |  |                                 | 5.7  |      |   | 6.4      |  |   | (0.7     | ) |  | (11  | )%
|Interest expense                     |  |                                 | 7.0  |      |   | 9.4      |  |   | (2.4     | ) |  | (26  | )%
|Gain on extinguishment of debt       |  |                                 |     |      |   | 1.8      |  |   | (1.8     | ) |  | (100 | )%
|Income tax benefit                   |  |                                 | 0.2  |      |   | 0.3      |  |   | (0.1     | ) |  | (33  | )%
|Minority interest in subsidiary loss |  |                                 | 0.8  |      |   | 2.2      |  |   | (1.4     | ) |  | (64  | )%
|                                     |  |                                 |      |      |   |          |  |   |          |   |  |      |   
|Net loss                             |  | $                               | 44.0 |      | $ | 57.6     |  |   |          |   |  |      |   
|                                     |  |                                 |      |      |   |          |  |   |          |   |  |      |   



20



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##### Table of Contents

The following table sets forth a comparison of revenue by segment for the three month periods ended
September 30, 2006 and 2005 (in millions):



|                            |  |                                  |     |      |   |          |  |   |          |   |  |      |   
|--------------------------- |  | -------------------------------- | --- | ---- | - | -------- |  | - | -------- | - |  | ---- | --
|                            |  | Three months ended September 30, |    
|                            |  | 2006                             |     | 2005 |   | $ Change |  |   | % Change |  
|Product revenue:            |  |                                  |     |      |   |          |  |   |          |   |  |      |   
|454                         |  | $                                | 4.8 |      | $ | 3.0      |  | $ | 1.8      |   |  | 60   | % 
|                            |  |                                  |     |      |   |          |  |   |          |   |  |      |   
|Sequencing service revenue: |  |                                  |     |      |   |          |  |   |          |   |  |      |   
|454                         |  | $                                | 2.8 |      | $ | 0.7      |  | $ | 2.1      |   |  | 300  | % 
|                            |  |                                  |     |      |   |          |  |   |          |   |  |      |   
|Collaboration revenue:      |  |                                  |     |      |   |          |  |   |          |   |  |      |   
|CuraGen                     |  |                                  |    |      | $ | 0.9      |  | $ | (0.9     | ) |  | (100 | )%
|454                         |  | $                                | 0.4 |      |   |         |  | $ | 0.4      |   |  | 100  | % 
|                            |  |                                  |     |      |   |          |  |   |          |   |  |      |   
|Total                       |  | $                                | 0.4 |      | $ | 0.9      |  |   |          |   |  |      |   
|                            |  |                                  |     |      |   |          |  |   |          |   |  |      |   
|Grant revenue:              |  |                                  |     |      |   |          |  |   |          |   |  |      |   
|454                         |  | $                                | 0.9 |      | $ | 0.6      |  | $ | 0.3      |   |  | 50   | % 
|                            |  |                                  |     |      |   |          |  |   |          |   |  |      |   
|Milestone revenue:          |  |                                  |     |      |   |          |  |   |          |   |  |      |   
|454                         |  | $                                | 1.0 |      |   |         |  | $ | 1.0      |   |  | 100  | % 
|                            |  |                                  |     |      |   |          |  |   |          |   |  |      |   

The following table sets forth a comparison of revenue by segment for the nine month periods
ended September 30, 2006 and 2005 (in millions):



|                            |  |                                 |      |      |   |          |  |   |          |   |  |     |   
|--------------------------- |  | ------------------------------- | ---- | ---- | - | -------- |  | - | -------- | - |  | --- | --
|                            |  | Nine months ended September 30, |     
|                            |  | 2006                            |      | 2005 |   | $ Change |  |   | % Change |  
|Product revenue:            |  |                                 |      |      |   |          |  |   |          |   |  |     |   
|454                         |  | $                               | 14.7 |      | $ | 6.2      |  | $ | 8.5      |   |  | 137 | % 
|                            |  |                                 |      |      |   |          |  |   |          |   |  |     |   
|Sequencing service revenue: |  |                                 |      |      |   |          |  |   |          |   |  |     |   
|454                         |  | $                               | 7.5  |      | $ | 1.5      |  | $ | 6.0      |   |  | 400 | % 
|                            |  |                                 |      |      |   |          |  |   |          |   |  |     |   
|Collaboration revenue:      |  |                                 |      |      |   |          |  |   |          |   |  |     |   
|CuraGen                     |  | $                               | 2.3  |      | $ | 3.3      |  | $ | (1.0     | ) |  | (30 | )%
|454                         |  |                                 | 1.1  |      |   |         |  |   | 1.1      |   |  | 100 | % 
|                            |  |                                 |      |      |   |          |  |   |          |   |  |     |   
|Total                       |  | $                               | 3.4  |      | $ | 3.3      |  |   |          |   |  |     |   
|                            |  |                                 |      |      |   |          |  |   |          |   |  |     |   
|Grant revenue:              |  |                                 |      |      |   |          |  |   |          |   |  |     |   
|454                         |  | $                               | 2.3  |      | $ | 2.0      |  | $ | 0.3      |   |  | 15  | % 
|                            |  |                                 |      |      |   |          |  |   |          |   |  |     |   
|Milestone revenue:          |  |                                 |      |      |   |          |  |   |          |   |  |     |   
|454                         |  | $                               | 2.9  |      |   |         |  | $ | 2.9      |   |  | 100 | % 
|                            |  |                                 |      |      |   |          |  |   |          |   |  |     |   

Product revenue. 454s product revenue for the three and nine month periods
ended September 30, 2006 consisted of sales of GS20 instruments, reagents and disposables sold to 454s distribution partner, Roche, as well as royalties from Roche related to Roches third party product sales. 454 began selling
products directly to end users in the first quarter of 2005 and through Roche in the fourth quarter of 2005. Under 454s agreement with Roche, 454 receives payments at agreed upon transfer pricing for shipments of 454s products to Roche.
In addition, 454 receives a royalty from Roche upon its subsequent sale of these products to third parties. 454 recognizes royalties on these sales to third parties when they are earned based upon royalty reports received from Roche at the end of
each calendar quarter. Together, the transfer price and royalty received by 454 from Roche represents approximately 50% of the price paid by the third party.

The increases in product revenue during the three and nine months ended September 30, 2006 were primarily due to increases in the number of instruments, reagents and disposables sold, compared to the same periods
in 2005, partially offset by the sharing of revenue with Roche beginning in the fourth quarter of 2005. 454s product revenue is expected to fluctuate from quarter to quarter based on the timing of shipments to Roche and the recognition of
royalties 454 earns from Roche third party sales. Overall product revenue may decrease in the fourth quarter of 2006 as compared to the third quarter of 2006, based on Roches current inventory positions relative to their projected fourth
quarter 2006 demand. However, 454 anticipates that royalty revenue, which is a component of product revenue, related to Roches sales to third parties will increase in the fourth quarter of 2006 as compared to the third quarter of 2006 due to
projected increases in product demand.



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##### Table of Contents

Sequencing service revenue.The increase in sequencing service revenue during the three and
nine months ended September 30, 2006 was due to an increase in the number of sequencing service contracts and the size of the sequencing contracts completed, as compared to the same periods in 2005. 454 expects sequencing service revenue to
remain relatively consistent during the fourth quarter of 2006 in relation to sequencing service revenue recognized during the third quarter of 2006.

Collaboration revenue. Collaboration revenue for the three and nine month periods ended September 30, 2006 decreased as compared with the same periods in 2005. CuraGen completed the work
under its Pharmacogenomics Agreement with Bayer AG during the second quarter of 2006; accordingly, we do not expect to recognize additional collaboration revenue during the fourth quarter of 2006.

Under 454s Research and Development agreement with Roche, Roche has an obligation to fund certain research and development projects, for which
funding can be in the form of cash or in-kind contributions. During the three and nine month periods ended September 30, 2006, Roche funded $0.4 million and $1.1 million in cash, respectively, of 454s research and development. 454 expects
similar funding levels in the fourth quarter of 2006 as compared to the third quarter of 2006.

Grant revenue. Grant revenue
for the three and nine month periods ended September 30, 2006 remained relatively constant with the same periods in 2005. Grant revenue was related to two grants from the National Human Genome Research Institute, one of the National Institutes
of Health (NIH). 454 completed one of the two grants in the second quarter of 2006 and completed the third phase of the second NIH grant in the third quarter of 2006. The fourth phase of the second grant is not expected to begin until
2007, therefore 454 expects to recognize no grant revenue in the fourth quarter of 2006.

Milestone revenue.Under 454s
License, Supply and Distribution Agreement with Roche (the Roche License Agreement), 454 is entitled to receive both up-front milestone payments for specific events, including contract negotiation and signing, supplier agreement
execution and product launches, as well as potential future commission/royalty sales-based payments for significant cumulative sales by Roche. Up-front payments under the Roche License Agreement are deferred and amortized into revenue on a
straight-line basis from the later of the date the payment was earned or the effective date of the agreement, through the end of the agreement term. For the purposes of milestone revenue recognition, the effective date of the agreement was
determined by management of 454 to be October 2005, the date of the commercial launch by Roche of 454s products, and the end of the agreement is October 2010. Milestone revenue for the three and nine month periods ended September 30, 2006
relates to the amortization associated with $19.0 million of up-front and product launch payments from Roche earned during 2005. 454 expects milestone revenue to increase during the fourth quarter of 2006 due to recognition of revenue related to the
achievement of a $4.0 million milestone from Roche for the cumulative sale of an agreed upon number of instruments. This milestone was earned and received in October 2006. This milestone will be deferred and amortized into revenue on a straight-line
basis from the date earned through the end of the agreement term consistent with other up-front milestone payments.

Cost of product
revenue. The increase in cost of product revenue for the three and nine month periods ended September 30, 2006 was a result of increased product sales. Effective February 1, 2005, the date on which 454 successfully completed the
installation of its first sequencing instrument at a customer site, 454 began to capitalize, in inventory, the costs of manufacturing instrumentation and reagents for commercial sale. Certain items that were previously capitalized as fixed assets
were transferred into inventory at their net book value on February 1, 2005. In October 2005, 454 began selling instruments, reagents and disposables to Roche at an agreed upon transfer price, and earning royalties from Roche on Roche third
party sales. The profit margin 454 earned on products during the three and nine month periods ended September 30, 2006 as compared to same periods in 2005 was lower due to the non-recurring nature of the items transferred into inventory in 2005
and 454s selling of instruments and reagents to Roche at agreed upon transfer prices and royalties during 2006 while selling directly to third parties during the same period of 2005. The profit margin percentage for the remaining three months
of 2006 is expected to be consistent with the profit margin percentage earned in the first nine months of 2006, however, the timing of shipments of products to Roche and the royalties earned from Roche related to Roche sales to third parties in the
fourth quarter of 2006 may impact 454s profit margin percentage.

Cost of sequencing service revenue.The increase in
cost of sequencing service revenue during the three and nine month periods ended September 30, 2006, was due to the increased number of sequencing service contracts performed as compared to the same periods in 2005. 454 expects the cost of
sequencing service revenue and their profit margin percentage to remain relatively consistent during the fourth quarter of 2006 in relation to sequencing service revenue and the profit margin percentage recognized during the third quarter of 2006.



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##### Table of Contents

Grant research expenses.Grant research expenses for the three and nine month periods ended
September 30, 2006 were slightly higher than grant research expenses for the same periods in 2005. Grant research expenses were related to two federal grant awards from the NIH, and include personnel costs and lab supplies that are directly
related to the research outlined in the grant award. 454 completed one of the two grants in the second quarter of 2006 and completed the third phase of the second NIH grant in the third quarter of 2006. The fourth phase of the second grant is not
expected to begin until 2007 therefore 454 expects to recognize no grant research expenses in the fourth quarter of 2006.

Research and development expenses.The following table sets forth a comparison of research and development expenses by segment, for the three and nine month periods ended September 30, 2006 and
2005 (in millions):



|                                   |  |                                  |      |      |   |          |  |   |          |   |  |     |   
|---------------------------------- |  | -------------------------------- | ---- | ---- | - | -------- |  | - | -------- | - |  | --- | --
|                                   |  | Three months ended September 30, |     
|                                   |  | 2006                             |      | 2005 |   | $ Change |  |   | % Change |  
|Research and development expenses: |  |                                  |      |      |   |          |  |   |          |   |  |     |   
|CuraGen                            |  | $                                | 10.8 |      | $ | 17.4     |  | $ | (6.6     | ) |  | (38 | )%
|454                                |  |                                  | 3.4  |      |   | 2.7      |  |   | 0.7      |   |  | 26  | % 
|                                   |  |                                  |      |      |   |          |  |   |          |   |  |     |   
|Total                              |  | $                                | 14.2 |      | $ | 20.1     |  |   |          |   |  |     |   
|                                   |  |                                  |      |      |   |          |  |   |          |   |  |     |   
|                                   | 
|                                   |  | Nine months ended September 30,  |     
|                                   |  | 2006                             |      | 2005 |   | $ Change |  |   | % Change |  
|Research and development expenses: |  |                                  |      |      |   |          |  |   |          |   |  |     |   
|CuraGen                            |  | $                                | 33.2 |      | $ | 45.2     |  | $ | (12.0    | ) |  | (27 | )%
|454                                |  |                                  | 10.2 |      |   | 7.7      |  |   | 2.5      |   |  | 32  | % 
|                                   |  |                                  |      |      |   |          |  |   |          |   |  |     |   
|Total                              |  | $                                | 43.4 |      | $ | 52.9     |  |   |          |   |  |     |   
|                                   |  |                                  |      |      |   |          |  |   |          |   |  |     |   

Research and development expenses consist primarily of: salary and benefits; contractual and
manufacturing costs; supplies and reagents; perpetual license fees and milestone payments; depreciation and amortization; and allocated facility costs. Historically, our research and development efforts have been concentrated on four major project
areas: clinical trials; 454; preclinical drug candidates; and collaborations. However, upon completion of our work on the Bayer AG Pharmacogemomics Agreement during the second quarter of 2006, our research and development efforts are now being
concentrated on three project areas: clinical trials; 454; and preclinical drug candidates. With the exception of 454, we budget and monitor our research and development costs by expense category, rather than by project, because these costs often
benefit multiple projects and/or our technology platform.

Below is a summary that reconciles consolidated total research and
development expenses, for the three and nine month periods ended September 30, 2006 and 2005 (in millions):



|                                              |  |                                  |      |      |   |          |  |   |          |   |  |      |   
|--------------------------------------------- |  | -------------------------------- | ---- | ---- | - | -------- |  | - | -------- | - |  | ---- | --
|                                              |  | Three months ended September 30, |     
|                                              |  | 2006                             |      | 2005 |   | $ Change |  |   | % Change |  
|Salary and benefits                           |  | $                                | 4.4  |      | $ | 3.7      |  | $ | 0.7      |   |  | 19   | % 
|Contractual and manufacturing costs           |  |                                  | 4.8  |      |   | 6.8      |  |   | (2.0     | ) |  | (29  | )%
|Supplies and reagents                         |  |                                  | 1.6  |      |   | 1.1      |  |   | 0.5      |   |  | 45   | % 
|Perpetual license fees and milestone payments |  |                                  |     |      |   | 4.8      |  |   | (4.8     | ) |  | (100 | )%
|Depreciation and amortization                 |  |                                  | 0.7  |      |   | 1.0      |  |   | (0.3     | ) |  | (30  | )%
|Allocated facility costs                      |  |                                  | 2.7  |      |   | 2.7      |  |   |         |   |  |     |   
|                                              |  |                                  |      |      |   |          |  |   |          |   |  |      |   
|Total research and development expenses       |  | $                                | 14.2 |      | $ | 20.1     |  |   |          |   |  |      |   
|                                              |  |                                  |      |      |   |          |  |   |          |   |  |      |   
|                                              | 
|                                              |  | Nine months ended September 30,  |     
|                                              |  | 2006                             |      | 2005 |   | $ Change |  |   | % Change |  
|Salary and benefits                           |  | $                                | 12.6 |      | $ | 12.0     |  | $ | 0.6      |   |  | 5    | % 
|Contractual and manufacturing costs           |  |                                  | 14.4 |      |   | 17.0     |  |   | (2.6     | ) |  | (15  | )%
|Supplies and reagents                         |  |                                  | 4.6  |      |   | 5.0      |  |   | (0.4     | ) |  | (8   | )%
|Perpetual license fees and milestone payments |  |                                  | 1.3  |      |   | 8.5      |  |   | (7.2     | ) |  | (85  | )%
|Depreciation and amortization                 |  |                                  | 2.6  |      |   | 3.0      |  |   | (0.4     | ) |  | (13  | )%
|Allocated facility costs                      |  |                                  | 7.9  |      |   | 7.4      |  |   | 0.5      |   |  | 7    | % 
|                                              |  |                                  |      |      |   |          |  |   |          |   |  |      |   
|Total research and development expenses       |  | $                                | 43.4 |      | $ | 52.9     |  |   |          |   |  |      |   
|                                              |  |                                  |      |      |   |          |  |   |          |   |  |      |   

The decrease in research and development expenses for CuraGen for the three month period ended
September 30, 2006 as compared to the same period in 2005 was primarily due to a decrease in contractual and manufacturing costs, a third quarter 2005 milestone payment of approximately $4.8 million (related to our collaboration with
TopoTarget) and a decrease in salary and benefits caused by a decrease in personnel, offset by increased non-cash expenses related to stock options and restricted stock recorded under SFAS 123R. The decrease in research and development expenses for
CuraGen for the nine month period ended September 30, 2006 as compared to the same period in 2005 was



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##### Table of Contents

primarily due to first and third quarter 2005 perpetual license fee and milestone payments of approximately $8.5 million (primarily related to our
collaborations with TopoTarget and Seattle Genetics), a decrease in contractual and manufacturing costs, a decrease in supplies and reagents, and a decrease in salary and benefits caused by a decrease in personnel, offset by a second quarter 2006
milestone payment (related to our collaboration with Seattle Genetics) and increased non-cash expenses related to stock options and restricted stock recorded under SFAS 123R. We anticipate research and development expenses to remain constant during
the fourth quarter of 2006, as compared to the prior quarters in 2006.

The increases in research and development expenses for 454 for the
three and nine month periods ended September 30, 2006 as compared to the same periods in 2005 were primarily due to increased salary and benefits as a result of an increase in personnel, non-cash expenses for stock options recorded under SFAS
123R, and increased supply and reagent expenses. We expect 454s research and development expenses to increase slightly in the fourth quarter of 2006 due to the completion of one of 454s two grants and the completion of the third phase of
the second grant. The personnel who were supporting these grants will be utilized in other internal research and development projects.

As soon as we advance a potential clinical candidate into clinical trials, we begin to track the direct research and development expenses associated with that potential clinical candidate. The following tables show the cumulative
direct research and development expenses as of September 30, 2006, as well as the current direct research and development expenses for the three and nine month periods ended September 30, 2006 and 2005, that were incurred on or after we
started conducting a Phase I clinical trial for a clinical candidate (in millions)



|                                        |  |                         |  |                                                                  |  |                     |  |                   
|--------------------------------------- |  | ----------------------- |  | ---------------------------------------------------------------- |  | ------------------- |  | ------------------
|Therapeutic Area and Clinical Candidate |  | Class                   |  | Cumulative as ofSeptember 30, 2006(since commencementof
Phase I) |  | Indication          |  | Trial Status      
|Cancer Supportive Care                  |  |                         |  |                                                                  |  |                     |  |                   
|                                        |  |                         |  |                                                                 
|Velafermin                              |  | Protein                 |  | $33.5                                                            |  | Oral Mucositis      |  | Phase II          
|                                        |  |                         |  |                                                                 
|Oncology                                |  |                         |  |                                                                  |  |                     |  |                   
|                                        |  |                         |  |                                                                 
|PXD101                                  |  | Small Molecule          |  | $26.6                                                            |  | Various Cancers     |  | Various Phase I/II
|                                        |  |                         |  |                                                                 
|CR011-vcMMAE                            |  | Antibody-Drug Conjugate |  | $3.8                                                             |  | Metastatic Melanoma |  | Phase I           
|                                        |  |                         |  |                                                                 
|Kidney Inflammation                     |  |                         |  |                                                                  |  |                     |  |                   
|                                        |  |                         |  |                                                                 
|CR002                                   |  | Antibody                |  | $1.7                                                             |  | Kidney Inflammation |  | Phase I           



|                                        |  |                    |     |                   |   |                   |  |                   |     |  |   |     
|--------------------------------------- |  | ------------------ | --- | ----------------- | - | ----------------- |  | ----------------- | --- |  | - | ----
|                                        |  | Three Months Ended |     | Nine months Ended
|Therapeutic Area and Clinical Candidate |  | September 30,2006  |     | September 30,2005 |   | September 30,2006 |  | September 30,2005
|Cancer Supportive Care                  |  |                    |     |                   |   |                   |  |                   |     |  |   |     
|                                        |  |                    |     |                  
|Velafermin                              |  | $                  | 3.4 |                   | $ | 3.0               |  | $                 | 7.9 |  | $ | 6.3 
|                                        |  |                    |     |                  
|Oncology                                |  |                    |     |                   |   |                   |  |                   |     |  |   |     
|                                        |  |                    |     |                  
|PXD101                                  |  | $                  | 2.6 |                   | $ | 7.5               |  | $                 | 7.6 |  | $ | 14.1
|                                        |  |                    |     |                  
|CR011-vcMMAE                            |  | $                  | 1.0 |                   |   |                  |  | $                 | 3.8 |  |   |    
|                                        |  |                    |     |                  
|Kidney Inflammation                     |  |                    |     |                   |   |                   |  |                   |     |  |   |     
|                                        |  |                    |     |                  
|CR002                                   |  | $                  | 0.1 |                   | $ | 0.2               |  | $                 | 0.2 |  | $ | 0.9 

Currently, our potential pharmaceutical products require significant research and development
efforts and preclinical testing, and will require extensive evaluation in clinical trials prior to submitting an application to regulatory agencies for their commercial use. Although we are conducting or have conducted human studies with



24



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respect to velafermin, PXD101, CR011-vcMMAE, and CR002, we may not be successful in developing or commercializing these or other products. Our product
candidates are subject to the risks of failure inherent in the development and commercialization of pharmaceutical products and we cannot currently provide reliable estimates as to when, if ever, our product candidates will generate revenue and cash
flows.

Completion of research and development, preclinical testing and clinical trials may take many years. Estimates of completion
periods for any of our major research and development projects are highly speculative and variable, and dependent on the nature of the disease indication, how common the disease is among the general populace, and the results of the research. For
example, preclinical testing and clinical trials can often go on for an indeterminate period of time since the results of tests are continually monitored, with each test considered complete only when sufficient data has been accumulated
to assess whether the next phases of clinical trials are warranted or whether the effort should be abandoned. Typically, Phase I clinical trials are expected to last between 12 and 24 months, Phase II clinical trials are expected to last between 24
and 36 months and Phase III clinical trials are expected to last between 24 and 60 months. The most significant time and costs associated with clinical development are the Phase III trials as they tend to be the longest and most comprehensive
studies conducted during the drug development process.

In addition, many factors may delay the commencement and speed of completion of
preclinical testing and clinical trials, including, but not limited to, the number of patients participating in the trial, the duration of patient follow-up required, the number of clinical sites at which the trials are conducted, and the length of
time required to locate and enroll suitable patient subjects. The successful completion of our development programs and the successful development of our product candidates are highly uncertain and are subject to numerous challenges and risks.
Therefore, we cannot presently estimate anticipated completion dates for any of our projects.

Due to the variability in the length of time
necessary to develop a product candidate, the uncertainties related to the cost of projects and the need to obtain governmental approval for commercialization, accurate and meaningful estimates of the ultimate costs to bring our product candidates
to market are not available. If our major research and development projects are delayed, then we can expect to incur additional costs in conducting our preclinical testing and clinical trials, and a longer period of time before we might achieve
profitability from our operating activities. Accordingly, the timing of the potential market approvals for our existing product candidates, velafermin, PXD101, CR011-vcMMAE, CR002, and future product development candidates, may have a significant
impact on our capital requirements.

General and administrative expenses.The following table sets forth a
comparison of general and administrative expenses by segment, for the three and nine month periods ended September 30, 2006 and 2005 (in millions)



|                                     |  |                                  |      |      |   |          |  |          |     |  |    |  
|------------------------------------ |  | -------------------------------- | ---- | ---- | - | -------- |  | -------- | --- |  | -- | -
|                                     |  | Three months ended September 30, |     
|                                     |  | 2006                             |      | 2005 |   | $ Change |  | % Change |    
|General and administrative expenses: |  |                                  |      |      |   |          |  |          |     |  |    |  
|CuraGen                              |  | $                                | 3.6  |      | $ | 3.3      |  | $        | 0.3 |  | 9  | %
|454                                  |  |                                  | 3.1  |      |   | 1.7      |  |          | 1.4 |  | 82 | %
|                                     |  |                                  |      |      |   |          |  |          |     |  |    |  
|Total                                |  | $                                | 6.7  |      | $ | 5.0      |  |          |     |  |    |  
|                                     |  |                                  |      |      |   |          |  |          |     |  |    |  
|                                     | 
|                                     |  | Nine months ended September 30,  |     
|                                     |  | 2006                             |      | 2005 |   | $ Change |  | % Change |    
|General and administrative expenses: |  |                                  |      |      |   |          |  |          |     |  |    |  
|CuraGen                              |  | $                                | 10.3 |      | $ | 9.4      |  | $        | 0.9 |  | 10 | %
|454                                  |  |                                  | 6.7  |      |   | 4.6      |  |          | 2.1 |  | 46 | %
|                                     |  |                                  |      |      |   |          |  |          |     |  |    |  
|Total                                |  | $                                | 17.0 |      | $ | 14.0     |  |          |     |  |    |  
|                                     |  |                                  |      |      |   |          |  |          |     |  |    |  

CuraGens general and administrative expenses for the three month period ended
September 30, 2006 increased slightly as compared to the same period in 2005, resulting from a decrease in overhead expenses offset by consulting and legal fees incurred in connection with the strategic review of 454 and non-cash expenses
related to stock options and restricted stock recorded under SFAS 123R. The increase in CuraGens general and administrative expenses for the nine month period ended September 30, 2006, as compared to the same period in 2005 was primarily
a result of executive recruiting costs, consulting and legal fees incurred in connection with the strategic review of 454 and other financing efforts, and non-cash expenses for stock options and restricted stock recorded under SFAS 123R. Our general
and administrative expenses are expected to increase slightly for the full year 2006 as compared to 2005.

The increase in 454s
general and administrative expenses for the three and nine month periods ended September 30, 2006 was attributable to an increase in personnel as a result of the commercialization of 454s products, non-cash expenses for stock options
recorded under SFAS 123R and professional service expenses associated with financing



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efforts. We expect 454s general and administrative expenses to decrease during the fourth quarter of 2006 as compared to the third quarter of 2006 due
to a projected decrease in fourth quarter non-recurring expenses associated with financing efforts.

Interest income.
Interest income for the three and nine month periods ended September 30, 2006 decreased slightly as compared to the same period in 2005 primarily due to lower cash and investment balances, offset by higher yields on our investment portfolio. We
earned an average yield of 3.8% during the third quarter of 2006 as compared to 3.0% in the third quarter of 2005, and earned an average yield of 3.8% during the first nine months of 2006 as compared to 2.8% during the same period in 2005. During
2006, we expect the yields in our investment portfolio to continue to be slightly higher than 2005. However, due to the utilization of cash and investment balances in the normal course of operations, we anticipate interest income to decrease in 2006
by approximately $1.2 million as compared to 2005. In the event that during the remainder of 2006 we use cash to repurchase a portion of our remaining debt due in 2007, the size of the anticipated decrease in interest income for 2006 will differ
accordingly.

Interest expense. Interest expense for the three and nine month periods ended September 30, 2006 decreased
compared to the same period in 2005 primarily due to the repurchases by us during the second and third quarters of 2005 of $63.8 million of our 6% convertible subordinated debentures due 2007. We expect interest expense, including interest paid to
debt holders as well as amortization of deferred financing costs, to decrease by approximately $2.3 million during 2006 as compared to 2005 due to the repurchases as described above. In the event that during the remainder of 2006 we use cash to
repurchase a portion of our remaining existing debt due in 2007, our estimate of 2006 interest expense will differ accordingly.

Income tax benefit. CuraGen recorded an income tax benefit during the three and nine month periods ended September 30, 2006 as a result of Connecticut legislation, which allows companies to obtain cash refunds from the
State of Connecticut at a rate of 65% of their annual research and development expense credit, in exchange for forgoing carryforward of the research and development credit. We expect our 2006 income tax benefit for CuraGen to be consistent with 2005
(before any fourth quarter adjustments to reflect statute expirations), as 2006 qualified expenses are expected to remain relatively constant as compared to 2005.

Minority interest in subsidiary loss. Minority interest in subsidiary loss for the three and nine month periods ended September 30, 2006 (which is the portion of 454s loss attributable
to shareholders of 454 other than us) decreased as compared to the same periods in 2005, due to an increase in 454 revenue recognized during these periods from the sales of instruments and reagents, as well as sales of sequencing services. During
the third quarter 2006, the cumulative losses applicable to the minority interest in subsidiary exceeded the minority interest in the equity capital of 454, therefore, going forward, all future losses applicable to the minority interest will be
charged to us, until such time as 454 has future income and/or financing from the minority interest. For the third quarter 2006, 28% of 454s net loss was allocated to the minority interest in subsidiary as compared to 34% in prior periods.

Liquidity and Capital Resources

Since
our inception, we have financed our operations and met our capital expenditure requirements primarily through: private placements of equity securities; convertible subordinated debt offerings; public equity offerings; revenues received under our
collaborative research agreements; receipt of milestone payments and government grants; and sales and royalties from sales of instruments and reagents. Since inception, we have not had any off-balance sheet arrangements. To date, inflation has not
had a material effect on our business.

454 received two federal grants during 2004 for specific purposes that are subject to review and
audit by the grantor agencies. Such audits could lead to requests for reimbursement by the grantor agency for any expenditures disallowed under the terms of the grant. Additionally, any noncompliance with the terms of the grant could lead to loss of
current or future awards.



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##### Table of Contents

Cash and investments.The following table depicts the components of our operating,
investing and financing activities for the nine month periods ended September 30, 2006 and 2005, using the direct cash flow method (in millions):



|                                                                             |  |                                |       |   |      |   |       |  
|---------------------------------------------------------------------------- |  | ------------------------------ | ----- | - | ---- | - | ----- | -
|                                                                             |  | Nine months endedSeptember 30, |      
|                                                                             |  | 2006                           |       |   | 2005 |  
|Cash received from collaborators, customers and grantors                     |  | $                              | 24.8  |   |      | $ | 23.1  |  
|Cash paid to suppliers and employees                                         |  |                                | (66.7 | ) |      |   | (63.1 | )
|Restructuring and related charges paid                                       |  |                                | (1.3  | ) |      |   | 0.5   |  
|Interest income received                                                     |  |                                | 5.7   |   |      |   | 6.2   |  
|Interest expense paid                                                        |  |                                | (8.5  | ) |      |   | (12.2 | )
|Income tax benefit received                                                  |  |                                | 0.9   |   |      |   | 0.5   |  
|                                                                             |  |                                |       |   |      |   |       |  
|Net cash and investments used in operating activities                        |  |                                | (45.1 | ) |      |   | (45.0 | )
|                                                                             |  |                                |       |   |      |   |       |  
|Cash paid to acquire property and equipment                                  |  |                                | (1.1  | ) |      |   | (8.7  | )
|Proceeds from sale of fixed assets                                           |  |                                | 0.1   |   |      |   | 0.4   |  
|Cash paid to acquire non-perpetual licenses                                  |  |                                | (0.8  | ) |      |   | (0.8  | )
|                                                                             |  |                                |       |   |      |   |       |  
|Net cash and investments used in investing activities                        |  |                                | (1.8  | ) |      |   | (9.1  | )
|                                                                             |  |                                |       |   |      |   |       |  
|Cash received from employee stock option exercises                           |  |                                | 0.7   |   |      |   | 0.6   |  
|Cash received from the issuance of common stock, net of stock issuance costs |  |                                |      |   |      |   | 20.8  |  
|Cash paid for extinguishment of debt                                         |  |                                |      |   |      |   | (61.5 | )
|                                                                             |  |                                |       |   |      |   |       |  
|Net cash and investments provided by (used in) financing activities          |  |                                | 0.7   |   |      |   | (40.1 | )
|                                                                             |  |                                |       |   |      |   |       |  
|Unrealized gain (loss) on short-term investments and marketable securities   |  |                                | 0.9   |   |      |   | (1.3  | )
|                                                                             |  |                                |       |   |      |   |       |  
|Net decrease in cash and investments                                         |  |                                | (45.3 | ) |      |   | (95.5 | )
|Cash and investments, beginning of period                                    |  |                                | 226.5 |   |      |   | 328.1 |  
|                                                                             |  |                                |       |   |      |   |       |  
|Cash and investments, end of period                                          |  | $                              | 181.2 |   |      | $ | 232.6 |  
|                                                                             |  |                                |       |   |      |   |       |  

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

Future
liquidity. During the next eighteen months, we expect to continue to fund our operations through a combination of the following sources: cash and investment balances; product revenue; sequencing service revenue; milestone payments; grant
revenue; interest income; potential public securities offerings; and/or private strategic-driven common stock offerings. We plan to continue making substantial investments to advance our preclinical and clinical drug pipeline, as well as to advance
454s next-generation sequencing technologies. Accordingly, over the next eighteen months, we foresee the following as significant uses of liquidity: contractual services related to clinical trials and manufacturing; salary and benefits;
perpetual license fees; supplies and reagents; potential milestone payments; and costs related to 454. In addition, we expect the payments of interest to the holders of our 2007 and 2011 convertible subordinated debt to be a continued significant
use of liquidity, as well as the repayment of $66.2 million of the existing 6% convertible subordinated debentures due upon maturity in February 2007.

Depending on market and other conditions, we may continue to repurchase or refinance portions of the existing 6% convertible subordinated debentures due 2007 in open market purchases, in privately negotiated
transactions, or otherwise. Such repurchases may be material and may affect interest income and interest expense, as well as gains or losses on extinguishment of debt. In addition, we also may use sources of liquidity for working capital, for
general corporate purposes, and potentially for future acquisitions of complementary businesses or technologies. The amounts and timing of our actual expenditures will depend upon numerous factors, including the amount and extent of our
acquisitions, our product development activities, and our investments in technology and the amount of cash generated by our operations. Actual expenditures may vary substantially from our estimates. Our failure to use sources of liquidity
effectively could have a material adverse effect on our business, results of operations and financial condition.

We believe that our
existing cash and investment balances and other sources of liquidity, including potentially leveraging our investment in 454 or obtaining alternative sources of financing, will be sufficient to meet our requirements for the next eighteen months. We
consider our operating and capital expenditures to be crucial to our future success, and by continuing to make strategic investments in our preclinical and clinical drug pipeline, as well as 454, we believe that we are building substantial value for
our shareholders. The adequacy of available funds to meet our future operating and capital requirements, including the repayment of the remaining balance of our $66.2 million



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of 6% convertible subordinated debentures due February 2, 2007, and our $110.0 million of 4% convertible subordinated notes due February 15, 2011,
will depend on many factors. These factors include: the number, breadth and progress of our research, product development and clinical programs; the amounts and timing of sales of 454s products and services; the costs and timing of obtaining
regulatory approvals for any of our products; examination of strategic options to leverage our investment in 454; potential future acquisitions of complementary businesses or technologies; in-licensing of pharmaceutical products; and costs incurred
in enforcing and defending our patent claims and other intellectual property rights.

While we will continue to explore alternative sources
for financing our business activities, including the possibility of public securities offerings and/or private strategic-driven common stock offerings, we cannot be certain that in the future these sources of liquidity will be available when needed
or that our actual cash requirements will not be greater than anticipated. In appropriate strategic situations, we may seek financial assistance from other sources, including the sale of certain assets, contributions by others to joint ventures,
other collaborative or licensing arrangements for the development and testing of products under development, and strategic options with respect to our investment in 454. However, should we be unable to obtain future financing either through the
methods described above or through other means, we may be unable to meet the critical objective of our long-term business plan, which is to successfully develop and market pharmaceutical products, and may be unable to continue operations. This
result could cause our shareholders to lose all or a substantial portion of their investment.

Contractual Obligations

Our major outstanding contractual obligations relate to long-term debt obligations, interest on convertible subordinated debt,
operating leases and purchase commitments. The disclosures relating to our contractual obligations in our Annual Report on Form 10-K for the year ended December 31, 2005 have not materially changed since we filed that report.

Recently Enacted Pronouncements

In December 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (SFAS 123R) which is a revision of
FASB Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (SFAS 123) and which supersedes Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees. SFAS 123, as originally issued, is effective until the provisions of SFAS 123R are fully adopted. In addition, in March 2005, the FASB issued Staff Accounting Bulletin No. 107, which provided guidance regarding the interaction
between SFAS 123R and certain SEC rules and regulations and provided additional guidance regarding the valuation of share-based payment arrangements for public companies. SFAS 123R is effective for public entities that do not file as a small
business issuer, as of the beginning of the first annual reporting period that begins after September 15, 2005, and therefore, we adopted SFAS 123R on January 1, 2006. Effective with the adoption of SFAS 123R the proforma disclosures
previously permitted under SFAS 123 will no longer be an alternative to financial statement recognition. SFAS 123R establishes standards for the accounting of transactions in which an entity exchanges its equity instruments for goods or services. It
also addresses transactions in which an entity incurs liabilities in exchange for goods or services that are based on the fair value of the entitys equity instruments or that may be settled by the issuance of those equity instruments. Under
SFAS 123R, we must determine the appropriate fair value model to be used for valuing share-based payments, the attribution method for compensation cost and the transition method to be used at date of adoption. For public companies, the available
transition methods include modified prospective and retroactive adoption options. See Note 3 to our condensed consolidated financial statements for further details of the adoption of SFAS 123R.

In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN No. 48). FIN
No. 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprises financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes. This interpretation prescribes a
recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. It also provides guidance on derecognition, classification, interest and
penalties, accounting for taxes in interim periods and disclosure requirements. For our Company, this interpretation will be effective beginning January 1, 2007. We are currently evaluating the impact this interpretation will have on our
financial statements.

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, Fair Value
Measurements (SFAS 157). SFAS 157 defines fair value, establishes a framework for measuring fair value in



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generally accepted accounting principles and expands disclosures about fair value measurements. SFAS 157 is effective for the Company as of January 1,
2008. We do not expect the adoption of SFAS 157 to have a material impact on our consolidated financial statements.

Certain Factors That May Affect
Results of Operations

The SEC encourages companies to disclose forward-looking information so that investors can better understand a
companys future prospects and make informed investment decisions. This Quarterly Report on Form 10-Q contains such forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All
statements other than statements of historical facts are forward-looking statements for purposes of these provisions, including any projections of earnings, revenues or other financial items, any statement of the plans and objectives of
management for future operations, any statements concerning proposed new products or licensing or collaborative arrangements, any statements regarding future economic conditions or performance, and any statement of assumptions underlying any of the
foregoing. It is our intent that such statements be protected by the safe harbor created thereby. Forward-looking statements are subject to certain risks and uncertainties. Examples of such statements include, but are not limited to,
estimate, project, plan, intend, expect, believe, anticipate, should, may, will, and similar expressions. Forward-looking
statements may include statements about our:



| |  |  | anticipated progress of clinical development programs;
| | - |  | ------------------------------------------------------



| |  |  | anticipated progress in technology development and commercialization strategy;
| | - |  | ------------------------------------------------------------------------------



| |  |  | results and projected timetables of our clinical trials;
| | - |  | --------------------------------------------------------



| |  |  | potential future licensing fees, milestone payments, grants and royalty payments;
| | - |  | ---------------------------------------------------------------------------------



| |  |  | ability to market, commercialize and achieve market acceptance for our product candidates or products that we develop;
| | - |  | ----------------------------------------------------------------------------------------------------------------------



| |  |  | ability to expand our relevant market;
| | - |  | --------------------------------------



| |  |  | expected future financial results, including estimated revenues, cost of product revenue, cost of sequencing service revenue, operating expenses, interest income, interest expense,
income tax benefit and minority interest in subsidiary loss;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | estimates regarding the future sufficiency of our cash resources;
| | - |  | -----------------------------------------------------------------



| |  |  | expectation that we may repurchase or refinance additional portions of the existing 6% convertible subordinated debentures due 2007; and
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------



| |  |  | plans to continue to explore alternative sources for financing our business activities.
| | - |  | ---------------------------------------------------------------------------------------

These forward-looking statements involve a number of risks and uncertainties that could cause actual results to differ materially from those suggested by the forward-looking statements. Such statements are based on
managements current expectations and are subject to a number of risks and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. We caution investors that there can be no
assurance that actual results or business conditions will not differ materially from those projected or suggested in such forward looking statements as a result of various factors, including, but not limited to, the following: the risk that any one
or more of our drug development programs will not proceed as planned for technical, scientific or commercial reasons or due to patient enrollment issues or based on new information from nonclinical or clinical studies or from other sources; the
success of competing products and technologies; our stage of development as a biopharmaceutical company; government regulation and healthcare reform; technological uncertainty and product development risks; product liability exposure; uncertainty of
additional funding; our history of incurring losses and the uncertainty of achieving profitability; reliance on research collaborations and strategic alliances; competition; patent infringement claims against our products, processes and
technologies; our ability to protect our patents and proprietary rights; and, uncertainties relating to commercialization rights. Please refer to our Annual Report on Form 10-K for the year ended December 31, 2005 and Item 1A of this
report for a description of these risks. 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, unless required by law.



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Item 3. Quantitative and Qualitative Disclosures About Market Risk

Our outstanding current liabilities as
of September 30, 2006 include $66.2 million of our 6% convertible subordinated debentures due February 2, 2007. Our outstanding long-term liabilities as of September 30, 2006 include $110.0 million of our 4% convertible subordinated
notes due February 15, 2011 and the long-term portion of 454s deferred revenue in the amount of $11.4 million. As the debentures and notes bear interest at a fixed rate, our results of operations are not affected by interest rate changes.
As of September 30, 2006, the market value of our $66.2 million 6% convertible subordinated debentures due 2007, based on quoted market prices, was $66.0 million, and the market value of our $110.0 million 4% convertible subordinated notes due
2011, based on quoted market prices, was $84.3 million. Although future borrowings may bear interest at a floating rate, and our result of operations would therefore be affected by interest rate changes, at this point we do not anticipate any
significant future borrowings at floating interest rates, and therefore do not believe that a change of 100 basis points in interest rates would have a material effect on our financial condition.

There have been no other significant changes in our market risk compared to the disclosures in Item 7a of our Annual Report on Form 10-K for the
year ended December 31, 2005.

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 the Companys
disclosure controls and procedures as of September 30, 2006. The term disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are
designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SECs rules and
forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated
and communicated to the companys management, including its principal executive and principal financial officers as appropriate to allow timely decisions regarding required disclosure. Our management recognizes that any controls and procedures,
no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on
the evaluation of our disclosure controls and procedures as of September 30, 2006, our chief executive officer and chief financial officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable
assurance level.

(b) Changes in Internal Controls

No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the fiscal quarter ended September 30, 2006 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 1A. Risk Factors

Item 1A, Risk Factors, of our Form 10-K for the year ended
December 31, 2005 includes a detailed discussion of our risk factors. The information presented below updates, and should be read in conjunction with, the risk factors and information disclosed in our Form 10-K.

454s Sequencing System and reagent kits have been offered commercially for only a short period of time and its technology platform is based on new and
relatively unproven technologies and methods. Our future success depends on market acceptance of our current products and our continued research, development and commercialization efforts relating to the future versions of our sequencing systems.

We began marketing, selling and distributing our 454 Sequencing System in 2005 as the GS20 and, as of December 31, 2005, had
placed twenty systems. The future versions of our sequencing systems are either in development or the early stages of commercialization. Compared to well-known technologies, our DNA sequencing system has not yet been widely adopted or accepted.
Accordingly, to be successful, our current and future sequencing systems, and the technologies underlying those products, must be accepted by our target markets. This market acceptance and the success of our products will depend on numerous factors,
including:



| |  |  | the ability to use our products for large-scale applications of DNA sequencing in a cost effective and dependable manner;
| | - |  | -------------------------------------------------------------------------------------------------------------------------



| |  |  | whether customers adopt our DNA sequencing systems, as opposed to the products and technologies offered by our competitors;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------



| |  |  | the willingness and ability of more researchers to invest in DNA sequencing technology than have already done so to date;
| | - |  | -------------------------------------------------------------------------------------------------------------------------



| |  |  | the willingness and ability of customers to adopt new technologies requiring additional capital investment; and
| | - |  | ---------------------------------------------------------------------------------------------------------------



| |  |  | our ability to manufacture, market, sell and distribute our DNA sequencing systems and reagent kits on a competitive cost basis.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------

If 454 infringes or is alleged to infringe the intellectual property rights of third parties, it will adversely affect our business.

We are aware of certain issued U.S. patents (the Illumina Patents), owned by Illumina, Inc. (Illumina), that could be asserted by
Illumina to be infringed by aspects of 454s original or current 454 Sequencing System technology. It is possible that Illumina may file suit against 454 seeking damages and/or requesting a court to permanently enjoin the use of any aspect of
the 454 Sequencing System technology that may be found to infringe. If Illumina were to initiate patent litigation against 454, 454 would raise defenses including patent noninfringement and/or invalidity. We do not believe that the 454 Sequencing
System technology infringes any valid claim in the Illumina Patents. However, the issues relevant to potential patent litigation are complex and not free from doubt, and a court may disagree with our analysis and grant damages and/or injunctive
relief.

If the Illumina patents are asserted against 454, this could result in protracted and costly litigation with Illumina, which could
(A) result in 454s inability to manufacture and sell products and services using aspects of the 454 Sequencing System technology that may be found to infringe, (B) require 454 to secure a license from Illumina on as yet undetermined
financial and other terms or (C) require 454 to further redesign its technology. We cannot predict with certainty the outcome of such litigation or whether 454 will be able to continue to manufacture, sell and use those aspects of the GS20 and
454 Sequencing System technology as currently configured that may be found to infringe. Such litigation could adversely affect 454s relationship with Roche and its customers. It is possible that the above could have a material adverse effect
on the market price of our common stock.

454 has recently introduced changes to its 454 Sequencing System technology. The recent 454 Sequencing System
modification or future modifications may not be acceptable to 454s customers, which could adversely and permanently affect its reputation with its current and potential customers and adversely affect our business.

454 continually makes changes to its products to improve performance and, in some cases, to lessen risk of third party patent infringement. 454 has
recently modified one aspect of the 454 Sequencing System technology as it



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relates to the GS20 in an effort to further avoid the scope of the Illumina Patents. 454 has successfully tested the modified 454 Sequencing System in its
laboratories; however, this modified technology has not yet been introduced in products placed with its existing customers or incorporated into the GS20 to be sold to potential customers.

454s current and future commercial success depends upon acceptance by its existing and potential customers of the 454 Sequencing System technology
as recently modified and as may be modified in the future. Introducing modified products to 454s current customers is time consuming and expensive, and could result in dissatisfied customers, harm to its reputation and a reduced ability to
attract new customers. While 454 has successfully tested recent updates to its technology in its laboratories, successful customer implementation in the field and market acceptance of the modified 454 Sequencing System will not be known until after
454s updated products have been commercially launched and assimilated into the marketplace. If the changes made to the 454 Sequencing technology do not prove effective in the market, or if such changes prompt claims of patent infringement,
current and potential customers may not accept 454s products, and 454 may be required to undertake further changes to its product design. If for these or other reasons 454s current or potential customers do not accept recent or future
modifications to its 454 Sequencing technology, the demand for 454 products could be diminished, its reputation and our business could be adversely affected.



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Item 6. Exhibits



|             |  |                                                                                                                                                               
|------------ |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------
|             | 
|Exhibit 31.1 |  | Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                           
|             | 
|Exhibit 31.2 |  | Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                           
|             | 
|Exhibit 32   |  | Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Subsections (a) and (b) of Section 1350, Chapter 63 of Title 18, United States Code).



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SIGNATURES

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



|                        |  |                     |  |                                                                                                                               
|----------------------- |  | ------------------- |  | ------------------------------------------------------------------------------------------------------------------------------
|Dated: November 8, 2006 |  | CuraGen Corporation
|                        |  |                    
|                        |  | By:                 |  | /s/ Frank M. Armstrong, M.D.                                                                                                  
|                        |  |                     |  | Frank M. Armstrong, M.D.                                                                                                      
|                        |  |                     |  | Chief Executive Officer and President                                                                                         
|                        |  |                     |  | (principal executive officer of the registrant)                                                                               
|                        |  |                    
|                        |  | By:                 |  | /s/ David M. Wurzer                                                                                                           
|                        |  |                     |  | David M. Wurzer                                                                                                               
|                        |  |                     |  | Executive Vice-President, Chief Financial Officer and Treasurer (principal financial and accounting officer of the registrant)



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CURAGEN CORPORATION

EXHIBIT INDEX



|             |  |                                                                                                                                                               
|------------ |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------
|No.          |  |                                                                                                                                                               
|Exhibit 31.1 |  | Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                           
|             | 
|Exhibit 31.2 |  | Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.                                                           
|             | 
|Exhibit 32   |  | Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Subsections (a) and (b) of Section 1350, Chapter 63 of Title 18, United States Code).



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