**UNITED STATES SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

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**FORM 10-K**

**x**ANNUAL REPORT PURSUANT TO SECTION 13OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934

**FORTHE FISCAL YEAR ENDED DECEMBER 31, 2006**

**OR**

**o**TRANSITION REPORT PURSUANT TO SECTION 13OR 15(D)OF THE SECURITIES EXCHANGE ACT OF 1934

**Commissionfile number:  0-21379**

**CUBIST PHARMACEUTICALS, INC.**

*(Exact Name of Registrant asSpecified in Its Charter)*

| **Delaware**                       |   | **22-3192085**         |
|------------------------------------|--------|------------------------|
| *(State  or Other Jurisdiction of* |   | *(I.R.S.  Employer*    |
| *Incorporation  or Organization)*  |   | *Identification  No.)* |

 

**65 Hayden Avenue,Lexington, MA 02421**

*(Address of Principal ExecutiveOffices and Zip Code)*

**(781) 860-8660**

*(Registrant’s Telephone Number,Including Area Code)*

Securities registeredpursuant to Section 12(b) of the Act:

| Title of each class                                                     | ** ** | **Name of each exchange on which registered** |
|-------------------------------------------------------------------------|------------|-----------------------------------------------|
| **Common  Stock, $0.001 Par Value**                                     | ** ** | **Nasdaq  Global Select Market****SM**        |
| **Series A  Junior Participating Preferred Stock Purchase Rights** | ** ** | **Nasdaq  Global Select Market****SM**        |

 

Securities registered pursuant to Section 12(g) ofthe Act:

**None**

*(Title of Each Class)*

*(Name of Each Exchange on WhichRegistered)*

Indicate by check mark ifthe registrant is a well-known seasoned issuer, as defined in Rule 405 ofthe Securities Act. Yes x   No o

Indicate by check mark ifthe registrant is not required to file reports pursuant to Section 13 or Section 15(d) ofthe Exchange Act. Yes o   No x

Indicate by check markwhether the registrant: (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required tofile such reports), and (2) has been subject to such filing requirementsfor the past 90 days. Yes x   No o

Indicate by check mark ifdisclosure of delinquent filers pursuant to Item 405 of Regulation S-K isnot contained herein, and will not be contained, to the best of registrant’sknowledge, in definitive proxy or information statements incorporated byreference in Part III of this Form 10-K or any amendment tothis Form 10-K. o

Indicate by check mark whether the registrant is a largeaccelerated filer, an accelerated filer, or a non-accelerated filer. Seedefinition of “accelerated filer and large accelerated filer” in Rule 12b-2of the Exchange Act. (Check one):
| Large accelerated filer x | Accelerated  filer o | Non-accelerated  filer o |
|--------------------------------|---------------------------|-------------------------------|

 

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

The aggregate market valueof the registrant’s common stock, $0.001 par value per share, held bynon-affiliates of the registrant as of June 30, 2006 was approximately$822.5 million, based on 32,666,343 shares held by such non-affiliates at theclosing price of a share of common stock of $25.18 as reported on the NASDAQGlobal Select MarketSM onsuch date. The number of outstanding shares of common stock of Cubist on February 23,2007 was 55,131,674.

DOCUMENTS INCORPORATED BY REFERENCEPORTIONS OF THE REGISTRANT’S DEFINITIVE PROXY STATEMENT FOR ITSANNUAL MEETING OF STOCKHOLDERS TO BE HELD ON JUNE 7, 2007ARE INCORPORATED BY REFERENCE INTO PART III.

 

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**CubistPharmaceuticals, Inc.**

**Annual Report on Form 10-K**

**Tableof Contents**
| Item          | ** ** | ** **                                                                                                                | ** ** | ** ** | ** ** | **Page** | ** ** |
|---------------|------------|---------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|----------|------------|
| PART I   |       |
| 1.            |       | Business                                                                                                                  |       | 5          |       |
| 1A.           |       | Risk Factors                                                                                                              |       | 20         |       |
| 1B.           |       | Unresolved Staff  Comments                                                                                                |       | 38         |       |
| 2.            |       | Properties                                                                                                                |       | 38         |       |
| 3.            |       | Legal Proceedings                                                                                                         |       | 38         |       |
| 4.            |       | Submission of  Matters to a Vote of Security Holders                                                                      |       | 38         |       |
| PART II  |       |
| 5.            |       | Market for  Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases  of Equity Securities  |       | 39         |       |
| 6.            |       | Selected Financial  Data                                                                                                  |       | 41         |       |
| 7.            |       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                               |       | 42         |       |
| 7A.           |       | Quantitative  and Qualitative Disclosures About Market Risk                                                               |       | 57         |       |
| 8.            |       | Financial Statements  and Supplementary Data                                                                              |       | 59         |       |
| 9.            |       | Changes in and Disagreements  With Accountants on Accounting and Financial Disclosure                                     |       | 87         |       |
| 9A.           |       | Controls and  Procedures                                                                                                  |       | 87         |       |
| 9B.           |       | Other Information                                                                                                         |       | 87         |       |
| PART III |       |
| 10.           |       | Directors,  Executive Officers and Corporate Governance                                                                   |       | 87         |       |
| 11.           |       | Executive  Compensation                                                                                                   |       | 88         |       |
| 12.           |       | Security  Ownership of Certain Beneficial Owners and Management and Related Stockholder  Matters           |       | 88         |       |
| 13.           |       | Certain  Relationships and Related Transactions, and Director Independence                                                |       | 88         |       |
| 14.           |       | Principal  Accountant Fees and Services                                                                                   |       | 88         |       |
| PART IV  |       |
| 15.           |       | Exhibits and  Financial Statement Schedule                                                                                |       | 88         |       |
|          |       | Signatures                                                                                                                |       | 93         |       |

 

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**FORWARD-LOOKINGSTATEMENTS**

Thisdocument contains and incorporates by reference ‘‘forward-looking statements”within the meaning of section 27A of the Securities Act of 1933 and Section 21Eof the Securities Exchange Act of 1934. In some cases, these statements can beidentified by the use of forward-looking terminology such as ‘‘may,” ‘‘will,” ‘‘could,”‘‘should,” ‘‘would,” ‘‘expect,” ‘‘anticipate,” ‘‘continue” or other similarwords. These statements discuss future expectations, contain projections of resultsof operations or of financial condition, or state trends and knownuncertainties or other forward-looking information. You are cautioned thatforward-looking statements are based on current expectations and are inherentlyuncertain. Actual performance and results of operations may differ materiallyfrom those projected or suggested in the forward-looking statements due tocertain risks and uncertainties, including the risks and uncertaintiesdescribed or discussed in the section entitled “Risk Factors” in this AnnualReport. The forward-looking statements contained and incorporated hereinrepresent our judgment as of the date of this Annual Report, and we cautionreaders not to place undue reliance on such statements. The informationcontained in this Annual Report is provided by us as of the date of this AnnualReport, and we do not undertake any obligation to update any forward-lookingstatements contained in this document as a result of new information, futureevents or otherwise.

Forward-looking statements include informationconcerning possible or assumed future results of our operations, includingstatements regarding:

·       thecontinued acceptance of CUBICIN by physicians, patients, third-party payors andthe medical community;

·       ourexpectations regarding the future market demand and medical need for CUBICIN;

·       ourexpectations regarding the effectiveness of our sales force;

·       ourexpectations regarding the continued launch of CUBICIN in Europe and othercountries;

·       ourexpectations regarding clinical trials, development time lines and regulatoryauthority approval for and oversight of CUBICIN or other drug candidates;

·       ourexpectations regarding our ability to continue to have sufficient quantities ofCUBICIN manufactured in accordance with current Good Manufacturing Practicesand other requirements of the regulatory approvals for CUBICIN;

·       ourexpectations regarding the breadth and enforceability of the patents protectingCUBICIN and any other products;

·       ourability to use our research and development and technology platforms andmethods to identify potential drug candidates;

·       ourexpectations regarding selection of clinical development candidates;

·       ourexpectations regarding our ability to further identify, develop andcommercialize products in the coming years;

·       thepossible shift from a drop-ship program of delivery, to a program allowingwholesalers to stock CUBICIN;

·       thecontinuation of our collaborations and our ability to establish and maintainsuccessful manufacturing, sales and marketing, distribution and developmentcollaborations;

·       ourexpectations regarding the payment of dividends;

·       theimpact of new accounting pronouncements;

·       ourfuture capital requirements and our ability to finance our operations; and

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·       ourexpectations regarding general business conditions and growth in thebiopharmaceutical industry and the overall economy.

Many factors could affect our actual financial resultsand could cause these actual results to differ materially from those in theseforward-looking statements. These factors include the following:

·       thelevel of acceptance of CUBICIN by physicians, patients, third-partypayors and the medical community;

·       anychanges in the current or anticipated market demand or medical need forCUBICIN;

·       anyunexpected adverse events related to CUBICIN, particularly as CUBICIN is usedin the treatment of a growing number of patients around the world;

·       competitionin the markets in which we and our partners market CUBICIN, including marketingapprovals for new products that will be competitive with CUBICIN;

·       whetherthe U.S. Food and Drug Administration, or FDA, accepts proposed clinical trialprotocols that may be achieved in a timely manner for additional studies ofCUBICIN or any other drug candidate we seek to enter into clinical trials;

·       whetherwe will receive, and the potential timing of, regulatory approvals orclearances to market CUBICIN in other countries;

·       legislativeand policy changes in the United States and other jurisdiction where ourproducts are sold that may affect the ease of getting a new product or a newindication approved, as well as government reimbursement for our or ourcompetitors’ products;

·       whetheror not third parties may seek to market generic versions of our products byfiling Abbreviated New Drug Applications, or ANDAs, with the FDA, and theresults of any litigation that we file to defend and/or assert our patentsagainst such generic companies;

·       ourability to conduct successful clinical trials in a timely manner;

·       theeffect that the results of ongoing or future clinical trials of CUBICIN mayhave on its acceptance in the medical community;

·       theability of our third party manufacturers, including our single source providerof active pharmaceutical ingredient, or API, to manufacture sufficientquantities of CUBICIN in accordance with Good Manufacturing Practices and otherrequirements of the regulatory approvals for CUBICIN and at an acceptable cost;

·       ourdependence upon collaborations with our partners and our partners’ ability to executeon development, regulatory and sales expectations in their territories;

·       ourability to finance our operations;

·       theeffectiveness of our sales force and our sales force’s ability to accesstargeted physicians;

·       potentialcosts resulting from product liability or other third party claims;

·       ourability to protect our proprietary technologies;

·       ourability to integrate successfully the operations of any business that we mayacquire and the potential impact of any future acquisition on our financialresults;

·       ourability to discover, acquire or in-license drug candidates and develop andachieve commercial success for drug candidates; and

·       avariety of risks common to our industry, including ongoing regulatory review,public and investment community perception of the industry, legislative orregulatory changes, and our ability to attract and retain talented employees.

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**PART I**

**ITEM1.**                BUSINESS

**Overview**

Cubist Pharmaceuticals, Inc., which we refer to as “Cubist” or the “Company”, is a biopharmaceuticalcompany focused on the research, development and commercialization ofpharmaceutical products that address unmet medical needs in the acute careenvironment. To date, we have concentrated exclusively on developing productsfor the antiinfective marketplace.

**Corporate Overview and Business Strategy**

Cubist was incorporated inDelaware in 1992. We completed our initial public offering in 1996, and ourshares are listed on the NASDAQ Global Select Market, where our symbol is CBST.Our principal offices are located at 65 Hayden Avenue, Lexington,Massachusetts. Our telephone number is 781-860-8660, and ourwebsite address is www.cubist.com.

We have one marketedproduct, CUBICIN® (daptomycin for injection), which was launchedin the U.S. in November 2003. CUBICIN is approved in the U.S. for thetreatment of complicated skin and skin structure infections, or cSSI, caused by*S. aureus*and certain otherGram-positive bacteria, and for *S. aureus*blood-streaminfections (bacteremia), including right-sided infective endocarditis caused byMRSA and MSSA. Since its U.S. launch, CUBICIN has also been approved formarketing for complicated skin infections caused by various Gram-positivepathogens in the European Union, Israel, Taiwan and Argentina, and also hasbeen approved for *S. aureus* bloodstream infectionsin Israel.

Wehave focused our pipeline building efforts on opportunities that leverage ourantiinfective and acute-care discovery, development, regulatory, andcommercialization expertise. Currently, our research and development prioritiesinclude:

·       ourlipopeptide program, which focuses on the evaluation of product candidates totreat infections caused by Gram-positive and Gram-negative pathogens;

·       aresearch collaboration begun in 2006 with Ilypsa, Inc. to develop anon-antibiotic, toxin binder therapy for the treatment of *Clostridiumdifficile (C. difficile)*associated diarrhea; and

·       our natural products screening program.

**The Infectious Disease Marketplace**

*Overview of Infectious Diseases and Drug Resistance*

Infectious diseases arecaused by pathogens present in the community or in health care institutionsthat enter the body through the skin or mucous membranes of the lungs, nasalpassages or gastrointestinal tract and overwhelm the body’s immune system.These pathogens establish themselves in various tissues and organs throughoutthe body and cause a number of serious and, in some cases, lethal infections,including infections of the bloodstream, skin, heart, lung and urinary tract.

The antiinfective marketcan be broken down into three main categories: antibacterials (often referredto as antibiotics), antifungals and antivirals. Currently marketedantibacterial drugs have, in many cases, proven highly successful incontrolling the morbidity and mortality that accompany serious bacterialinfections. These drugs work by inhibiting specific critical processes in a bacterialpathogen, thereby inhibiting growth or causing the death of the pathogen. Manyantibiotics were developed and introduced into the market during the 1970s and1980s. Most of these were developed from existing classes of drugs such assemi-synthetic penicillins, cephalosporins, macrolides, quinolones andcarbapenems and proved to be efficacious in treating most bacterial infections.Only two new antibiotics from new chemical classes 

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havebeen introduced to the market in the past 35 years—Zyvox, which is knowngenerically as linezolid and is from the oxazolidinones chemical class, andCUBICIN, which is a lipopeptide.

The increasing prevalence of drug-resistant bacterialpathogens has led to significantly increased mortality rates, prolongedhospitalizations, and increased healthcare costs. The resistant organisms haveemerged from both the Gram-positive and Gram-negative classes of bacteria.Gram-positive bacteria can be differentiated from Gram-negative bacteria by thedifferences in the structure of the bacterial envelope. Gram-positive bacteriapossess a single cellular membrane and a thick cell wall component, whereasGram-negative bacteria possess a double cellular membrane with a thin cell wallcomponent. These cellular structures greatly affect the ability of anantibiotic to penetrate the bacteria and reach its target site.

Examples ofresistant Gram-positive bacterial pathogens include:

·       **MRSA (methicillin-resistant *Staphylococcus aureus***): *S. aureus*, often referred to simply as “staph,”are bacteria commonly carried on the skin or in the nose of healthy people. Insome cases, staph can cause an infection, and staph bacteria are one of themost common causes of skin infections in the U.S. Most of these infections areminor (such as pimples and boils) and many can be treated without antibiotics.However, staph bacteria can also cause serious infections (such aspost-surgical wound infections, pneumonia, and infections of the bloodstreamand of the bone and joints). In the past, most serious staph bacterialinfections were treated with antibiotics related to penicillin. Over the past50 years, treatment of these infections has become more difficult becausestaph bacteria have become resistant to various antibiotics, including thecommonly used penicillin-related antibiotics. These resistant bacteria arecalled methicillin-resistant *S. aureus*,or MRSA.

While MRSA iscurrently found mostly in hospital and long-term care settings, the incidenceof community-acquired MRSA infections continues to rise rapidly. Of greatconcern to the infectious disease community and public health authorities, suchas the U.S. Centers for Disease Control and Prevention, is the fact thatcommunity-acquired MRSA infections show up in otherwise healthy individuals—notfitting the traditional profile for an “at risk” patient such as a frequentuser of the health care system who is more likely to be exposed to MRSAinfections—and can therefore be more easily missed in initial diagnosis. As aresult, the patients can get more seriously ill and require hospitalizationbefore being appropriately treated for the MRSA infection. Of additionalconcern to the infectious disease community is the fact that mostcommunity-acquired MRSA strains encode the Panton-Valentine leukocidin (PVL) gene.This gene creates a “more fit” pathogen and confers an ability to defeat thehost’s immune system, thereby resulting in an infection becoming more severemore quickly.

·       **GISA or VISA (glycopeptide- or vancomycin-intermediately susceptible *S. aureus***): The first reportsof*S. aureus* infections withdecreased susceptibility to vancomycin occurred in 1998. Such bacterial strainshave been found in wide geographic areas throughout Japan and North America andhave recently emerged in Europe. However, the incidence of these strainsremains rare.

·       **Heteroresistance**:Heteroresistance refers to the situation in which a small sub-population ofbacteria survives at higher concentrations of antibiotic than the majority ofthe population. Specialized testing techniques are required to detectheteroresistance to vancomycin. This heteroresistance appears to be becomingmore common in *S. aureus*. The clinical impact ofheteroresistance is unknown.

·       **VRSA (vancomycin-resistant*S. aureus***): During 2002, the first isolates offully vancomycin-resistant*S. aureus*were discovered in the U.S. Unexpectedly, rather than evolving from a VISAstrain, these VRSA emerged from MRSA strains that had acquired thevancomycin-resistance gene from vancomycin-resistant Enterococci, or VRE.

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·       **VRE (vancomycin-resistant Enterococci)**: The emergence of VREstrains in the 1990s has led to infections for which only limited commerciallyavailable therapy exists.

·       ***Clostridium difficile:****C.difficile* is an opportunistic anaerobic bacterium causingthe most commonly diagnosed form of nosocomial diarrhea—*Clostridiumdifficile* associated diarrhea, (CDAD). Recent years have witnessedthe emergence of a hypervirulent strain of *C. difficile*(termed ribotype 027, toxinotype III) that produces much higher levels of ToxinA and B and a third toxin named binary toxin. This strain also demonstrateshigh level resistance to fluoroquinolones which may have contributed to itsspread through the U.S., Canada, United Kingdom, the Netherlands and Belgium. Physicianshave noted an increase in incidence, mortality rates and increases in numbersof patients requiring emergency colectomy (removal of all or part of the colon)or admission to ICUs.

Examplesof resistant Gram-negative pathogens are:

·       **Pan-resistant*Pseudomonas aeruginosa*:***P.aeruginosa* is a major cause of opportunistic infectionsamong immunocompromised patients. Multi-drug resistance is increasinglyobserved in clinical isolates reflecting both their innate resistance (limitedpermeability of the *P. aeruginosa*outer membrane) along with acquisition of resistance mechanisms. It is nowcommonplace for a burn patient to develop an infection with a pan-resistantorganism—resistant to B-lactams, fluoroquinolones, tetracycline,chloramphenicol, macrolides, trimethoprim/sulfa, and aminoglycosides.

·       **ESBL positive Gram-negatives:**Extended-spectrum B-lactamases(ESBLs) are plasmid-mediated bacterial enzymes that result from geneticmutations of native B-lactamases such that they confer resistance to a broadergroup of antibiotics including third-generation cephalosporins. Since the firstESBL positive strain was recognized approximately 20 years ago, these ESBLproducing pathogens have spread and are now found in every part of the world.Clinical failures have been associated with use of the third generationcephalosporins—most frequently ceftazidime. Proper detection of ESBLs andappropriate treatment strategies are needed to overcome such rising resistance.

The prevalence ofresistant organisms creates a growing need for new therapies with novelmechanisms of action.

*Shortcomings of Current Antibacterial Therapies*

Currentantibacterial therapies do not provide adequate treatment for some serious andlife-threatening infections. For example:

·                     Somepathogens have become resistant to almost all antibiotics and there are fewagents available that can effectively treat the infections caused by thesedrug-resistant pathogens. The practical definition of resistance for a pathogenis when the minimum inhibitory concentration, or MIC value, exceeds apre-specified limit for that specific antibiotic. Vancomycin has been thestandard of care for patients who have serious MRSA infections. However, several strains of staphylococci,such as VISA (MIC = 8-16 μg/ml), and VRSA (MIC >/= 32 μg/ml), havedeveloped reduced susceptibility or resistance to vancomycin. In addition,recent published reports document a poor clinical success rate for vancomycintherapy against some *S. aureus*isolates with a vancomycin MIC of 1.0 to 2.0 μg/ml; levels which arestill officially designated as within the FDA susceptibility range (</= 4μg/ml) for vancomycin. In recognition of the issues with vancomycinsusceptibility, the CLSI (Clinical Laboratory Standards Institute) hasapproved lower susceptibility criteria (</=2 mcg/mL as susceptible) forvancomycin against *S. aureus*, andthe American Society of Microbiology has issued a statement in support of thesetighter standards. A citizen’s petition has been filed with the FDA by CLSIadvocating tighter standards for vancomycin susceptibility against *S. aureus*; the FDA response is uncertain.

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·       Many of the existingantibiotics used to treat serious infections are difficult or inconvenient toadminister. Most of these drugs must be administered multiple times a day inorder to be effective, are not well tolerated by patients, or require lengthyinfusion times when administered. The difficulty or inconvenience ofadministration of these drugs makes them unattractive choices.

·       Existing antibiotics maycause side effects in some patients, such as severe allergic reaction, lowerblood pressure, suppression of the bone marrow, inflammation and swelling atthe site of injection, and headaches. Some of these side effects may besignificant enough to require that therapy be discontinued. Some of these sideeffects become more pronounced with prolonged therapy, thereby limitingtreatment options for serious infections that require a longer duration oftherapy.

·       Some existing antibiotics,which are *bacteriostatic* agents,do not kill the pathogens that cause the infection but merely inhibit theirgrowth. Bacteriostatic drugs are thought to be less effective in treatingbacteremia and endocarditis (an infection of the heart valves) than are *bactericidal* antibiotics, which kill thepathogens. Bactericidal antibiotics may be most important forimmuno-compromised patients because their weakened immune systems have greaterdifficulty responding to even growth-inhibited pathogens.

**Our FlagshipProduct: CUBICIN**

CUBICIN is the first antibiotic froma new class of antiinfectives called lipopeptides. CUBICIN is currently theonly marketed once-daily, bactericidal, intravenous (IV) antibiotic.CUBICIN is approved in the U.S. for the treatment of complicated skin and skinstructure infections, or cSSSI, caused by *S.aureus* and certain otherGram-positive bacteria, and for *S. aureus*bloodstream infections (bacteremia), including right-sided infectiveendocarditis caused by MRSA and MSSA. In the European Union, or EU, CUBICIN isapproved for the treatment of complicated skin and soft tissue infections, orcSSTI, caused by certain Gram-positive bacteria, and is under regulatory reviewfor an expanded label based on the data from our *S. aureus*bacteremia and endocarditis trial.

We believe that CUBICIN providesimportant advantages over existing antibiotic therapies in its approvedindications, given its rapid bactericidal properties demonstrated *in vitro**, distinct mechanism of action, convenientonce-daily dosing regimen, and established safety profile. In addition, CUBICIN’sapproval in the U.S. for the treatment of *S. aureus bloo*dstreaminfections is the first such approval by the FDA in more than 20 years, and isbased on results from the only prospective, randomized, and controlledregistration trial of *S. aureus*bacteremiaand endocarditis ever undertaken. CUBICIN’s spectrum of activity includes bothsusceptible strains of Gram-positive pathogens and strains that are resistantto other antibiotic therapies. The increasing prevalence of drug-resistantbacterial pathogens is a concern to the infectious disease community.

In our review of theinfectious disease marketplace above, we referenced the increasing prevalenceof drug-resistant bacterial pathogens as a concern to the infectious diseasecommunity. The need for multiple mutation steps and the small impact of eachstep on susceptibility substantially decreases the likelihood thatdaptomycin-susceptible bacteria will become daptomycin-resistant. At year-end,CUBICIN had been on the market for thirty-eight months and has been used in thetreatment of an estimated 285,000 patients. The number of reported resistantisolates, compared to the number of patients treated (or the numbers ofbacteria being tested for susceptibility) continues to be extremely small,consistent with the findings of the pre-NDA clinical program. Where clinicalcircumstances are known, S. aureus nonsusceptible isolates are generallyassociated with antibiotic underdosing or difficult-to-treat infectionsinvolving undrained abscesses or retained material.

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*                    the clinicalrelevance of *in vitro* data has not beenestablished.

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*ClinicalDevelopment of CUBICIN*

Wecontinue to undertake research which can add to the medical knowledge aboutCUBICIN.****In Q1 2007 we are beginning toenroll patients in a Phase 2 clinical study of CUBICIN at 10 mg/kg for 4 days,compared with standard of care, to treat complicated skin infections. In Q22007, we expect to begin enrolling patients in an exploratory Phase 2 safetytrial comparing CUBICIN dosing of 6 and 8 mgs/kg, and standard of care therapy,for the treatment of infections associated with prosthetic joint osteomyelitis.We expect that both of these Phase 2 studies will continue into 2008.

We also are working on a pediatric development plan asa follow up to the single dose Phase 1 pharmacokinetic study in pediatricpatients we completed in 2006, and anticipate a discussion with FDA on nextsteps in pediatrics in the first half of 2007.

We expect to have twoPhase 4 programs underway in 2007. A study in patients with renal impairmentwho have skin infections, a commitment from the original FDA approval forCUBICIN, proved extremely difficult to enroll. We met with the FDA in December,2006 and the FDA agreed to the termination of this study and has now replacedit with a two step requirement: first a Phase 4 pharmacokinetic study withnon-infected patients with renal impairment, followed by a Phase 4 study toassess efficacy and safety of CUBICIN with infected patients (cSSSI and *S.aureus* bacteremia) with moderate and severe renalimpairment. For our more recent Phase 4 commitment to study dual therapy for *S. aureus* infective endocarditis, we submitted a protocol tothe FDA in November 2006 and expect to get their feedback shortly.

*CUBICIN in the U.S.Market*

We generated$113.4 million in U.S. net product sales of CUBICIN in 2005 and $189.5million in U.S. net product sales of CUBICIN in 2006. We market CUBICIN toapproximately 1,850 of the top U.S. hospitals and infusion centers thatdispense the majority of the prescriptions for IV antibiotics to treat seriousGram-positive infections. In addition to our in-house marketing team, our salesforce as of year end 2006 consisted of approximately 135 clinical businessmanagers (CBMs), 14 regional business directors (RBDs), and two Senior SalesDirectors (SSDs). Most of our CBMs and RBDs have extensive acute-care pharmaceuticalsales experience and many have previously sold antiinfectives to the hospitalsin their current territories.

*Our InternationalMarketing Partners for CUBICIN*

In 2006, total international revenue for CUBICIN wasabout $800,000. CUBICIN is being introduced to markets outside the U.S. throughalliances we have entered into with other companies. Novartis AG, or Novartis,through its subsidiary Chiron Healthcare Ireland, Ltd, or Chiron, isresponsible for regulatory filings, sales, marketing and distribution costs inEurope, Australia, New Zealand, India, and certain Central American, SouthAmerican and Middle Eastern countries. Other international partners for CUBICINinclude Medison Pharma, Ltd., for Israel, Oryx Pharmaceuticals, Inc. forCanada, TTY BioPharm for Taiwan, and Kuhnil Pharma Co., Ltd. for Korea. In2006, AstraZeneca AB, or AstraZeneca, licensed rights to CUBICIN in China aswell as all otherwise unlicensed CUBICIN territories other than Japan. Cubistis seeking to name a CUBICIN partner for Japan, the last unpartnered countryoutside of the U.S.

Each partner is responsible for seeking regulatoryapprovals to market CUBICIN in its territory. CUBICIN now has been approved formarketing for complicated skin infections caused by various Gram-positivepathogens in the following markets outside the U.S.: the European Union,Israel, Taiwan and Argentina; and has an additional approval for *S. aureus* blood stream infections in Israel. Filings havebeen made for both complicated skin and bloodstream infection indications inCanada, for *S. aureus*bloodstream infections in theEU, and for complicated skin infections in Korea.

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For international markets,Cubist is responsible for manufacturing and supplying CUBICIN to our partnersin exchange for a transfer price and, in the case of Novartis, a possibleadditional royalty.

**Our ProductPipeline**

Our research and development programs focus onopportunities created by unmet needs in the acute care and antiinfective marketand leverage the expertise and experience we have gained through thedevelopment of and continued clinical program supporting CUBICIN. We have fourpreclinical programs underway.

Lipopeptide programs (Gram-positive andGram-negative): Candidates that have the Gram-positive antimicrobial spectrum ofdaptomycin and efficacy in the lung are undergoing efficacy and safety testingto determine if an IND worthy candidate can be advanced in the near future.Lipopeptide candidates with efficacy against Gram-negative bacteria, includingmulti-drug resistant pathogens such as *Pseudomonas* and*Acinetobacter*, are undergoing preliminary safety and PKtesting.

CDAD program: In a research collaboration announced in2006, Cubist-funded scientists at Ilypsa, Inc., or Ilypsa, are using theirpolymer-based expertise to move discovery work forward, with goal ofidentifying multiple toxin binder products to begin screening as potential INDcandidates.

Cubist natural product screening: More than 30% of newchemical entities on the market today—and more than 70% of antibiotics—havebeen derived from natural products. Our efforts in this area are focused onscreening for novel antimicrobial drug candidates. We announced in our year-endconference call that a new class of molecule with potent antibacterial activityhas been discovered, and we are now using Medicinal Chemistry to optimize themolecule for further evaluation.

Our research anddevelopment expenditures, which include research related to CUBICIN, as well asour drug discovery projects, were $57.4 million, $51.7 million, and$57.2 million in 2006, 2005, and 2004, respectively.

**Our IntellectualProperty Portfolio**

We seek to protect our novel compounds, clonedtargets, expressed proteins, assays, organic synthetic processes, screeningtechnology and other technologies by, among other things, filing, or causing tobe filed on our behalf, patent applications.

To date, we own or co-own37 issued U.S. patents, 12 pending U.S. patent applications, 45 issued foreignpatents and approximately 104 pending foreign patent applications. We haveexclusively licensed rights from Eli Lilly and Company, or Eli Lilly, underU.S. patents and foreign patents related to the composition, manufacture, anduse of daptomycin, the active ingredient in CUBICIN. The primary composition ofmatter patent covering daptomycin in the U.S. has expired; however, currentlythere are six issued U.S. patents owned by or exclusively licensed to Cubist(U.S. Patent Nos. 6,852,689; 6,696,412; 6,468,967; RE39,071; 4,885,243; and4,874,843) that cover the drug product, manufacture, and/or administration oruse of daptomycin. In addition, we have also filed a number of patentapplications in our name relating to the composition, manufacture,administration and/or use of daptomycin and/or other lipopeptides.

**Manufacturing,Distribution and Other Agreements**

In June 2000, we entered into a manufacturing andsupply agreement with DSM Capua SpA, or DSM, pursuant to which DSM agreed tomanufacture and supply to us bulk daptomycin, the active pharmaceuticalingredient, or API for CUBICIN for commercial purposes in accordance with GoodManufacturing Practices, or GMP standards. We purchased API from DSM throughthe end of May 2006, at which time the contract with DSM was terminated.

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In September 2001, we entered into amanufacturing and supply agreement with ACS Dobfar SpA, or ACS, pursuant towhich ACS agreed to provide scale-up services and to construct a productionfacility dedicated to the manufacture and sale of API for CUBICIN exclusivelyto us for commercial purposes. In accordance with this agreement, we purchaseAPI from ACS subject to minimum annual quantity requirements. We also currentlyengage ACS to manufacture API for our clinical trials of CUBICIN. Upon thetermination of our contract with DSM, ACS became the single source supplier of API forCUBICIN. ACS’s substantial fermentation and purification plant capacity leadsus to expect that ACS can meet all of our anticipated needs for CUBICIN API,and Cubist therefore no longer requires a second supplier for this portion ofthe CUBICIN supply chain.

In April 2000, we entered into an agreement withHospira, Inc., or Hospira, formerly the core global hospital productsbusiness of Abbott Laboratories. Under this agreement, Hospira currentlyconverts API into our finished, vialed formulation of CUBICIN. In September 2003,we entered into a packaging services agreement with Cardinal Health PTS, LLC,or Cardinal, pursuant to which Cardinal packages and labels the finishedCUBICIN product. In September 2004, we entered into an additional servicesagreement with Cardinal to provide fill/finish as well as packaging servicesfor the finished CUBICIN product. Hospira and Cardinal both continue to providefill/finish services for CUBICIN, with Cardinal also providing packagingservices.

In June 2003, we entered into a servicesagreement with Integrated Commercialization Solutions, Inc., or ICS,whereby ICS agreed to exclusively manage our CUBICIN warehousing and inventoryprogram and to distribute finished product to our customers. ICS also providesus with order processing, order fulfillment, shipping, collection and invoicingservices in support of the direct ship model we have employed since the launchof CUBICIN in the U.S.

In September 2001,Cubist entered into a services agreement with PPD Development, LLC, or PPD,pursuant to which PPD has agreed to provide various clinical, laboratory, GMPand other research and testing services.

**Competition**

CUBICIN is currentlyapproved in the U.S. for the treatment of cSSSI caused by certain Gram-positivebacteria, and for the treatment of *S. aureus*bloodstream infections (bacteremia), including right-sided infectiveendocarditis caused by MRSA and MSSA. There are many currently approved antibiotics used to treatthese types of infections. The most commonly prescribed antibiotics forsusceptible strains of bacteria are: first-generation cephalosporins, such ascefazolin, and semi-synthetic penicillins, such as oxacillin and nafcillin. Forthe treatment of resistant organisms, the most commonly prescribed treatmentsare vancomycin and linezolid. All of these antibiotics, except linezolid, whichis marketed as Zyvox, and Tygacycline, a broad spectrum antibiotic which ismarketed as Tygacil, are distributed by generic manufacturers at low cost. Inaddition, there are drug candidates in development, examples of which aredalbavancin, telavancin, ceftobiprole, oritavancin, and ceftaroline, which, ifapproved, would compete in the IV antibiotic market. Currently, NDAs fordalbavancin and telavancin are before the FDA. Both seek approval for thetreatment of cSSSI.

**GovernmentRegulation**

*Overview*

Our development,manufacture and marketing of pharmaceutical drugs is subject to extensiveregulation by numerous governmental agencies within the jurisdictions where wechoose to market our products, principally the FDA in the United States, theEuropean Medicines Agency, or EMEA for EU member states, and by variouscountry-specific regulatory bodies in other countries. These regulations definenot only the form and content of safety and efficacy data regarding a proposedproduct, but also 

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imposespecific requirements regarding manufacture of the product, quality assurance,packaging, storage, documentation and record keeping, labeling, advertising andmarketing procedures. All of these regulations and required oversight areintended to ensure the efficacy, safety and consistency of pharmaceuticals. Thetime and expense involved in meeting the requirements to obtain and maintainregulatory approvals are quite substantial.

*FDA Process*

*PreClinical Testing:* Before testing of any compounds withpotential therapeutic value in human subjects may begin in the U.S., stringentgovernment requirements for pre-clinical data must be satisfied. Pre-clinicaltesting includes both *in vitro*and *in vivo* (within a livingorganism) laboratory evaluation and characterization of the safety and efficacyof a drug and its formulation. Pre-clinical testing results obtained fromstudies in several animal species, as well as from *in vitro*studies, are submitted to the FDA as part of anInvestigational New Drug, or IND, application, and are reviewed by the FDAprior to the commencement of human clinical trials. These pre-clinical datamust provide an adequate basis for evaluating both the safety and thescientific rationale for the initial clinical studies in human volunteers.Unless the FDA objects to an IND, the IND becomes effective 30 daysfollowing its receipt by the FDA. Once trials have commenced, the FDA may stopthe trials by placing them on “clinical hold” because of concerns about, forexample, the safety of the product being tested.

*ClinicalTrials:* Clinical trials involve the administration ofthe drug to healthy human volunteers or to patients under the supervision of aqualified investigator, usually a physician, pursuant to an FDA-reviewedprotocol. Human clinical trials are typically conducted in three sequentialphases, although the phases may overlap with one another. Clinical trials mustbe conducted under protocols that detail the objectives of the study, theparameters to be used to monitor safety, and the efficacy criteria to beevaluated. Each protocol must be submitted to the FDA as part of the IND. Eachclinical trial must be conducted under the auspices of an Institutional ReviewBoard that considers, among other things, ethical factors, the safety of humansubjects, the possible liability of the institution and the informed consentdisclosure, which must be made to participants in the clinical trial.

*Phase1 Clinical Trials:* Phase 1 clinical trials representthe initial administration of the investigational drug to a small group ofhealthy human subjects or, more rarely, to a group of selected patients withthe targeted disease or disorder. The goal of Phase 1 clinical trials istypically to test for safety, dose tolerance, absorption, bio-distribution,metabolism, excretion and clinical pharmacology and, if possible, to gain earlyevidence regarding efficacy.

*Phase2 Clinical Trials:* Phase 2 clinical trials involve asmall sample of the actual intended patient population and seek to assess theefficacy of the drug for specific targeted indications, to determine doseresponse and the optimal dose range and to gather additional informationrelating to safety and potential adverse effects.

*Phase3 Clinical Trials:* Once an investigational drug isfound to have some efficacy and an acceptable safety profile in the targetedpatient population, Phase 3 clinical trials are initiated to establish furtherclinical safety and efficacy of the investigational drug in a broader sample ofthe general patient population at geographically dispersed study sites in orderto determine the overall risk-benefit ratio of the drug and to provide an adequatebasis for product labeling. The Phase 3 clinical development program consistsof expanded, large-scale studies of patients with the target disease ordisorder to obtain *definitive*statistical evidence of the efficacy and safety of the proposed product anddosing regimen.

All of the phases of clinical studies must beconducted in conformance with the FDA’s bioresearch monitoring regulations.

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*NewDrug Application:* All data obtained from acomprehensive development program including research and product development,manufacturing, pre-clinical and clinical trials and related information aresubmitted in a New Drug Application, or NDA, to the FDA and in similarregulatory filings with the corresponding agencies in other countries forreview and approval. In certain circumstances, this information is submitted ina Biologics License Application, or BLA. In addition to reports of the trialsconducted under the IND, the NDA includes information pertaining to thepreparation of the new drug analytical methods, details of the manufacture offinished products and proposed product packaging and labeling. Although theFood Drug and Cosmetic Act requires the FDA to review NDAs within 180 daysof their filing, in practice, longer times may be required.

In some cases, the FDA may decide to expedite thereview of new drugs that are intended to treat serious or life threateningconditions and demonstrate the potential to address unmet medical needs. Cubistwas granted such a Priority Review after the CUBICIN NDA was submitted in 2002;and in 2005 after submission of the sNDA for the expansion of the CUBICIN labelfor the treatment of *S. aureus*bacteremia and endocarditis.

*Hatch-WaxmanAct:* Under the Drug Price Competition and Patent TermRestoration Act of 1984, also known as the Hatch-Waxman Act, Congress createdan abbreviated FDA review process for generic versions of pioneer (brand name)drug products like CUBICIN. The law also provides incentives by awarding, incertain circumstances, non-patent marketing exclusivities to pioneer drugmanufacturers. Newly approved drug products and changes to the conditions ofuse of approved products may benefit from periods of non-patent marketingexclusivity in addition to any patent protection the drug product may have. TheHatch-Waxman Act provides five years of “new chemical entity”, or NCE,marketing exclusivity to the first applicant to gain approval of a NDA for aproduct that does not contain an active ingredient found in any other approvedproduct. The FDA granted CUBICIN five years of NCE exclusivity, which expireson September 12, 2008. During this five-year period, the FDA is prohibitedfrom accepting any Abbreviated New Drug Application, or ANDA, for a genericdrug. The FDA is also prohibited from accepting any NDA during this five-yearperiod where the applicant does not own or have a legal right of reference toall of the data required for approval, otherwise known as a 505(b)(2) application.The five-year exclusivity protects the entire new chemical entity franchise,including all products containing the active ingredient for any use and in anystrength or dosage form. This exclusivity will not prevent the submission orapproval of a full NDA, as opposed to an ANDA or 505(b)(2) application,for any drug, including, for example, a drug with the same active ingredient,dosage form, route of administration, strength and conditions of use.

The Hatch-Waxman Act also provides three years ofexclusivity for applications containing the results of new clinicalinvestigations (other than bioavailability studies) essential to the FDA’sapproval of new uses of approved products, such as new indications, dosageforms, strengths, or conditions of use. The FDA granted CUBICIN three years ofexclusivity, which expires on May 25, 2009, for the additional indicationof *Staphylococcus aureus*, or *S.aureus,*bloodstream infections (bacteremia). However, thisexclusivity only protects against the approval of ANDAs and 505(b)(2) applicationsfor the protected use and will not prohibit the FDA from accepting or approvingANDAs or 505(b)(2) applications for other products containing the sameactive ingredient.

The Hatch-Waxman Act requires NDA applicants and NDAholders to provide certain patent information for listing in “Approved DrugProducts with Therapeutic Equivalence Evaluations,” also known as the “OrangeBook”. ANDA and 505(b)(2) applicants must then certify regarding each ofthe patents listed with the FDA for the reference product(s). A certificationthat each listed patent is invalid or will not be infringed by the marketing ofthe applicant’s product is called a “Paragraph IV certification.” If aParagraph IV certification is filed, the ANDA or 505(b)(2) applicantmust also provide notice to the NDA holder and patent owner stating that the applicationhas been submitted and providing the factual and legal basis for the applicant’sopinion that the patent is invalid or not infringed. If the ANDA or 

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505(b)(2) applicantprovides such a notification of patent invalidity or noninfringement, then theFDA may accept the ANDA or 505(b)2) application four years after approval ofthe NDA. However, if the NDA holder or patent owner files suit against the ANDAor 505(b)(2) applicant for patent infringement within 45 days ofreceiving notice of the Paragraph IV certification, a one-time 30-monthstay of FDA’s ability to approve the ANDA or 505(b)(2) application istriggered. The FDA may approve the proposed product before the expiration ofthe 30-month stay if a court finds the patent invalid or not infringed,or if the court shortens the period because the parties have failed tocooperate in expediting the litigation.

Because a significantportion of patent life can be lost during the time it takes to obtainregulatory approval, the Hatch-Waxman Act also provides for the extension ofpatents to compensate for the lost patent term. Only one patent claiming theproduct or its approved method of use is eligible for patent term restoration,and the application for restoration must be approved by the United StatesPatent and Trademark Office, in consultation with FDA. The maximum period ofrestoration cannot exceed 5 years, or restored the total remaining term of thepatent to greater than 14 years from the date of FDA approval of the product.

*The EMEA Process*

In the EU, the EMEArequires approval of a marketing authorization application, or MAA before apharmaceutical drug is brought to market in EU member states. In many EUcountries, pricing negotiations also must take place before the product issold.

*Other RegulatoryProcesses*

We are subject to avariety of financial disclosure and securities trading regulations as a publiccompany in the United States, including the laws relating to the oversightactivities of the Securities and Exchange Commission and the regulations of theNASDAQ Stock Market, on which our shares are traded. We are also subject toregulation under other federal laws and regulation under state and local laws,including laws relating to occupational safety, laboratory practices,environmental regulations, and hazardous substance control.

**Our Employees**

As of February 1,2007, we had approximately 410 full-time employees, approximately 134 of whomwere engaged in research and development and approximately 276 of whom wereengaged in management, marketing, sales, administration and finance. Weconsider our employee relations to be good.

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**Our Executive Officers and Directors**

| Michael W. Bonney                              | 48 | President, Chief  Executive Officer and Director                        |
|------------------------------------------------|----|-------------------------------------------------------------------------|
| Lindon M. Fellows                              | 55 | Senior Vice President,  Technical Operations                            |
| Oliver S. Fetzer, Ph.D.,  MBA                  | 42 | Senior Vice President,  Corporate Development, Research and Development |
| Christopher D.T.  Guiffre, J.D., MBA           | 38 | Senior Vice President,  General Counsel & Secretary            |
| David W.J. McGirr, MBA                         | 52 | Senior Vice  President & Chief Financial Officer               |
| Robert J. Perez, MBA                           | 42 | Senior Vice President,  Commercial Operations                           |
| William Pullman, M.D.,  Ph.D.                  | 52 | Senior Vice President,  Chief Medical Officer                           |
| Gordon L. Archer M.D.  (2) (4)            | 63 | Director                                                                |
| Kenneth M. Bate, MBA (1)                       | 56 | Lead Director                                                           |
| Sylvie Grégoire, Pharm.  D. (3) (4)  | 45 | Director                                                                |
| David W.  Martin, Jr., M.D. (2) (4)* | 66 | Director                                                                |
| Walter R.  Maupay, Jr., MBA (2) (3)* | 68 | Director                                                                |
| Martin Rosenberg, Ph.D.  (3) (4)          | 61 | Director                                                                |
| J. Matthew Singleton,  MBA, CPA (1)*           | 54 | Director                                                                |
| Martin H. Soeters  (1) (3)                | 52 | Director                                                                |
| Michael B. Wood, M.D. (2)*                     | 63 | Director                                                                |

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(1)          Member of AuditCommittee

(2)          Member of CompensationCommittee

(3)          Member of CorporateGovernance and Nominating Committee

(4)          Member of ScientificAffairs Committee

*                    Chair ofCommittee

***Mr. Bonney*******has served as our President & Chief ExecutiveOfficer and as a member of the Board of Directors since June 2003. From January 2002to June 2003, he served as our President & Chief OperatingOfficer. From 1995 to 2001, he held various positions of increasingresponsibility at Biogen, Inc., a biopharmaceutical company, includingVice President, Sales and Marketing from 1999 to 2001. While at Biogen, Mr. Bonneybuilt the commercial infrastructure for the launch of Avonex. Prior to that, Mr. Bonneyheld various positions of increasing responsibility in sales, marketing andstrategic planning at Zeneca Pharmaceuticals, ending his eleven-year careerthere serving as National Business Director. Mr. Bonney received a B.A. inEconomics from Bates College. Mr. Bonney is a director of NPSPharmaceuticals, Inc., a biopharmaceutical company, and serves on theBoard of Trustees of the Beth Israel Deaconess Medical Center and BatesCollege.

***Mr. Fellows***has served as our Senior Vice President, Technical Operations since August 2005.From July 2004 until August 2005 Mr. Fellows was Vice President,Corporate Quality Assurance of Millennium Pharmaceuticals, a biopharmaceuticalcompany, where he was responsible for ensuring product quality and complianceto both U.S. and international requirements. From July 1995 until July 2004,Mr. Fellows held various positions of increasing responsibility at DSMLife Sciences Products, including Managing Director, Director of QualityCompliance, and Vice President of Quality Assurance and Regulatory Affairs withresponsibility for antiinfectives, fine chemicals, and food sciences. Mr. Fellowsholds a B.S. in Microbiology from Colorado State.

***Dr. Fetzer***has served as our Senior Vice President,Corporate Development, Research and Development since July 2004. From January 2003to July 2004, he served as our Senior Vice President, CorporateDevelopment and Chief Business Officer. FromJuly 2002 to January 2003, he served as our 

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SeniorVice President, Business Development. Prior to joining Cubist, he served asVice President and Director from 2000 to 2002, as Manager from 1997 to 2000, asProject Leader from 1995 to 1997 and as Consultant from 1993 to 1995 at TheBoston Consulting Group. While there, he focused on domestic and internationalstrategic issues, predominantly in the healthcare industry, covering allfunctions of the pharmaceutical value chain. Dr. Fetzer received a B.S. inBiochemistry from the College of Charleston (South Carolina), a Ph.D. inPharmaceutical Sciences from the Medical University of South Carolina and anM.B.A. from Carnegie Mellon University. Dr. Fetzer is a director of AuxiliumPharmaceuticals, Inc., a pharmaceuticals company.

***Mr. Guiffre***has served as our Senior Vice President,General Counsel and Secretary since January 2004. He served as our VicePresident, General Counsel and Secretary from December 2001 to December 2003.From 1997 to 2001, Mr. Guiffre held various positions of increasingresponsibility at Renaissance Worldwide, Inc., a provider of informationtechnology consulting services, including Counsel, Corporate Counsel andDirector of Legal Affairs, and Vice President, General Counsel and Clerk. Priorto joining Renaissance Worldwide, he was an Associate at Bingham McCutchen LLP,a national law firm. He received a B.S. in Marketing from Babson College, aJ.D. from Boston College Law School, and an M.B.A. from Boston College CarrollSchool of Management. Mr. Guiffre is a member of the Massachusetts Bar.

***Mr. McGirr*** has served as our Senior Vice President and ChiefFinancial Officer since November 2002. He also served as our Treasurerfrom November 2002 until January 2003. From 1999 to 2002, Mr. McGirrwas the President and Chief Operating Officer of hippo inc, an internettechnology, venture-financed company. Mr. McGirr served as a member ofhippo’s Board of Directors from 1999 to 2003. From 1996 to 1999, he was thePresident of GAB Robins North America, Inc., a risk management company,serving also as Chief Executive Officer from 1997 to 1999. Mr. McGirr wasa private equity investor from 1995 to 1996. From 1978 to 1995, Mr. McGirrserved in various positions within the S.G. Warburg Group, ultimately as ChiefFinancial Officer, Chief Administrative Officer and Managing Director of S.G.Warburg & Co., Inc., a position held from 1992 to 1995. Mr. McGirrreceived a B.Sc. in Civil Engineering from the University of Glasgow andreceived an M.B.A. from The Wharton School at the University of Pennsylvania.

***Mr. Perez***has served as our Senior Vice President, Commercial Operations since July 2004.From August 2003 to July 2004 he served as our Senior Vice President,Sales and Marketing. Prior to joining Cubist, he served as Vice President ofBiogen, Inc.’s CNS Business Unit where he was responsible for leading theU.S. neurology franchise. From 1995 to 2001 he served as a Regional Director,Director of Sales, and Avonex® Commercial Executive at Biogen. From 1987 to1995, Mr. Perez held various sales and marketing positions at ZenecaPharmaceuticals, ultimately serving as Regional Business Director, responsiblefor sales, marketing and national accounts for the Western Regional BusinessUnit. Mr. Perez is a director of Epix Pharmaceuticals, Inc., abiopharmaceuticals company. Mr. Perez received a B.S. from CaliforniaState University, Los Angeles and an M.B.A. from The Anderson School at UCLA.

***Dr. Pullman***hasserved as our Senior Vice President and Chief Medical Officer since May 2006.From July 2005 to May 2006, he served as Senior Vice President, ExploratoryDevelopment at TransForm Pharmaceuticals, where he built and led theclinical group to support product development efforts. From October 2004to July 2005, Dr. Pullman served as Senior Vice President, Clinicaland Exploratory Pharmacology at Sanofi-Aventis, a pharmaceutical company. From April 2004until October 2004, Dr. Pullman served as Senior Vice President ofClinical Discovery and Human Pharmacology at Aventis, providing scientificleadership in the early clinical development of pharmaceutical products. From July 2001until April 2004, Dr. Pullman was Vice President of ClinicalDiscovery and Human Pharmacology at Aventis. From 1995 to 2001, he heldnumerous positions at Eli Lilly & Company, a pharmaceuticals company,including serving as Medical Leader for the development and regulatorysubmission of Cialis. Dr. Pullman’s industry experience began at PfizerInc., a pharmaceutical company, from 1992 to 1995, where he served as aclinical pharmacologist. He is a fellow 

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of the Royal Australian Collegeof Physicians and received his Ph.D. in Immunology from the Australian NationalUniversity, and M.B., B.S. (M.D. equivalent) from the University of WesternAustralia.

***Dr. Archer*** has served as one of our directors since September 2006.Since 2005, he has been Associate Dean for Research at Virginia CommonwealthUniversity (VCU) School of Medicine, and, since 2003, Director of the school’sM.D./Ph.D. program. Additionally, Dr. Archer has served as Professor ofMedicine and Microbiology/Immunology at VCU since 1985 and, from 1992 to 2005,served as Chairman of the Division of Infectious Diseases at theschool. Since 1975, Dr. Archer has held various faculty roles atVCU and began his career as an Instructor of Medicine in 1974 at the Universityof Michigan Medical School. He is a previous member and chair of theNational Institutes of Health (NIH) Study Section on Bacteriology andMycology and the NIH Study Section on Drug Discovery and Mechanisms ofResistance to Antimicrobials. Additionally, Dr. Archer was a member of theFood and Drug Administration’s Antiinfective Advisory Board and he is currentlyon the Scientific Advisory Board of Micuron Pharmaceuticals. He received a B.A.in Pre-med and German from Washington and Lee University in Virginia, and hisM.D. from the University of Virginia School of Medicine.

***Mr. Bate*** has served as one of our directors since June 2003and became our lead director in June 2006. Since January 2007, Mr. Batehas been President and Chief Executive Officer and a director of Nitromed, Inc.,a pharmaceutical company. From March 2006 until January 2007, Mr. Batewas Chief Operating Officer and Chief Financial Officer of Nitromed. From2002 to January 2005, Mr. Bate was head of commercial operations andChief Financial Officer at Millennium Pharmaceuticals, Inc. In 1999, Mr. Bateco-founded JSB Partners, an investment banking and transaction advisory firmserving the biopharmaceutical industry. He was a partner at JSB Partnersthrough 2002. From 1997 to 1999, Mr. Bate served as Senior ManagingDirector and Chief Executive Officer of MPM Capital, LP, a venture capitalcompany. He was also an advisor to BB Bioventures, a venture capital fund.Mr. Bate’s life sciences industry experience also includes six years atBiogen, Inc., a biotechnology company; from 1993 to 1996 as the company’svice president of sales and marketing, and as Chief Financial Officer from 1990to 1993. Mr. Bate is a director of Coley Pharmaceutical Group, a biopharmaceuticalcompany. Mr. Bate received his B.A. degree in Chemistry from WilliamsCollege, and an MBA from The Wharton School of the University of Pennsylvania.

***Dr. Grégoire*** has served as one of our directors since June 2006. From 2004 to2005, Dr. Grégoire served as President and Chief Executive Officer ofGlycoFi, Inc., a biotherapeutics company. From 2003 to 2004, Dr. Grégoire was aconsultant to the biopharmaceuticals industry. From 2001 through 2003, Dr.Grégoire served as Executive Vice President, Technical Operations, of BiogenIdec Inc., a biotechnology company, and from 1995 to 2001, she held variousroles of increasing responsibility with Biogen. Prior to Biogen, Dr. Grégoireheld clinical research and regulatory roles with Merck & Co., apharmaceuticals company. She is currently a director of IDM-Pharma, abiopharmaceuticals company, and Caprion Pharmaceuticals, Inc., abiotechnology company. She received her Pharm.D. degree from the StateUniversity of New York at Buffalo and her pharmacy graduate degree(Bachalaureat en Pharmacie) from the Université Laval, Quebec City.

***Dr. Martin***has served as one of our directors since October 1997 and as our leaddirector from October 2004 until June 2006. Since 2004, he has beenthe Founder, Chairman, and Chief Executive Officer of AvidBiotics Corporation,a biotechnology company. In 2003, he was Chairman and Chief Executive Officerof GangaGen, Inc., a biotechnology company. From July 1997 until April 2003,Dr. Martin served as President, Chief Executive Officer and a founder ofEos Biotechnology, Inc., a biotechnology company. From 1995 to 1996, Dr. Martinwas President and Chief Executive Officer of Lynx Therapeutics, Inc., abiotechnology company. During 1994 and through May 1995, Dr. Martinserved as Senior Vice President of Chiron Corporation, a biopharmaceuticalcompany. From 1991 to 1994, Dr. Martin served as Executive Vice Presidentof DuPont Merck Pharmaceutical Company. From 1983 to 

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1990, Dr. Martin wasVice President and then Senior Vice President of Research and Development atGenentech, Inc., a biopharmaceutical company. Prior to 1983, Dr. Martinwas a Professor of Medicine, Professor of Biochemistry and an Investigator ofthe Howard Hughes Medical Institute at the University of California, SanFrancisco. Dr. Martin is also Lead Director of Varian Medical Systems, Inc.,a medical equipment and software supplier. Dr. Martin received an M.D.from Duke University.

***Mr. Maupay*** has served as one of our directors since June 1999.From January 1995 to June 1995, Mr. Maupay served as GroupExecutive of Calgon Vestal Laboratories, a division of Bristol-Myers SquibbCorporation. From 1988 to 1995, Mr. Maupay served as President of CalgonVestal Laboratories, a subsidiary of Merck and Company. From 1984 to 1988, Mr. Maupayserved as Vice President, Healthcare at Calgon Vestal Laboratories. Mr. Maupayis a director of SyntheMed, Inc., a biomaterials company, and PolyMedicaCorporation, a healthcare distribution company. He is also a director andnon-executive chair of Kensey Nash Corporation, a medical device company. Mr. Maupayreceived his B.S. in Pharmacy from Temple University and an M.B.A. from LehighUniversity.

***Dr. Rosenberg*** has served as one of our directors since March 2005.Since 2003, Dr. Rosenberg has been the Chief Scientific Officer of PromegaCorporation, a biotechnology company. From 2001 to 2003, Dr. Rosenbergserved as Vice President, Research and Development of Promega Corporation. From2000 until 2001, Dr. Rosenberg was Senior Vice President, Anti-Infectives,Drug Discovery at GlaxoSmithKline, a pharmaceutical company. From 1996 until2000, Dr. Rosenberg was Senior Vice President, Anti-Infectives atSmithKline Beecham Corporation, the predecessor company to GlaxoSmithKline.Prior to 2000, Dr. Rosenberg held a variety of roles of increasingresponsibility with SmithKline Beecham Corporation. Before joining SmithKlineBeecham, Dr. Rosenberg spent 10 years at the National Institutes of Healthand was a Section Chief at the National Cancer Institute. Dr. Rosenbergis a director of Promega Corporation, the Medical College of WisconsinResearch Foundation, NereusPharmaceuticals, Inc., a pharmaceutical company, Anacor Pharmaceuticals, apharmaceutical company, and Scarab Genomics, a biotechnology company. Healso serves as a member of the Advisory Council for the National Institutes ofAllergy & Infectious Diseases at the National Institute of Health. Heparticipates on a variety of academic and industry Scientific Advisory Boardsand holds an adjunct Professorship at the University of Wisconsin, Department ofBacteriology, Madison, WI. Dr. Rosenberg is Editor-in-Chief of CurrentOpinions in Biotechnology, a Senior Editor of the Journal of Bacteriology and amember of several other journal Editorial Boards. Dr. Rosenberg received a B.A. degree from the University ofRochester and a Ph.D. from Purdue University.

***Mr. Singleton***has served as one of our directors since June 2003. From 2000 to thepresent, he has served as Executive Vice President and Chief Financial Officerof CitationShares, LLC, a majority-owned subsidiary of Cessna Aircraft Companyand Textron Inc. From 1994 to 1997, Mr. Singleton served as a ManagingDirector, Executive Vice President and Chief Administrative Officer of CIBCWorld Markets, an investment banking firm. Previous to that, he served in avariety of roles from 1974 until 1994 at Arthur Andersen & Co., apublic accounting firm, ending his tenure there as Partner-In-Charge of theMetro New York Audit and Business Advisory Practice. During 1980 and 1981, heserved as a Practice Fellow at the Financial Accounting Standards Board. Mr. Singletonserved as a director of Salomon Asset Reinvestment Company from 1998 to 2006.He received an A.B. in Economics from Princeton University and an M.B.A. fromNew York University. Mr. Singleton is a Certified Public Accountant.

***Mr. Soeters***has served as one of our directors since September 2006. Since 2000, Mr. Soetershas served as President of Novo Nordisk and Senior Vice President of Novo Nordisk North America, a healthcarecompany. From 1998 to 2000, he servedas Senior Vice President International Marketing at Novo Nordisk Denmark, andfrom 1994 to 1998 he served as Managing Director of Novo Nordisk France. From1992 to 1995, Mr. Soeters was Managing Director at Novo Nordisk Belgium,and in 1991, he was International Marketing Director at Novo Nordisk Denmark.Prior to that time, he held various sales and marketing positions at NovoNordisk in the Netherlands between 1980 and 1991. Mr. Soeters is a member 

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ofthe Board of Overseers of the Joslin Diabetes Center, a Trustee of theHealthCare Institute of New Jersey, and since 2005, a member of theBiotechnology Industry Organization (BIO) Board. From 2004-2006, heserved on the Board of Directors of the Pharmaceutical Research andManufacturers of America (PhRMA) in Washington, D.C. Mr. Soeters studiedmeteorology, as well as sales, product and marketing management in theNetherlands, and he also attended the Stanford Executive Program.

***Dr. Wood***has served as one of our directors since March 2005. Dr. Wood iscurrently an Orthopedic Surgeon and retired President-emeritus of the MayoFoundation and Professor of Orthopedic Surgery, Mayo Clinic School of Medicine.He was previously Chief Executive Officer of the Mayo Foundation from 1999until 2003. Prior to 1999, Dr. Wood held a variety of roles within theMayo Clinic. Dr. Wood is a director of Steris Corporation, a medicalsterilization company, Assistive Technology Group, Inc., a rehabilitationand durable medical equipment company, and Visionshare, Inc., a softwarecompany. Dr. Wood is also a director of SingHealth, an integratedhealth system in Singapore and a member of the board of overseers of theBaldrige National Quality Award. Dr. Woodreceived a B.A. degree from Franklin and Marshall College, an M.D., C.M. degreefrom McGill University and an M.S. degree from the University of Minnesota.

**WHERE YOU CAN FINDMORE INFORMATION**

We are subject to the information and reportingrequirements of the Securities Exchange Act of 1934, or the Exchange Act, underwhich we file periodic reports, proxy and information statements and otherinformation with the SEC. Copies of the reports, proxy statements and otherinformation may be examined without charge at the Public Reference Section ofthe SEC, 100 F Street, N.E., Room 1580, Washington, D.C. 20549, or on theInternet at http://www.sec.gov. Copies of all or a portion of such materialscan be obtained from the Public Reference Room of the SEC upon payment ofprescribed fees. Please call the SEC at 1-800-SEC-0330 for furtherinformation about the Public Reference Room.

Financial and other information about Cubist isavailable on our website (http://www.cubist.com). We make available on ourwebsite, free of charge, copies of our annual report on Form 10-K,quarterly reports on Form 10-Q, current reports on Form 8-K,and amendments to those reports filed or furnished pursuant to Section 13(a) or15(d) of the Exchange Act as soon as reasonably practicable after filingsuch material electronically or otherwise furnishing it to the SEC. Copies areavailable in print to any Cubist shareholder upon request in writing to “InvestorRelations, Cubist Pharmaceuticals, Inc., 65 Hayden Ave., Lexington, MA02421.”

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**ITEM 1A.**        RISKFACTORS

*Investingin our company involves a high degree of risk. You should consider carefullythe risks described below, together with the other information in andincorporated by reference into this annual report. If any of the following risksactually occur, our business, operating results or financial condition could bematerially adversely affected. This could cause the market price of our commonstock to decline, and could cause you to lose all or part of your investment.*

***Risks Related to Our Business***

**We depend heavilyon the success of our lead product CUBICIN, which may not continue to be widelyaccepted for the treatment of cSSSI and may not be widely accepted fortreatment of the new indication *S. aureus*bacteremia,including right-sided endocarditis caused by MRSA and MSSA, by physicians,patients, third-party payors, or the medical community in general.**

We have invested a significant portion of our time andfinancial resources in the development of CUBICIN. We anticipate that for theforeseeable future our ability to generate revenues will depend solely on thecommercial success of CUBICIN, which depends upon its continued acceptance bythe medical community and the future market demand and medical need forCUBICIN. CUBICIN was approved by the FDA in September 2003 for thetreatment of complicated skin and skin structure infections, or cSSSI, andlaunched in the United States in November 2003. On May 25, 2006, theFDA approved CUBICIN for the additional indication of *S. aureus*bloodstreaminfections (bacteremia), including those with right-sided infectiveendocarditis, caused by methicillin-susceptible and methicillin-resistantisolates.

At year-end 2006, we had just over three yearsexperience as to the sales of this product, and two quarters of sales since theapproval of the new indication. Accordingly, we cannot be sure that CUBICINwill continue to be accepted by purchasers in the pharmaceutical market for thetreatment of cSSSI or that CUBICIN will be widely accepted for the treatment of*S. aureus* bacteremia, includingthose with right-sided infective endocarditis, caused by MRSA and MSSA.Further, CUBICIN currently competes with a number of existing antiinfectivedrugs manufactured and marketed by major pharmaceutical companies andpotentially will compete against new antiinfective drugs whose approval isanticipated in the near future and others that are in development at othercompanies.

The degree ofcontinued market acceptance of CUBICIN, and our ability to grow revenues fromthe sale of CUBICIN, depends on a number of additional factors, including:

·       thecontinued safety and efficacy of CUBICIN, including any unanticipated adversereactions to the drug in patients;

·       theadvantages and disadvantages of CUBICIN compared to alternative therapies;

·       ourability to educate the medical community about the safety and efficacy ofCUBICIN;

·       thereimbursement policies of government and third-party payors;

·       thelevel of access that our sales force has to physicians who are likely to prescribeCUBICIN;

·       ourcontinued ability to sell CUBICIN in the outpatient and home infusion settings,where a significant portion of the market opportunity exists and is expected togrow;

·       themarket price of CUBICIN as compared to alternative therapies and physicians andthird-party payers attitudes towards the relative value of CUBICIN versus othertherapies; and

·       theability of target organisms to develop resistance to CUBICIN.

We cannot be sure that physicians, patients,third-party payors, or the medical community in general will continue to acceptand utilize CUBICIN. Even if the medical community accepts that CUBICIN is 

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safe and efficacious forits approved indications and any future approved indications, physicians maychoose to restrict the use of CUBICIN due to antibiotic resistance concerns,and both physicians and pharmacy departments may choose othercurrently-marketed or later-approved antibiotics on the basis of cost,availability of reimbursement, convenience, safety, efficacy, or other factors.

Because CUBICIN is theonly product that we sell currently and, given our current pipeline drugcandidates, will sell for the foreseeable future, any impediment to the successof this product would have a significant effect on our business and financialresults.

**If weare unable to maintain satisfactory sales and marketing capabilities, we maynot succeed in commercializing CUBICIN.**

Until our launch of CUBICIN in November 2003, wehad not previously marketed or sold a drug product. In connection with ourlaunch of CUBICIN, we developed our own sales and marketing capabilities in theUnited States, and we continue to develop those capabilities. We added 36 salesterritories during the first quarter of 2006. Therefore, our expanded U.S.sales and marketing team has worked together for a limited period of time. Wecannot guarantee that we will continue to be successful in marketing CUBICIN onour own in the United States. Our partner in Europe, Novartis, has significantpharmaceutical sales experience but limited experience marketing and sellingCUBICIN. Novartis began its launch of CUBICIN in the United Kingdom, Ireland,Benelux, Spain, Austria, Denmark, Finland, Norway and Germany in 2006. Even ifwe or our international partners obtain additional approvals to market CUBICINin one or more of the countries in which our partners intend to commercializeCUBICIN pursuant to our license agreement with Novartis or our other current orfuture collaborations, we cannot guarantee that we or our partners will be successfulin marketing CUBICIN in international markets.

**Weface significant competition from other biotechnology and pharmaceuticalcompanies, particularly with respect to CUBICIN, and our operating results willsuffer if we fail to compete effectively.**

The biotechnologyand pharmaceutical industries are intensely competitive. We have competitorsboth in the United States and internationally, including major multinationalpharmaceutical and chemical companies, biotechnology companies and universitiesand other research institutions. Many of our competitors have greater financialand other resources, such as larger research and development staffs and moreexperienced marketing and manufacturing organizations. Our competitors maysucceed in developing, acquiring or licensing on an exclusive basistechnologies and drug products that are more effective or less costly thanCUBICIN or any drug candidate that we are currently developing or that we mayhave or develop, which could render our technology obsolete and noncompetitive.If price competition inhibits the acceptance of CUBICIN, if the reluctance ofphysicians to switch from existing drug products to CUBICIN inhibits theacceptance of CUBICIN, or if physicians switch to new drug products, or chooseto reserve CUBICIN for use in limited circumstances, we will not achieve ourbusiness plan. In addition, CUBICIN may face competition from drug candidatescurrently in clinical development and drug candidates that could receiveregulatory approval before CUBICIN in countries outside the United States andthe European Union.

The competition in the market for therapeutic productsthat address infectious diseases is intense. CUBICIN faces competition in theUnited States from commercially available drugs such as vancomycin, marketedgenerically by Abbott, Shionogi & Co., Ltd. and others, Zyvox,marketed by Pfizer, Inc., Synercid, marketed by King Pharmaceuticals, Inc.,and Tygacil, marketed by Wyeth. In particular, vancomycin has been a widelyused and well known antibiotic for over 40 years and is sold in arelatively inexpensive generic form. In addition, in 2007, Pfizer could receiveFDA approval to market Dalbavancin in the United States and Theravance, Inc.could receive FDA approval to market Telavancin. Other antibiotics in clinicaldevelopment could compete with CUBICIN, if approved by the appropriateregulatory agencies, in future years.

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Any inability on our partto compete with existing drug products or subsequently introduced drug productswould have a material adverse impact on our operating results.

**We are completelydependent on third parties to manufacture CUBICIN, and our commercialization ofCUBICIN could be stopped, delayed, or made less profitable if those thirdparties fail to provide us with sufficient quantities of CUBICIN or fail to doso at acceptable prices.**

We do not have the capability to manufacture our ownCUBICIN active pharmaceutical ingredient, or API. We have entered into amanufacturing and supply agreement with ACS Dobfar SpA, or ACS, to manufactureand supply us with CUBICIN API for commercial purposes. ACS is our soleprovider of our commercial supply of CUBICIN API. Pursuant to our agreementwith ACS, ACS currently stores some CUBICIN API at its facilities in Italy.

In order to offset the risk of a single-source APIsupplier, we currently hold a safety stock of API. Any disaster at the facilitywhere we hold this safety stock, such as a fire or loss of power, that causes aloss of this safety stock, would heighten the risk that we face from havingonly one supplier of API.

In addition, we do not have the capability tomanufacture our own CUBICIN finished drug product. We have entered intomanufacturing and supply agreements with both Hospira Worldwide, Inc. orHospira, and Cardinal Health PTS, LLC, or Cardinal, to manufacture and supplyto us finished product.

If Cardinal, Hospira, or, in particular, ACS,experiences any significant difficulties in its respective manufacturingprocesses for CUBICIN API or finished product, we could experience significantinterruptions in the supply of CUBICIN. Our inability to coordinate the effortsof our third party manufacturing partners, or the lack of capacity available atour third party manufacturing partners, could impair our ability to supplyCUBICIN at required levels. Because of the significant regulatory requirementsthat we would need to satisfy in order to qualify a new bulk or finishedproduct supplier, if we face these or other difficulties with our current suppliers,we could experience significant interruptions in the supply of CUBICIN if wedecided to transfer the manufacture of CUBICIN to one or more suppliers in aneffort to deal with the difficulties.

Because the ACS manufacturing facilities are locatedin Italy, we must ship CUBICIN API to the United States for finishing,packaging and labeling. While in transit, our API, each shipment of which is ofsignificant value, could be lost or damaged. Moreover, at any time aftershipment to the United States, our API could be lost or damaged as it is storedat ICS and moves through our finished product manufacturers. Appropriate riskmitigation steps have been taken and insurance is in place. However, dependingon when in this process the API is lost or damaged, we may have limitedrecourse for recovery against our finished product manufacturers or insurers.As a result, our financial performance could be impacted by any such loss ordamage to our API. We are also subject to financial risk from volatile fuelcosts due to shipping CUBICIN API to the United States, as well as shipping offinished product within the United States and to our international distributionpartners for packaging, labeling and distribution.

We may also experience interruption or significantdelay in the supply of CUBICIN API due to natural disasters, acts of war orterrorism, shipping embargoes, labor unrest or political instability in Italy.In any such event, the supply of CUBICIN API stored at ACS could also beimpacted.

While we have reduced thecost of producing CUBICIN in recent years, we cannot guarantee that we will beable to continue to reduce the costs of commercial scale manufacturing ofCUBICIN over time. If the manufacturing costs of CUBICIN remain high, it maysignificantly impact our operating results. In order to reduce costs, we mayneed to develop and implement process improvements. In order to implement suchprocess improvements, we will need, from time to time, to notify or makesubmissions with regulatory authorities, and the improvements may be subject toapproval by such regulatory authorities. We cannot be sure that such approvalswill be granted or granted in a timely fashion. We cannot guarantee 

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that wewill be able to enhance and optimize output in our commercial manufacturingprocess. If we cannot enhance and optimize output, we may not be able to reduceour costs over time.

**Our ability to growrevenues from the commercialization and sale of CUBICIN will be limited if ourpartners do not obtain approval to market CUBICIN for any additionalindications, or if they do not receive approvals to market CUBICIN at all or,if they fail to fulfill certain post-approval requirements of the FDA relatingto CUBICIN.**

We may seek regulatory approval for additionalindications for CUBICIN. To do so, we would need to successfully conductadditional clinical trials and then apply for and obtain the appropriateregulatory approvals. Our revenues may not grow as expected and our businessand operating results may be harmed if additional indications for CUBICIN arenot approved in the United States.

In January 2006, the EMEA granted final approvalfor marketing CUBICIN in the EU for the treatment of cSSTI, where the presenceof susceptible Gram-positive bacteria is confirmed or suspected. In July 2006,Novartis filed an additional MAA with the EMEA for an expanded label in the EUbased on the results of our *S. aureus*bacteremiaand endocarditis trial. We cannot be sure that the EMEA will approve thisapplication or do so on a timely basis. Novartis and our other collaboratorshave submitted or plan on submitting applications for approvals to marketCUBICIN in other territories, however, we cannot be sure that any regulatoryauthority will approve these or any future submissions on a timely basis or atall.

In addition, the FDA approval to market CUBICIN in theUnited States for the treatment of cSSSI requires that we conduct aPhase 4 clinical trial to assess the safety, efficacy and pharmacokineticsof CUBICIN in renal impairment patients with cSSSI who also have variousdegrees of renal impairment, including those that require dialysis. Clinicalsites began screening for eligible subjects for our Phase 4 renalimpairment study in February 2005. Enrollment of eligible subjects in thisstudy had been difficult and slower than expected. A meeting with the FDA todiscuss these issues took place in December 2006. After the meeting, theFDA replaced the original requirement with two steps. The first step is toconduct a Phase 4 clinical trial to assess the pharmacokinetics of CUBICIN innon-infected subjects who are on hemodialysis or Continuous AmbulatoryPeritoneal Dialysis. For step two, once this pharmacokinetic study iscompleted, the FDA will require a Phase 4 study to assess the efficacy and safetyof CUBICIN in infected patients (cSSI and *S. aureus*bacteremia)with moderate and severe (on dialysis) renal impairment.

In connection with the recent FDA approval tomarket CUBICIN in the United States for *S. aureus*bacteremia, including those with right-sided infective endocarditis, we will berequired to design and complete a Phase 4 clinical trial evaluating thepotential impact of CUBICIN in combination therapy in the treatment of *S. aureus* infective endocarditis. Theprotocol for this trial was submitted in December 2006. We also areworking on a pediatric development plan as a follow-up to the single dose Phase1 pharmacokinetic study in pediatric patients that we completed in 2006 andanticipate a discussion with the FDA on next steps in pediatrics in the firsthalf of 2007.

Our business would be seriously harmed if we do notcomplete these studies and the FDA, as a result, requires us to change themarketing label for CUBICIN in respect to combination therapy or patients withrenal impairment.

In addition, adversemedical events that occur during the Phase 4 clinical trials or duringcommercial marketing could result in the temporary or permanent withdrawal ofCUBICIN from commercial marketing, which could seriously harm our business andcause our stock price to decline.

**If we are unable todiscover, in-license, or acquire drug candidates, we will not be able toimplement our current business strategy.**

Our approach to drug discovery is unproven.Notwithstanding the investment of significant resources to research anddevelopment over the years since Cubist was founded, we have not reached thestage of 

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clinical testing in humansof any drug candidates developed from our drug discovery program. We cannotassure you that we will reach this stage for any internally developed drugcandidates or that there will be clinical benefits associated with any drugcandidates that we do develop. While we areresearching other drug candidates for potential clinical development, most drugcandidates never make it to the clinical development stage. Even those that domake it into clinical development have only a small chance of gainingregulatory approval and becoming a drug product.

Our drug product, CUBICIN, and most of our othercurrent and former drug candidates are the result of in-licensing patents andtechnologies from third parties. These in-licensing activities represent asignificant expense for Cubist and generally require us to pay royalties toother parties on product sales. Unless we are able to use our drug discoveryapproach to identify suitable drug candidates, acquisition or in-licensing willbe our only source of drug candidates. However, there can be no assurance thatwe will be able to acquire or in-license additional desirable drug candidateson acceptable terms, or at all. In fact, we have faced and will continue toface significant competition for the acquisition or in-licensing of anypromising drug candidates from a variety of other companies with interest inthe antiinfective and acute care marketplace, many of which have significantlymore experience than we have in pharmaceutical development and sales andsignificantly more financial resources than Cubist. Because of the risingintensity of the level of competition for such products, the cost of acquiringor in-licensing such candidates has grown dramatically in recent years, andcandidates are often priced and sold at levels that we cannot afford or webelieve are not justified by market potential. Such competition and higher prices is most pronounced for late-stagecandidates and already-marketed products, which have the lowest risk and wouldhave the most immediate impact on our business.

If we are unable todiscover or acquire promising candidates, we will not be able to implement ourbusiness strategy. Even if we succeed in discovering or acquiring drugcandidates, there can be no assurance that we will be successful in developingthem. For example in February 2004, we discontinued, due to observedadverse events, clinical development of CAB-175, a parenteralcephalosporin antibiotic that we had in-licensed from Sandoz GmbH. Also, in April 2004,we discontinued, as a result of data from human clinical research studies,development of oral formulations of ceftriaxone, a broad-spectrum antibiotic forwhich we had licensed the underlying technology from International HealthManagement Associates and the University of Utah. More recently, we announcedin the third quarter of 2006 that we have decided not to make any furtherinvestment in the development of HepeX-B while we evaluate our strategicoptions for this drug candidate. Failure to develop new drug candidatessuccessfully would have a material adverse effect on our business, operatingresults and financial condition.

**If pre-clinical orclinical trials for our drug candidates are unsuccessful or delayed, we will beunable to meet our anticipated development and commercialization timelines,which could harm our business.**

Before we receive regulatory approvals for thecommercial sale of any of our drug candidates, our drug candidates are subjectto extensive pre-clinical testing and clinical trials to demonstrate theirsafety and efficacy in humans. Conducting pre-clinical testing and clinicaltrials is a lengthy, time-consuming and expensive process that often takes manyyears. Furthermore, we cannot be sure that pre-clinical testing or clinicaltrials of any drug candidates will demonstrate the safety and efficacy of ourdrug candidates at all or to the extent necessary to obtain regulatory approvals.Companies in the biotechnology and pharmaceutical industries, includingcompanies with greater experience in pre-clinical testing and clinical trialsthan we have, have suffered significant setbacks in advanced clinical trials,even after demonstrating promising results in earlier trials. In our own case,clinical trials of CUBICIN for the treatment of community acquired pneumoniafailed to demonstrate sufficient efficacy despite promising results inpre-clinical and early clinical trials.

Our clinical trials must be carried out underprotocols that are acceptable to regulatory authorities and to the committeesresponsible for clinical studies at the sites at which the studies areconducted. There 

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may be delays in preparingprotocols or receiving approval for them that may delay either or both of thestart and finish of our clinical trials. Feedback from regulatory authoritiesor results from earlier stage clinical studies might require modifications ordelays in later stage clinical trials or could cause a termination orsuspension of drug development. These types of delays or suspensions can resultin increased development costs and delayed regulatory approvals. Our ability tosecure clinical trial insurance at a reasonable cost could also cause delays.

Furthermore, thereare a number of additional factors that may cause delays in our clinicaltrials. We have limited experience in conducting pre-clinical testing orclinical trials. The rate of completion of our clinical trials is alsodependent in part on the rate of patient enrollment. There may be limitedavailability of patients who meet the criteria for certain clinical trials. Forexample, the limited number of patients each year who receive liver transplantsfor Hepatitis B, the target population for our drug candidate HepeX-B, in partled us to discontinue investment in clinical development of HepeX-B. Delays inplanned patient enrollment can result in increased development costs and delaysin regulatory approvals. For example, our clinical trial to determine thesafety and efficacy of using CUBICIN to treat bacteremia with known orsuspected endocarditis experienced delays attributable to slow enrollment. Inaddition, our clinical trials may be delayed by one or more of the followingfactors:

·       inabilityto manufacture sufficient quantities of acceptable materials for use inclinical trials;

·       inabilityto adequately follow patients after treatment;

·       thefailure of third-party clinical trial managers to perform their oversightof the trials;

·       thefailure of our clinical investigational sites and related facilities andrecords to be in compliance with the FDA’s Good Clinical Practices;

·       inabilityto enroll study subjects;

·       ourinability to reach agreement with the FDA on a trial design that we are able toexecute; or

·       theFDA placing a trial on “clinical hold” or temporarily or permanently stopping atrial for a variety of reasons, principally for safety concerns.

If clinical trials for ourdrug candidates are unsuccessful, delayed, or cancelled, we will be unable tomeet our anticipated development and commercialization timelines, which couldharm our business and cause our stock price to decline.

**We will need toobtain regulatory approvals for our other drug candidates, and our ability togenerate revenues from the commercialization and sale of products resultingfrom our development efforts will be limited by any failure to obtain theseapprovals.**

The FDA and comparable regulatory agencies in foreigncountries impose substantial requirements for the development, production andcommercial introduction of drug products. These include lengthy and detailedpre-clinical, laboratory and clinical testing procedures, sampling activitiesand other costly and time-consuming procedures. All of our drug candidates willrequire governmental approvals for commercialization. To date, we have notobtained government approval in the United States for any drug product otherthan CUBICIN for the indications of cSSSI and *S.aureus* bacteremia, including those with right-sided infectiveendocarditis. Our collaborator, Novartis, has received approval for marketingCUBICIN in the European Union for the indication of cSSTI and in Argentina forcSSSI, our collaborator, TTY Biopharm Co. Ltd has received approval formarketing CUBICIN in Taiwan for cSSSI, and our collaborator, Medison Pharma,Ltd., has received approval for marketing CUBICIN in Israel for the sameindications for which we have approval in the United States. We and ourpartners are pursuing approvals for CUBICIN in various other countries.Pre-clinical testing, clinical trials and manufacturing of our drug candidateswill be subject to rigorous and extensive regulation by the FDA andcorresponding 

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foreign regulatoryauthorities. In addition, regulation is not static and regulatory authorities,including the FDA, evolve in their staff, interpretations and practices and mayimpose more stringent requirements than currently in effect, which mayadversely affect our planned drug development and/or our sales and marketingefforts. Satisfaction of the requirements of the FDA and of foreign regulatoryagency requirements typically takes a significant number of years and can varysubstantially based upon the type, complexity and novelty of the drugcandidate. The approval procedure and the time required to obtain approval alsovaries among countries. Regulatory agencies may have varying interpretations ofthe same data, and approval by one regulatory authority does not ensureapproval by regulatory authorities in other jurisdictions.

No product can receive FDA approval unless humanclinical trials show both safety and efficacy for each target indication inaccordance with FDA standards. We have limited experience conducting clinicaltrials. The large majority of drug candidates that begin human clinical trialsfail to demonstrate the desired safety and efficacy characteristics. Failure todemonstrate the safety and efficacy of our drug candidates for each targetindication in clinical trials would prevent us from obtaining requiredapprovals from regulatory authorities, which would prevent us fromcommercializing those drug candidates. The results of our clinical testing of adrug candidate may cause us to suspend, terminate or redesign our clinicaltesting program for that drug candidate. We cannot be sure when we,independently or with our collaborators, might be in a position to submitadditional drug candidates for regulatory review. Negative or inconclusiveresults from the clinical trials or adverse medical events during the trialscould cause them to be repeated or extended, or a program to be terminated,even if other studies or trials relating to the program are successful. Inaddition, data obtained from clinical trials are susceptible to varyinginterpretations that could delay, limit or prevent regulatory approval and caneven effect the commercial success of a product that is already on the marketbased on earlier trials, such as CUBICIN. In addition, we cannot be sure thatregulatory approval will be granted for drug candidates that we submit forregulatory review. Moreover, if regulatory approval to market a drug product isgranted, the approval may impose limitations on the indicated use for which thedrug product may be marketed as well as additional post-approval requirements.

Our ability to generaterevenues from the commercialization and sale of additional drug products willbe limited by any failure to obtain these approvals.

**The FDA may change its approval requirementsor policies for antibiotics, or apply interpretations to its requirements orpolicies, in a manner that could delay or prevent commercialization of any newantibiotic product candidates or any additional indications for CUBICIN that wemay seek in the United States.**

Regulatory requirements for the approval of antibiotics in the UnitedStates may change in a manner that requires us to conduct additionallarge-scale clinical trials, which may delay or prevent commercialization ofany new antibiotic product candidates or any additional indications for CUBICINthat we may seek. Historically, the FDA has not required placebo-controlledclinical trials for approval of antibiotics but instead have relied onnon-inferiority studies. In a non-inferiority study, a drug candidate iscompared with an approved antibiotic treatment and it must be shown that theproduct candidate is not less effective than the approved treatment by adefined margin.

In 2006, the FDA, for certain types of antibiotics, refused to acceptsuccessfully completed non-inferiority studies as the basis for approval.Instead, the FDA is requiring for some antibiotic products, or other trialsinvolving comparator antibiotics, placebo-controlled trials demonstrating thesuperiority of a drug candidate to placebo before considering approval. Conductingplacebo-controlled trials for antibiotics can be time-consuming, expensive, anddifficult to complete. Institutional review boards may not grant approval forplacebo-controlled trials because of ethical concerns about denying someparticipating patients access to any antibiotic therapy during the course ofthe trial. Even if institutional review board approval is obtained, it may bedifficult to enroll patients in placebo-controlled trials because certainpatients would not receive antibiotic therapy. In addition, the FDA has notissued guidance articulating 

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new standards or policies for demonstratingthe safety and efficacy of antibiotics, and has not indicated whether allantibiotics would require superiority studies for FDA approval. The lack of guidancefrom the FDA creates uncertainties about the standards for the approval ofantibiotics in the United States. These factors could delay for several yearsor ultimately prevent commercialization of any new antibiotic productcandidates or any additional indications for CUBICIN in the United States forwhich the FDA requires placebo-controlled trials. Even if we complete thesetrials, we may not be able to obtain adequate evidence of safety or efficacy tosupport approval.

Moreover, recent events, including complications arising fromFDA-approved drugs have raised questions about the safety of marketed drugs andmay result in new legislation by the U.S. Congress and increased caution by theFDA and comparable foreign regulatory authorities in reviewing new drugs basedon safety, efficacy or other regulatory approvals. In particular,non-inferiority studies have come under scrutiny from Congress, in part becauseof a congressional investigation as to the safety of Ketek®, an antibiotic approved by the FDA on the basis of non-inferioritystudies. Certain key members of Congress have asked the U.S. GovernmentAccountabilty Office (GAO), an independent, nonpartisan arm of Congress, toinvestigate the FDA’s reliance on non-inferiority studies as a basis for approval.Congress may draft, introduce, and pass legislation that could significantlychange the approval of antibiotics by the FDA.

The increased scrutiny by Congress andregulatory authorities may significantly delay or prevent regulatory approval,as well as impose more stringent product labeling and post-marketing testingrequirements on pharmaceutical products generally, and particularly in ourareas of focus. Any delay in obtaining, or an inability to obtain, applicableregulatory approvals would prevent us from commercializing any new antibioticproduct candidates and any additional indications for CUBICIN, generatingrevenues, and achieving and sustaining profitability.

**If we are unable togenerate revenues from any drug products other than CUBICIN, our ability tocreate long-term shareholder value may be limited.**

Apart from CUBICIN, wehave no other drug products that have been approved by the FDA, and our currentpipeline does not include any drug candidates that are in clinical development.Because of the long development time of drug candidates, even once they are inclinical development, none of the drug candidates that we are currentlydeveloping, even if one were to overcome the significant hurdles of apre-clinical candidate ever making it to the commercial market, would generaterevenues for many years. Unless and until we are able to develop, in-license oracquire other successful drug products, we will continue to rely solely onCUBICIN for our sales revenues. If we are unable to bring any of our current orfuture drug candidates to market, or to acquire any marketed drug products, ourability to create long-term shareholder value may be limited.

**We may not be ableto obtain, maintain or protect certain proprietary rights necessary for thedevelopment and commercialization of CUBICIN, our other drug candidates and ourresearch technologies.**

Our commercial success will depend in part onobtaining and maintaining U.S. and foreign patent protection for CUBICIN, ourdrug candidates, and our research technologies and successfully enforcing anddefending these patents against third party challenges. We consider that in theaggregate our unpatented proprietary technology, patent applications, patentsand licenses under patents owned by third parties are of material importance toour operations. The patent positions of pharmaceutical and biotechnologycompanies can be highly uncertain and involve complex legal and factualquestions. The actual protection afforded by a patent can vary from country tocountry and may depend upon the type of patent, the scope of its coverage andthe availability of legal remedies in the country. Legal standards relating tothe validity and scope of patents covering pharmaceutical and biotechnologicalinventions are continually developing, both in the United States and in otherimportant markets outside the United 

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States. Our patentposition is highly uncertain and involves complex legal and factual questions,and we cannot predict the scope and breadth of patent claims that may beafforded to our patents or to other companies’ patents. We cannot assure youthat the patents we obtain or the unpatented proprietary technology we holdwill afford us significant commercial protection.

The primary composition of matter patent coveringCUBICIN in the United States has expired. We own or have licensed rights to alimited number of patents directed toward methods of administration and methodsof manufacture of CUBICIN. We cannot be sure that patents will be granted withrespect to any of our pending patent applications for CUBICIN, our other drugcandidates, or our research technologies or with respect to any patentapplications filed by us in the future; nor can we be sure that any of ourexisting patents or any patents that may be granted to us in the future will becommercially useful in protecting CUBICIN, our other drug candidates or ourother technology.

The degree of future protection for our proprietaryrights is uncertain. We cannot be certain that the named applicants orinventors of the subject matter covered by our patent applications or patents,whether directly owned by us or licensed to us, were the first to invent or thefirst to file patent applications for such inventions. Third parties maychallenge, infringe, circumvent or seek to invalidate existing or futurepatents owned by or licensed to us. Even if we have valid and enforceablepatents, these patents still may not provide sufficient protection againstcompeting products or processes.

Of particular concern for a company like ours, havingone marketed product, is that third parties may seek to market generic versionsof CUBICIN by filing an Abbreviated New Drug Application, or ANDA, with the FDAin which they claim that patents protecting CUBICIN owned or licensed by us areinvalid, unenforceable and/or not infringed, a so-called Paragraph IV filing.From 1997 through 2002, about one third of all new chemical entities, such asdaptomycin, the chemical ingredient in CUBICIN, have been the subject of aParagraph IV filing. September 2007 will be the first opportunity underUnited States patent law, for a generic company to make a Paragraph IV filing.If such a filing is made, we may need to defend and/or assert our patents,including by filing lawsuits alleging patent infringement. In any of thesetypes of proceedings, a court or other agency with jurisdiction may find ourpatents invalid and/or unenforceable.

If our collaborators or consultants develop inventionsor processes independently that may be applicable to our products underdevelopment, disputes may arise about ownership of proprietary rights to thoseinventions and/or processes. Such inventions and/or processes will notnecessarily become our property but may remain the property of those persons ortheir employers. Protracted and costly litigation could be necessary to enforceand determine the scope of our proprietary rights. Moreover, the laws offoreign countries in which we market our drug products may afford little or noeffective protection of our intellectual property, thereby easing ourcompetitors’ ability to compete with us in such countries.

We have and may in the future engage incollaborations, sponsored research agreements, and other arrangements withacademic researchers and institutions that have received and may receivefunding from U.S. government agencies. As a result of these arrangements, theU.S. government or certain third parties may have rights in certain inventionsdeveloped during the course of the performance of such collaborations and agreementsas required by law or by such agreements.

We also rely on trade secrets and other unpatentedproprietary information in our product development activities. To the extentthat we maintain a competitive advantage by relying on trade secret and unpatentedproprietary information, such competitive advantage may be compromised ifothers independently develop the same or similar technology, resulting in anadverse effect on our business, financial condition and results of operations.We seek to protect trade secrets and proprietary information in part throughconfidentiality provisions and invention assignment provisions in agreementswith our collaborative partners, employees and consultants. It is possible thatthese agreements could be breached and we might not have adequate remedies forany such breaches.

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Our trademarks, CUBICIN and Cubist in the aggregateare considered to be material to our business. These trademarks are covered byregistrations or pending applications for registration in the U.S. Patent andTrademark Office and in other countries. Trademark protection continues in somecountries for as long as the mark is used and, in other countries, for as longas it is registered. Registrations generally are for fixed, but renewable,terms. We cannot assure you that the trademark protection that we have pursuedor will pursue in the future will afford us significant commercial protection.

Beyond the specificconcerns addressed above, intellectual property laws and regulations areconstantly changing, and vary amongst different jurisdictions around the world,in ways that may affect our ability to protect or enforce our rights.

**Third-party patent and intellectual property rightsmay interfere with our ability to commercialize drug products and researchtechnologies.**

Because the patentpositions of pharmaceutical and biotechnology companies can be highly uncertainand involve complex legal and factual questions, there can be no assurance thatthe patents owned and licensed by us, or any future patents, will ensure thatothers will not be issued patents in the United States and elsewhere that mayprevent the sale of our drug products or require licensing and the payment ofsignificant fees or royalties. Moreover, to the extent that any of our drugproducts or methods infringe the patents of a third party, or that our patentsor future patents fail to give us an exclusive position in the subject matterclaimed in those patents, we will be adversely affected. Patent disputes arefrequent and can preclude the commercialization of products. If our drugcandidates, drug products, or processes are found to infringe the patents ofothers or are found to impermissibly utilize the intellectual property ofothers, our development, manufacture and sale of any such infringing drugcandidates or drug products could be severely restricted or prohibited. We maybe unable to avoid infringement of a third-party patent and may have to obtaina license, defend an infringement action, or challenge the validity of a patentin a court of law or agency of competent jurisdiction. A license may beunavailable on terms and conditions acceptable to us, if at all. Intellectualproperty litigation can be expensive and time-consuming, and we may be unableto prevail in any such litigation or devote sufficient resources to pursue suchlitigation. If we do not obtain an appropriate license, if we are found liablefor patent infringement or trade secret misappropriation, or if we are not ableto have such patents declared invalid and/or unenforceable, we may be liablefor significant monetary damages, may encounter significant delays in bringingproducts to market, and/or may be precluded from participating in themanufacture, use, or sale of products or methods of treatment requiring suchlicenses.

**If we are not successful in attracting and retaininghighly qualified personnel, we may not be able to successfully implement ourbusiness strategy.**

Our ability to compete inthe highly competitive biotechnology and pharmaceuticals industries depends inlarge part upon our ability to attract and retain highly qualified managerial,scientific and medical personnel. Historically, we have been highly dependenton our management and scientific and medical personnel. In order to inducevaluable employees to remain at Cubist, we have provided options that vest overtime. The value to employees of these options is significantly affected bymovements in our stock price that we cannot control and may at any time beinsufficient to counteract more lucrative offers from other companies. We havealso provided retention letters to a limited number of key employees. Despiteour efforts to retain valuable employees, members of our management, scientificand medical teams may terminate their employment with us on short notice. Theloss of the services of any of our executive officers or other key employeescould potentially harm our business or financial results. Our success alsodepends on our ability to continue to attract, retain and motivate highlyskilled junior, mid-level, and senior managers as well as junior, mid-level,and senior scientific and medical personnel. Other biotechnology andpharmaceutical companies with which we compete for qualified personnel have 

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greaterfinancial and other resources, different risk profiles, and a longer history inthe industry than we do. They also may provide more diverse opportunities andbetter chances for career advancement. Some of these characteristics may bemore appealing to high quality candidates than what we have to offer. If we areunable to grow our business according to our business plan, including bydeveloping or acquiring additional drug products, we may become a lessattractive place to work for our existing employees and for high qualitycandidates. If we are unable to continue to attract and retain high quality personnel,the rate and success at which we can discover, develop and commercialize drugcandidates will be limited.

**We havecollaborative relationships that may expose us to a number of risks.**

We have entered into, and anticipate continuing toenter into, collaborative arrangements with multiple third parties to discover,test, manufacture and market drug candidates and drug products. In October 2003,we entered into an international license and product supply agreement withNovartis to seek regulatory approvals and commercialize CUBICIN in Europe,Australia, New Zealand, India and certain Central American, South American andMiddle Eastern countries. In April 2006, Novartis AG acquired Chiron. In December 2006,we entered into a license and product supply agreement with AstraZeneca to seekregulatory approvals and commercialize CUBICIN in China and other countries inAsia, Africa and the Middle East. We have also entered into agreements withpartners for the commercialization of CUBICIN in Israel, Taiwan, Canada andSouth Korea. In addition to commercial collaborations, we collaborate with avariety of other companies for manufacturing, clinical trials, clinical andpreclinical testing, and research activities. Collaborations such as these arenecessary for us to research, develop, and commercialize drug candidates. Wecannot be sure that we will be able to establish any additional collaborativerelationships on terms acceptable to us or that we will be able to worksuccessfully with our existing collaborators or their successors.

Reliance oncollaborative relationships poses a number of risks including the following:

·       ourcollaborators may not perform their obligations as expected;

·       thefocus of, amount and timing of resources dedicated by our collaborators totheir respective collaborations with us is not under our control;

·       somedrug candidates discovered in collaboration with us may be viewed by ourcollaborators as competitive with their own drug candidates or drug products;

·       ourcollaborators may not elect to proceed with the development of drug candidatesthat we believe to be promising;

·       disagreementswith collaborators, including disagreements over proprietary rights, contractinterpretation, or the preferred course of development, might cause delays ortermination of the research, development or commercialization of drugcandidates, might lead to additional responsibilities with respect to drugcandidates, or might result in litigation or arbitration, any of which would betime-consuming and expensive; and

·       someof our collaborators might develop independently, or with others, drug productsthat could compete with ours.

Collaborative arrangementswith third parties are a critical part of our business strategy, and anyinability on our part to establish collaborations on terms favorable to us orworking successfully with our collaborators will have an adverse effect on ouroperations and financial performance.

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**A variety of risks associated with our internationalbusiness relationships could materially adversely affect our business.**

We havemanufacturing, collaborative and clinical trial relationships outside theUnited States, and we expect CUBICIN to be marketed worldwide through licenseesand distributors. Consequently, we are, and will continue to be, subject toadditional risks related to operating in foreign countries. Associated risks ofconducting operations in foreign countries include:

·       differingregulatory requirements for drug approvals in foreign countries;

·       thepotential for so-called parallel importing;

·       unexpectedadverse events to CUBICIN that occur in foreign markets that we have notexperienced in the United States;

·       unexpectedchanges in tariffs, trade barriers and regulatory requirements;

·       economicweakness, including inflation, or political instability in particular foreigneconomies and markets;

·       compliancewith tax, employment, immigration and labor laws for employees living ortraveling abroad;

·       foreigntaxes, including withholding of payroll taxes;

·       foreigncurrency fluctuations, which could result in increased operating expenses andreduced revenues, and other obligations incident to doing business in anothercountry;

·       workforceuncertainty in countries where labor unrest is more common than in the UnitedStates;

·       productionshortages resulting from any events affecting raw material supply ormanufacturing capabilities abroad; and

·       businessinterruptions resulting from geo-political actions, including war andterrorism, and natural disasters in other countries.

These and other risksassociated with our international operations may materially adversely affectour ability to attain or maintain profitable operations.

**We depend on third parties in the conduct of ourclinical trials for CUBICIN and expect to do so with respect to other drugcandidates, and any failure of those parties to fulfill their obligations couldadversely affect our development and commercialization plans.**

We depend on independentclinical investigators, contract research organizations and other third partyservice providers in the conduct of our clinical trials for CUBICIN and expectto do so with respect to other drug candidates. We rely heavily on theseparties for successful execution of our clinical trials but do not control manyaspects of their activities. For example, the investigators are not ouremployees. However, we are responsible for ensuring that each of our clinicaltrials is conducted in accordance with the general investigational plan andprotocols for the trial. Third parties may not complete activities on scheduleor may not conduct our clinical trials in accordance with regulatoryrequirements or our stated protocols. The failure of these third parties tocarry out their obligations could delay or prevent the further development,approval and commercialization of CUBICIN and that of future drug candidates.

**We have incurredsubstantial losses in the past and may incur additional losses.**

Since we began operations, we have incurredsubstantial net losses in every fiscal period until the third quarter of2006. We incurred a net loss of $0.4 million for the year ended December 31,2006 and 

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$31.9 million for theyear ended December 31, 2005. At December 31, 2006, we had anaccumulated deficit of $484.2 million. These losses have resulted from costsassociated with conducting research and development, conducting clinicaltrials, commercialization efforts and associated administrative costs.

We cannot be certain thatwe will not incur additional operating losses related to the continueddevelopment and commercialization of CUBICIN, the development of our other drugcandidates, as well as investments in other product opportunities. As a result,we cannot make specific predictions about our future profitability. If we failto maintain profitability, the market price of our common stock may decline.

**We may requireadditional funds.**

Until the third quarter of 2006, we were not aself-sustaining business, and we cannot guarantee that certain economic andstrategic factors will not require us to seek additional funds. We believe thatthe net proceeds from our recent convertible debt offering, our existing cash,cash equivalents, investments and the anticipated cash flow from revenues willbe sufficient to fund our operating expenses, debt obligations and capitalrequirements under our current business plan for the foreseeable future. Weexpect capital outlays and operating expenditures to increase over the nextseveral years as we continue our commercialization of CUBICIN, actively seek toacquire or in-license additional products or product candidates, and expand ourresearch and development activities and infrastructure. We may need to spendmore money than currently expected because of unforeseen circumstances orcircumstances beyond our control. We have no committed sources of capital anddo not know whether additional financing will be available when needed, or, ifavailable, that the terms will be favorable to our shareholders or us.

We may seek additional funding through public orprivate financing or other arrangements with collaborators. If we raiseadditional funds by issuing equity securities, further dilution to existingstockholders may result. In addition, as a condition to providing additionalfunds to us, future investors may demand, and may be granted, rights superiorto those of existing stockholders. We cannot be certain, however, thatadditional financing will be available from any of these sources or, ifavailable, will be available on acceptable or affordable terms.

Our annual debt service obligationson our $350.0 million 2.25% subordinated convertible notes due in June 2013are approximately $7.9 million per year in interest payments. We may addadditional lease lines to finance capital expenditures and may obtainadditional long-term debt and lines of credit. If we issue other debtsecurities in the future, our debt service obligations will increase further.If we are unable to generate sufficient cash to meet these obligations and needto use existing cash or liquidate investments in order to fund our debt serviceobligations or to repay our debt, we may be forced to delay or terminateclinical trials or curtail operations. We may also be forced to obtain fundsthrough collaborative and licensing arrangements that may require us to relinquishcommercial rights or potential markets or grant licenses on terms that are notfavorable to us. If we fail to obtain additional capital, if needed, we willnot be able to execute our current business plan successfully.

**We may undertake additional strategic acquisitions inthe future, and we may not realize the benefits of such acquisitions.**

Although we have limitedexperience in acquiring businesses and have completed only one businessacquisition since our inception, we may acquire additional businesses that webelieve will complement or augment our existing business. Acquisitions involvea number of risks, including: diversion of management’s attention from currentoperations; disruption of our ongoing business; difficulties in integrating andretaining all or part of the acquired business, its customers and itspersonnel; assumption of disclosed and undisclosed liabilities; dealing withunfamiliar laws, customs and practices in foreign jurisdictions; and theeffectiveness of the acquired company’s internal controls and procedures. Theindividual or combined effect of these risks could have a material adverseeffect on our business. As well, 

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inpaying for an acquisition we may deplete our cash resources or dilute ourshareholder base by issuing additional shares. Furthermore, there is the riskthat our valuation assumptions and our models for an acquired product orbusiness may be erroneous or inappropriate due to foreseen or unforeseencircumstances and thereby cause us to overvalue an acquisition target. There isalso the risk that the contemplated benefits of an acquisition may notmaterialize as planned or may not materialize within the time period or to theextent anticipated. If we acquire businesses with promising drug candidates ortechnologies, we may not be able to realize the benefit of acquiring suchbusinesses if we are unable to move one or more drug candidates throughpre-clinical and/or clinical development to regulatory approval andcommercialization We cannot assure you that, following an acquisition, we willachieve revenues, specific net income or loss levels that justify theacquisition or that the acquisition will result in increased earnings, orreduced losses, for the combined company in any future period. Moreover, we mayneed to raise additional funds through public or private debt or equityfinancing to acquire any businesses, which would result in dilution forstockholders or the incurrence of indebtedness. We may not be able to operateacquired businesses profitably or otherwise implement our growth strategysuccessfully.

**Our business maysuffer if we fail to manage our growth effectively.**

If our potential drugcandidates progress in development or we are able to continue expanding thecommercialization of CUBICIN, we will continue to build our organization andrequire significant additional investment in personnel, management systems andresources. Our ability to develop and grow the commercialization of ourproducts, achieve our research and development objectives, and satisfy ourcommitments under our collaboration agreements depends on our ability torespond effectively to these demands and expand our internal organization toaccommodate additional anticipated growth. If we are unable to manage ourcontinued growth effectively, there could be a material adverse effect on ourbusiness.

***Risks Related to Our Industry***

**We may become involved in patent litigation or otherintellectual property proceedings relating to our products or processes thatcould result in liability for damage or stop our development andcommercialization efforts.**

The pharmaceuticalindustry has been characterized by significant litigation and interference andother proceedings regarding patents, patent applications, trademarks and otherintellectual property rights. The types of situations in which we may becomeparties to such litigation or proceedings include:

·       Weor our collaborators may initiate litigation or other proceedings against thirdparties to enforce our patent rights;

·       Weor our collaborators may initiate litigation or other proceedings against thirdparties to seek to invalidate the patents held by such third parties or toobtain a judgment that our products or processes do not infringe such thirdparties’ patents;

·       Ifour competitors file patent applications that claim technology also claimed byus, we or our collaborators may participate in interference or oppositionproceedings to determine the priority of invention;

·       Ifthird parties initiate litigation claiming that our processes or products infringetheir patent or other intellectual property rights, we and our collaboratorswill need to defend against such proceedings;

·       Ifthird parties initiate litigation claiming that our brand names infringe theirtrademarks, we and our collaborators will need to defend against suchproceedings; and

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·       Ifthird parties file ANDAs with the FDA seeking to market generic versions of ourproducts prior to expiration of relevant patents owned or licensed by us, wemay need to defend our patents, including by filing lawsuits alleging patentinfringement.

An adverse outcome in any litigation or otherproceeding could subject us to significant liabilities to third parties andrequire us to cease using the technology that is at issue or to license thetechnology from third parties. We may not be able to obtain any requiredlicenses on commercially acceptable terms or at all.

The cost of any patentlitigation or other proceeding, even if resolved in our favor, could besubstantial. Some of our competitors may be able to sustain the cost of suchlitigation and proceedings more effectively than we can because of theirsubstantially greater resources. Uncertainties resulting from the initiationand continuation of patent litigation or other proceedings could have a materialadverse effect on our ability to compete in the marketplace. Patent litigationand other proceedings may also absorb significant management time.

**Competitors may develop drug products that make ourdrug products obsolete, less cost effective or otherwise less attractive touse.**

Researchers arecontinually learning more about diseases, which may lead to new technologiesfor treatment. Even if we are successful in developing effective drug products,new drug products introduced after we commence marketing of any drug productmay be safer, more effective, less expensive, or easier to administer than ourdrug products.

**Revenues generated by products we currently market orthat we successfully develop and for which we obtain regulatory approval dependon reimbursement from third**-party payers such that if reimbursement for our products isreduced or is insufficient, there could be a negative impact on the utilizationof our products.

Acceptable levels of reimbursement for costs ofdeveloping and manufacturing drug products and treatments related to those drugproducts by government authorities, private health insurers, and otherorganizations, such as HMOs, can have an affect on the successfulcommercialization of, and attracting collaborative partners to invest in thedevelopment of, our drug products and drug candidates. In both the UnitedStates and in foreign jurisdictions, legislative and regulatory actions canaffect health care systems and reimbursement for our products.

For example, the Medicare Prescription Drug,Improvement, and Modernization Act of 2003, and its implementing regulations,altered the manner in which Medicare sets payment levels for many prescriptiondrugs, including CUBICIN. Under this legislation, beginning in 2005, Medicarereimbursement for CUBICIN was based on average sales price, or the ASP, ratherthan average wholesale price in both the physician office and hospitaloutpatient settings. This resulted in lower payment rates in 2005 as comparedto 2004. Moreover, under this payment methodology the payment rate for CUBICINis set on a quarterly basis based upon the ASP for previous quarters, andsignificant downward fluctuations in such reimbursement rate could negativelyaffect sales of CUBICIN. In addition, further changes to this methodology arepossible. There have been a number of legislative and regulatory actionsaffecting health care systems. The current uncertainty and the potential foradoption of additional changes could affect the timing and amount of ourproduct revenue, our ability to raise capital, obtain additional collaboratorsand market our products. Medicare payments for CUBICIN can influence pricing inthe non-Medicare market as third party payers may base their reimbursement onthe Medicare rate. Also, we cannot be sure that reimbursement amounts will notreduce the demand for, or the price of, our drug products. Any reduction indemand would adversely affect our business. If reimbursement is not availableor is available only at limited levels, we may not be able to obtaincollaborators to manufacture and commercialize drug 

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products, and may not beable to obtain a satisfactory financial return on our own manufacture andcommercialization of any future drug products.

Another relevant aspect of this legislation was theestablishment of an expanded, voluntary Medicare prescription drug benefiteffective January 1, 2006, commonly known as Medicare Part D.Although Cubist was already and continues to be covered by Medicare Part B,and the Part D benefit was intended to cover products that were notpreviously covered by Medicare, such as oral medications, CUBICIN is coveredunder this benefit by some of the private insurance companies that contractwith Medicare to offer Part D plans. These companies have considerablediscretion as to the drugs provided through such offerings. Although we do notexpect many Medicare beneficiaries to obtain CUBICIN through Medicare Part D(and the preexisting Medicare coverage of CUBICIN will continue unchanged),some products that are competitive with CUBICIN but were not previously coveredby Medicare are now covered by Medicare through Part D. If such newcoverage causes physicians to prescribe products competitive with CUBICINinstead of CUBICIN, our product sales could suffer. Because Part D hasbeen implemented for only one year the significant variations in drugs offeredby plans and beneficiary cost sharing obligations among the plans, and thelimited information available on experience to date, we cannot yet concludewhat impact the establishment of Medicare Part D has had or will have onsales of CUBICIN.

Third-party payors areincreasingly challenging prices charged for medical products and services.Also, the trend toward managed health care in the United States and theconcurrent growth of organizations such as HMOs, as well as possiblelegislative changes to reform health care or reduce government insuranceprograms, may result in lower prices for pharmaceutical products, including anyproducts that may be offered by us in the future. Cost-cutting measures thathealth care providers are instituting, and the effect of any health carereform, could materially adversely affect our ability to sell any drug productsthat are successfully developed by us and approved by regulators. Moreover, weare unable to predict what additional legislation or regulation, if any,relating to the health care industry or third-party coverage and reimbursementmay be enacted in the future or what effect such legislation or regulationwould have on our business. Outside the United States, certain countries setprices in connection with the regulatory process. We cannot be sure that suchprices will be acceptable to us or our collaborators or may negatively impactour sales revenue in those countries.

**Our products willbe subject to ongoing regulatory review.**

Regulatory approvals inthe United States and elsewhere can be conditioned on certain factors that maydelay the marketing of drug products and increase the cost of developing,manufacturing, or marketing drug products. Our company, our drug products, themanufacturing facilities for our drug products and our promotion and marketingmaterials are subject to continual review and periodic inspection by the FDAand other regulatory agencies for compliance with pre-approval andpost-approval regulatory requirements, including good manufacturing practices,or GMP, regulations, adverse event reporting, advertising and product promotionregulations, and other requirements. In addition, if there are any modificationsto a drug product that we are developing or commercializing, further regulatoryapproval will be required. Failure to comply with manufacturing and otherpost-approval regulations of the FDA and other regulatory agencies can, amongother things, result in fines, denial or withdrawal of regulatory approvals,product recalls or seizures, forced discontinuance of or changes to importantpromotion and marketing campaigns, operating restrictions and criminalprosecution. Later discovery of previously unknown problems with a drugproduct, manufacturer or facility may result in restrictions on the drugproduct, us or our manufacturing facilities, including withdrawal of the drugproduct from the market. The cost of compliance with pre- and post-approvalregulation may have a negative effect on our operating results and financialcondition.

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**Our corporate compliance program cannot ensure that weare in compliance with all applicable**“fraud and abuse” laws and regulations and other applicable laws and regulations in the jurisdictions in whichwe sell CUBICIN, and a failure to comply with such regulations orprevail in litigation related to noncompliance could harm our business.

Our general operations,and the research, development, manufacture, sale and marketing of our products,are subject to extensive laws and regulation, including but not limited to,health care “fraud and abuse” laws, such as the federal false claims act, thefederal anti-kickback statute, and other state and federal laws andregulations. While we have developed and implemented a corporate complianceprogram based upon what we believe are current best practices, we cannotguarantee that this program will protect us from governmental investigations orother actions or lawsuits stemming from a failure to be in compliance with suchlaws or regulations. If any such actions are instituted against us, and we arenot successful in defending ourselves or asserting our rights, those actionscould have a significant impact on our business, including the imposition ofsignificant fines or other sanctions.

**We could incur substantial costs resulting fromproduct liability claims relating to our pharmaceutical products.**

The nature of our businessexposes us to potential liability risks inherent in the testing, manufacturingand marketing of pharmaceutical and biotechnology products. Our products andthe clinical trials utilizing our products and drug candidates may expose us toproduct liability claims and possible adverse publicity. Product liabilityinsurance is expensive, is subject to deductibles and coverage limitations, andmay not be available in the future. While we currently maintain productliability insurance coverage that we believe is adequate for our currentoperations, we cannot be sure that such coverage will be adequate to cover anyincident or all incidents. In addition, we cannot be sure that we will be ableto maintain or obtain insurance coverage at acceptable costs or in a sufficientamount, that our insurer will not disclaim coverage as to a future claim orthat a product liability claim would not otherwise adversely affect ourbusiness, operating results or financial condition.

**Our use of hazardous materials, chemicals,microorganisms and radioactive compounds exposes us to potential liabilities.**

Our research anddevelopment involves the controlled use of hazardous materials, chemicals,viruses, bacteria and various radioactive compounds. We are subject to numerousenvironmental and safety laws and regulations. We are subject to periodicinspections for possible violations of these laws and regulations. Any suchviolation and the cost of compliance with any resulting order or fine couldadversely effect our operations. Although we believe that our safety proceduresfor handling and disposing of hazardous materials comply with the standardsprescribed by state and federal regulations, we cannot completely eliminate therisk of accidental contamination or injury from these materials. In the eventof an accident or a determination of non-compliance, we could be held liablefor significant damages or fines.

**If we are unable to adequately protect ourconfidential, electronically stored, transmitted and communicated information,it could significantly harm our business.**

In our business, we storeelectronically large amounts of scientific, technical, employee, customer andother data. The amount of confidential, digital information that we store andthat we transmit and communicate to third parties continues to grow astechnology continues to evolve. If we have inadequate security to protect thisinformation from a breach and/or if such a breach should occur, crucialconfidential information about our research, development, employees, customersand future prospects could be unintentionally disclosed. In addition, ourinformation could be improperly disclosed if we are unable to restrict whatthird parties with whom we share such information may do with the information,or how long 

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they mayaccess it. If our competitors were able to acquire our confidential information,our business and future prospects could be harmed.

***Risks Related to Ownership of Our Common Stock***

**Our stock price maybe volatile, and the value of our stock could decline.**

The trading priceof our common stock has been, and is likely to continue to be volatile. Ourstock price could be subject to downward fluctuations in response to a varietyof factors, including the following:

·       failureto meet or exceed revenue and financial projections we provide to the public;

·       actualor anticipated variations in quarterly operating results;

·       failureto meet or exceed the estimates and projections of the investment community;

·       failureof third party reporters of sales data to accurately report our sales figures;

·       adverseresults or delays in clinical trials;

·       ourdecision to initiate a clinical trial, not to initiate a clinical trial or toterminate an existing clinical trial;

·       inabilityto obtain adequate product supply for any approved drug product or inability todo so at acceptable prices;

·       thetermination of a collaboration or the inability to establish additionalcollaborations;

·       adverseregulatory decisions;

·       unanticipatedserious safety concerns related to the use of CUBICIN;

·       introductionof new products or services offered by us or our competitors;

·       announcementsof significant acquisitions, strategic partnerships, joint ventures or capitalcommitments by us or our competitors;

·       expectationsin the financial markets that Cubist may or may not be the target of potentialacquirors;

·       ourfailure to develop additional drug candidates and commercialize additional drugproducts;

·       issuancesof debt or equity securities;

·       significantlawsuits, including stockholder litigation;

·       theperception of the pharmaceutical industry by the public, legislatures,regulators and the investment community; and

·       otherevents or factors, many of which are beyond our control.

In addition, the stockmarket in general, and the NASDAQ Global Select Market and biotechnologycompanies in particular, have experienced extreme price and volume fluctuationsthat have often been unrelated or disproportionate to the operating performanceof these companies. Broad market and industry factors may negatively affect themarket price of our common stock, regardless of our actual operatingperformance. In the past, following periods of volatility in the market priceof a company’s securities, securities class action litigation has often beeninstituted against companies. This type of litigation, if instituted, couldresult in substantial costs and a diversion of management’s attention andresources, which would harm our business.

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**Ifour officers, directors and certain stockholders choose to act together, theymay be able to significantly influence our management and operations, acting intheir best interests and not necessarily those of other stockholders.**

As of January 1,2007, our directors, executive officers and greater than 5% stockholders andtheir affiliates beneficially owned approximately 42% of our issued andoutstanding common stock. Accordingly, they collectively may have the abilityto significantly influence the election of all of our directors and tosignificantly influence the outcome of corporate actions requiring stockholderapproval. They may exercise this ability in a manner that advances their bestinterests and not necessarily those of other stockholders.

**Wehave implemented anti-takeover provisions that could discourage, prevent ordelay a takeover, even if the acquisition would be beneficial to ourstockholders.**

The existence of ourstockholder rights plan and provisions of our amended and restated certificateof incorporation and bylaws, as well as provisions of Delaware law, could makeit difficult for a third party to acquire us, even if doing so would benefitour stockholders.

**ITEM1B.**       UNRESOLVED STAFF COMMENTS

None.

**ITEM2.**                PROPERTIES

Our headquarters arelocated at 65 Hayden Avenue in Lexington, Massachusetts, where we ownapproximately 88,000 square feet of commercial and laboratory space and twelveacres of land.

Our operating leasesconsist of approximately 53,000 square feet of office and data center space at45/55 Hayden Avenue in Lexington, Massachusetts, pursuant to a term lease thatexpires in April 2016, 24,000 square feet of commercial space at 24 EmilyStreet in Cambridge, Massachusetts, pursuant to a term lease that expires in September 2008and 15,000 square feet of commercial space at 148 Sidney Street in CambridgeMassachusetts, pursuant to a term lease that expires in December 2010. Wehave subleased the space located at 24 Emily Street for a term that coincideswith the September 2008 lease expiration. We have subleased the spacelocated at 148 Sidney Street through October 2010.

**ITEM3.**                LEGAL PROCEEDINGS

In response to an inquiryfrom the Company, the staff of the Boston office of the Securities and ExchangeCommission has stated that it does not presently intend to make an enforcementrecommendation to the Commission with regard to the Company arising from theinvestigation referenced on page 40 of our Form 10-Q for the thirdquarter of 2006. The Company understands that this advice is subject to theguidelines in the final paragraph of Securities Act Release No. 5310.

**ITEM4.**                SUBMISSION OFMATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submittedto a vote of security holders during the last quarter of the fiscal year ended December 31,2006.

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**PART II**

**ITEM 5.**                MARKETFOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUERPURCHASES OF EQUITY SECURITIES

The information requiredto be disclosed by Item 201(d) of Regulation S-K, “SecuritiesAuthorized for Issuance Under Equity Compensation Plans,” is included underItem 12 of Part III of this Annual Report on Form 10-K.

**Market Information**

Cubist’scommon stock is traded on the NASDAQ Global Select MarketSM under the symbol CBST. The following tableshows the high and low sales price for Cubist’s common stock as reported by theNASDAQ Global Select MarketSM for each quarter in the years ended December 31,2006 and 2005.

| ** **     | ** ** | **Common Stock Price** | ** ** |
|----------------|------------|----------------------------------|------------|
| ** **     | ** ** | **2006**                         | ** ** | **2005** | ** ** |
| ** **     | ** ** | **High**                         | ** ** | **Low** | ** ** | **High** | ** ** | **Low** | ** ** |
| First Quarter  |       | $                                | 25.30      |   | $ | 19.84 |   | $ | 12.21 |   | $ | 9.78 |   |
| Second Quarter |       | $                                | 26.77      |   | $ | 18.63 |   | $ | 13.54 |   | $ | 8.64 |   |
| Third Quarter  |       | $                                | 25.40      |   | $ | 19.56 |   | $ | 21.56 |   | $ | 12.90 |   |
| Fourth Quarter |       | $                                | 23.35      |   | $ | 17.82 |   | $ | 23.47 |   | $ | 16.69 |   |

 

**Holders**

As of February 23,2007, Cubist had 215 stockholders of record. This figure does not reflectpersons or entities that hold their stock in nominee or “street” name throughvarious brokerage firms.

**Dividends**

Cubist has never declaredor paid cash dividends on its capital stock and does not anticipate paying anydividends in the foreseeable future. The Company intends to retain futureearnings, if any, to operate and expand the business. Payment of any futuredividends will be at the discretion of the board of directors after taking intoaccount various factors, including the Company’s financial condition, operatingresults, cash needs and growth plans.

**Recent Sales ofUnregistered Securities**

None.

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**Corporate Performance Graph**

*The following PerformanceGraph and related information shall not be deemed “soliciting material” or tobe “filed” with the Securities and Exchange Commission, nor shall suchinformation be incorporated by reference into any future filing under theSecurities Act of 1933 or Securities Exchange Act of 1934, each as amended,except to the extent that the Company specifically incorporates it by referenceinto such filing.*

The following graphcompares the performance of Cubist’s common stock to the NASDAQ Stock Market(U.S.) and to the NASDAQ Pharmaceutical Index from December 31, 2001through December 31, 2006. The comparison assumes $100 was invested on December 31,2001 in our common stock and in each of the foregoing indices and assumesreinvestment of dividends, if any. The points on the graph are as of December 31of the year indicated.

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**ITEM 6.**                SELECTEDFINANCIAL DATA

Theselected financial data presented below for the years ended December 31,2006, 2005, 2004, 2003, and 2002 are derived from our audited consolidatedfinancial statements.

| ** **                                                                                            | ** ** | **Year Ended December 31,**                                             | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------|------------|
| ** **                                                                                            | ** ** | **2006**                                                                               | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                                                                                            | ** ** | **(in thousands, except share and per share data)** | ** ** |
| **Statement of Operations Data:**                                                                     | ** ** | ** **                                                                             | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Product revenues,  net                                                                                |       | $                                                                                      | 190,320    |   | $ | 113,514 |   | $ | 58,559 |   | $ | 1,673 |   | $ | — |   |
| Other revenues                                                                                        |       | 4,428                                                                                  |       | 7,131 |   | 9,512 |   | 2,043 |   | 11,486 |   |
| Total revenues, net                                                                                   |       | 194,748                                                                                |       | 120,645 |   | 68,071 |   | 3,716 |   | 11,486 |   |
| Costs and expenses:                                                                                   |       |                                                                                   |       |   |   |   |   |   |   |   |   |
| Cost of product revenues                                                                              |       | 48,803                                                                                 |       | 32,739 |   | 20,249 |   | 816 |   | — |   |
| Research and development                                                                              |       | 57,405                                                                                 |       | 51,673 |   | 57,182 |   | 54,505 |   | 59,012 |   |
| Sales and marketing                                                                                   |       | 56,879                                                                                 |       | 42,331 |   | 35,019 |   | 21,090 |   | 8,703 |   |
| General and administrative                                                                            |       | 26,745                                                                                 |       | 19,335 |   | 20,234 |   | 29,978 | (1) | 17,471 |   |
| Total costs and expenses                                                                              |       | 189,832                                                                                |       | 146,078 |   | 132,684 |   | 106,389 |   | 85,186 |   |
| Interest income                                                                                       |       | 10,589                                                                                 |       | 3,292 |   | 1,767 |   | 2,182 |   | 5,199 |   |
| Interest expense                                                                                      |       | (15,893                                                                                | )          | (9,836 | ) | (13,607 | ) | (13,601 | ) | (13,796 | ) |
| Other income  (expense)                                                                               |       | 12                                                                                     |       | 125 |   | (59 | ) | (911 | ) | (115 | ) |
| Net loss                                                                                              |       | $                                                                                      | (376       | ) | $ | (31,852 | ) | $ | (76,512 | ) | $ | (115,003 | ) | $ | (82,412 | ) |
| Basic and diluted  net loss per common share                                                          |       | $                                                                                      | (0.01      | ) | $ | (0.60 | ) | $ | (1.86 | ) | $ | (3.61 | ) | $ | (2.89 | ) |
| Weighted average number  of common shares outstanding for basic and diluted net loss per common share |       | 54,490,376                                                                             |       | 53,053,307 |   | 41,228,275 |   | 31,872,555 |   | 28,515,435 |   |

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(1)          In2003, Cubist recorded a lease termination charge of $12.9 million relatedto the planned closure of its UK facility.

| ** **                              | ** ** | **Year Ended December 31,** | ** ** |
|-----------------------------------------|------------|--------------------------------------------|------------|
| ** **                              | ** ** | **2006**                                   | ** ** | **2005** | ** ** | **2004** | ** ** | **2003** | ** ** | **2002** | ** ** |
| ** **                              | ** ** | **(in thousands)**                    | ** ** |
| **Balance  Sheet Data:**                |       |                                       |       |   |   |   |   |   |   |   |   |
| Cash, cash  equivalents and investments |       | $                                          | 309,169    |   | $ | 101,748 |   | $ | 128,417 |   | $ | 142,429 |   | $ | 151,220 |   |
| Working capital                         |       | 303,482                                    |       | 99,004 |   | 93,703 |   | 90,530 |   | 131,268 |   |
| Total assets                            |       | 439,035                                    |       | 218,065 |   | 215,908 |   | 222,558 |   | 221,522 |   |
| Total debt                              |       | 350,000                                    |       | 165,000 |   | 165,000 |   | 197,500 |   | 210,033 |   |
| Long-term  obligations                  |       | 351,760                                    |       | 165,000 |   | 165,078 |   | 195,693 |   | 208,022 |   |
| Stockholders’  equity (deficit)    |       | 40,590                                     |       | 16,599 |   | 20,846 |   | (18,216 | ) | (6,900 | ) |
| Dividends                               |       | —                                     |       | — |   | — |   | — |   | — |   |
|                                         |            |                                            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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**ITEM 7.**                MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

*Thefollowing discussion should be read in conjunction with Cubist’s financialstatements and related notes appearing elsewhere in this annual report. Thefollowing discussion contains forward-looking statements. Actual results maydiffer significantly from those projected in the forward-looking statements.Factors that might cause future results to differ materially from thoseprojected in the forward-looking statements include, but are not limited to,those discussed in “Risk Factors” and elsewhere in this annual report. See also“Forward-Looking Statements.”*

**Overview**

Cubist is a biopharmaceutical company headquartered inLexington, Massachusetts, focused on the research, development andcommercialization of pharmaceutical products that address unmet medical needsin the acute care environment. We have one marketed product, CUBICIN, which waslaunched in the U.S. in November 2003. CUBICIN is currently the only marketedonce-daily, bactericidal, intravenous (IV) antibiotic. CUBICIN is approvedin the U.S. for the treatment of cSSSI, caused by *S. aureus*and certain other Gram-positive bacteria, and for *S. aureus*bloodstream infections (bacteremia),including those with right-sided infective endocarditis, caused bymethicillin-susceptible and methicillin-resistant isolates. In the EU, CUBICINis approved for the treatment of complicated skin and soft tissue infections,or cSSTI, caused by certain Gram-positive bacteria and is under regulatoryreview for an expanded label.

Our focus in 2006 was to continue the successfulpromotion and development of CUBICIN by seeking additional indications. On May 25,2006, the FDA approved CUBICIN for the additional indication of *S. aureus,*bloodstream infections (bacteremia), including those with right-sidedinfective endocarditis, caused by methicillin-susceptible andmethicillin-resistant isolates. We expanded our sales force in the firstquarter of 2006 in anticipation of the FDA approval and trained our salesorganization on the details of this important new indication in connection withthe approval.

In June 2006, we issued $350.0 million aggregateprincipal amount of 2.25% convertible subordinated notes resulting in netproceeds to Cubist, after debt issuance costs, of $339.1 million. We used aportion of the proceeds from this offering to repay the principal andoutstanding interest of our $165.0 million aggregate principal amount of 5.5%convertible subordinated notes, plus a prepayment penalty. This prepaymentresulted in charges of $5.7 million related to the prepayment penalty and thewrite-off of debt issuance costs associated with the debt. Our cash, cashequivalents and investments at December 31, 2006 were $309.2 million.

In January 2006, the European Medicines Agency, or EMEA, granted Chiron marketingapproval for CUBICIN in the EU, for the treatment of complicated skin and softtissue infections, or cSSTI, where the presence of susceptible Gram-positivebacteria is confirmed or suspected. In April 2006, Novartis AG acquiredChiron, and, currently, both Novartis AG and its subsidiary Chiron carry outactivities under our license agreement. Novartis began its launch of CUBICIN inthe United Kingdom, Ireland, Benelux, Spain, Austria, Denmark, Finalnd, Norwayand Germany in 2006. In July 2006, Novartis filed an additional marketingauthorization application, or MAA, with the EMEA for an expanded CUBICIN labelin the EU to include *S. aureus*bacteremia including infective endocarditis based on the Phase 3 study whichsupported our May 25, 2006 label expansion. In December 2006,AstraZeneca licensed rights to CUBICIN in China as well as all otherwiseunlicensed CUBICIN territories other than Japan. We are seeking to name aCUBICIN partner for Japan, the last unpartnered country outside the U.S.

We continue to sell CUBICIN in the U.S. in accordancewith our drop-ship program under which orders are processed through wholesalersbut shipments are sent directly to our end-users. This provides us with greatervisibility into end-user ordering and reordering trends. We outsource many ofour supply chain activities, including: (i) manufacturing and supplyingCUBICIN API; (ii) converting CUBICIN API 

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into its finished, vialedand packaged formulation; (iii) managing warehousing and distribution ofCUBICIN to our customers; and (iv) performing the order processing, orderfulfillment, shipping, collection and invoicing services related to our CUBICINproduct sales.

We have focused our pipeline building efforts onopportunities that leverage our antiinfective and acute-care discovery,development, regulatory, and commercialization expertise. We****are currently working to identify viableGram-positive and Gram-negative candidates from our lipopeptide program. We arealso working with Ilypsa to develop a non-antibiotic, toxin bindertherapy for the treatment of *C. difficile*associateddiarrhea (CDAD). In the third quarter of 2006, we decided to discontinue investment in theHepeX-B program and are currently investigating strategic options for thisinvestigational drug to treat patients who have had a liver transplantsecondary to Hepatitis B. We continue to evaluate acute care product candidateswhich we might acquire to build our pipeline.

Since our inception, wehave incurred net losses in every fiscal period until the third quarter of 2006principally as a result of research and development efforts, preclinicaltesting, clinical trials, and administrative costs. As of December 31,2006, we had an accumulated deficit of $484.2 million.

**Results ofOperations**

**Years Ended December 31,2006 and 2005**

*Revenues*

Thefollowing table sets forth revenues for the years ended December 31, 2006and 2005:

| ** **             | ** ** | **December 31,**  | ** ** | ** ** | ** ** |
|------------------------|------------|------------------------|------------|------------|------------|
| ** **             | ** ** | **2006**               | ** ** | **2005**   | ** ** | **% Change** | ** ** |
| ** **             | ** ** | **(in millions)** | ** ** | ** ** | ** ** |
| Product revenues,  net |       |                   | $          | 190.3      |       |   | $ | 113.5 |   |   | 68 | % |   |
| Other revenues         |       |                   | 4.4        |       |       | 7.1 |   |   | -38 | % |   |
| Total revenues,  net   |       |                   | $          | 194.7      |       |   | $ | 120.6 |   |   | 61 | % |   |

 

*Product Revenues,net*

Net sales of CUBICIN were $190.3 million and$113.5 million in 2006 and 2005, respectively. Gross sales of CUBICINtotaled $199.8 million and $118.6 million for the years ended December 31,2006 and 2005, respectively, and are offset by $9.5 million and$5.1 million of allowances for sales returns, Medicaid rebates,chargebacks, prompt-pay discounts, wholesaler management fees and customerrebates. The increase in revenue was primarily due to increased customervolume. Also impacting net product revenues was a 6.6% price increase in October 2005and an additional 6.5% price increase in May 2006. Included in net productrevenues for the year ended December 31, 2006 is $0.8 million ofinternational sales.

We generally do not allowwholesalers to stock CUBICIN. We have a drop-ship program in place throughwhich orders are processed through wholesalers, but shipments are sent directlyto our end-users. This results in sales trends closely tracking actual hospitaland out-patient administration location purchases of our product. In thefuture, we may shift from the drop-ship program to a program that may allowwholesalers to stock CUBICIN, however, we have not determined if or when thechange will occur. If we discontinue the drop-ship program and allowwholesalers to stock CUBICIN, our net product sales may be impacted by thetiming of wholesaler inventory stocking purchases and provisions for returnsbased on estimated product in the distribution channel. Leading wholesalershave begun to seek various fees for data supply and administration services.Net product revenue is reduced by any such fees paid to the wholesalers.

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*Other Revenues*

Other revenues for theyear ended December 31, 2006, were $4.4 million as compared to$7.1 million for the year ended December 31, 2005, a decrease of$2.7 million or 38%. The decrease in other revenues is primarily due to adecrease in revenue related to our 2003 license agreement with Novartis. Otherrevenues under this agreement totaled $4.0 million for the year ended December 31,2006 compared to $6.5 million for the year ended December 31, 2005. Otherrevenues under this agreement recognized in the year ended December 31,2006 consisted of payments received as a result of regulatory and pricing approvals for CUBICIN in Europe which wererecognized as revenue upon their receipt. Other revenues under this agreementrecognized in the year ended December 31, 2005 consisted of therecognition of $4.3 million of previously deferred upfront payments and $2.2million of development revenue. The upfront payments totaled$11.3 million, and included a $3.3 million premium paid upon purchasingour common stock. This $11.3 million was recorded as deferred revenue andwas amortized to license fee revenues over the estimated development period ofthe agreement of two years which was completed in September 2005. Alsoincluded in other revenues for the year ended December 31, 2006 and 2005are Small Business Innovation Research, or SBIR, grant revenue of $0.3 millionand $0.4 million, respectively.

*Costs and Expenses*

Thefollowing table sets forth costs and expenses for the years ended December 31,2006 and 2005:

| ** **                  | ** ** | **December 31,**  | ** ** | ** ** | ** ** |
|-----------------------------|------------|------------------------|------------|------------|------------|
| ** **                  | ** ** | **2006**               | ** ** | **2005**   | ** ** | **% Change** | ** ** |
| ** **                  | ** ** | **(in millions)** | ** ** | ** ** | ** ** |
| Cost of product  revenues   |       | $                      | 48.8       |       | $          | 32.7 |   |   | 49 | % |   |
| Research and  development   |       | 57.4                   |       | 51.7       |       |   | 11 | % |   |
| Sales and  marketing        |       | 56.9                   |       | 42.3       |       |   | 34 | % |   |
| General and  administrative |       | 26.7                   |       | 19.3       |       |   | 38 | % |   |
| Total costs and  expenses   |       | $                      | 189.8      |       | $          | 146.0 |   |   | 30 | % |   |

 

*Cost of ProductRevenues*

Cost of product revenues were $48.8 million and$32.7 million in the years ended December 31, 2006 and 2005,respectively. Our gross margin for the year ended December 31, 2006, was74% as compared to 71% for the year ended December 31, 2005, primarily dueto reduced overall pricing from our manufacturing vendors as well as highervolume****resulting in lower cost perunit sold. Included in our cost of product revenues are royalties owed to EliLilly on net sales of CUBICIN under our license agreement with Eli Lilly. In March of2005, we issued to Eli Lilly $20.0 million of our common stock in exchange fora 2% reduction in the royalties payable to Eli Lilly. In 2003, we issued to EliLilly $8.0 million of our common stock in exchange for a 1% reduction in theroyalties payable to Eli Lilly. We also issued 38,922 shares of our commonstock valued at $0.5 million in 2003 as a milestone payment to Eli Lilly. Theseamounts have been capitalized on our balance sheet as intangible assets and areamortized to cost of product revenues over the remaining life of our licenseagreement with Eli Lilly. Amortization included in cost of product revenuesrelated to these expenses was $2.5 million and $1.9 million for the years endedDecember 31, 2006 and 2005, respectively.

As our production volumesincrease, there is the potential for our gross margin to increase as we work todevelop manufacturing process improvements. Whether that potential can berealized and the extent to which such potential can be realized are uncertain.

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*Research andDevelopment Expense*

Total research and development expense in the yearended December 31, 2006, was $57.4 million as compared to$51.7 million in the year ended December 31, 2005, an increase of$5.7 million or 11%. The increase in research and development expenses wasdue primarily to (i) anincrease of $9.4 million in payroll, benefits, travel and other employeerelated expenses due to increased headcount as well as non-cash stock-basedcompensation charges associated with the implementation of FAS 123(R); (ii) anincrease of $2.1 million in collaborations expense due primarily to costsassociated with our Ilypsa collaboration which we entered into in the secondquarter of 2006; (iii) an increase of $1.2 million in process developmentcosts associated with the development of our lipopeptide program; (iv) anincrease of $0.9 million in research grants; (v) an increase of $1.3million in lab supplies, equipment, and services; (vi) an increase of $0.7million in non-clinical studies; and (vii) an increase of $0.7 million inpublications expense. These increases were offset by (i) a decrease of$6.2 million in clinical study costs due primarily to our decision todiscontinue investment in our HepeX-B program as well as the completion of ourclinical trial of CUBICIN in the treatment of bacteremia with known orsuspected endocarditis caused by *S. aureus*; (ii) a$1.6 million decrease in medical education expense; and (iii) a $0.7million decrease in process development costs related to HepeX-B. Additionally,$1.6 million of manufacturing development costs associated with our licenseagreement with Novartis, and $0.8 million of costs related to the establishmentof a second API manufacturer and a second fill-finish manufacturer for ourCUBICIN product were incurred in 2005 and were not repeated in 2006.

We expect to continueincurring substantial research and development expenses related to: (i) Phase2 and Phase 4 clinical trials for CUBICIN; (ii) pre-clinical and clinicaltesting of other products under development, such as our lipopeptide programand potential compounds under our natural products screening program; (iii) regulatorymatters; and (iv) medical affairs activities.

*Sales and MarketingExpense*

Sales and marketingexpense in the year ended December 31, 2006, was $56.9 million ascompared to $42.3 million in the year ended December 31, 2005, anincrease of $14.5 million or 34%. The increase in sales and marketingexpense is primarily due to an increase of $12.4 million in payroll, benefits,travel and other employee related expenses due to our sales force expansion inthe first quarter of 2006 and the non-cash stock-based compensation charges associatedwith the implementation of FAS 123(R). Also included in sales and marketingexpense is an increase of $2.8 million in promotional programs.

*General andAdministrative Expense*

General and administrativeexpense in the year ended December 31, 2006, was $26.7 million ascompared to $19.3 million in the year ended December 31, 2005, anincrease of $7.4 million or 38%. This increase is primarily due to (i) anincrease of $4.7 million in payroll, benefits and other employee relatedexpenses due to headcount growth and the non-cash stock-based compensation charges associated with the implementationof FAS 123(R); (ii) an increase of $1.6 million in professional services; and(iii) an increase of $0.9 million in rent expense due to additional space wehave leased at 55 Hayden Avenue in Lexington, MA.

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*Other Expense, net*

Thefollowing table sets forth other expense, net for the years ended December 31,2006 and 2005: 

| ** **                | ** ** | **December 31,**  | ** ** | ** ** | ** ** |
|---------------------------|------------|------------------------|------------|------------|------------|
| ** **                | ** ** | **2006**               | ** ** | **2005**   | ** ** | **% Change** | ** ** |
| ** **                | ** ** | **(in millions)** | ** ** | ** ** | ** ** |
| Interest income           |       | $                      | 10.6       |       | $          | 3.3 |   |   | 222 | % |   |
| Interest expense          |       | (15.9                  | )          | (9.8       | )          |   | 62 | % |   |
| Other income              |       | —                 |       | 0.1        |       |   | -90 | % |   |
| Total other  expense, net |       | $                      | (5.3       | )          | $          | (6.4 | ) |   | (18 | )% |   |

 

*Interest Income andExpense*

Interest income in the year ended December 31,2006, was $10.6 million as compared to $3.3 million in the year endedDecember 31, 2005, an increase of $7.3 million or 222%. The increasein interest income was due to a higher average cash balance from June toDecember 2006 compared to the same period in 2005 as well as higher rates ofreturn on our investments. The higher average cash balance is due to the netproceeds of $339.1 million resulting from the closing of our $350.0 millionaggregate principal amount of 2.25% convertible subordinated notes offering onJune 6, 2006, offset by the repayment of the principal and outstanding interestof our $165.0 million aggregate principal amount of 5.5% convertiblesubordinated notes, plus a prepayment penalty. 

Interest expense in theyear ended December 31, 2006, was $15.9 million as compared to $9.8million in the year ended December 31, 2005, an increase of $6.1 million or62%. The increase in interest expense is primarily due to the early repaymentof our $165.0 million aggregate principal amount of 5.5% convertiblesubordinated notes due in November 2008 on June 28, 2006. The early repaymentof the $165.0 million aggregate principal amount of 5.5% convertiblesubordinated notes resulted in charges to interest expense of the prepaymentpenalty of $3.9 million as well as the write-off of the remaining unamortizedbalance of related debt issuance costs of $1.8 million. 

*Other Income*

Other income in the yearended December 31, 2006, was $0 as compared to $0.1 million in theyear ended December 31, 2005. Other income for the year ended December 31,2005 primarily consisted of a gain of $0.1 million due to the merger of Syrrx,Incorporated, or Syrrx, and Takeda Pharmaceutical Company Limited, whichresulted in the return of our original investment in Syrrx.

**Years EndedDecember 31, 2005 and 2004**

*Revenues*

Thefollowing table sets forth revenues for the year ended December 31, 2005 and2004:

| ** **             | ** ** | **December 31,**  | ** ** | ** ** | ** ** |
|------------------------|------------|------------------------|------------|------------|------------|
| ** **             | ** ** | **2005**               | ** ** | **2004**   | ** ** | **% Change** | ** ** |
| ** **             | ** ** | **(in millions)** | ** ** | ** ** | ** ** |
| Product revenues,  net |       | $                      | 113.5      |       | $          | 58.6 |   |   | 94 | % |   |
| Other revenues         |       | 7.1                    |       | 9.5        |       |   | -25 | % |   |
| Total revenues,  net   |       | $                      | 120.6      |       | $          | 68.1 |   |   | 77 | % |   |

 

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*Product Revenues,net*

Net sales of CUBICIN were$113.5 million and $58.6 million in 2005 and 2004, respectively. Grosssales of CUBICIN totaled $118.6 million and $60.6 million for theyears ended December 31, 2005 and 2004, respectively, and are offset by$5.1 million and $2.0 million of allowances for sales returns,Medicaid rebates, chargebacks, prompt-pay discounts and wholesaler managementfees. The increase in revenue was primarily due to increased customer volume.Also impacting net product revenues was a 6.6% price increase in October 2005and a 6% price increase in November 2004.

*Other Revenues*

Other revenues for theyear ended December 31, 2005 were $7.1 million as compared to $9.5 million forthe year ended December 31, 2004, a decrease of $2.4 million or 25%. Thisdecrease was primarily due to the recognition in 2004 of $2.5 million ofpreviously deferred license fee revenues related to our 1999 cross licenseagreement with Diversa upon the expiration of a repayment provision. Otherrevenues related to our 2003 license agreement with Novartis were $6.5 millionand $5.9 million for the years ended December 31, 2005 and 2004, respectively. Underthis agreement, we received up-front payments totaling $11.3 million,including a $3.3 million premium paid upon purchasing our common stock.This $11.3 million was recorded as deferred revenue and was amortized tolicense fee revenues over the estimated development period of the agreement oftwo years which was completed in September 2005. The final $4.3 million ofrevenue related to these deferred amounts was recognized during the year endedDecember 31, 2005, as compared to $5.7 million of revenue recognizedfor the year ended December 31, 2004. Development revenue related to this agreement,included in other revenues, of $2.2 million, was recognized for the year endedDecember 31, 2005 compared to $0.3 million of development revenue for the yearended December 31, 2004. Also included in other revenues for the years endedDecember 31, 2005 and 2004 are SBIR grant revenues of $0.4 million and $0.9million, respectively.

*Costs and Expenses*

Thefollowing table sets forth costs and expenses for the year ended December 31,2005 and 2004:

| ** **                  | ** ** | **December 31,**  | ** ** | ** ** | ** ** |
|-----------------------------|------------|------------------------|------------|------------|------------|
| ** **                  | ** ** | **2005**               | ** ** | **2004**   | ** ** | **% Change** | ** ** |
| ** **                  | ** ** | **(in millions)** | ** ** | ** ** | ** ** |
| Cost of product  revenues   |       | $                      | 32.7       |       | $          | 20.3 |   |   | 62 | % |   |
| Research and  development   |       | 51.7                   |       | 57.2       |       |   | -10 | % |   |
| Sales and  marketing        |       | 42.3                   |       | 35.0       |       |   | 21 | % |   |
| General and  administrative |       | 19.3                   |       | 20.2       |       |   | -4 | % |   |
| Total costs and  expenses   |       | $                      | 146.0      |       | $          | 132.7 |   |   | 10 | % |   |

 

*Cost of ProductRevenues*

Cost of product revenueswere $32.7 million and $20.3 million in the year endedDecember 31, 2005 and 2004, respectively. Our gross margin for the yearended December 31, 2005, was 71% as compared to 65% for the year ended December31, 2004, primarily due to reduced overall pricing from our manufacturingvendors as well as higher volume****resultingin lower cost per unit sold. Included in our cost of product revenues areroyalties owed to Eli Lilly on net sales of CUBICIN under our license agreementwith Eli Lilly. In March of 2005, we issued to Eli Lilly $20.0 million of ourcommon stock in exchange for a 2% reduction in the royalties payable to EliLilly. In 2003, we made payments to Eli Lilly totaling $8.5 million in the formof common stock related to our license agreement with Eli Lilly. Amortizationincluded in cost of product revenues related to these expenses was $1.9 millionand $0.7 million for the year ended December 31, 2005 and 2004, respectively.

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*Research and Development Expense*

Total research anddevelopment expense in the year ended December 31, 2005, was$51.7 million as compared to $57.2 million in the year endedDecember 31, 2004, a decrease of $5.5 million or 10%. The decreasefrom 2004 to 2005 is primarily due to $3.9 million of costs incurred in 2004related to the CAB-175 program which was discontinued in 2004, a decrease of$3.3 million in clinical trial expenses and a decrease of $2.8 million in costsrelated to the establishment of a second API manufacturer and a secondfill-finish manufacturer for our CUBICIN product, which both became fullyoperational in the first quarter of 2005. These decreases were partially offsetby $1.6 million in increased manufacturing development costs incurred in 2005associated with our license agreement with Chiron; an increase of $1.3 millionin medical education expenses and an increase of $0.9 million in lab servicesexpenses.

*Sales and Marketing Expense*

Sales and marketingexpense in the year ended December 31, 2005, was $42.3 million ascompared to $35.0 million in the year ended December 31, 2004, anincrease of $7.3 million or 21%. The increase in sales and marketingexpense is primarily due to an increase of $6.2 million in salaries, benefits,travel and other employee related expenses due to our sales force expansion inthe first quarter of 2005 as well as an increase in expenses in anticipation ofthe approval by the FDA to expand CUBICIN’s label for use in *S. aureus* bacteremia with known or suspected endocarditis.

*General and Administrative Expense*

General and administrativeexpense in the year ended December 31, 2005, was $19.3 million ascompared to $20.2 million in the year ended December 31, 2004, adecrease of $0.9 million or 4%. The decrease in general and administrativeexpense is primarily due to the $2.2 million impairment charge recorded in thefourth quarter of 2004 to write down a patent, unrelated to our CUBICINproduct, to its net realizable value. Also contributing to the decrease is $0.4million of lower depreciation and amortization expense, primarily due to thelower patent amortization per month as a result of the patent impairmentcharge. These decreases are offset primarily by $2.1 million of higher salariesand other employee related expenses as a result of our growth.

*Other Expense, net*

Thefollowing table sets forth other expense, net for the year endedDecember 31, 2005 and 2004: 

| ** **               | ** ** | **December 31,**  | ** ** |
|--------------------------|------------|------------------------|------------|
| ** **               | ** ** | **2005**               | ** ** | **2004** | ** ** | **% Change** | ** ** |
| ** **               | ** ** | **(in millions)** | ** ** | ** ** | ** ** |
| Interest income          |       | $                      | 3.3        |   | $ | 1.8 |   |   | 86 | % |   |
| Interest expense         |       | (9.8                   | )          | (13.6 | ) |   | -28 | % |   |
| Other income  (expense)  |       | 0.1                    |       | (0.1 | ) |   | -312 | % |   |
| Total other expense, net |       | $                      | (6.4       | ) | $ | (11.9 | ) |   | -46 | % |   |

 

*Interest Income and Expense*

Interest income in theyear ended December 31, 2005, was $3.3 million as compared to$1.8 million in the year ended December 31, 2004, an increase of$1.5 million or 86%. The increase in interest income was due to a higheraverage cash balance throughout 2005 as compared to 2004 and as a result ofholding more investments in auction rate securities which have had a higherrate of return as compared to our other investment vehicles.

Interest expense in theyear ended December 31, 2005, was $9.8 million as compared to $13.6million in the year ended December 31, 2004, a decrease of $3.8 million or28%. We repaid the remaining 

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outstandingaggregate principal amount of our 81⁄2% senior convertible notes inDecember 2004. Our remaining debt obligation as of December 31, 2005,related to our $165.0 million aggregate principal amount of our 51⁄2%subordinated convertible notes due in 2008. Interest expense related to our$165.0 million aggregate principal amount of our 51⁄2 % subordinatedconvertible notes was approximately $9.1 million for both years endedDecember 31, 2005 and 2004. Interest expense related to our 81⁄2% seniorconvertible notes was zero and approximately $3.2 million in 2005 and2004, respectively. Included in interest expense for the years endedDecember 31, 2005 and 2004 is $0.8 million and $1.2 million ofinterest expense related to the amortization of debt issuance costs.

*Other Income(Expense)*

Other income in the yearended December 31, 2005, was $0.1 million as compared to otherexpense of $0.1 million in the year ended December 31, 2004.

**Liquidity andCapital Resources**

Currently, werequire cash to fund our working capital needs, to purchase capital assets, andto pay our debt service, including principal, interest and capital leaseobligations. We fund our cash requirements through the following methods:

·       salesof CUBICIN;

·       paymentsfrom our strategic collaborators including license fees, royalties andmilestone payments, sponsored research funding and research grants;

·       equityand debt financings; and

·       interestearned on invested capital.

We have incurred net losses since our inception untilthe third quarter of 2006, principally as a result of research and developmentefforts including pre-clinical testing and clinical trials. As ofDecember 31, 2006, we had an accumulated deficit of $484.2 million. Weexpect to incur significant expenses in the future for the continueddevelopment and commercialization of CUBICIN for additional indications, thedevelopment of our other drug candidates, as well as investments in otherproduct opportunities. Our total cash, cash equivalents and investments atDecember 31, 2006, were $309.2 million as compared to$101.7 million at December 31, 2005. Based on our current businessplan, we believe that our existing cash, cash equivalents, investments andprojected cash inflows from revenues will be sufficient to fund our operatingexpenses, debt obligation and capital requirements under our current businessplan for the foreseeable future. Certain economic or strategic factors mayrequire that we seek to raise additional cash by selling debt or equitysecurities. However, such funds may not be available when needed, or, we maynot be able to obtain funding on favorable terms, or at all.

Net cash provided by operating activities was$30.7 million in 2006, compared to net cash used in operating activitiesof $30.6 million and $90.2 million in 2005 and 2004, respectively.Net cash provided by operating activities in 2006 includes our net loss for theyear of $376,000 offset by non-cash charges of $25.1 million that primarilyconsists of $11.1 million of stock-based compensation expenses, $9.2 million ofdepreciation and amortization expense, $3.1 million of amortization of debtissuance costs and $1.8 million in expense associated with our401(k) company match that is made in the form of common stock shares.Accounts receivable increased $6.4 million due to increased sales of CUBICIN.Inventory increased $1.4 million primarily due to increased purchases fromour manufacturing vendors as we build a sufficient supply of CUBICIN to meetprojected sales requirements. These uses of cash were offset by a $10.6 millionincrease in deferred revenue, primarily due to the receipt of a $10.3 millionupfront payment from AstraZeneca. This upfront fee was received as part of ourentering into a license agreement with AstraZeneca for the development andcommercialization of CUBICIN in China and certain other 

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countries in Asia, theMiddle East and Africa not yet covered by existing CUBICIN internationalpartnering agreements.

Net cash used in investing activities in 2006 was$227.8 million, compared to $32.9 million provided by investing activitiesin 2005 and $6.4 million used in investing activities in 2004. Cash used ininvesting activities in 2006 represents cash outflows from the purchase ofsecurities, as well as cash outflows for purchases of property and equipment.Purchases of property and equipment during the year ended December 31,2006, were $7.4 million compared to $2.1 million and $6.9 million inthe years ended December 31, 2005 and 2004, respectively. Property andequipment additions in 2006 consisted primarily of lab equipment, expendituresrelated to building out additional leased space at 55 Hayden Avenue, as well asvarious IT upgrades. Netcash used in investing activities may fluctuate significantly from period toperiod due to the timing of our capital expenditures and other investments.

Net cash of $184.0 million was provided by financingactivities in the year ended December 31, 2006, as compared to $6.2million and $82.9 million provided by financing activities in the years endedDecember 31, 2005 and 2004, respectively. Proceeds from financingactivities in 2006 consisted primarily of net proceeds of $339.1 million fromour public offering of $350.0 million aggregate principal amount of 2.25%convertible subordinated notes as well as $10.0 million from employees’exercise of stock options and purchases of common stock through our employeestock purchase plan. These proceeds were offset by the early repayment of our$165.0 million aggregate principal amount of 5.5% convertible subordinatednotes with an original maturity date of November 2008.

In June 2006, we completed the public offering of$350.0 million aggregate principal amount of 2.25% convertiblesubordinated notes (less financing costs of $10.9 million). The notes are convertibleat any time prior to maturity into common stock at an initial conversion rateof 32.4981 shares of common stock per $1,000 principal amount of convertiblenotes, subject to adjustment upon certain events, which equates toapproximately $30.77 per share. Interest is payable on each June 15 andDecember 15, beginning December 15, 2006.

In March 2005, we announced that we had enteredinto an agreement to purchase from Eli Lilly a 2% reduction in the royalty ratepayable to Eli Lilly on net sales of CUBICIN. We issued to Eli Lilly $20.0 millionin Cubist common stock with associated registration rights. A total of1,876,173 shares were issued at a price of $10.66 in March 2005. Ourglobal royalty rate obligation payable to Eli Lilly on CUBICIN sales wasreduced by two percentage points upon registration of the common stock onApril 22, 2005. In July 2003, we entered into an amendment to thelicense agreement with Eli Lilly and issued to Eli Lilly 723,619 shares ofcommon stock valued at $8.0 million, in consideration for a 1% reductionin the royalty rate payable to Eli Lilly on net sales of CUBICIN.

InNovember 2004, we completed the sale of 10,714,200 shares of common stockat $11.20 per share. Gross proceeds from the stock offering totaled approximately$120.0 million. Proceeds to us, net of $7.6 million in underwriters’commissions, discounts and issuance costs, totaled approximately$112.4 million.

InOctober 2003, we completed the sale of 8,571,410 shares of common stock at$10.50 per share. Gross proceeds from the stock offering totaled approximately$90.0 million. Proceeds to us, net of $5.7 million in underwriters’commissions, discounts and issuance costs, totaled $84.3 million.

In April 2003, we entered into a term loanagreement with Citizen’s Bank under which we borrowed $5.0 million.Advances under this facility were to be repaid over a 24-month period,commencing on June 30, 2003. Interest on the borrowings accrued at thebank’s LIBOR rate plus a margin of 2.75% (5.31% at December 31, 2004). InOctober 2004 we repaid the outstanding principal and interest of$2.0 million under this facility.

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In October 2001, we completed the privateplacement of $165.0 million aggregate principal amount of 51⁄2% convertiblesubordinated notes (less financing costs of $5.3 million). The notes wereconvertible at any time prior to maturity into common stock at a conversionprice of $47.20 per share, subject to adjustment upon certain events. Interestwas payable on each November 1 and May 1, beginning May 1, 2002.Cubist paid $9.1 million in interest on these notes during 2005 and 2004.We used a portion of the proceeds from the June 2006 $350.0 million 2.25%convertible subordinated notes offering to repay the principal and outstandinginterest of our $165.0 million aggregate principal amount of 5.5% convertiblesubordinated notes, plus a prepayment penalty. This repayment resulted incharges of $5.7 million related to the prepayment penalty and the write-off ofdebt issuance costs associated with the debt.

In September 2000, weissued $39.0 million aggregate principal amount of senior convertiblenotes to John Hancock to finance the purchase of our company headquarters. Thefive-year notes carried a coupon rate of 81⁄2% and were convertible at any timeat the option of the holder into our common stock at $63.8625 per share. Cubistretained the right to redeem these notes after three years at 103% of theirprincipal amount outstanding. In December 2003, we repaid$10.0 million of the senior convertible notes. In December 2004, werepaid the outstanding principal and interest of $29.5 million as well asa 3% prepayment penalty of $0.9 million related to these notes.

*ContractualObligations*

Contractual obligations represent futurecash commitments and liabilities under agreements with third parties andexclude contingent liabilities, such as royalties on future sales above thecontractual minimums or known accrued royalty balance, for which we cannotreasonably predict future payment. The following summarizes our significantcontractual obligations at December 31, 2006, and the effects suchobligations are expected to have on our liquidity and cash flows in futureperiods.

| ** **                                  | ** ** | **Payments due by period** | ** ** |
|---------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                  | ** ** | **1 year or**                   | ** ** | **2-3** | ** ** | **4-5** | ** ** | **More than** | ** ** | ** ** | ** ** |
| ** **                                  | ** ** | **less**                                  | ** ** | **Years** | ** ** | **Years** | ** ** | **5 Years** | ** ** | **Total** | ** ** |
| ** **                                  | ** ** | **(in millions)**                    | ** ** |
| Subordinated  convertible notes             |       |                                      | $          | — |   |   | $ | — |   | $ | — |   |   | $ | 350.0 |   |   | $ | 350.0 |   |
| Interest on subordinated  convertible notes |       |                                      | 7.9        |   |   | 15.8 |   | 15.8 |   |   | 11.8 |   |   | 51.3 |   |
| Operating leases,  net of sublease income   |       |                                      | 1.2        |   |   | 2.6 |   | 2.8 |   |   | 6.6 |   |   | 13.2 |   |
| Inventory  purchase obligations             |       |                                      | 23.0       |   |   | 20.0 |   | 22.3 |   |   | 40.1 |   |   | 105.4 |   |
| External  collaborations                    |       |                                      | 12.9       |   |   | — |   | — |   |   | — |   |   | 12.9 |   |
| Total contractual  cash obligations         |       |                                      | $          | 45.0 |   |   | $ | 38.4 |   | $ | 40.9 |   |   | $ | 408.5 |   |   | $ | 532.8 |   |

 

The subordinated convertible notes consist of$350.0 million aggregate principal amount of our 2.25% convertiblesubordinated notes, due in June 2013. These notes require semi-annualinterest payments through maturity.

Our operating leases consist of approximately 53,000square feet of office and data center space at 45/55 Hayden Avenue inLexington, Massachusetts, pursuant to a term lease that expires in April 2016,24,000 square feet of commercial space at 24 Emily Street in Cambridge,Massachusetts, pursuant to a term lease that expires in September 2008 and15,000 square feet of commercial space at 148 Sidney Street in CambridgeMassachusetts, pursuant to a term lease that expires in December 2010. Wehave subleased the space located at 24 Emily Street for a term that coincideswith the September 2008 lease expiration. We have subleased the spacelocated at 148 Sidney Street through October 2010.

The inventory purchaseobligations listed above represent minimum volumes that we are required topurchase from our contract manufacturers. The external collaboration listedabove represents minimum royalties owed on sales of CUBICIN product.

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**Critical AccountingPolicies and Estimates**

Cubist prepares its consolidated financial statementsin conformity with accounting principles generally accepted in the UnitedStates of America. The Company is required to make certain estimates, judgmentsand assumptions that affect certain reported amounts and disclosures; actualamounts may differ.

We believe that thefollowing critical accounting policies affect the more significant judgmentsand estimates used in the preparation of our consolidated financial statements:

·       Revenuerecognition;

·       Inventories;

·       Accrued clinical researchcosts;

·       Investments;

·       Long-livedassets;

·       Income taxes; and

·       Stock-based compensation.

**I.**                   Revenuerecognition

We recognize revenue inaccordance with SEC Staff AccountingBulletin No. 101 (SAB 101), as amended by SAB 104, and EmergingIssues Task Force (EITF) Issue No. 00-21. Principal sources ofrevenue are sales of CUBICIN,license fees and milestone payments that are derived from collaborativeagreements with other biopharmaceutical companies and distribution agreements.We have followed the following principles in recognizing revenue:

*Product Revenues,net*

We recognize revenue from product sales whenpersuasive evidence of an arrangement exists, title to product and associatedrisk of loss has passed to the customer, the price is fixed or determinable,collection from the customer is reasonably assured and we have no furtherperformance obligations. Provisions for returns, chargebacks, discounts,wholesaler management fees and rebates are recorded as a deduction to arrive atour net sales in the same period the related sales are recorded.

Since the launch of CUBICIN in November 2003, wegenerally have not allowed wholesalers to stock CUBICIN. Instead, we instituteda drop-ship program that we have continued to maintain. Under our drop-shipprogram, orders are processed through wholesalers, but shipments are sentdirectly to our end-users, who are generally hospitals and outpatientadministration centers. This results in sales trends closely tracking actualhospital and outpatient administration center purchases of our product, andalso prevents unusual purchasing patterns since it closely tracks end-userdemand.

We maintain a return policy that allows our customersto return product within a specified period prior to and subsequent to theexpiration date. Our estimate of the provision for returns is analyzedquarterly and is based upon many factors, including industry data of productreturn rates, historical experience of actual returns, analysis of level inventoryin the distribution channel, if any, and reorder rates of end-users. If thehistory of our product returns changes, the reserve will be adjustedappropriately. If we discontinue the drop ship program and allow wholesalers tostock CUBICIN, our net product sales may be impacted by the timing ofwholesaler inventory stocking and activity and provisions for returns whichwill be based on estimated product in the distribution channel that may notsell through to end-users.

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We analyze our estimates and assumptions forchargebacks and Medicaid rebate reserves quarterly. Our Medicaid and chargebackreserves have two components: i) an estimate of outstanding claims forknown end-user rebate eligible sales that have occurred, but for which relatedclaim submissions have not been received; and ii) an estimate ofchargebacks and Medicaid rebates based on an analysis of customer sales mixdata to determine which sales may flow through to a rebate or chargebackeligible customer. Because the second component is calculated based on theamount of inventory in the distribution channel, if any, our assessment ofdistribution channel inventory levels impacts our estimated reserverequirements. We accrue for the expected liability at the time we record thesale, however, the time lag between sale and payment of rebate can be lengthy.Due to the time lag, in any particular period our rebate adjustments mayincorporate revisions of accruals for several periods.

Reserves for Medicaid rebate programs are included inaccrued liabilities and were $652,000 and $356,000 at December 31, 2006and 2005, respectively. Reserves for returns, discounts, chargebacks,wholesaler management fees and customer rebates are netted against accountsreceivable and were $2.8 million and $1.4 million at December 31, 2006 and2005, respectively. In the year ended December 31, 2006 and 2005,provisions for sales returns, chargebacks, rebates, wholesaler management feesand prompt-pay discounts that were netted against product revenues totaled $9.5million and $5.1 million, respectively.

We believe that thereserves we have established are reasonable and appropriate based upon currentfacts and circumstances. Applying different judgments to the same facts andcircumstances would result in the estimated amounts for sales returns,chargebacks and Medicaid rebate reserves to vary. However, due to the drop-shipmodel that we currently operate under, and the low level of actual productreturns, chargebacks and Medicaid rebate claims experienced to date, we do notexpect that the differences would be material.

*Multiple ElementArrangements*

We analyze our multipleelement arrangements to determine whether the elements can be separated andaccounted for individually as separate units of accounting in accordance withEITF No. 00-21, “*RevenueArrangements with Multiple Deliverables.”*We recognize up-frontlicense payments as revenue if the license has standalone value and the fairvalue of the undelivered items can be determined. If the license is consideredto have standalone value but the fair value on any of the undelivered itemscannot be determined, the license payments are recognized as revenue over theperiod of performance for such undelivered items or services. We have anarrangement that included an up-front license payment and that obligated us toperform development services and to manufacture and supply drug product. Thepricing for the manufacturing and supply services was determined to be at fairvalue. Although the license was determined to have standalone value, we couldnot establish fair value for the development services and, as such, the licenseand development services were accounted for as a single unit of accounting.Accordingly, the up-front license payment was recognized over the estimated developmentperiod of two years. Our estimate of the development period and ourdetermination that the terms of the manufacturing and supply agreement are atfair value both involve management judgment.

*License Revenues*

Non-refundable licensefees are recognized depending on the provisions of each agreement. License feeswith ongoing involvement or performance obligations are recorded as deferredrevenue once received and are generally recognized ratably over the period ofsuch performance obligation only after both the license period has commencedand the technology has been delivered. If an agreement contains productdevelopment services, the relevant time period for the product developmentphase is based on management estimates and could vary depending on the outcomeof clinical trials and the regulatory 

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approvalprocess. Such changes could materially impact the revenue recognized and as aresult, management reviews the estimates related to the relevant time period ofproduct development quarterly.

*Milestones*

Revenues from milestonepayments related to arrangements under which we have continuing performanceobligations are recognized as revenue upon achievement of the milestone only ifall of the following conditions are met: the milestone payments are non-refundable;achievement of the milestone was not reasonably assured at the inception of thearrangement; substantive effort is involved in achieving the milestone; and theamount of the milestone is reasonable in relation to the effort expended or therisk associated with the achievement of the milestone. If any of theseconditions are not met, the milestone payments are deferred and recognized asrevenue over the term of the arrangement as we complete our performanceobligations. Contingent payments under license agreements that do not involvesubstantial effort on the part of the Company are not considered substantivemilestones. Such payments are recognized as revenue when the contingency is metonly if there are no remaining performance obligations or any remainingperformance obligations are priced at fair value. Otherwise, the contingentpayment is recognized as the Company completes its performance obligationsunder the arrangement.

*Research services*

Revenues from SBIR grantsto conduct research and development are recognized as the eligible costs areincurred up to the granted funding limit.

**II.**              Inventories

Inventories are stated atthe lower of cost or market with cost determined under the first-in, first-out,or FIFO, basis. Included in the cost of inventories are employee stock-basedcompensation costs capitalized under SFAS 123(R). On a quarterly basis, weanalyze our inventory levels, and write-down inventory that is expected toexpire prior to being sold, inventory that has a cost basis in excess of itsexpected net realizable value, inventory in excess of expected salesrequirements, or inventory that has been deemed no longer suitable forcommercial sale through a charge to cost of product revenues. Expired inventoryis disposed of and the related costs are written off. Charges for inventorywrite-downs are not reversed if it is later determined that the product issaleable, therefore, any such inventory would be sold at zero cost. If actualmarket conditions are less favorable than those projected by management,additional inventory write-downs may be required.

**III.**         Accruedclinical research costs

We utilize externalentities such as contract research organizations, independent clinicalinvestigators, and other third-party service providers to assist us with theexecution of our clinical studies. We record costs for clinical studyactivities based upon the estimated amount of services provided but not yetinvoiced for each study, and include these costs in accrued liabilities in ourConsolidated Balance Sheets and within research and development expense in ourConsolidated Statements of Operations. Contracts and studies vary significantlyin length, and are generally composed of a fixed management fee, variableindirect reimbursable costs that have a dollar limit cap, and amounts owed on aper patient enrollment basis. We monitor the activity levels and patient enrollmentlevels of the studies to the extent possible through communication with theservice providers, detailed invoice and task completion review, analysis ofactual expenses against budget, pre-approval of any changes in scope, andreview of contractual terms. These estimates may or may not match the actualservices performed by the service providers as determined by actual patientenrollment levels and other variable activity costs. Clinical trial expensestotaled $2.6 million, $8.8 million and $12.1 million for the yearsended December 31, 2006, 2005, and 2004, respectively. The level ofclinical study expense may vary from period to period based on the number of 

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studiesthat are in process, the duration of the study, the required level of patientenrollment, and the number of sites involved in the study. Clinical trials thatbear the greatest risk of change in estimates are typically those with asignificant number of sites, require a large number of patients, have complexpatient screening requirements and that span multiple years. If we receiveincomplete or inaccurate information from our third-party service providers, wemay under or over estimate activity levels associated with various studies at agiven point in time. In this event, we could record adjustments to prior periodaccruals that increase or reverse research and development expenses in futureperiods when the actual activity level becomes known.

**IV.**           Investments

It is our intent to holdall investments to maturity in accordance with our investment policy. However,if the circumstances regarding an investment were to change, such as a changein an investment’s external credit rating, we would consider a sale of therelated security to minimize any losses. The appropriateness of all investmentclassifications is reviewed at each reporting date.

**V.**                Long-livedassets

In the ordinary course of our business, we incursubstantial costs to purchase and construct property, plant and equipment. Thetreatment of costs to purchase or construct these assets depends on the natureof the costs and the stage of construction. We generally depreciate plant andequipment using the straight-line method over the asset’s estimated economiclife, which ranges from 3 years to 40 years. Determining the economiclives of plant and equipment requires us to make significant judgments that canmaterially impact our operating results. Property and equipment primarilyconsists of our corporate headquarters building.

As of December 31, 2006, there were approximately$25.6 million of net other intangible assets on our consolidated balancesheet, which consisted of patents, intellectual property, acquired technologyrights, manufacturing rights, and other intangibles. We amortize our intangibleassets using the straight-line method over their estimated economic lives,which range from 5 years to 16 years. Determining the economic livesof intangible assets requires us to make significant judgment and estimates,and can materially impact our operating results.

Property and equipment and intangible assets arereviewed for impairment whenever events or changes in circumstances indicatethat the carrying value of an asset may not be recoverable. Judgments regardingthe existence of impairment indicators are based on historical and projectedfuture operating results, changes in the manner of use of the acquired assets,overall business strategy, and market and economic trends. Future events couldcause management to conclude that impairment indicators exist and that certainlong-lived assets are impaired.

In 2004, based on aninternal analysis, we estimated that the undiscounted future cash flows from apatent, unrelated to its CUBICIN product, were less than its carrying value,indicating that the patent was impaired. We recorded an impairment charge of$2.2 million in the quarter ended December 31, 2004 based upon thedifference between the expected discounted future cash flows and its carryingvalue. The $2.2 million charge was recorded to general and administrativeexpense.

**VI.**           IncomeTaxes

We record deferred taxassets and liabilities based on the net tax effects of tax credits, operatingloss carry forwards, and temporary differences between the carrying amounts ofassets and liabilities for financial reporting purposes and the amounts usedfor income tax purposes. We then assess the likelihood that deferred tax assetswill be recovered from future taxable income and, to the extent that wedetermine that recovery is not likely, a valuation allowance is established.The valuation allowance is based on 

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estimatesof taxable income by jurisdiction in which we operate and the period over whichdeferred tax assets will be recoverable. Through December 31, 2006, webelieve it is more likely than not that all of our deferred tax assets will notbe realized and, accordingly, have recorded a valuation allowance against alldeferred tax assets. If results of operations in the future indicate that someor all of the deferred tax assets will be recovered, the reduction of thevaluation allowance will be recorded as a tax benefit during one or over manyperiods.

**VI.**           Stock-BasedCompensation

Effective January 1, 2006, our accounting policyrelated to stock option accounting changed upon our adoption of SFAS 123(R).SFAS 123(R) requires us to expense the fair value of employee stockoptions and other forms of share-based compensation. Under the fair valuerecognition provisions of SFAS 123(R), share-based compensation cost isestimated at the grant date based on the value of the award and is recognized asexpense ratably over the requisite service period of the award (generally thevesting period of the equity award). Determining the appropriate fair valuemodel and calculating the fair value of share-based awards requires judgment,including estimating the expected life of the share-based award, the expectedstock price volatility over the expected life of the share-based award andforfeiture rates.

In order to determine the fair value of share-basedawards on the date of grant, we use the Black-Scholes option-pricing model.Inherent in this model are assumptions related to expected stock pricevolatility, option life, risk-free interest rate and dividend yield. Therisk-free interest rate is a less subjective assumption as it is based onfactual data derived from public sources. We use a dividend yield of zero as wehave never paid cash dividends and have no intention to pay cash dividends inthe immediate future. The expected stock price volatility and option lifeassumptions require a greater level of judgment which makes them criticalaccounting estimates. Estimating forfeitures also requires significantjudgment.

Our expected stock-pricevolatility assumption is based on both current and historical volatilities ofour stock which is obtained from public data sources. The expected liferepresents the weighted average period of time that share-based awards areexpected to be outstanding giving consideration to vesting schedules and ourhistorical exercise patterns. We determine the expected life assumption basedon the exercise behavior and post-vesting behavior that has been exhibitedhistorically, adjusted for specific factors that may influence future exercisepatterns. We estimate forfeitures based on our historical experience ofshare-based pre-vesting cancellations. We believe that our estimates are basedon outcomes that are reasonably likely to occur. To the extent actualforfeitures differ from our estimates, such amounts will be recorded as acumulative adjustment in the period estimates are revised. During the yearended December 31, 2006 we incurred $10.6 million of compensation costunder SFAS 123(R).

**Recent AccountingPronouncements**

In September 2006, the FASB issued SFAS No. 157,*“Fair Value Measurements,”* or SFAS 157,which is effective for financial statements issued for fiscal years beginningafter November 15, 2007 and interim periods within those fiscal years.Early adoption is not permitted. Therefore, we will adopt SFAS No. 157 on January 1,2008. SFAS 157 defines fair value, establishes a framework for measuring fairvalue in accordance with Generally Accepted Accounting Principles, and expandsdisclosures about fair value measurements. The Statement codifies thedefinition of fair value as the price that would be received to sell an assetor paid to transfer a liability in an orderly transaction between marketparticipants at the measurement date. The standard clarifies the principle thatfair value should be based on the assumptions market participants would usewhen pricing the asset or liability and establishes a fair value hierarchy thatprioritizes the information used to develop those assumptions. Theimplementation of SFAS 157 is not expected to have a material impact onthe Company’s financial statements.

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In September 2006, the SEC staff issued StaffAccounting Bulletin Topic 1N (SAB 108), “*FinancialStatements—Considering the Effects of Prior Year Misstatements when QuantifyingMisstatements in Current Year Financial Statements*,” or SAB 108,which is effective for calendar year companies as of December 31, 2006.SAB 108 provides guidance on how prior year misstatements should be takeninto consideration when quantifying misstatements in current year financialstatements for purposes of determining whether the financial statements arematerially misstated. Under this guidance, companies should take into accountboth the effect of a misstatement on the current year balance sheet as well asthe impact upon the current year income statement in assessing the materialityof a current year misstatement. Once a current year misstatement has beenquantified, the guidance in SAB Topic 1M, “Financial Statements—Materiality,”or SAB 99, should be applied to determine whether the misstatement ismaterial. The implementation of SAB 108 did not have an impact on theCompany’s financial statements.

In June 2006, the FASB issued FASB InterpretationNo. 48, “*Accounting for Uncertainty in Income Taxes—anInterpretation of FASB Statement 109”*, or FIN 48. FIN 48 clarifiesthe accounting for uncertainty in income taxes recognized in an enterprise’sfinancial statements in accordance with SFAS No. 109, *“Accountingfor Income Taxes.”* This interpretation requires that we determinewhether it is more likely than not that a tax position will be sustained uponexamination by the appropriate taxing authority. This interpretation alsoprovides guidance on derecognition, classification, interest and penalties,accounting in interim periods, disclosure, and transition. FIN 48 is effectivefor fiscal years beginning after December 15, 2006. The Company iscurrently evaluating the impact of adopting this interpretation.

In May 2005, the FASB issued SFAS No. 154, “*Accounting Changes and Error Corrections*,” or SFAS 154,which replaces APB Opinion No. 20, “*Accounting Changes*,”and FASB Statement No. 3, “*Reporting AccountingChanges in Interim Financial Statements—an amendment of APB Opinion No. 28.*”SFAS 154 changes the requirements of the accounting for and reporting of achange in accounting principle and also provides guidance on the accounting forand reporting of error corrections. Prior to SFAS 154, most voluntary changesin accounting principle were recognized by including in net income of theperiod of change the cumulative effect of changing to the new accounting principle.SFAS 154 requires retrospective application to prior periods’ financialstatements of changes in accounting principle and to changes required by anaccounting pronouncement in the instance that the pronouncement does notinclude specific transition provisions, unless it is impracticable to determineeither the period specific effects or the cumulative effect of the change. SFAS154 is effective for accounting changes and corrections of errors made infiscal years beginning after December 15, 2005. The adoption of SFAS 154did not have a significant impact on the Company’s results of operations.

In December 2004, theFASB issued SFAS No. 151, *“Inventory Costs,”*or SFAS 151. SFAS 151 requires abnormal amounts of inventory costsrelated to idle facility, freight handling and wasted material expenses to berecognized as current period charges. Additionally, SFAS 151 requires thatallocation of fixed production overheads to the costs of conversion be based onthe normal capacity of the production facilities. The standard is effective forfiscal years beginning after June 15, 2005. The adoption of SFAS 151did not have a material impact on the Company’s consolidated financialstatements.

**ITEM 7A.**        QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We invest our cash in a variety of financialinstruments; principally securities issued by the U.S. government and itsagencies, investment grade corporate bonds and notes, auction rate securities,and money market instruments. These investments are denominated in U.S.dollars. All of our interest-bearing securities are subject to interest raterisk, and could decline in value if interest rates fluctuate.

We currently own financial instruments that aresensitive to market risks as part of our investment portfolio. The investmentportfolio is used to preserve capital until it is required to fund operations.None of these market-risk sensitive instruments are held for trading purposes.The investment portfolio includes 

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investment grade debtinstruments. These bonds are subject to interest rate risk, and could declinein value if interest rates fluctuate. Due to our policy to hold theseinstruments to maturity, we do not believe that we have a material exposure tointerest rate risk.

As of December 31, 2006, the fair market value ofour 2.25% convertible subordinated notes due in 2013 amounted to$319.0 million. The estimated fair value of long-term debt was determinedusing quoted market rates. The interest rates on the 2.25% convertiblesubordinated notes and capital lease obligation are fixed and are therefore notsubject to interest rate risk.

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**ITEM8.**                FINANCIALSTATEMENTS

**CubistPharmaceuticals, Inc.Index to Consolidated Financial Statements and Schedule**
|                                                                                                                                            |   |   |
|--------------------------------------------------------------------------------------------------------------------------------------------|--------|--------|
| Report of Independent  Registered Public Accounting Firm                                                                                   |   | 60     |
| Consolidated Balance  Sheets as of December 31, 2006 and 2005                                                                         |   | 62     |
| Consolidated  Statements of Operations for the years ended December 31, 2006, 2005 and  2004                                          |   | 63     |
| Consolidated  Statements of Cash Flows for the years ended December 31, 2006, 2005  and 2004                                     |   | 64     |
| Consolidated  Statements of Changes in Stockholders’ Equity (Deficit) for the years ended  December 31, 2006, 2005 and 2004 |   | 65     |
| Notes to  Consolidated Financial Statements                                                                                                |   | 66     |
| Financial Statement Schedule:                                                                                                              |   |   |
| Schedule  II Valuation and Qualifying Accounts for the years ended December 31,  2006, 2005 and 2004                             |   | 89     |

 

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**REPORTOF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

To the Board of Directors and Stockholders of CubistPharmaceuticals, Inc.:

We have completedintegrated audits of Cubist Pharmaceuticals, Inc.’s consolidated financialstatements and of its internal control over financial reporting as of December 31,2006, in accordance with the standards of the Public Company AccountingOversight Board (United States). Our opinions, based on our audits, arepresented below.

*Consolidatedfinancial statements and financial statement schedule*

In our opinion, the consolidated financial statementslisted in the accompanying index present fairly, in all material respects, thefinancial position of Cubist Pharmaceuticals, Inc. and its subsidiaries atDecember 31, 2006 and 2005, and the results of their operations and theircash flows for each of the three years in the period ended December 31,2006 in conformity with accounting principles generally accepted in the UnitedStates of America. In addition, in our opinion, the financial statementschedule listed in the accompanying index presents fairly, in all materialrespects, the information set forth therein when read in conjunction with therelated consolidated financial statements. These financial statements andfinancial statement schedule are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on these financialstatements and financial statement schedule based on our audits. We conductedour audits of these statements in accordance with the standards of the PublicCompany Accounting Oversight Board (United States). Those standards requirethat we plan and perform the audit to obtain reasonable assurance about whetherthe financial statements are free of material misstatement. An audit offinancial statements includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements, assessing theaccounting principles used and significant estimates made by management, andevaluating the overall financial statement presentation. We believe that ouraudits provide a reasonable basis for our opinion.

As discussed in Note B tothe consolidated financial statements, the Company changed the manner in whichit accounts for share-based compensation in fiscal 2006.

*Internal controlover financial reporting*

Also, in our opinion, management’s assessment,included in Management’s Report on Internal Control Over Financial Reportingappearing under Item 9A, that the Company maintained effective internal controlover financial reporting as of December 31, 2006 based on criteriaestablished in *Internal Control—Integrated Framework*issued by the Committee of Sponsoring Organizations of the Treadway Commission(“COSO”), is fairly stated, in all material respects, based on those criteria.Furthermore, in our opinion, the Company maintained, in all material respects,effective internal control over financial reporting as of December 31,2006, based on criteria established in *Internal Control—IntegratedFramework* issued by the COSO. The Company’s management isresponsible for maintaining effective internal control over financial reportingand for its assessment of the effectiveness of internal control over financialreporting. Our responsibility is to express opinions on management’s assessmentand on the effectiveness of the Company’s internal control over financialreporting based on our audit. We conducted our audit of internal control overfinancial reporting in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that weplan and perform the audit to obtain reasonable assurance about whethereffective internal control over financial reporting was maintained in allmaterial respects. An audit of internal control over financial reportingincludes obtaining an understanding of internal control over financialreporting, evaluating management’s assessment, testing and evaluating thedesign and operating effectiveness of internal control, and performing such otherprocedures as we consider necessary in the circumstances. We believe that ouraudit provides a reasonable basis for our opinions.

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A company’s internal control over financial reportingis a process designed to provide reasonable assurance regarding the reliabilityof financial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles. A company’sinternal control over financial reporting includes those policies andprocedures that (i) pertain to the maintenance of records that, inreasonable detail, accurately and fairly reflect the transactions anddispositions of the assets of the company; (ii) provide reasonableassurance that transactions are recorded as necessary to permit preparation offinancial statements in accordance with generally accepted accountingprinciples, and that receipts and expenditures of the company are being madeonly in accordance with authorizations of management and directors of thecompany; and (iii) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

Because of its inherentlimitations, internal control over financial reporting may not prevent ordetect misstatements. Also, projections of any evaluation of effectiveness tofuture periods are subject to the risk that controls may become inadequatebecause of changes in conditions, or that the degree of compliance with thepolicies or procedures may deteriorate.

/s/ PricewaterhouseCoopersLLP

Boston, MassachusettsMarch 1, 2007

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**CUBIST PHARMACEUTICALS, INC.CONSOLIDATED BALANCE SHEETS**

| ** **                                                                                                                                                                       | ** ** | **December 31,**                                    | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                                                                                                                                       | ** ** | **2006**                                                 | ** ** | **2005** | ** ** |
| ** **                                                                                                                                                                       | ** ** | **(in thousands, except  share amounts)** | ** ** |
| **ASSETS**                                                                                                                                                                       |       |
| Current assets:                                                                                                                                                                  |       |                                                     |       |   |   |
| Cash and cash equivalents                                                                                                                                                        |       | $                                                        | 15,979     |   | $ | 29,149 |   |
| Short-term investments                                                                                                                                                           |       | 278,012                                                  |       | 68,046 |   |
| Accounts receivable, net                                                                                                                                                         |       | 21,070                                                   |       | 14,701 |   |
| Inventory, net                                                                                                                                                                   |       | 18,111                                                   |       | 16,695 |   |
| Prepaid expenses and other current assets                                                                                                                                        |       | 5,195                                                    |       | 5,629 |   |
| Total current assets                                                                                                                                                             |       | 338,367                                                  |       | 134,220 |   |
| Property and  equipment, net                                                                                                                                                     |       | 49,584                                                   |       | 46,027 |   |
| Intangible  assets, net                                                                                                                                                          |       | 25,639                                                   |       | 30,480 |   |
| Long-term  investments                                                                                                                                                           |       | 15,178                                                   |       | 4,553 |   |
| Other assets                                                                                                                                                                     |       | 10,267                                                   |       | 2,785 |   |
| Total assets                                                                                                                                                                     |       | $                                                        | 439,035    |   | $ | 218,065 |   |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                    |       |
| Current  liabilities:                                                                                                                                                            |       |                                                     |       |   |   |
| Accounts payable                                                                                                                                                                 |       | $                                                        | 3,602      |   | $ | 8,543 |   |
| Accrued liabilities                                                                                                                                                              |       | 31,038                                                   |       | 26,595 |   |
| Current portion of capital lease obligations                                                                                                                                     |       | 245                                                      |       | 78 |   |
| Total current liabilities                                                                                                                                                        |       | 34,885                                                   |       | 35,216 |   |
| Long-term  deferred revenue                                                                                                                                                      |       | 11,800                                                   |       | 1,250 |   |
| Other long-term  liabilities                                                                                                                                                     |       | 1,760                                                    |       | — |   |
| Long-term debt                                                                                                                                                                   |       | 350,000                                                  |       | 165,000 |   |
| Total liabilities                                                                                                                                                                |       | 398,445                                                  |       | 201,466 |   |
| Commitments and  contingencies (Notes D, N and O)                                                                                                                                |       |                                                     |       |   |   |
| Stockholders’ equity:                                                                                                                                                       |       |                                                     |       |   |   |
| Preferred stock, non-cumulative; convertible, $.001  par value; authorized 5,000,000 shares; no shares issued and outstanding                                                    |       | —                                                   |       | — |   |
| Common stock, $.001 par value; authorized  100,000,000 shares; 55,001,058 and 53,883,581 shares issued and outstanding  as of December 31, 2006 and 2005, respectively |       | 55                                                       |       | 54 |   |
| Additional  paid-in capital                                                                                                                                                      |       | 524,726                                                  |       | 500,360 |   |
| Accumulated  deficit                                                                                                                                                             |       | (484,191                                                 | )          | (483,815 | ) |
| Total stockholders’ equity                                                                                                                                                  |       | 40,590                                                   |       | 16,599 |   |
| Total liabilities and  stockholders’ equity                                                                                                                                 |       | $                                                        | 439,035    |   | $ | 218,065 |   |

 

The accompanying notes are an integral part of the consolidated financial statements.

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**CUBIST PHARMACEUTICALS, INC.CONSOLIDATED STATEMENTS OF OPERATIONS**

| ** **                                                                                                  | ** ** | **For the Years Ended December 31,**                            | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------|------------|
| ** **                                                                                                  | ** ** | **2006**                                                                                 | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                                                  | ** ** | **(in thousands except share and per share amounts)** | ** ** |
| Revenues:                                                                                                   |       |                                                                                     | ** ** | ** ** |   |   | ** ** |
| Product revenues, net                                                                                       |       | $                                                                                        | 190,320    |   | $ | 113,514 |   | $ | 58,559 |   |
| Other revenues                                                                                              |       | 4,428                                                                                    |       | 7,131 |   | 9,512 |   |
| Total revenues, net                                                                                         |       | 194,748                                                                                  |       | 120,645 |   | 68,071 |   |
| Costs and  expenses:                                                                                        |       |                                                                                     |       |   |   |   |   |
| Cost of product revenues                                                                                    |       | 48,803                                                                                   |       | 32,739 |   | 20,249 |   |
| Research and development                                                                                    |       | 57,405                                                                                   |       | 51,673 |   | 57,182 |   |
| Sales and marketing                                                                                         |       | 56,879                                                                                   |       | 42,331 |   | 35,019 |   |
| General and administrative                                                                                  |       | 26,745                                                                                   |       | 19,335 |   | 20,234 |   |
| Total costs and expenses                                                                                    |       | 189,832                                                                                  |       | 146,078 |   | 132,684 |   |
| Operating income (loss)                                                                                     |       | 4,916                                                                                    |       | (25,433 | ) | (64,613 | ) |
| Other income  (expense):                                                                                    |       |                                                                                     |       |   |   |   |   |
| Interest income                                                                                             |       | 10,589                                                                                   |       | 3,292 |   | 1,767 |   |
| Interest expense                                                                                            |       | (15,893                                                                                  | )          | (9,836 | ) | (13,607 | ) |
| Other income (expense)                                                                                      |       | 12                                                                                       |       | 125 |   | (59 | ) |
| Total other income (expense), net                                                                           |       | (5,292                                                                                   | )          | (6,419 | ) | (11,899 | ) |
| Net loss                                                                                                    |       | $                                                                                        | (376       | ) | $ | (31,852 | ) | $ | (76,512 | ) |
| Basic and diluted net loss per common share                                                                 |       | $                                                                                        | (0.01      | ) | $ | (0.60 | ) | $ | (1.86 | ) |
| Weighted average number  of common shares outstanding for basic and diluted net loss per common  share |       | 54,490,376                                                                               |       | 53,053,307 |   | 41,228,275 |   |

 

The accompanying notes are an integral part of the consolidated financial statements.

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**CUBIST PHARMACEUTICALS, INC.CONSOLIDATED STATEMENTS OF CASH FLOWS**

| ** **                                                                                      | ** ** | **For the Years Ended December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                                                                      | ** ** | **2006**                                                      | ** ** | **2005** | ** ** | **2004** | ** ** |
| ** **                                                                                      | ** ** | **(in thousands)**                                       | ** ** |
| Cash flows from operating activities:                                                           |       |                                                          |       |   |   |   |   |
| Net loss                                                                                        |       | $                                                             | (376       | ) | $ | (31,852 | ) | $ | (76,512 | ) |
| Adjustments to reconcile net loss to net cash  provided by (used in) operating activities: |       |                                                          |       |   |   |   |   |
| Depreciation and  amortization                                                                  |       | 9,194                                                         |       | 7,835 |   | 6,830 |   |
| Patent impairment charge                                                                        |       | —                                                        |       | — |   | 2,241 |   |
| Amortization and  write-off of debt issuance costs                                              |       | 3,123                                                         |       | 760 |   | 1,208 |   |
| Amortization of premium  or discount on investments                                             |       | (144                                                          | )          | 251 |   | 456 |   |
| Stock-based compensation  expense                                                               |       | 11,105                                                        |       | 438 |   | 72 |   |
| Charge for company  401(k) common stock match                                              |       | 1,825                                                         |       | 1,394 |   | 1,048 |   |
| Other non-cash                                                                                  |       | 11                                                            |       | 13 |   | 115 |   |
| Changes in assets and liabilities:                                                              |       |                                                          |       |   |   |   |   |
| Accounts receivable                                                                             |       | (6,369                                                        | )          | (4,847 | ) | (8,544 | ) |
| Inventory                                                                                       |       | (1,447                                                        | )          | (8,681 | ) | (1,098 | ) |
| Prepaid expenses and  other current assets                                                      |       | 434                                                           |       | (2,003 | ) | (1,027 | ) |
| Other assets                                                                                    |       | 273                                                           |       | 162 |   | (351 | ) |
| Accounts payable and  accrued liabilities                                                       |       | 718                                                           |       | 9,639 |   | (6,420 | ) |
| Deferred revenue                                                                                |       | 10,550                                                        |       | (3,700 | ) | (8,168 | ) |
| Other long-term  liabilities                                                                    |       | 1,760                                                         |       | — |   | — |   |
| Total adjustments                                                                               |       | 31,033                                                        |       | 1,261 |   | (13,638 | ) |
| Net cash provided by  (used in) operating activities                                            |       | 30,657                                                        |       | (30,591 | ) | (90,150 | ) |
| Cash flows from investing activities:                                                           |       |                                                          |       |   |   |   |   |
| Purchases of property  and equipment                                                            |       | (7,391                                                        | )          | (2,052 | ) | (6,872 | ) |
| Purchases of investments                                                                        |       | (1,714,151                                                    | )          | (696,142 | ) | (596,134 | ) |
| Maturities of  investments                                                                      |       | 1,493,704                                                     |       | 731,136 |   | 596,600 |   |
| Net cash provided by  (used in) investing activities                                            |       | (227,838                                                      | )          | 32,942 |   | (6,406 | ) |
| Cash flows from financing activities:                                                           |       |                                                          |       |   |   |   |   |
| Issuance of common  stock, net                                                                  |       | 10,010                                                        |       | 6,357 |   | 115,502 |   |
| Proceeds from sale of  convertible subordinated debt                                            |       | 350,000                                                       |       | — |   | — |   |
| Costs associated with  sale of convertible subordinated debt                                    |       | (10,925                                                       | )          | — |   | — |   |
| Repayments of long-term  debt and capital lease obligations                                     |       | (165,078                                                      | )          | (117 | ) | (32,615 | ) |
| Net cash provided by  financing activities                                                      |       | 184,007                                                       |       | 6,240 |   | 82,887 |   |
| Net increase (decrease)  in cash and cash equivalents                                           |       | (13,174                                                       | )          | 8,591 |   | (13,669 | ) |
| Effect of changes in  foreign exchange rates on cash balances                                   |       | 4                                                             |       | (14 | ) | 579 |   |
| Cash and cash  equivalents at beginning of year                                                 |       | 29,149                                                        |       | 20,572 |   | 33,662 |   |
| Cash and cash  equivalents at end of year                                                       |       | $                                                             | 15,979     |   | $ | 29,149 |   | $ | 20,572 |   |
| Cash paid during the year for:                                                                  |       |                                                          |       |   |   |   |   |
| Interest                                                                                        |       | $                                                             | 8,672      |   | $ | 9,075 |   | $ | 13,023 |   |
| Supplemental disclosures of cash flow information:                                              |       |                                                          |       |   |   |   |   |
| Non-cash investing and financing activities:                                                    |       |                                                          |       |   |   |   |   |
| Issuance of common stock  to Eli Lilly                                                          |       | $                                                             | —     |   | $ | 20,000 |   | $ | — |   |
| Capital lease obligations incurred                                                              |       | $                                                             | 245        |   | $ | — |   | $ | — |   |

 

The accompanying notes are an integral part of the consolidated financial statements.

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**CUBIST PHARMACEUTICALS, INC.CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (DEFICIT)**

| ** **                                                                               | ** ** | **Number of**                                                 | ** ** | ** ** | ** ** | **Additional** | ** ** | ** **      | ** ** | **Total**                 | ** ** |
|------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------|------------|------------|------------|----------------|------------|-----------------|------------|---------------------------|------------|
| ** **                                                                               | ** ** | **Common**                                                         | ** ** | **Common** | ** ** | **Paid-in**    | ** ** | **Accumulated** | ** ** | **Stockholders**          | ** ** |
| ** **                                                                               | ** ** | **Shares**                                                         | ** ** | **Stock**  | ** ** | **Capital**    | ** ** | **Deficit**     | ** ** | **Equity (Deficit)** | ** ** |
| ** **                                                                               | ** ** | **(in thousands, except per share data)** | ** ** |
| **Balance at December 31, 2003**                                                    |       | 40,031,008                                                         |       |       | $          | 40             |       |            |       | $                         | 357,195    |   |   |   | $ | (375,451 | ) |   |   | $ | (18,216 | ) |   |
| Exercise of stock options                                                                |       | 284,815                                                            |       |       | —     |           |       |            | 1,804      |                      |       |   | — |   |   |   | 1,804 |   |   |
| Shares issued in connection with employee stock  purchase plan and 401(k) plan      |       | 119,412                                                            |       |       | —     |           |       |            | 1,256      |                      |       |   | — |   |   |   | 1,256 |   |   |
| Issuance of common stock, net of  issuance costs                                         |       | 10,714,200                                                         |       |       | 11         |           |       |            | 112,431    |                      |       |   | — |   |   |   | 112,442 |   |   |
| Stock-based compensation                                                                 |       | 4,392                                                              |       |       | —     |           |       |            | 72         |                      |       |   | — |   |   |   | 72 |   |   |
| Net loss                                                                                 |       | —                                                             |       |       | —     |           |       |            | —     |                      |       |   | (76,512 | ) |   |   | (76,512 | ) |   |
| **Balance at December 31, 2004**                                                    |       | 51,153,827                                                         |       |       | 51         |           |       |            | 472,758    |                      |       |   | (451,963 | ) |   |   | 20,846 |   |   |
| Exercise of stock options                                                                |       | 680,860                                                            |       |       | 1          |           |       |            | 5,650      |                      |       |   | — |   |   |   | 5,651 |   |   |
| Shares issued in connection with employee stock purchase  plan and 401(k) plan |       | 160,724                                                            |       |       | —     |           |       |            | 1,737      |                      |       |   | — |   |   |   | 1,737 |   |   |
| Issuance of common stock related to business  agreements.                                |       | 1,876,173                                                          |       |       | 2          |           |       |            | 20,003     |                      |       |   | — |   |   |   | 20,005 |   |   |
| Stock-based compensation                                                                 |       | 11,997                                                             |       |       | —     |           |       |            | 212        |                      |       |   | — |   |   |   | 212 |   |   |
| Net loss                                                                                 |       | —                                                             |       |       | —     |           |       |            | —     |                      |       |   | (31,852 | ) |   |   | (31,852 | ) |   |
| **Balance at December 31, 2005**                                                    |       | 53,883,581                                                         |       |       | 54         |           |       |            | 500,360    |                      |       |   | (483,815 | ) |   |   | 16,599 |   |   |
| Exercise of stock options                                                                |       | 892,790                                                            |       |       | 1          |           |       |            | 8,871      |                      |       |   | — |   |   |   | 8,872 |   |   |
| Shares issued in connection with employee stock purchase  plan and 401(k) plan |       | 207,062                                                            |       |       | —     |           |       |            | 3,968      |                      |       |   | — |   |   |   | 3,968 |   |   |
| Stock-based compensation                                                                 |       | 17,625                                                             |       |       | —     |           |       |            | 11,527     |                      |       |   | — |   |   |   | 11,527 |   |   |
| Net loss                                                                                 |       | —                                                             |       |       | —     |           |       |            | —     |                      |       |   | (376 | ) |   |   | (376 | ) |   |
| **Balance  at December 31, 2006**                                                   |       | 55,001,058                                                         |       |       | $          | 55             |       |            |       | $                         | 524,726    |   |   |   | $ | (484,191 | ) |   |   | $ | 40,590 |   |   |

 

The accompanying notes are an integral part of the consolidated financial statements.

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**CUBISTPHARMACEUTICALS, INC.NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**A.**                NATUREOF BUSINESS

Cubist is a biopharmaceutical company headquartered inLexington, Massachusetts, focused on the research, development andcommercialization of pharmaceutical products that address unmet medical needsin the acute-care environment. Cubist has one marketed product, CUBICIN(daptomycin for injection), which was launched in the U.S. in November 2003.CUBICIN is approved in the U.S. for the treatment of cSSSI, caused by *S. aureus* and certain other Gram-positive bacteria, and for *S. aureus*bloodstreaminfections (bacteremia), including those with right-sided infective endocarditis,caused by methicillin-susceptible and methicillin-resistant isolates. TheCompany has focused its pipeline building efforts on opportunities thatleverage its antiinfective and acute-care discovery, development, regulatory,and commercialization expertise. Currently, Cubist is working to identifyviable candidates from its lipopeptideprogram with potential activity in the lung. The Company continues to evaluateacute care product candidates which it might acquire to build its pipeline.

Cubist is subject to riskscommon to companies in the pharmaceutical industry including, but not limitedto, risks related to the development by Cubist or its competitors of newtechnological innovations, the ability to market products or services, theCompany’s dependence on key personnel, the market acceptance of CUBICIN, theCompany’s dependence on key suppliers, protection of the Company’s proprietarytechnology, the Company’s ability to obtain additional financing, and theCompany’s compliance with governmental and other regulations.

**B.**               ACCOUNTINGPOLICIES

**Basis ofPresentation and Consolidation**

The accompanyingconsolidated financial statements include the accounts of Cubist and its whollyowned subsidiaries. All intercompany balances and transactions have beeneliminated.

**Use of Estimates**

The preparation offinancial statements in conformity with U.S. generally accepted accountingprinciples, or GAAP, requires the use of estimates and assumptions that affectthe reported amounts of assets and liabilities and disclosure of contingentassets and contingent liabilities at the date of the financial statements and thereported amounts of revenues and expenses during the reporting period. The mostsignificant assumptions are employed in estimates used in determining values ofinventories, long-lived assets, accrued clinical research costs, income taxes,stock-based compensation, sales rebate and return accruals, legalcontingencies, as well as in estimates used in applying the revenue recognitionpolicy. Actual results could differ from estimated results.

**Fair Value ofFinancial Instruments**

The carrying amounts of Cubist’s cash and cashequivalents, short-term investments, accounts receivable, accounts payable, andaccrued expenses approximate their fair value due to the short-term maturitiesof these instruments. At December 31, 2006, long-term investments had afair value of $15.0 million and a cost of $15.0 million. At December 31,2006, the carrying amounts of long-term investments approximate their fairvalue. At December 31, 2005, long-term investments had a fair value of$4.4 million and a cost of $4.5 million. The fair value of theseinvestments reflects unrealized holding losses of $0.1 million. The fair marketvalue of long-term debt at December 31, 2006, amounted to$319.0 million, 

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and consisted offixed-rate debt due in 2013. The estimated fair value of long-term debt wasdetermined using quoted market rates.

In evaluating the fairvalue information, considerable judgment is required to interpret the marketdata used to develop the estimates. The use of different market assumptionsand/or different valuation techniques may have a material effect on theestimated fair value amounts. Accordingly, the estimates of fair valuepresented herein may not be indicative of the amounts that could be realized ina current market exchange.

**Cash and CashEquivalents**

Cash and cash equivalentsconsist of short-term interest-bearing instruments with initial maturities ofthree months or less at the date of purchase. These instruments are carried atcost, which approximates market value.

**Investments**

Investments with amaturity of more than three months when purchased, consisted of corporatebonds, government bonds and agencies, and investment-grade commercial paper at December 31,2006 and 2005. Investments, which are held to maturity, are stated at amortizedcost plus accrued interest, which approximates market value. Included inshort-term investments are auction rate municipal bonds classified asavailable-for-sale securities. Cubist’s investments in these securities arerecorded at cost, which approximates fair market value due to their variableinterest rates, which typically reset every 7 to 35 days, and, despite thelong-term nature of their stated contractual maturities, Cubist has the abilityto quickly liquidate these securities. As a result, Cubist had no cumulativegross unrealized holding gains (losses) or gross realized gains (losses) fromthese current investments. All income generated from these short-terminvestments was recorded as interest income. Investment classification detailcan be found in Note E in the Notes to Consolidated Financial Statements.

**Concentration ofCredit Risk**

Financial instruments,which potentially subject the Company to concentrations of credit risk, consistprincipally of cash and cash equivalents, investments and accounts receivable.Cash, cash equivalents and investments consist of commercial paper, corporatebonds, U.S. Government securities, money market funds and auction ratesecurities all held with financial institutions. Approximately 87% and 86% ofthe accounts receivable balances represent amounts due from three wholesalersat December 31, 2006 and 2005, respectively.

**Inventory**

Inventories are stated at the lower of cost or market.Cost is computed using standard cost, which approximates actual cost, on afirst-in, first-out, or FIFO, basis. The Company analyzes its inventory levelsquarterly, and writes-down inventory that has become obsolete, inventory thathas a cost basis in excess of its expected net realizable value and inventoryin excess of expected sales requirements to cost of product revenues. Expiredinventory is disposed of and the related costs are written off to cost ofproduct revenues. Additionally, the Company may be required to expensepreviously capitalized inventory that fails to meet commercial salespecifications.

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Inventoriesconsisted of the following at December 31:

| ** **      | ** ** | **2006**                | ** ** | **2005** | ** ** |
|-----------------|------------|-------------------------|------------|----------|------------|
| ** **      | ** ** | **(in thousands)** | ** ** |
| Raw materials   |       | $                       | 8,240      |     | $          | 9,019 |   |
| Work in process |       | 3,616                   |       | 3,146    |       |
| Finished goods  |       | 6,255                   |       | 4,530    |       |
|            |       | $                       | 18,111     |     | $          | 16,695 |   |

 

**Property andEquipment**

Propertyand equipment, including leasehold improvements, are recorded at cost and aredepreciated when placed into service using the straight-line method, based onuseful lives as follows:

| **Asset Description**      | ** ** | **Useful Life (Years)** | ** ** |
|---------------------------------|------------|-----------------------------------|------------|
| Building                        |       |                              | 40         |   |   |
| Fermentation  equipment         |       |                              | 15         |   |   |
| Lab equipment                   |       |                              | 5          |   |   |
| Furniture and  fixtures         |       |                              | 5          |   |   |
| Computer hardware and  software |       |                              | 3          |   |   |

 

Leasehold improvements areamortized over the shorter of the useful life of the asset or the lease term.Costs for capital assets not yet placed into service have been capitalized asconstruction in progress and will be depreciated in accordance with the aboveguidelines once placed into service. Costs for repairs and maintenance areexpensed as incurred, while major betterments are capitalized. When assets areretired or otherwise disposed of, the assets and related allowances fordepreciation and amortization are eliminated from the accounts and anyresulting gain or loss is reflected in operating costs and expenses.

**Capital Leases**

Assets acquired undercapital lease agreements are recorded at the present value of the futureminimum rental payments using interest rates appropriate at the inception ofthe lease. Property and equipment subject to capital lease agreements areamortized over the shorter of the life of the lease or the estimated usefullife of the asset unless the lease transfers ownership or contains a bargainpurchase option, in which case the leased asset is amortized over the estimateduseful life of such asset.

**Intangible Assets**

Cubist’s intangible assetsconsist of acquired intellectual property, processes, patents and technologyrights. These assets are amortized on a straight-line basis over theirestimated useful life of four to seventeen years. The fair value of patentsobtained through an acquisition transaction are capitalized and amortized overthe lesser of the patent’s remaining legal life or its useful life. Costs toobtain, maintain and defend the Company’s patents are expensed as incurred.

**Impairment ofLong-Lived Assets**

In accordance with SFAS No. 144“*Accounting for the Impairment or Disposalof Long-Lived Assets,*” Cubist reviews long-lived assets forimpairment whenever events or changes in business circumstances indicate thatthe carrying amount of the assets may not be fully recoverable or that theuseful lives of these assets are no longer appropriate. Each impairment test isbased on a comparison of the undiscounted cash flows to the recorded value ofthe asset. If impairment is indicated, the asset is written down by the amountby which the carrying value of the asset exceeds the related fair value of theasset. A charge of $2.2 million 

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wasrecorded in the fourth quarter of 2004 for the impairment of a patent unrelatedto CUBICIN (see Note H.)

**Revenue Recognition**

Cubist recognizes revenuein accordance with SEC Staff Accounting Bulletin No. 101 (SAB 101), asamended by SAB 104, and Emerging Issues Task Force (EITF) Issue No. 00-21.Principal sources of revenue are sales of CUBICIN, license fees and milestonepayments that are derived from collaborative agreements with otherbiotechnology companies and distribution agreements. The Company has followedthe following principles in recognizing revenue:

*Multiple ElementArrangements*

Cubist analyzes itsmultiple element arrangements to determine whether the elements can beseparated and accounted for individually as separate units of accounting inaccordance with EITF No. 00-21,*“RevenueArrangements with Multiple Deliverables.”* An element of a contractcan be accounted for separately if the delivered elements have stand-alonevalue and the fair value of any undelivered elements is determinable. If anelement is considered to have standalone value but the fair value of any of theundelivered items cannot be determined, all elements of the arrangement arerecognized as revenue over the period of performance for such undelivered itemsor services.

*Product Revenues,net*

Cubist recognizes revenue from product sales whenpersuasive evidence of an arrangement exists, title to product and associatedrisk of loss has passed to the customer, the price is fixed or determinable,collection from the customer is reasonably assured and the Company has nofurther performance obligations. All revenues from product sales are recordednet of applicable provisions for returns, chargebacks, rebates, wholesalermanagement fees and discounts in the same period the related sales arerecorded.

Certain product salesqualify for rebates or discounts from standard list pricing due to governmentsponsored programs or other contractual agreements. Reserves for rebateprograms are included in accrued liabilities and were $652,000 and $356,000 at December 31,2006 and 2005, respectively. The Company allows customers to return productwithin a specified period prior to and subsequent to the expiration date.Reserves for product returns are based upon many factors, including industrydata of product return rates, historical experience of actual returns, analysisof the level of inventory in the distribution channel and reorder rates ofend-users. Reserves for returns, discounts, chargebacks, customer rebates andwholesaler management fees are netted against accounts receivable and were $2.8million and $1.4 million at December 31, 2006 and 2005, respectively. Inthe year ended December 31, 2006 and 2005, provisions for sales returns,chargebacks, rebates, wholesaler management fees and prompt-pay discounts thatwere netted against product revenues totaled $9.5 million and $5.1 million,respectively.

*Product Revenuesfrom International Distribution Partners*

Under agreements withinternational distribution partners, Cubist sells its product to internationaldistribution partners based upon a transfer price arrangement. The transferprice is generally established annually. Once Cubist’s distribution partnersells the product to a third party, Cubist is owed an additional payment basedon a percentage of the net selling price to the third party, less the transferprice previously paid on such product. Under no circumstances would thesubsequent royalty adjustment result in a refund to the distributor. Cubistrecognizes revenue related to product shipped to international distributionpartners when persuasive evidence of an arrangement exists, title to productand associated risk of loss has 

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passedto the distribution partner, the price is fixed or determinable, collectionfrom the distribution partner is reasonably assured and the Company has nofurther performance obligations.

*License Revenues*

Non-refundable licensefees are recognized depending on the provisions of each agreement. License feeswith ongoing involvement or performance obligations are recorded as deferredrevenue once received and are generally recognized ratably over the period ofsuch performance obligation only after both the license period has commencedand the technology has been delivered.

*Research services*

Revenues from SBIR grantsto conduct research and development are recognized as the eligible costs areincurred up to the granted funding limit.

*Milestones*

Revenue from milestonepayments related to arrangements under which the Company has continuingperformance obligations are recognized as revenue upon achievement of themilestone only if all of the following conditions are met: the milestonepayments are non-refundable; achievement of the milestone was not reasonablyassured at the inception of the arrangement; substantive effort is involved inachieving the milestone; and the amount of the milestone is reasonable inrelation to the effort expended or the risk associated with the achievement ofthe milestone. If any of these conditions are not met, the milestone paymentsare deferred and recognized as revenue over the term of the arrangement as theCompany completes its performance obligations. Contingent payments underlicense agreements that do not involve substantial effort on the part of theCompany are not considered substantive milestones. Such payments are recognizedas revenue when the contingency is met only if there are no remainingperformance obligations or any remaining performance obligations are priced atfair value. Otherwise, the contingent payment is recognized as the Companycompletes its performance obligations under the arrangement.

**Research andDevelopment**

All research anddevelopment costs, including upfront fees and milestones paid to collaborators,are expensed as incurred if no planned alternative future use exists for thetechnology. When the Company is reimbursed by a collaborative partner for workit performs it records the costs incurred as research and development expensesand the related reimbursement as collaborative agreement and other revenues inits Consolidated Statement of Operations. Research and development expensesconsist of internal labor, clinical and non-clinical studies, materials andsupplies, facilities, depreciation, third party costs for contracted services,manufacturing process improvement and testing costs, and other research anddevelopment related costs.

**Advertising Costs**

Advertising costs areexpensed as incurred and are included in sales and marketing expense within theConsolidated Statements of Operations.

**Income Taxes**

Cubist accounts for incometaxes under the asset and liability method. Under this method, deferred taxassets and liabilities are recognized for the estimated future tax consequencesattributable to differences between the financial statement carrying amounts ofexisting assets and liabilities and their respective tax bases. Deferred taxassets and liabilities are measured using enacted rates in effect for the yearin which those temporary differences are expected to be recovered or settled. Adeferred tax asset is 

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establishedfor the expected future benefit of net operating loss and credit carryforwards.A valuation reserve against net deferred tax assets is required if, based uponavailable evidence, it is “more likely than not” that some or all of thedeferred tax assets will not be realized.

**Foreign CurrencyTranslation**

The functional currency ofCubist’s U.K. subsidiary is the U.S. dollar. Accordingly, the remeasurementmethod is used to convert the foreign currency balances from the local currencyinto the U.S. dollar.

**Comprehensive Loss**

Comprehensive loss iscomprised of only net loss, as there was no other comprehensive income (loss)for the years ended December 31, 2006, 2005 and 2004.

**Basic and DilutedNet Loss Per Common Share**

Basic netincome (loss) per share has been computed by dividing net income (loss)by the weighted average number of shares outstanding during the period. Exceptwhere the result would be antidilutive to income from continuing operations,diluted net income (loss) per share has been computed assuming the conversionof convertible obligations and the elimination of the related interest expense,and the exercise of stock options, as well as their related income tax effects.

Potentialcommon shares excluded from the calculation of diluted net income (loss) pershare as their inclusion would have been antidilutive, were:

| ** **                                                                  | ** ** | **2006**   | ** ** | **2005**  | ** ** | **2004**  | ** ** |
|-----------------------------------------------------------------------------|------------|------------|------------|-----------|------------|-----------|------------|
| Options to  purchase shares of common stock                                 |       | 7,271,450  |       | 6,836,077 |       | 5,850,156 |       |
| Convertible debt and  notes payable convertible into shares of common stock |       | 11,374,335 |       | 3,495,763 |       | 3,495,763 |       |

 

**Stock BasedCompensation**

In December 2004, theFinancial Accounting Standards Board, or FASB, issued SFAS No. 123(revised 2004), *“Share-Based Payment,”*or SFAS 123(R), which requires all companies to measure compensation costfor all share-based payments (including employee stock options) at fair value.SFAS 123(R) supersedes APB Opinion No. 25, *“Accounting for Stock Issued to Employees”* and amends SFAS No. 95,“*Statement of Cash Flows.”*In March 2005,the Securities and Exchange Commission issued Staff Accounting Bulletin No. 107(“SAB 107”) relating to SFAS 123(R). The Company has applied the provisions ofSAB 107 in its adoption of SFAS 123(R). SFAS 123(R) requires thedetermination of the fair value of the share-based compensation at the grantdate and the recognition of the related expense over the requisite serviceperiod. The Company elected to adopt the modified prospective applicationmethod as provided by SFAS 123(R). As a result, the Company recognizedcompensation expense associated with awards granted after January 1, 2006,and the unvested portion of previously granted awards that remained outstandingas of January 1, 2006. See Note M. for additional information.

**Recent AccountingPronouncements**

In September 2006, the FASB issued SFAS No. 157,*“Fair Value Measurements,”* or SFAS 157,which is effective for financial statements issued for fiscal yearsbeginning after November 15, 2007 and interim periods within those fiscalyears. Early adoption is not permitted. Therefore, Cubist will adopt SFAS No. 157on January 1, 2008. SFAS 157 defines fair value, establishes a frameworkfor measuring fair value in accordance with Generally Accepted AccountingPrinciples, and expands disclosures about fair 

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value measurements. TheStatement codifies the definition of fair value as the price that would bereceived to sell an asset or paid to transfer a liability in an orderlytransaction between market participants at the measurement date. The standardclarifies the principle that fair value should be based on the assumptionsmarket participants would use when pricing the asset or liability andestablishes a fair value hierarchy that prioritizes the information used todevelop those assumptions. The implementation of SFAS 157 is not expectedto have a material impact on the Company’s financial statements.

In September 2006, the SEC staff issued StaffAccounting Bulletin Topic 1N (SAB 108), “*FinancialStatements—Considering the Effects of Prior Year Misstatements when QuantifyingMisstatements in Current Year Financial Statements*,” or SAB 108,which is effective for calendar year companies as of December 31, 2006.SAB 108 provides guidance on how prior year misstatements should be takeninto consideration when quantifying misstatements in current year financialstatements for purposes of determining whether the financial statements arematerially misstated. Under this guidance, companies should take into accountboth the effect of a misstatement on the current year balance sheet as well asthe impact upon the current year income statement in assessing the materialityof a current year misstatement. Once a current year misstatement has beenquantified, the guidance in SAB Topic 1M, “*FinancialStatements—Materiality*,” or SAB 99, should be applied todetermine whether the misstatement is material. The implementation ofSAB 108 did not have an impact on the Company’s financial statements.

In June 2006, the FASB issued FASB InterpretationNo. 48, “*Accounting for Uncertainty in Income Taxes—anInterpretation of FASB Statement 109”*, or FIN 48. FIN 48 clarifiesthe accounting for uncertainty in income taxes recognized in an enterprise’sfinancial statements in accordance with SFAS No. 109, *“Accountingfor Income Taxes.”* This interpretation requires that we determinewhether it is more likely than not that a tax position will be sustained uponexamination by the appropriate taxing authority. This interpretation alsoprovides guidance on derecognition, classification, interest and penalties,accounting in interim periods, disclosure, and transition. FIN 48 is effectivefor fiscal years beginning after December 15, 2006. The Company iscurrently evaluating the impact of adopting this interpretation.

In May 2005, the FASB issued SFAS No. 154, “*Accounting Changes and Error Corrections*,” or SFAS 154,which replaces APB Opinion No. 20, “*Accounting Changes*,”and FASB Statement No. 3, “*Reporting AccountingChanges in Interim Financial Statements—an amendment of APB Opinion No. 28*.”SFAS 154 changes the requirements of the accounting for and reporting of achange in accounting principle and also provides guidance on the accounting forand reporting of error corrections. Prior to SFAS 154, most voluntary changesin accounting principle were recognized by including in net income of theperiod of change the cumulative effect of changing to the new accountingprinciple. SFAS 154 requires retrospective application to prior periods’financial statements of changes in accounting principle and to changes requiredby an accounting pronouncement in the instance that the pronouncement does notinclude specific transition provisions, unless it is impracticable to determineeither the period specific effects or the cumulative effect of the change. SFAS154 is effective for accounting changes and corrections of errors made infiscal years beginning after December 15, 2005. The adoption of SFAS 154did not have a significant impact on the Company’s results of operations.

In December 2004, theFASB issued SFAS No. 151, *“Inventory Costs,”*or SFAS 151. SFAS 151 requires abnormal amounts of inventory costsrelated to idle facility, freight handling and wasted material expenses to berecognized as current period charges. Additionally, SFAS 151 requires thatallocation of fixed production overheads to the costs of conversion be based onthe normal capacity of the production facilities. The standard is effective forfiscal years beginning after June 15, 2005. The adoption of SFAS 151did not have a material impact on the Company’s consolidated financialstatements.

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**D.**              BUSINESSAGREEMENTS

*LicensingAgreements*

In June 2004, Cubist entered into a licenseagreement with XTLbio for the worldwide development and commercialization ofHepeX-B. In consideration for such license, Cubist paid XTLbio an up-front feeof $1.0 million. Cubist may also pay an additional $3.0 million uponthe achievement of certain regulatory milestones. In addition, Cubist will berequired to pay royalties to XTLbio on any sales of HepeX-B. Cubist will fundthe development costs of HepeX-B and will be solely responsible forregistration and commercialization of the product worldwide. The $1.0 millionup-front fee was paid in the quarter ended June 30, 2004 and was recordedas an element of research and development expense. In the third quarter of2006, Cubist decided to discontinue investment in the HepeX-BTM program and is currentlyinvestigating strategic options for this investigational drug to treat patientswho have had a liver transplant secondary to Hepatitis B.

In June 2001, Cubist and Syrrx Incorporated, orSyrrx, announced the formation of an antiinfective drug discoverycollaboration. The joint effort used Syrrx and Cubist technologies for thehigh-throughput characterization of novel antiinfective drug targets andrational drug design. As a result of the Company’s decision in the firstquarter of 2003 to discontinue its target-based drug discovery program, theparties ceased work under this collaboration and terminated the relationship.In the first quarter of 2005, Syrrx and Takeda Pharmaceutical Company Limitedmerged which resulted in the return of Cubist’s original investment in Syrrx.The Company’s net equity investment carrying value in Syrrx was zero and $0.2million at December 31, 2005 and 2004, respectively.

In November 1997, Cubist entered into a licenseagreement with Eli Lilly that was amended and restated in October 2000,and pursuant to which Cubist acquired exclusive worldwide rights to develop,manufacture and market CUBICIN. In exchange for such license, Cubist paid anupfront license fee in cash and, if certain drug development milestones wereachieved, agreed to pay milestone payments by issuing shares of common stock toEli Lilly. In addition, Cubist is required to pay royalties to Eli Lilly onworldwide sales of CUBICIN. In July 2003, Cubist entered into an amendmentto the restated license agreement with Eli Lilly and issued to Eli Lilly723,619 shares of common stock valued at $8.0 million, in considerationfor a 1% reduction in the royalty rates under the original license agreement.The $8.0 million was recorded as an intangible asset within the ConsolidatedBalance Sheet and is being amortized over approximately 13 years, which was theestimated remaining life of the license agreement with Eli Lilly on the date ofthe transaction. In September 2003, Cubist issued 38,922 shares of commonstock valued at $0.5 million as a milestone payment to Eli Lilly uponCubist receiving FDA approval for the commercial sale of CUBICIN. The $0.5million was recorded as an intangible asset within the Consolidated BalanceSheet and is being amortized over approximately 13 years, which was theremaining life of the license agreement with Eli Lilly on the date of thetransaction. In March 2005, Cubist entered into a second amendment to thelicense agreement with Eli Lilly and issued to Eli Lilly 1,876,173 shares ofcommon stock valued at $20.0 million, in consideration for a 2% reductionin the royalty rates under the original license agreement. The $20.0 millionwas recorded as an intangible asset within the Consolidated Balance Sheet andis being amortized over approximately 11 years, which was the remaining life ofthe license agreement with Eli Lilly on the date of the transaction.

As part of Cubist’sacquisition of TerraGen Discovery Inc., or TerraGen, in October 2000,Cubist assumed the rights and obligations originally held by TerraGen pursuantto a cross-license agreement dated November 1999 between TerraGen andDiversa Corporation, or Diversa. Under the terms of the agreement, TerraGengranted Diversa a co-exclusive worldwide non-royalty bearing license (withoutthe right to sublicense) to certain patented technology, subject to certainrestrictions. The parties also granted each other certain non-exclusive rightsto other patent technology owned by the parties. Under the agreement, Diversapaid an up-front license fee of $2.5 million and commencing in 2000 paysannual 

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licensemaintenance fees, until the patents owned by TerraGen (now owned by Cubist)expire. Cubist was required to repay the up-front license fee if, prior to November 2004,Cubist merged with or was acquired by a company whose primary business, priorto November 1999, was related to molecular breeding involving *in vitro* DNA shuffling. Accordingly, theentire upfront licensing fee was recorded as deferred revenue at the time ofthe agreement and was recognized into revenue in November 2004 upon theexpiration of the repayment provision.

*CommercializationAgreements*

In December 2006, Cubist entered into a licenseagreement with AstraZeneca, for the development and commercialization ofCUBICIN in China and certain other countries in Asia, the Middle East andAfrica not yet covered by existing CUBICIN international partnering agreements.In exchange for development and commercialization rights, AstraZeneca paidCubist an up-front fee of $10.3 million. This $10.3 million was recorded asdeferred revenue. Additionally, Cubist will receive payments upon AstraZenecareaching regulatory and sales milestones. AstraZeneca will pay Cubist atransfer price for their purchases of CUBICIN. Cubist may receive payments forthe achievement of the aforementioned milestones of up to $24.3 million underthe agreement.

In July 2005, Cubist entered into a DistributionAgreement with Kuhnil Pharmaceuticals, Inc., or Kuhnil. Under theagreement, Kuhnil will commercialize in the Republic of Korea, or Korea,CUBICIN on an exclusive basis. In exchange for exclusive rights tocommercialize CUBICIN in Korea, Kuhnil paid Cubist an up-front fee of $0.6million, which was recorded as deferred revenue and will be recognized asrevenue over the manufacturing and supply period commencing on first shipmentof product in Korea. Kuhnil will pay Cubist a transfer price for theirpurchases of CUBICIN. Cubist may earn milestones of up to $0.9 million underthe agreement.

In December 2003, Cubist entered into aDistribution Agreement with Biopharm Company Limited, or TTY. Under theagreement, TTY will commercialize CUBICIN in Taiwan on an exclusive basis. Inexchange for exclusive rights to commercialize CUBICIN in Taiwan, TTY paidCubist an up-front fee of $0.5 million, which was recorded as deferred revenueand will be recognized as revenue over the manufacturing and supply periodcommencing on first shipment of product in Taiwan. In December 2003,Cubist also received $0.2 million from TTY for the achievement of a milestoneunder this agreement, which was also recorded to deferred revenue and will berecognized over the manufacturing and supply period commencing on firstshipment of product in Taiwan. TTY will pay Cubist a transfer price for theirpurchases of CUBICIN. Cubist may earn additional milestones of up to $0.8million under the agreement.

In October 2003, Cubist signed a LicenseAgreement and a Manufacturing and Supply Agreement with Novartis for thedevelopment and commercialization of CUBICIN in Western and Eastern Europe,Australia, New Zealand, India and certain Central American, South American andMiddle Eastern countries. Novartis paid Cubist an up-front licensing fee of$8.0 million, which was recorded as deferred revenue and was amortized torevenue over the estimated development period of two years, which completed in September 2005.Per the License Agreement, Cubist is entitled to receive from Novartisadditional cash payments of up to $32.0 million upon achievement ofcertain development and sales milestones. Per the Manufacturing and SupplyAgreement, Novartis shall pay Cubist a transfer price for CUBICIN and per theLicense Agreement, Novartis will owe Cubist royalty payments based on Novartis’ssales of CUBICIN.

In October 2003, Cubist also entered into a StockPurchase Agreement with Novartis pursuant to which Novartis purchased 529,942shares of Cubist common stock for $10.0 million, at a 50% premium to thefair value of the Company’s common stock. The premium paid was allocated to theLicense Agreement and was accounted for as part of the up-front payment andamortized over the estimated development period of two years, which completedin September 2005.

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**E.**               INVESTMENTS

Investments are carried in Cubist’s ConsolidatedBalance Sheets at amortized cost plus interest receivable. Interest receivablerelated to short-term investments was $0.7 million and $0.2 million at December 31,2006 and 2005, respectively. Interest receivable related to long-terminvestments was $0.1 million at December 31, 2006 and 2005.

Includedin short-term investments are auction rate securities which are consideredavailable-for-sale investments. The carrying value, gross unrecorded gains andlosses and fair value for these securities are as follows:

| ** **              | ** ** | **December 31, 2006** | ** ** | **December 31, 2005** | ** ** |           |
|-------------------------|------------|---------------------------------|------------|---------------------------------|------------|----------------|
| ** **              | ** ** | ** **                      | ** ** | **Gross**                       | ** ** | **Gross**      | ** ** | ** ** | ** ** | ** ** | ** ** | **Gross** | ** ** | **Gross** | ** ** | ** ** | ** ** |   |
| ** **              | ** ** | **Carrying**                    | ** ** | **Unrecorded**                  | ** ** | **Unrecorded** | ** ** | ** ** | ** ** | **Carrying** | ** ** | **Unrecorded** | ** ** | **Unrecorded** | ** ** | ** ** | ** ** |   |
| ** **              | ** ** | **Value**                       | ** ** | **Gains**                       | ** ** | **Losses**     | ** ** | **Fair Value** | ** ** | **Value** | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Fair Value** | ** ** |   |
| ** **              | ** ** | **(in thousands)**         | ** ** | **(in thousands)**         | ** ** |           |
| Auction rate securities |       |                            | $          | 256,950                         |       |           |   | $ | — |   |   |   | $ | — |   |   |   | $ | 256,950 |   |   | $ | 48,800 |   |   | $ | — |   |   |   | $ | — |   |   |   | $ | 48,800 |   |   |
| Total                   |       |                            | $          | 256,950                         |       |           |   | $ | — |   |   |   | $ | — |   |   |   | $ | 256,950 |   |   | $ | 48,800 |   |   | $ | — |   |   |   | $ | — |   |   |   | $ | 48,800 |   |   |

 

Theamortized cost, gross unrealized gains and losses and fair value ofheld-to-maturity securities are as follows:

| ** **  | ** ** | **December 31, 2006** | ** ** | **December 31, 2005** | ** ** |
|-------------|------------|---------------------------------|------------|---------------------------------|------------|
| ** **  | ** ** | ** **                      | ** ** | **Gross**                       | ** ** | **Gross** | ** ** | ** ** | ** ** | ** ** | ** ** | **Gross** | ** ** | **Gross** | ** ** | ** ** | ** ** |
| ** **  | ** ** | **Amortized**                   | ** ** | **Unrealized**                  | ** ** | **Unrealized** | ** ** | ** ** | ** ** | **Amortized** | ** ** | **Unrealized** | ** ** | **Unrealized** | ** ** | ** ** | ** ** |
| ** **  | ** ** | **Cost**                        | ** ** | **Gains**                       | ** ** | **Losses** | ** ** | **Fair Value** | ** ** | **Cost** | ** ** | **Gains** | ** ** | **Losses** | ** ** | **Fair Value** | ** ** |
| ** **  | ** ** | **(in thousands)**         | ** ** | **(in thousands)**         | ** ** |
| Short-Term: |       |                            |       |                            |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
|             |            |                                 |            |                                 |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

| Corporate bonds  |   | $      | 13,360 |   |   | $      | 2      |   |   |   | $      | — |   |   |   | $      | 13,362 |   |   |   | $      | 2,033  |   |   |   | $      | — |   |   |   | $      | (25    | )      |   |   | $ | 2,008  |   |   |
|------------------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|--------|---|--------|--------|--------|
| Government bonds |   | 7,000  |   |   | — |   |   |   | (16    | )      |   |   | 6,984  |   |   |   | 17,002 |   |   |   | — |   |   |   | (122   | )      |   |   | 16,880 |   |   |
| Total            |   | $      | 20,360 |   |   | $      | 2      |   |   |   | $      | (16    | )      |   |   | $      | 20,346 |   |   |   | $      | 19,035 |   |   |   | $      | — |   |   |   | $      | (147   | )      |   |   | $ | 18,888 |   |   |
| Long-Term:       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Corporate bonds  |   | $      | — |   |   | $      | — |   |   |   | $      | — |   |   |   | $      | — |   |   |   | $      | — |   |   |   | $      | — |   |   |   | $      | — |   |   |   | $ | — |   |   |
| Government bonds |   | 15,038 |   |   | — |   |   |   | (32    | )      |   |   | 15,006 |   |   |   | 4,506  |   |   |   | — |   |   |   | (91    | )      |   |   | 4,415  |   |   |
| Total            |   | $      | 15,038 |   |   | $      | — |   |   |   | $      | (32    | )      |   |   | $      | 15,006 |   |   |   | $      | 4,506  |   |   |   | $      | — |   |   |   | $      | (91    | )      |   |   | $ | 4,415  |   |   |

 

Thefollowing is a summary of the carrying value, amortized cost and estimated fairvalue of investments at December 31, 2006 by contractual maturity:

| ** **                             | ** ** | **Available-for-Sale**  | ** ** | **Held-to-Maturity**    | ** ** |
|----------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                             | ** ** | **Carrying**            | ** ** | ** **              | ** ** | **Amortized** | ** ** | ** ** | ** ** |
| ** **                             | ** ** | **Value**               | ** ** | **Fair Value**     | ** ** | **Cost** | ** ** | **Fair Value** | ** ** |
| ** **                             | ** ** | **(in thousands)** | ** ** | **(in thousands)** | ** ** |
| Due within one  year                   |       | $                       | 256,950    |                    | $          | 256,950 |   |   | $ | 20,360 |   |   |   | $ | 20,346 |   |   |
| Due after one  year through five years |       | —                  |       | —                  |       |   | 15,038 |   |   |   | 15,006 |   |   |
| Total                                  |       | $                       | 256,950    |                    | $          | 256,950 |   |   | $ | 35,398 |   |   |   | $ | 35,352 |   |   |

 

Included in the tableabove are auction rate securities, which typically reset to current interestrates every 7 to 35 days, but are included in the table above based ontheir effective maturities.

**F.**                ACCOUNTSRECEIVABLE

Cubist’s trade receivablesin 2006 and 2005 primarily represent amounts due to the Company from wholesalersand distributors of its pharmaceutical product. Cubist performs ongoing creditevaluations of its customers and generally does not require collateral.

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**G.**              PROPERTYAND EQUIPMENT

Propertyand equipment consisted of the following at December 31,

| ** **                     | ** ** | **2006**                | ** ** | **2005** | ** ** |
|--------------------------------|------------|-------------------------|------------|----------|------------|
| ** **                     | ** ** | **(in thousands)** | ** ** |
| Building                       |       | $                       | 43,069     |     | $          | 42,708 |   |
| Leasehold  improvements        |       | 9,473                   |       | 6,905    |       |
| Laboratory  equipment          |       | 12,988                  |       | 11,257   |       |
| Furniture and  fixtures        |       | 1,482                   |       | 1,196    |       |
| Computer  equipment            |       | 8,812                   |       | 7,248    |       |
| Construction in  progress      |       | 1,474                   |       | 348      |       |
|                           |       | 77,298                  |       | 69,662   |       |
| Less accumulated  depreciation |       | (27,714                 | )          | (23,635  | )          |
| Property and equipment,  net   |       | $                       | 49,584     |     | $          | 46,027 |   |

 

Depreciation expense was$4.1 million, $4.0 million and $4.0 million in 2006, 2005 and2004, respectively.

**H.**              INTANGIBLEASSETS

Intangibleassets consisted of the following at:

| ** **                                                 | ** **                                                | **December 31,**   | ** ** |
|------------------------------------------------------------|-----------------------------------------------------------|-------------------------|------------|
| ** **                                                 | ** **                                                | **2006**                | ** ** | **2005** | ** ** |
| ** **                                                 | ** **                                                | **(in thousands)** | ** ** |
| Patents                                                    |                                                      | $                       | 2,673      |   | $ | 2,627 |   |
| Manufacturing  rights                                      |                                                      | 2,500                   |       | 11,590 |   |
| Acquired  technology rights                                |                                                      | 28,500                  |       | 28,500 |   |
| Intellectual  property and processes and other intangibles |                                                      | 5,388                   |       | 5,388 |   |
|                                                       |                                                      | 39,061                  |       | 48,105 |   |
| Less:                                                      | accumulated  amortization—patents                    |                    | (2,063     | ) | (1,998 | ) |
|                                                       | accumulated  amortization—manufacturing rights       |                    | (833       | ) | (7,559 | ) |
|                                                       | accumulated  amortization—acquired technology rights |                    | (5,152     | ) | (2,695 | ) |
|                                                       | accumulated  amortization—intellectual property      |                    | (5,374     | ) | (5,373 | ) |
| Intangible assets, net                                     |                                                      | $                       | 25,639     |   | $ | 30,480 |   |

 

There were no additions to intangible assets duringthe twelve months ended December 31, 2006. Additions to intangible assetsduring 2005 resulted from $20.0 million of payments made to Eli Lilly, inthe form of common stock in exchange for a 2% reduction in the royalty ratepayable to Eli Lilly on net sales of CUBICIN pursuant to the Company’s licenseagreement with Eli Lilly. Cubist is amortizing the $20.0 million overapproximately eleven years, which was the remaining life of the licenseagreement with Eli Lilly on the date of the transaction. There were noadditions to intangible assets during the twelve months ended December 31,2004. In 2003, Cubist issued to Eli Lilly $8.0 million of common stock inexchange for a 1% reduction in the royalties payable to Eli Lilly. The Companyalso issued 38,922 shares of common stock in valued at $0.5 million in 2003 asa milestone payment to Eli Lilly. This $8.5 million payment is being amortizedover approximately thirteen years, which was the estimated remaining life ofthe license agreement with Eli Lilly on the dates of the transactions. Theamortization of the Eli Lilly intangible assets are included in cost of productrevenues.

In November 2005, Cubist announced that it hasselected ACS as the single source supplier of API for CUBICIN. Cubist providednotice to DSM in accordance with contract agreement terms to terminate its 

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manufacturing and supplyagreement with DSM for API. The useful life of the DSM manufacturing rights wasadjusted to coincide with the revised termination date of May 2006. AsCubist will receive no future benefit from the DSM manufacturing rights, theirgross asset value and related allowance for amortization expense wereeliminated from the accounts with no resulting gain or loss. Amortization ofthese assets was allocated to inventory and is expensed to cost of productrevenues as the related inventory lots are sold. The manufacturing rightsassociated with the ACS agreement are being amortized to inventory over thecontractual term of six years and expensed to cost of product revenues as therelated inventory lots are sold.

Based on an internal analysis in 2004, the Companyestimated that the discounted future cash flows from a patent, unrelated to itsCUBICIN product, were less than its carrying value, resulting in an impairmentcharge of $2.2 million. The $2.2 million charge was recorded togeneral and administrative expense in the quarter ended December 31, 2004.

Amortizationexpense was $4.9 million, $7.0 million and $2.8 million in 2006, 2005 and2004 respectively. The estimated aggregate amortization of intangible assets asof December 31, 2006, for each of the five succeeding years is as follows:

| ** **           | ** ** | **(in thousands)** | ** ** |
|----------------------|------------|-------------------------|------------|
| 2007                 |       |                    | $          | 2,941 |   |   |
| 2008                 |       |                    | 2,941      |   |   |
| 2009                 |       |                    | 2,941      |   |   |
| 2010                 |       |                    | 2,941      |   |   |
| 2011                 |       |                    | 2,524      |   |   |
| 2012 and  thereafter |       |                    | 11,351     |   |   |
|                 |       |                    | $          | 25,639 |   |   |

 

**I.**                   ACCRUEDLIABILITIES

Accruedliabilities consisted of the following at:

| ** **                      | ** ** | **December 31,**   | ** ** |
|---------------------------------|------------|-------------------------|------------|
| ** **                      | ** ** | **2006**                | ** ** | **2005** | ** ** |
| ** **                      | ** ** | **(in thousands)** | ** ** |
| Accrued payroll                 |       | $                       | 590        |   | $ | 551 |   |
| Accrued incentive  compensation |       | 2,353                   |       | 2,296 |   |
| Accrued bonus                   |       | 4,458                   |       | 4,316 |   |
| Accrued benefit  costs          |       | 1,879                   |       | 2,675 |   |
| Accrued clinical  trials        |       | 494                     |       | 1,787 |   |
| Accrued interest                |       | 350                     |       | 1,512 |   |
| Accrued  manufacturing costs    |       | 1,804                   |       | 1,722 |   |
| Accrued royalty                 |       | 12,905                  |       | 6,208 |   |
| Other accrued  costs            |       | 6,205                   |       | 5,528 |   |
| Total                           |       | $                       | 31,038     |   | $ | 26,595 |   |

 

**J.**                  ACCRUEDCLINICAL TRIAL EXPENSE

Accrued clinical trialexpenses are comprised of amounts owed to third party contract researchorganizations, or CROs, for research and development work performed on behalfof Cubist. At each period end, the Company evaluates the accrued clinical trialexpense balance based upon information received from each CRO, and ensures thatthe balance is appropriately stated based upon work performed to date. Theaccrued clinical trial expense balance of $494,000 and $1.8 million at December 31,2006 and 

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2005,respectively, represents the Company’s best estimate of amounts owed forclinical trial services performed through those periods based on allinformation available. Such estimates are subject to change as additionalinformation becomes available.

**K.**              EQUITYFINANCINGS

In November 2004,Cubist announced the completion of the sale of 10,714,200 shares of commonstock at $11.20 per share. Gross proceeds from the stock offering totaledapproximately $120.0 million. Proceeds to Cubist, net of $7.6 millionin underwriters’ commissions, discounts and issuance costs totaled approximately$112.4 million.

**L.**                STOCKHOLDERS’EQUITY

*Stock Issuances*

In March 2005, Cubist announced that it enteredinto an agreement to purchase from Eli Lilly a 2% reduction in the royalty ratepayable to Eli Lilly on net sales of CUBICIN. Cubist issued to Eli Lilly $20.0million in Cubist common stock with associated registration rights. A total of1,876,173 shares were issued at a price of $10.66 per share in March 2005.Cubist’s global royalty rate obligation to Eli Lilly on CUBICIN sales wasreduced by two percentage points upon registration of the common stock on April 22, 2005.

In October 2003,Cubist entered into a stock purchase agreement with Novartis pursuant to whichNovartis purchased 529,942 shares of Cubist common stock valued at$10.0 million at a 50% premium to the fair value of the Company’s commonstock. The premium paid was allocated to a license agreement with Novartis andwas included as part of the up-front payment under the license agreement. Theamounts were recorded to deferred revenue and were being recognized over theestimated development period of two years.

**M.**   EMPLOYEESTOCK BENEFIT PLANS

*Summary of StockOption Plans*

Cubist has several stock-based compensation plans.Under the Cubist Amended and Restated 1993 Stock Option Plan, options topurchase 5,837,946 shares of common stock were available for grant toemployees, directors, officers or consultants. The options were generallygranted at fair market value on the date of the grant, vested ratably over afour-year period and expired ten years from the date of grant. There are noshares available for future grant under this plan as it terminated inaccordance with plan terms in 2003.

Under the Cubist Amended and Restated 2000 EquityIncentive Stock Option Plan, or the 2000 Equity Incentive Plan, options aregenerally granted with exercise prices equal to the fair market value on thedate of the grant, vest ratably over a four-year period and expire ten yearsfrom the date of grant. The 2000 Equity Incentive Plan includes an evergreen formulapursuant to which the maximum number of shares of Cubist common stock thatshall be made available for sale under the 2000 Equity Incentive Plan shall be1,630,000 shares as of June 13, 2002 plus an annual increase to be addedon January 1st of each year, beginning on January 1, 2003 until andincluding January 1, 2006, equal to five percent (5%) of the total numberof shares of common stock and stock equivalents issued and outstanding as ofthe close of business on the immediately preceding December 31st. As ofJanuary 1, 2006, options to purchase 11,535,764 shares of common stock maybe granted to employees, directors, officers or consultants under this plan. AtDecember 31, 2006, there were 5,276,557 shares available for future grantunder this plan.

Under the Cubist Amended and Restated 2002 DirectorsStock Option Plan, options to purchase 675,000 shares of Common Stock may begranted to members of the Board of Directors. The options are 

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generally granted at fairmarket value on the date of the grant, vest ratably over a three-year periodand expire ten years from the date of grant. At December 31, 2006, therewere 318,750 shares available for future grant under this plan.

Cubist does not currentlyhold any treasury shares. Upon share option exercise, the Company issues newshares and delivers them to the participant. In line with its current businessplan, Cubist does not intend to repurchase shares in the foreseeable future.

*Summary of EmployeeStock Purchase Plan*

Qualifying employees areeligible to participate in an employee stock purchase plan sponsored by theCompany. Under this program, participants purchase Cubist common stock, after apre-determined six-month period, at 85% of the lower of the fair market valueat the beginning or end of the purchase period. Shares are purchased throughpayroll deductions of up to 15% of each participating employee’s annualcompensation, subject to certain limitations. The current plan allows for theissuance of 500,000 shares of common stock to eligible employees. During 2006,2005 and 2004 Cubist issued 79,558, 73,224 and 66,248 shares of commonstock, respectively, pursuant to this plan. At December 31, 2006 therewere 168,042 shares available for future issuance under this plan.

*Stock CompensationExpense Prior to the Adoption of SFAS 123(R)*

Priorto the adoption of SFAS 123(R), the Company provided the disclosures requiredunder SFAS No. 123, *“Accounting forStock-Based Compensation,”* as amended by SFAS No. 148, *“Accounting for Stock-Based Compensation—Transition and Disclosures.”*No significant employee stock-based compensation was reflected in net loss forthe years ended December 31, 2005 and 2004 related to employee optiongrants, as all options granted under those plans had an exercise price equal tothe market value of the underlying common stock on the date of grant. Thepro-forma information for the year ended December 31, 2005 and 2004 was asfollows:

| ** **                                                                                                                                           | ** ** | **Year Ended December 31,**                     | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                                                                                                                                           | ** ** | **2005**                                                       | ** ** | **2004** | ** ** |
| ** **                                                                                                                                           | ** ** | **(in thousands,  except per share data)** | ** ** |
| Net loss, as reported                                                                                                                                |       | $                                                              | (31,852    | ) | $ | (76,512 | ) |
| Add: Stock-based employee compensation recorded in  net loss, as reported                                                                       |       | 77                                                             |       | 72 |   |
| Deducted: Total stock-based employee compensation  expense determined under fair value based method for all awards, net of related  tax effects |       | (12,962                                                        | )          | (16,689 | ) |
| Pro forma net  loss                                                                                                                                  |       | $                                                              | (44,737    | ) | $ | (93,129 | ) |
| Loss per share:                                                                                                                                      |       |                                                           |       |   |   |
| Basic and  diluted—as reported                                                                                                                  |       | $                                                              | (0.60      | ) | $ | (1.86 | ) |
| Basic and diluted—pro  forma                                                                                                                    |       | $                                                              | (0.84      | ) | $ | (2.26 | ) |

 

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*Impact of theAdoption of SFAS 123(R)*

Theeffect of recording stock-based compensation in the Consolidated Statement ofOperations for the year ended December 31, 2006 was as follows: 

| Stock-based  compensation expense by type of award: |   |   |   |
|-----------------------------------------------------|--------|--------|--------|
| Employee stock options                              |   | $      | 10,214 |   |
| Employee stock  purchase plan                       |   | 409    |   |
| Total stock-based  compensation                     |   | $      | 10,623 |   |
| Effect on earnings per share:                       |   |   |   |
| Basic and diluted                                   |   | $      | 0.19   |   |

 

The carrying value of inventory in the Consolidated Balance Sheetfor the year ended December 31, 2006 includes employee stock-basedcompensation costs of $0.2 million.

*Valuation Assumptions*

The fair value of each share-based awardwas estimated on the date of grant using the Black-Scholes option-pricing modeland expensed under the accelerated method for option grants prior to the firstquarter of 2006 and under the straight-line method for option grants commencingin the first quarter of 2006. The following weighted-average assumptions wereused:

| ** **                                | ** ** | **2006**   | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------------------|------------|------------|------------|----------|------------|----------|------------|
| **Stock option plans:**                   |       |       |       |     |       |     |       |
| Expected stock  price volatility          |       | 52%        |       | 72%      |       | 100%     |       |
| Risk free  interest rate                  |       | 4.7%       |       | 3.9%     |       | 3.9%     |       |
| Expected annual  dividend yield per share |       | 0%         |       | 0%       |       | 0%       |       |
| Expected life of  options                 |       | 4.3  years |       | 5  years |       | 5  years |       |
| **Stock purchase plan:**                  |       |       |       |     |       |     |       |
| Expected stock price  volatility          |       | 30%        |       | —   |       | —   |       |
| Risk free  interest rate                  |       | 4.8%       |       | —   |       | —   |       |
| Expected annual  dividend yield per share |       | 0%         |       | —   |       | —   |       |
| Expected life of options                  |       | 6 months   |       | —   |       | —   |       |

 

Cubist’s expected stockprice volatility assumption is based on both current and historicalvolatilities of the Company’s stock which is obtained from public data sources.The expected stock price volatility is determined based on the instrument’s expectedterm. Since the employee stock purchase plan has a shorter term than the stockoption plans, volatility for this plan is estimated over a shorter period. Therisk-free interest rate is a less subjective assumption as it is based onfactual data derived from public sources. Cubist uses a dividend yield of zeroas it has never paid cash dividends and has no intention of paying cashdividends in the foreseeable future. The expected life represents the weightedaverage period of time that share-based awards are expected to be outstandinggiving consideration to vesting schedules and the Company’s historical exercisepatterns. Cubist determines the expected life assumption based on the exercisebehavior and post vesting cancellations that has been exhibited historically,adjusted for specific factors that may influence future exercise patterns. TheCompany estimates forfeitures based on its historical experience of share-basedpre-vesting cancellations. The Company believes that its estimates are based onoutcomes that are reasonably likely to occur. To the extent actual forfeituresdiffer from its estimates, such amounts will be recorded as a cumulativeadjustment in the period estimates are revised.

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*General OptionInformation*

Asummary of the status of Cubist’s stock option plans, as of December 31,2006, 2005 and 2004, and changes during each of the years then ended, ispresented below:

| ** **                                                                                 | ** ** | **2006**   | ** ** | **2005**                  | ** ** | **2004**   | ** ** |
|--------------------------------------------------------------------------------------------|------------|------------|------------|---------------------------|------------|------------|------------|
| ** **                                                                                 | ** ** | ** ** | ** ** | **Weighted Average** | ** ** | ** ** | ** ** | **Weighted Average** | ** ** | ** ** | ** ** | **Weighted Average** | ** ** |
| ** **                                                                                 | ** ** | **Number** | ** ** | **Exercise Price**   | ** ** | **Number** | ** ** | **Exercise Price** | ** ** | **Number** | ** ** | **Exercise Price** | ** ** |
| Balance at  January 1                                                                 |       | 6,836,077  |       |                      | $          | 14.14      |       |   | 5,850,156 |   |   | $ | 15.25 |   |   | 6,127,199 |   |   | $ | 16.86 |   |   |
| Granted                                                                                    |       | 2,140,175  |       |                      | $          | 22.14      |       |   | 2,221,964 |   |   | $ | 11.46 |   |   | 1,139,090 |   |   | $ | 10.78 |   |   |
| Exercised                                                                                  |       | (892,790   | )          |                      | $          | 9.94       |       |   | (680,860 | ) |   | $ | 8.30 |   |   | (285,565 | ) |   | $ | 6.33 |   |   |
| Canceled                                                                                   |       | (807,012   | )          |                      | $          | 18.83      |       |   | (555,183 | ) |   | $ | 22.30 |   |   | (1,130,568 | ) |   | $ | 21.62 |   |   |
| Balance at  December 31                                                               |       | 7,276,450  |       |                      | $          | 16.49      |       |   | 6,836,077 |   |   | $ | 14.14 |   |   | 5,850,156 |   |   | $ | 15.25 |   |   |
| Options exercisable on December 31,                                              |       | 3,832,398  |       |                      | $          | 16.18      |       |   | 3,549,379 |   |   | $ | 16.65 |   |   | 3,210,505 |   |   | $ | 17.83 |   |   |
| Weighted average grant-date  fair value of options granted during the year: |       |       |       |                      | $          | 10.40      |       |   |   |   |   | $ | 7.20 |   |   |   |   |   | $ | 8.21 |   |   |

 

The total intrinsic value of options exercised duringthe year ended December 31, 2006, 2005 and 2004 was $11.6 million, $5.2million, and $1.4 million, respectively. The aggregate intrinsic value ofoutstanding options as of December 31, 2006 was $11.8 million.

As of December 31, 2006, there was $16.3 millionof total unrecognized compensation cost related to nonvested options grantedunder the Plans. That cost is expected to be recognized over theweighted-average period of 1.5 years. The aggregate intrinsic value of fullyvested stock options exercisable at December 31, 2006 was $7.4 million.These options have a weighted-average remaining contractual life of 6.3 years.

The weighted-average fair value of vested shares at December 31,2006, 2005 and 2004 was $11.61, $13.13, and $14.21, respectively.

Thefollowing table summarizes information about stock options outstanding at December 31,2006:

| ** **               | ** ** | **Options Outstanding** | ** ** | **Options Exercisable** | ** ** |
|--------------------------|------------|------------------------------|------------|------------------------------|------------|
| **Range of**        | ** ** | **Number**                   | ** ** | **Remaining**                | ** ** | **Weighted-Average** | ** ** | **Number** | ** ** | **Weighted-Average** | ** ** |
| **Exercise Prices** | ** ** | **Outstanding**              | ** ** | **Contractual Life**    | ** ** | **Exercise Price** | ** ** | **Exercisable** | ** ** | **Exercise Price** | ** ** |
| $0.42—$6.34         |       |                         | 144,440    |                         |       |   | 2.1 |   |   |   | $ | 3.57 |   |   | 144,440 |   |   | $ | 3.57 |   |   |
| $6.35—$12.68        |       |                         | 3,648,892  |                         |       |   | 7.2 |   |   |   | $ | 10.28 |   |   | 2,216,548 |   |   | $ | 10.04 |   |   |
| $12.69—$19.01       |       |                         | 604,040    |                         |       |   | 7.4 |   |   |   | $ | 14.12 |   |   | 347,792 |   |   | $ | 13.66 |   |   |
| $19.02—$25.35       |       |                         | 2,078,621  |                         |       |   | 9.1 |   |   |   | $ | 22.16 |   |   | 323,161 |   |   | $ | 22.04 |   |   |
| $25.36—$31.69       |       |                         | 245,005    |                         |       |   | 3.8 |   |   |   | $ | 29.32 |   |   | 245,005 |   |   | $ | 29.32 |   |   |
| $31.70—$38.03       |       |                         | 529,426    |                         |       |   | 4.8 |   |   |   | $ | 35.13 |   |   | 529,426 |   |   | $ | 35.13 |   |   |
| $50.70—$57.04       |       |                         | 1,526      |                         |       |   | 2.0 |   |   |   | $ | 53.08 |   |   | 1,526 |   |   | $ | 53.08 |   |   |
| $57.05—$63.38       |       |                         | 24,500     |                         |       |   | 3.3 |   |   |   | $ | 61.71 |   |   | 24,500 |   |   | $ | 61.71 |   |   |
|                     |       |                         | 7,276,450  |                         |       |   | 7.3 |   |   |   | $ | 16.49 |   |   | 3,832,398 |   |   | $ | 16.18 |   |   |

 

Cubist records deferredcompensation for stock options issued with exercise prices below the fair valueof common stock as of the measurement date. No options were issued withexercise prices below fair value in 2006, 2005 or 2004. Deferred compensationis amortized and recorded as compensation expense 

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ratablyover the vesting period of the stock options. No compensation expense wasrecognized in 2006 or 2005 related to the amortization of deferredcompensation.

**N.   COMMITMENTSAND CONTINGENCIES**

*Leases*

Cubist leases various facilities and equipment underleases that expire at varying dates through 2016. Certain of these leasescontain renewal options and provisions that adjust the rent payment based uponchanges in the consumer price index and require Cubist to pay operating costs,including property taxes, insurance and maintenance.

At December 31,2006, future minimum lease payments under all non-cancelable leases net ofsublease income are as follows:

| ** **                                      | ** ** | **Operating**           | ** ** | **Capital** | ** ** |
|-------------------------------------------------|------------|-------------------------|------------|-------------|------------|
| ** **                                      | ** ** | **(in thousands)** | ** ** |
| 2007                                            |       |                    | $          | 1,172       |       |   |   | $ | 245 |   |   |
| 2008                                            |       |                    | 1,232      |        |       |   | — |   |   |
| 2009                                            |       |                    | 1,331      |        |       |   | — |   |   |
| 2010                                            |       |                    | 1,458      |        |       |   | — |   |   |
| 2011                                            |       |                    | 1,385      |        |       |   | — |   |   |
| Thereafter                                      |       |                    | 6,568      |        |       |   | — |   |   |
| Total minimum  lease payments                   |       |                    | $          | 13,146      |       |   |   | $ | 245 |   |   |
| Less amount  representing interest              |       |                    |       |        |       |   | — |   |   |
| Present value of  future minimum lease payments |       |                    |       |        |       |   | $ | 245 |   |   |
| Less: current  portion                          |       |                    |       |        |       |   | 245 |   |   |
| Long-term portion                               |       |                    |       |        |       |   | $ | — |   |   |

 

Rental expense foroperating leases was $3.6 million, $2.7 million and $3.0 millionin the years ended December 31, 2006, 2005 and 2004, respectively.Sublease income, which is recorded as a reduction of rent expense, was$2.5 million, $2.4 million and $2.4 million in the years ended December 31,2006, 2005 and 2004, respectively.

*Foreign currency*

Cubist operatesinternationally, which gives rise to a risk that earnings and cash flows may benegatively impacted by fluctuations in interest and foreign exchange rates.During 2006 and 2005, Cubist entered into limited foreign currency transactionsbetween the U.S. dollar, the European Euro and the British pound.

*Guarantees andIndemnification Obligations*

The Company has vacatedsome of its leased facilities or sublet them to third parties. When the Companysublets a facility to a third party, it remains the primary obligor under themaster lease agreement with the owner of the facility. As a result, if a thirdparty defaults on their payments related to the sublet facility, the Companywould be obligated to make lease or other payments under the master leaseagreement. The Company believes that the financial risk of default bysublessors is individually and in the aggregate not material to the Company’sfinancial position or results of operations.

*Other*

We have minimum volume purchase commitments with thirdparty contract manufacturers with scheduled payments over the next five yearsthat total $105.4 million at December 31, 2006.

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**O.**              DEBT

Cubist’s outstanding debt at December 31, 2006consists of $350.0 million aggregate principal amount of 2.25% convertiblesubordinated notes due June 2013. Cubist’s outstanding debt at December 31,2005 consisted of $165.0 million aggregate principal amount of 51⁄2%convertible subordinated notes due November 2008.

In June 2006, Cubist completed the publicoffering of $350.0 million aggregate principal amount of 2.25% convertiblesubordinated notes (the “2.25% Notes”). The 2.25% Notes are convertible at anytime prior to maturity into common stock at an initial conversion rate of32.4981 shares of common stock per $1,000 principal amount of convertiblenotes, subject to adjustment upon certain events, which equates toapproximately $30.77 per share of common stock. Cubist may deliver cash or acombination of cash and common stock in lieu of shares of common stock.Interest is payable on each June 15 and December 15, beginning December 15,2006. The 2.25% Notes mature on June 15, 2013. Cubist retains the right toredeem the 2.25% Notes at 100% of the principal amount to be redeemed plusaccrued and unpaid interest commencing in June 2011 if Cubist’s commonstock closing price exceeded the conversion price for a period of time asdefined in the 2.25% Notes agreement. The deferred financing costs associatedwith the sale of the 2.25% Notes were $10.9 million. These costs areamortized ratably over the life of the note.

In 2001, Cubist completed the private placement of$165.0 million aggregate principal amount of 5.5% convertible subordinatednotes (the “5.5% Notes”). The offering was made through initial purchasers toqualified institutional buyers under Rule 144A of the Securities Act. The5.5% Notes were convertible at any time prior to maturity into common stock ata conversion price of $47.20 per share, subject to adjustment upon certainevents. Interest was payable on each November 1 and May 1, beginning May 1,2002. The 5.5% Notes had a maturity date of November 1, 2008. Cubistretained the right to redeem the 5.5% Notes prior to November 2004 ifCubist’s common stock closing price exceeded the conversion price for a periodof time as defined in the 5.5% Notes agreement. The deferred financing costsassociated with the sale of the 5.5% Notes were $5.3 million. In June 2006,Cubist repaid the outstanding principal and accrued interest on the 5.5% Notes,plus a prepayment penalty of $3.9 million that was recorded to interest expense.The remaining unamortized balance of the debt issuance costs, totaling $1.8million, associated with the 5.5% Notes was written off to interest expense atthe time of the repayment.

In September 2000, Cubist purchased, for$34.0 million, a corporate headquarters building in Lexington,Massachusetts. The facility is approximately 88,000 square feet, approximately55,000 of which is constructed as laboratory space. In September 2001,Cubist relocated to the facility and depreciation expense commenced at thattime. To finance the purchase, Cubist issued $39.0 million aggregate principalamount of senior convertible notes to John Hancock Life Insurance Company. Thisfinancing covered the building purchase price of approximately$34.0 million and included $5.0 million for facility improvements.The five-year notes carried a coupon rate of 81⁄2% and were convertible at anytime at the option of the holder into Cubist common stock at $63.8625 pershare. Cubist retained the right to redeem these notes after three years at103% of their principal amount outstanding. On December 23, 2003 Cubistrepaid $10.0 million of the senior convertible notes, plus a 3% prepaymentpenalty. On December 13, 2004 Cubist repaid the outstanding principal andinterest of the senior convertible notes totaling $29.5 million, plus a 3%prepayment penalty of $0.9 million that was charged to interest expense.The deferred financing costs associated with the sale of the senior convertiblenotes were $1.3 million of which $0.4 million and $0.3 millionwere amortized to interest expense in 2004 and 2003, respectively.

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At December 31,2006, future payments of principal and interest on existing debt are due asfollows:

**Fiscal year ending December 31,**

| ** **            | ** ** | **Principal**           | ** ** | **Interest** | ** ** | **Total** | ** ** |
|-----------------------|------------|-------------------------|------------|--------------|------------|-----------|------------|
| ** **            | ** ** | **(in thousands)** | ** ** |
| 2007                  |       | $                       | —     |         | $          | 7,875     |       | $ | 7,875 |   |
| 2008                  |       | —                  |       | 7,875        |       | 7,875     |       |
| 2009                  |       | —                  |       | 7,875        |       | 7,875     |       |
| 2010                  |       | —                  |       | 7,875        |       | 7,875     |       |
| 2011                  |       | —                  |       | 7,875        |       | 7,875     |       |
| 2012                  |       | —                  |       | 7,875        |       | 7,875     |       |
| 2013                  |       | 350,000                 |       | 3,938        |       | 353,938   |       |
| Total payments        |       | $                       | 350,000    |         | $          | 51,188    |       | $ | 401,188 |   |
| Less current  portion |       | —                  |       |         |       |      |       |
| Total long term debt  |       | $                       | 350,000    |         |       |      |       |   |

 

**P.**                 EMPLOYEEBENEFITS

*401(k) SavingsPlan and Other Defined Contribution Plans*

Cubist maintains a 401(k) savings plan in whichsubstantially all of its permanent employees in the U.S. are eligible toparticipate. Participants may contribute up to 100% of their annual compensationto the plan, subject to certain limitations. Cubist matches in common stock upto 4% of a participant’s total compensation. Employer common stock matches haveimmediate vesting. Cubist issued 127,504, 87,500 and 53,164 shares of commonstock in 2006, 2005 and 2004, respectively, pursuant to this plan.

Cubist maintained aContracted In Money Purchase Scheme for all employees in the United Kingdomprior to its closure on August 31, 2004. Participants were able tocontribute up to 5% of their annual compensation to the scheme. Cubist matchedcontributions at a level up to 5% of an employee’s salary. During 2004, Cubist’sUnited Kingdom subsidiary contributed $55,000 to the scheme.

**Q.**              INCOMETAXES

Foreach of the years ended December 31, 2006, 2005 and 2004, Cubist’sstatutory tax rate was 34% and its effective tax rate was 0%. The effective taxrate was 0% for all periods as a full valuation allowance was recorded for allnet operating losses and other deferred tax assets generated. Based on Cubist’scurrent financial status, realization of Cubist’s deferred tax assets does notmeet the “more likely than not” criteria under SFAS No. 109. Thecomponents of the net deferred tax asset and the related valuation allowanceare as follows:

| ** **                        | ** ** | **2006**                | ** ** | **2005** | ** ** | **2004** | ** ** |
|-----------------------------------|------------|-------------------------|------------|----------|------------|----------|------------|
| ** **                        | ** ** | **(in thousands)** | ** ** |
| Deferred income  tax assets:      |       |                    |       |     |       |     |       |
| Net operating  loss carryforwards |       | $                       | 142,309    |     | $          | 138,910  |       | $ | 108,583 |   |
| Research and  development costs   |       | 31,012                  |       | 38,469   |       | 48,699   |       |
| Tax credit  carryforwards         |       | 16,923                  |       | 14,163   |       | 11,232   |       |
| Impairment charge                 |       | 738                     |       | 807      |       | 896      |       |
| Deferred revenues                 |       | 490                     |       | 491      |       | 205      |       |
| Other, net                        |       | 4,960                   |       | 2,301    |       | 776      |       |
| Total deferred  tax assets        |       | 196,432                 |       | 195,141  |       | 170,391  |       |
| Valuation  allowance              |       | (196,432                | )          | (195,141 | )          | (170,391 | )          |
| Net deferred tax assets           |       | $                       | —     |     | $          | —   |       | $ | — |   |

 

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Theeffective rate differs from the statutory rate of 34% due to the following:

| ** **                           | ** ** | **2006** | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Federal                              |       | 34.0     | %          | 34.0     | %          | 34.0     | %          |
| State                                |       | -49.8    | %          | 6.5      | %          | 6.6      | %          |
| Research and  development tax credit |       | 600.9    | %          | 8.9      | %          | 1.4      | %          |
| Valuation  allowance                 |       | -345.2   | %          | -47.6    | %          | -41.4    | %          |
| Other                                |       | -239.9   | %          | -1.8     | %          | -0.6     | %          |
| Effective tax rate                   |       | 0.0      | %          | 0.0      | %          | 0.0      | %          |

 

Changes in the effective tax rates from period toperiod may be significant as they depend on many factors including, but notlimited to, changes in circumstances surrounding the need for a valuationallowance, size of the Company’s income or loss, or one time activitiesoccurring during the period. At December 31, 2006, Cubist has federal netoperating loss carryforwards of approximately $381.1 million, which beginto expire in 2007, and state net operating loss carryforwards of $325.4million, which begin to expire in 2007. State net operating loss carryforwardsof $27.8 million and $10.0 million expired in 2006 and 2005, respectively.Of the $196.4 million valuation allowance at December 31, 2006, $7.9 millionrelates to the tax benefit of the exercise of stock options. This amount willresult in an increase in Additional Paid in Capital upon realization of theselosses. Cubist also has federal and state credit carryforwards of $13.3 millionand $5.6 million respectively, which begin to expire in 2008.

The American Jobs Creation Act of 2004, or the Act,was signed into law in October 2004. The Act contains numerous amendmentsand additions to the U.S. corporate income tax rules. None of these changes,either individually or in the aggregate, had a significant effect on theCompany’s income tax liability.

Ownership changesresulting from the issuance of capital stock may limit the amount of netoperating loss and tax credit carryforwards that can be utilized annually tooffset future taxable income. The amount of the annual limitation is determinedbased on Cubist’s value immediately prior to the ownership change. Subsequentsignificant changes in ownership could further affect the limitation in futureyears.

**R.**               BUSINESSSEGMENTS

Cubist operates in one business segment, the research,development and commercialization of pharmaceutical products that address unmetmedical needs in the acute care environment. The Company has concentratedexclusively on developing products for the antiinfective marketplace. TheCompany’s entire business is managed by a single management team, which reportsto the Chief Executive Officer. Substantially all of the Company’s revenues arecurrently generated within the U.S.

Revenues from CardinalHealth accounted for approximately 33%, 32% and 32% of all revenues for theyear ended December 31, 2006, 2005 and 2004, respectively. Revenues fromAmerisource Bergen Drug Corporation accounted for approximately 32%, 31% and31% of all revenues for the years ended December 31, 2006, 2005 and 2004,respectively. Revenues from McKesson Corporation accounted for approximately21%, 21% and 22% of all revenues for the year ended December 31, 2006,2005 and 2004, respectively.

**S.**                LEGALPROCEEDINGS

In response to an inquiryfrom the Company, the staff of the Boston office of the Securities and ExchangeCommission has stated that it does not presently intend to make an enforcementrecommendation to the Commission with regard to the Company arising from theinvestigation referenced 

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on page 40of our Form 10-Q for the third quarter of 2006. The Companyunderstands that this advice is subject to the guidelines in the finalparagraph of Securities Act Release No. 5310.

**T.**                 SELECTEDQUARTERLY FINANCIAL DATA (UNAUDITED)

Thefollowing table contains quarterly financial information for fiscal 2006 and2005. Cubist believes that the following information reflects all normalrecurring adjustments necessary for a fair presentation of the information forthe period presented. The operating results for any quarter are not necessarilyindicative of results for any future period.

| ** **                            | ** ** | **First**                                                          | ** ** | **Second**  | ** ** | **Third**   | ** ** | **Fourth**  | ** ** |
|---------------------------------------|------------|--------------------------------------------------------------------|------------|-------------|------------|-------------|------------|-------------|------------|
| ** **                            | ** ** | **Quarter**                                                        | ** ** | **Quarter** | ** ** | **Quarter** | ** ** | **Quarter** | ** ** |
| ** **                            | ** ** | **(in thousands, except per share data)** | ** ** |
| **2006**                              |       |                                                               |       |        |       |        |       |        |       |
| Total revenues,  net                  |       | $                                                                  | 40,055     |        | $          | 47,794      |       | $           | 50,419     |   | $ | 56,480 |   |
| Product revenues,  net                |       | $                                                                  | 37,941     |        | $          | 45,681      |       | $           | 50,318     |   | $ | 56,380 |   |
| Cost of product  revenues             |       | $                                                                  | 10,132     |        | $          | 11,790      |       | $           | 12,742     |   | $ | 14,139 |   |
| Net income (loss)                     |       | $                                                                  | (5,880     | )           | $          | (5,073      | )          | $           | 5,184      |   | $ | 5,393 |   |
| Basic net income  (loss) per share    |       | $                                                                  | (0.11      | )           | $          | (0.09       | )          | $           | 0.09       |   | $ | 0.10 |   |
| Diluted net  income (loss) per share  |       | $                                                                  | (0.11      | )           | $          | (0.09       | )          | $           | 0.09       |   | $ | 0.09 |   |
| **2005**                              |       |                                                               |       |        |       |        |       |        |       |
| Total revenues,  net                  |       | $                                                                  | 23,682     |        | $          | 28,255      |       | $           | 31,842     |   | $ | 36,866 |   |
| Product revenues,  net                |       | $                                                                  | 20,889     |        | $          | 25,642      |       | $           | 30,337     |   | $ | 36,646 |   |
| Cost of product  revenues             |       | $                                                                  | 6,925      |        | $          | 7,371       |       | $           | 8,074      |   | $ | 10,369 |   |
| Net loss                              |       | $                                                                  | (12,882    | )           | $          | (7,748      | )          | $           | (4,504     | ) | $ | (6,718 | ) |
| Basic and diluted net  loss per share |       | $                                                                  | (0.25      | )           | $          | (0.15       | )          | $           | (0.08      | ) | $ | (0.12 | ) |

 

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**ITEM 9.**                CHANGESIN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

**ITEM 9A.**        CONTROLSAND PROCEDURES

**ConclusionRegarding the Effectiveness of Disclosure Controls and Procedures**

Under the supervision andwith the participation of our management, including our principal executiveofficer and principal financial officer, we conducted an evaluation of ourdisclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgatedunder the Securities Exchange Act of 1934, as amended (the Exchange Act). Basedon this evaluation, our principal executive officer and our principal financialofficer concluded that our disclosure controls and procedures were effective asof the end of the period covered by this annual report.

**Management’s Reporton Internal Control Over Financial Reporting**

Management is responsible for establishing andmaintaining adequate internal control over financial reporting, as such term isdefined in Exchange Act Rule 13a-15(f). Under the supervision andwith the participation of our management, including our principal executiveofficer and principal financial officer, we conducted an evaluation of theeffectiveness of our internal control over financial reporting based on theframework in *Internal Control—IntegratedFramework* issued by the Committee of Sponsoring Organizations of theTreadway Commission. Based on our evaluation under the framework in *Internal Control—Integrated Framework*, ourmanagement concluded that our internal control over financial reporting waseffective as of December 31, 2006.

Management’s assessment of the effectiveness of ourinternal control over financial reporting as of December 31, 2006 has beenaudited by PricewaterhouseCoopers LLP, an independent registered public accountingfirm, as stated in their report which is included herein.

There have not been anychanges in the Company’s internal control over financial reporting during theyear ended December 31, 2006 that have materially affected, or arereasonably likely to materially affect, the Company’s internal control overfinancial reporting.

**ITEM 9B.**       OTHERINFORMATION

None.

**PART III**

**ITEM 10.**         DIRECTORS,EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

Certain information with respect to our executiveofficers and directors may be found under the section captioned “Our ExecutiveOfficers and Directors” in Part I of this Annual Report on Form 10-K.Other information required by Item 10 of Form 10-K may be found inthe definitive Proxy Statement to be delivered to stockholders in connectionwith the Annual Meeting of Stockholders to be held on June 7, 2007. Suchinformation is incorporated herein by reference.

Our board of directorsadopted a Code of Conduct and Ethics applicable to the board of directors, ourChief Executive Officer, Chief Financial Officer, other officers of Cubist andall other employees of Cubist. The Code of Conduct and Ethics is available onour web site, www.cubist.com and in our filings with the SEC.

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**ITEM 11.**         EXECUTIVECOMPENSATION

The information requiredwith respect to this item may be found in the definitive Proxy Statement to bedelivered to stockholders in connection with the Annual Meeting of Stockholdersto be held on June 7, 2007. Such information is incorporated herein byreference.

**ITEM 12.**         SECURITYOWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDERMATTERS

The information requiredwith respect to this item may be found in the definitive Proxy Statement to bedelivered to Stockholders in connection with the Annual Meeting of Stockholdersto be held on June 7, 2007. Such information is incorporated herein byreference.

**ITEM 13.**         CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

The information requiredwith respect to this item may be found in the definitive Proxy Statement to bedelivered to stockholders in connection with the Annual Meeting of Stockholdersto be held on June 7, 2007. Such information is incorporated herein byreference.

**ITEM 14.**         PRINCIPALACCOUNTANT FEES AND SERVICES

The information requiredwith respect to this item may be found in the definitive Proxy Statement to bedelivered to stockholders in connection with the Annual Meeting of Stockholdersto be held on June 7, 2007. Such information is incorporated herein byreference.

**PART IV**

**ITEM 15.**         EXHIBITSAND FINANCIAL STATEMENT SCHEDULES

(A)       DocumentsFiled As Part Of Form 10-K:

**1. FinancialStatements**

The followingfinancial statements and supplementary data are included in Part II Item 8filed as part of this report:

·       Report of IndependentRegistered Public Accounting Firm

·       Balance Sheets as of December 31,2006 and 2005

·       Statements of Operationsfor the years ended December 31, 2006, 2005 and 2004

·       Statements of Cash Flowsfor the years ended December 31, 2006, 2005 and 2004

·       Statements of Stockholders’Equity (Deficit) for the years ended December 31, 2006, 2005 and 2004

·       Notesto Financial Statements

**2. FinancialStatement Schedule**

The following financial statement schedule is filed aspart of this Annual Report on Form 10-K. Schedules not listed belowhave been omitted because they are not applicable, not required or theinformation required is shown in the financial statements or the notes thereto.

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**SCHEDULE II**

**CubistPharmaceuticals, Inc.Valuation and Qualifying Accounts and ReservesYears Ended December 31, 2006, 2005 and 2004**

| ** **                                                                   | ** ** | **Balance at**     | ** ** | ** **       | ** ** | ** **    | ** ** | ** **          | ** ** |
|------------------------------------------------------------------------------|------------|-------------------------|------------|------------------|------------|---------------|------------|---------------------|------------|
| ** **                                                                   | ** ** | **Beginning**           | ** ** | ** **       | ** ** | ** **    | ** ** | **Balance at** | ** ** |
| **Description**                                                              | ** ** | ** **              | ** ** | **of Year** | ** ** | **Additions** | ** ** | **Deductions**      | ** ** | **End of Year** | ** ** |
| ** **                                                                   | ** ** | **(In thousands)** | ** ** |
| Sales Returns &  Allowances, Chargebacks, Discounts and Rebates (1) |       |                    |       |             |       |          |       |                |       |   |   |   |   |   |   |   |   |
| Year Ended  December 31, 2006                                           |       |                    | $          | 1,554            |       |          |       | 9,140               |       |   |   | (7,276 | ) |   |   | $ | 3,418 |   |   |
| Year Ended  December 31, 2005                                           |       |                    | $          | 775              |       |          |       | 4,297               |       |   |   | (3,518 | ) |   |   | $ | 1,554 |   |   |
| Year Ended December 31,  2004                                           |       |                    | $          | 113              |       |          |       | 2,057               |       |   |   | (1,395 | ) |   |   | $ | 775 |   |   |
|                                                                              |            |                         |            |                  |            |               |            |                     |            |  |  |  |  |  |  |  |  |  |  |  |  |

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(1)*         *Additions to sales returns andallowances, chargebacks, discounts and rebates are recorded as a reduction ofrevenue.

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**3. List of Exhibits**

| 3.1              |   | Amended and  Restated Certificate of Incorporation (Exhibit 3.1, Cubist’s Quarterly  Report on Form 10-Q, filed on August 6, 2004, File  No. 000-21379)                                                                                                                                                               |
|------------------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.2              |   | Amended and  Restated By-Laws of Cubist, as amended to date (Exhibit 3.1, Quarterly  Report on Form 10-Q, filed November 3, 2006, File  No. 000-21379)                                                                                                                                                                     |
| 4.1              |   | Specimen  certificate for shares of Common Stock (Exhibit 4.1, Annual Report on  Form 10-K, filed on March 1, 2006, File No. 000-21379)                                                                                                                                                                                    |
| 4.2              |   | Rights Agreement,  dated as of July 21, 1999, between Cubist and BankBoston, N.A., as  Rights Agent (Exhibit 4.1, Current Report on Form 8-K filed  on August 5, 2005, File No. 000-21379)                                                                                                                       |
| 4.3              |   | First Amendment,  dated as of March 3, 2000, to the Rights Agreement, dated as of  July 21, 1999, between Cubist and Fleet National Bank f/k/a BankBoston,  N.A., as Rights Agent (Exhibit 4.2, Current Report on Form 8-K  filed on August, 5, 2005, File No. 000-21379)                                             |
| 4.4              |   | Amendment, dated  as of March 20, 2002, to the Rights Agreement, dated as of July 21,  1999, between Cubist and EquiServe Trust Company, N.A. (f/k/a Fleet National  Bank f/k/a BankBoston, N.A.), as Rights Agent (Exhibit 4.3, Current  Report on Form 8-K filed on August 5, 2005, File No. 000-21379)        |
| 4.5              |   | Third Amendment,  dated as of August 2, 2005, to the Rights Agreement, dated as of  July 21, 1999, between Cubist and EquiServe Trust Company, N.A. (f/k/a  Fleet National Bank f/k/a BankBoston, N.A.), as Rights Agent  (Exhibit 4.4, Current Report on Form 8-K filed on  August 5, 2005, File No. 000-21379) |
| 4.6              |   | Indenture, dated  as of June 6, 2006, between Cubist and The Bank of New York Trust  Company, N.A., as trustee (Exhibit 4.1, Current Report on Form 8-K  filed on June 9, 2006, File No. 000-21379)                                                                                                                   |
| 4.7              |   | Note, dated  June 6, 2006                                                                                                                                                                                                                                                                                                                 |
| **10.1           |   | Amended and  Restated 1993 Stock Option Plan (Exhibit 10.6, Pre-effective Amendment  No. 1 to Form S-1 Registration Statement filed on  July 31, 1996, File No. 333-6795)                                                                                                                                             |
| **10.2           |   | First Amendment  to Amended and Restated 1993 Stock Option Plan (Exhibit 10.3, Quarterly  Report on Form 10-Q, filed August 12, 1998, File No. 000-21379)                                                                                                                                                                  |
| **10.3           |   | 1997 Employee  Stock Purchase Plan (Exhibit 10.4, Quarterly Report on Form 10-Q,  filed August 12, 1998, File No. 000-21379)                                                                                                                                                                                               |
| **10.4           |   | Second Amendment  to Amended and Restated 1993 Stock Option Plan (Exhibit 10.41, Annual  Report on Form 10-K, filed March 10, 2000, File No. 000-21379)                                                                                                                                                                    |
| **10.5           |   | Third Amendment  to Amended and Restated 1993 Stock Option Plan (Exhibit 10.42, Annual  Report on Form 10-K, filed March 10, 2000, File No. 000-21379)                                                                                                                                                                     |
| ††10.6 |   | Development and  Supply Agreement, dated April 3, 2000, by and between Cubist and Abbott  Laboratories (Exhibit 10.3, Quarterly Report on Form 10-Q,  filed August 14, 2000, File No. 000-21379)                                                                                                                      |
| †10.7       |   | Assignment and  License Agreement, dated October 6, 2000, by and between Eli  Lilly & Company, or Eli Lilly, and Cubist (Exhibit 10.59,  Annual Report on Form 10-K, filed April 2, 2001, File No. 000-21379)                                                                                           |
| **10.8           |   | Fourth Amendment  to Amended and Restated 1993 Stock Option Plan (Exhibit 10.73, Annual  Report on Form 10-K, filed April 2, 2001, File No. 000-21379)                                                                                                                                                                     |

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| **10.9        |   | Fifth Amendment  to Amended and Restated 1993 Stock Option Plan (Exhibit 10.74, Annual  Report on Form 10-K, filed April 2, 2001, File No. 000-21379)                                                                                                                                          |
|---------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **10.10       |   | Sixth Amendment  to Amended and Restated 1993 Stock Option Plan (Exhibit 10.75, Annual  Report on Form 10-K, filed April 2, 2001, File No. 000-21379)                                                                                                                                          |
| **10.11       |   | Seventh Amendment  to Amended and Restated 1993 Stock Option Plan (Exhibit 10.62, Annual  Report on Form 10-K, filed March 29, 2002, File No. 000-21379)                                                                                                                                       |
| †10.12   |   | Manufacturing and  Supply Agreement, entered into as of September 30, 2001, by and between ACS  Dobfar S.p.A., or ACS, and Cubist (Exhibit 10.63, Annual Report on  Form 10-K, filed March 29, 2002, File No. 000-21379)                                                                  |
| **10.13       |   | Amended and  Restated 2000 Equity Incentive Plan (Exhibit 10.1, Quarterly Report on  Form 10-Q, filed August 8, 2002, File No. 000-21379)                                                                                                                                                      |
| †10.14   |   | Amendment No. 2  to the Manufacturing and Supply Agreement, entered into as of  September 30, 2001, by and between ACS and Cubist, dated as of  February 12, 2003 (Exhibit 10.67, Annual Report on Form 10-K,  filed March 28, 2003, File No. 000-21379)                                  |
| 10.15         |   | Form of  Employee Confidentiality Agreement (Exhibit 10.69, Annual Report on  Form 10-K, filed March 28, 2003, File No. 000-21379)                                                                                                                                                             |
| 10.16         |   | Amendment  No. 1 dated July 1, 2003 to the Assignment and License Agreement  dated October 20, 2000, between Cubist and Eli Lilly (Exhibit 10.2,  Quarterly Report on Form 10-Q, filed August 14, 2003, File  No. 000-21379)                                                    |
| †10.17   |   | License Agreement  dated as of October 2, 2003, by and between Cubist, Chiron Healthcare  Ireland Ltd. and Chiron Corporation (Exhibit 10.69, Annual Report on  Form 10-K, filed March 12, 2004, File No. 000-21379)                                                                      |
| 10.18         |   | Lease dated  January, 2004, between the California State Teachers’ Retirement System, or  CALSTERS, and Cubist regarding 55 Hayden Avenue (Exhibit 10.1, Quarterly  Report on Form 10-Q filed on May 7, 2004, File No. 000-21379)                                                              |
| †10.19   |   | Amendment #1  dated April 1, 2004 to the License Agreement dated October 2, 2003,  by and between Cubist, Chiron Healthcare Ireland, Ltd., and Chiron  Corporation (Exhibit 10.2, Quarterly Report on Form 10-Q  filed on August 6, 2004, File No. 000-21379)                        |
| 10. 20        |   | Amendment  No. 2, dated March 31, 2005, to the Assignment and License  Agreement dated October 20, 2000 between Cubist and Eli Lilly  (Exhibit 10.1, Quarterly Report on Form 10-Q, filed  May 5, 2005, File No. 000-21379)                                                     |
| †10.  21 |   | Processing  Services Agreement entered into as of August 11, 2004 by and between  Cardinal Health PTS, LLC and Cubist (Exhibit 10.3, Quarterly Report on  Form 10-Q filed on November 4, 2005, File No. 00021379)                                                                         |
| **10.22       |   | Amended and  Restated 1997 Employee Stock Purchase Plan (Exhibit 10.1, Quarterly  Report on Form 10-Q filed on August 4, 2005, File  No. 000-21379)                                                                                                                                            |
| **10.23       |   | First Amendment  to Amended and Restated 2000 Equity Incentive Plan (Exhibit 10.1,  Current Report on Form 8-K filed on August 5, 2005, File  No. 000-21379)                                                                                                                                   |
| **10.24       |   | Amended and  Restated 2002 Directors’ Stock Option Plan (Appendix B, Definitive Proxy  Statement on Form DEF-14A filed on April 21, 2006, File  No. 000-21379)                                                                                                                                      |
| †10.25   |   | Amendment  No. 3 to the Manufacturing and Supply Agreement entered into as of  September 30, 2001 by and between ACS Dobfar, SpA, or ACS, and Cubist,  dated as of October 20, 2005 (Exhibit 10.2, Quarterly Report on  Form 10-Q filed on November 4, 2005, File No. 00021379) |

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| 10.26   |   | First Amendment  to Lease, dated September 29, 2005 by and between Cubist and The Realty  Associates Fund VI LP, successor-in-interest to CALSTERS (Exhibit 10.7,  Quarterly Report on Form 10-Q filed on November 4, 2005, File  No. 00021379)                                                           |
|---------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **10.27 |   | Short Term  Incentive Plan Terms and Conditions (Exhibit 10.1, Current Report on  Form 8-K filed on December 13, 2006, File No. 000-21379)                                                                                                                                                                     |
| **10.28 |   | Director  Compensation and Benefits Summary Sheet (Exhibit 10.2, Current Report on  Form 8-K filed on December 16, 2005, File No. 000-21379)                                                                                                                                                                   |
| **10.29 |   | Retention Letter  dated December 13, 2005 by and between Cubist and Michael J. Bonney  (Exhibit 10.3, Current Report on Form 8-K filed on  December 16, 2005, File No. 000-21379)                                                                                                                         |
| **10.30 |   | Form of  Retention Letter by and between Cubist and Barry I. Eisenstein, Oliver S.  Fetzer, David W.J. McGirr, and Robert J. Perez (Exhibit 10.4, Current  Report on Form 8-K filed on December 16, 2005, File  No. 000-21379)                                                                            |
| *10.31  |   | First Amendment,  dated as of June 1, 2006, to Development and Supply Agreement entered into  as of April 3, 2000 by and between Cubist and Hospira  Worldwide, Inc. (f/k/a Abott Laboratories) (Exhibit 10.1, Quarterly  Report on Form 10-Q filed on August 9, 2006, File No. 000-21379) |
| *10.32  |   | Amendment  No. 4 to the Manufacturing and Supply Agreement entered into as of  September 30, 2001 by and between ACS, and Cubist dated as of  September 22, 2006 (Exhibit 10.1, Quarterly Report on Form 10-Q  filed on November 3, 2006, File No. 000-21379)                                   |
| 14.1    |   | Code of Conduct  and Ethics (Exhibit 14.1, Current Report on Form 8-K filed on  July 31, 2006, File No. 000-21379)                                                                                                                                                                                             |
| 23.1    |   | Consent of  PricewaterhouseCoopers LLP                                                                                                                                                                                                                                                                                             |
| 31.1    |   | Certification  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                                                      |
| 31.2    |   | Certification  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                                                      |
| 32.1    |   | Certification  pursuant to 18 U.S.C Section 1305, as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                  |
| 32.2    |   | Certification  pursuant to 18 U.S.C Section 1305, as adopted pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002                                                                                                                                                                                                  |

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Any of the above-listedExhibits containing parenthetical information are incorporated by referencefrom the Company’s filing indicated next to the title of such exhibit. Allother above listed exhibits are filed herewith.

†                    ConfidentialTreatment granted.

*                    ConfidentialTreatment requested.

††             ConfidentialTreatment granted and extension requested.

**             Management contractor compensatory plan or arrangement required to be filed as an exhibit to thisannual report.

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**SIGNATURES**

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct, the registrant has duly caused this amendment to be signed on its behalfby the undersigned, thereunto duly authorized.

|            | ** ** | ** ** | **CUBIST PHARMACEUTICALS, INC.** |
|------------|------------|------------|----------------------------------|
| ** ** |       |       | By:                              | /s/  MICHAEL W. BONNEY |
| ** ** |       |       |                             | Michael W. Bonney*President and Chief Executive  Officer* |

 

Pursuant to therequirements of the Securities Exchange Act, this report has been signed by thefollowing persons in the capacities and on the dates indicated.

|                                      | **Signature** | ** **                                                      | ** ** | ** **          | **Title** | ** ** | ** ** | ** ** | **Date** | ** ** |
|--------------------------------------|---------------|-----------------------------------------------------------------|------------|---------------------|-----------|------------|------------|------------|----------|------------|
| /s/  MICHAEL W. BONNEY     |          | President, Chief  Executive                                     |       | March 1,  2007 |
| Michael W. Bonney                    |          | Officer and Director  (Principal Executive Officer)             |       |                |
| /s/  DAVID W.J. MCgIRR     |          | Senior Vice President and  Chief                                |       | March 1,  2007 |
| David W.J. McGirr                    |          | Financial Officer  (Principal Financial and Accounting Officer) |       |                |
| /s/  GORDON L. ARCHER      |          | Director                                                        |       | March 1,  2007 |
| Gordon L. Archer                     |          |                                                            |       |                |
| /s/  KENNETH M. BATE       |          | Director                                                        |       | March 1,  2007 |
| Kenneth M. Bate                      |          |                                                            |       |                |
| /s/  SYLVIE GRÉGOIRE  |          | Director                                                        |       | March 1,  2007 |
| Sylvie Grégoire                 |          |                                                            |       |                |
| /s/  DAVID W. MARTIN, JR.  |          | Director                                                        |       | March 1,  2007 |
| David W.  Martin, Jr.           |          |                                                            |       |                |
| s/  WALTER R. MAUPAY, JR.  |          | Director                                                        |       | March 1,  2007 |
| Walter R.  Maupay, Jr.          |          |                                                            |       |                |
| /s/  MARTIN ROSENBERG      |          | Director                                                        |       | March 1,  2007 |
| Martin Rosenberg                     |          |                                                            |       |                |
| /s/  J.  MATTHEW SINGLETON |          | Director                                                        |       | March 1,  2007 |
| J. Matthew  Singleton                |          |                                                            |       |                |
| /s/  MARTIN H. SOETERS     |          | Director                                                        |       | March 1,  2007 |
| Martin H. Soeters                    |          |                                                            |       |                |
| /s/  MICHAEL B. WOOD       |          | Director                                                        |       | March 1,  2007 |
| Michael B. Wood                      |          |                                                            |       |                |

 

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