10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2008

OR

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

For the transition period from              to             

Commission File Number 000-23223

CURAGEN CORPORATION

(Exact name of registrant as specified in its charter)

Delaware	06-1331400
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

322 East Main Street, Branford, Connecticut	06405
(Address of principal executive offices)	(Zip Code)

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

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large Accelerated Filer	¨	Accelerated Filer	x
Non-Accelerated Filer	¨ (Do not check if a smaller reporting company)	Smaller Reporting Company	¨

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

The number of shares outstanding of the registrant’s common stock as of October 31, 2008 was 57,544,131.

CURAGEN CORPORATION AND SUBSIDIARY

FORM 10-Q

INDEX

			Page
PART I. Financial Information
	Item 1.	Financial Statements
		Condensed Consolidated Balance Sheets as of September 30, 2008 and December 31, 2007 (unaudited)	3
		Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2008 and 2007 (unaudited)	4
		Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2008 and 2007 (unaudited)	5
		Notes to Condensed Consolidated Financial Statements (unaudited)	6 -13
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	14 - 23
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	23
	Item 4.	Controls and Procedures	23
PART II. Other Information
	Item 1A.	Risk Factors	24 - 37
	Item 6.	Exhibits	38
Signatures			39
Exhibit Index			40

CURAGEN CORPORATION AND SUBSIDIARY

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except par value and share data)

(unaudited)

	September 30, 2008			December 31, 2007
ASSETS
Current assets:
Cash and cash equivalents	$	7,421		$	16,730
Restricted cash		—			14,533
Short-term investments		40,413			19,039
Marketable securities		43,594			64,675
Cash, restricted cash and investments		91,428			114,977
Income taxes receivable		263			419
Prepaid expenses		464			2,290
Total current assets		92,155			117,686
Property and equipment, net		130			479
Intangible and other assets, net		300			1,117
Total assets	$	92,585		$	119,282
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	828		$	254
Accrued expenses		2,609			3,140
Accrued payroll and related items		826			1,613
Interest payable		63			1,048
Current portion of deferred revenue		—			89
Other current liabilities		847			3,698
Total current liabilities		5,173			9,842
Long-term liabilities:
Convertible subordinated debt		18,967			69,890
Deferred revenue, net of current portion		—			1,085
Total long-term liabilities		18,967			70,975
Commitments and contingencies
Stockholders’ equity:
Common Stock; $.01 par value, issued and outstanding 57,534,175 shares at September 30, 2008, and 58,074,127 shares at December 31, 2007		575			581
Additional paid-in capital		527,162			525,481
Accumulated other comprehensive loss		(221	)		(23	)
Accumulated deficit		(459,071	)		(487,574	)
Total stockholders’ equity		68,445			38,465
Total liabilities and stockholders’ equity	$	92,585		$	119,282

See accompanying notes to condensed consolidated financial statements

3

CURAGEN CORPORATION AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(unaudited)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2008			2007			2008			2007
Collaboration revenue	$	—		$	22		$	1,174		$	66
Operating expenses:
Research and development		3,453			8,074			12,459			30,480
General and administrative		1,076			2,568			4,235			9,631
Restructuring charges		—			1,058			—			8,537
Total operating expenses		4,529			11,700			16,694			48,648
Gain on sale of intangible asset		—			—			36,397			—
(Loss) income from operations		(4,529	)		(11,678	)		20,877			(48,582	)
Interest income		741			1,861			2,471			4,060
Interest expense		(226	)		(1,273	)		(1,474	)		(4,172	)
Gain on extinguishment of debt		—			169			6,991			169
Gain on sale of long-term marketable securities		—			973			—			973
(Loss) income from continuing operations before income taxes		(4,014	)		(9,948	)		28,865			(47,552	)
Income tax benefit (provision)		32			50			(362	)		160
(Loss) income from continuing operations		(3,982	)		(9,898	)		28,503			(47,392	)
Discontinued operations:
Loss from discontinued operations		—			—			—			(2,991	)
Gain on sale of subsidiary		—			—			—			78,352
Income from discontinued operations		—			—			—			75,361
Net (loss) income	$	(3,982	)	$	(9,898	)	$	28,503		$	27,969
Basic (loss) income per share from continuing operations	$	(0.07	)	$	(0.18	)	$	0.50		$	(0.85	)
Basic income per share from discontinued operations		—			—			—			1.35
Basic net (loss) income per share	$	(0.07	)	$	(0.18	)	$	0.50		$	0.50
Diluted (loss) income per share from continuing operations	$	(0.07	)	$	(0.18	)	$	0.49		$	(0.85	)
Diluted income per share from discontinued operations		—			—			—			1.35
Diluted net (loss) income per share	$	(0.07	)	$	(0.18	)	$	0.49		$	0.50
Weighted average number of shares used in computing:
Basic (loss) income per share		56,822			55,965			56,693			55,699
Diluted (loss) income per share		56,822			55,965			61,240			55,699

See accompanying notes to condensed consolidated financial statements

4

CURAGEN CORPORATION AND SUBSIDIARY

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

	Nine Months Ended September 30,
	2008			2007
Cash flows from operating activities:
Net income	$	28,503		$	27,969
Income from discontinued operations		—			(75,361	)
Adjustments to reconcile net income to net cash used in operating activities:
Deferred revenue		(1,174	)		(66	)
Depreciation and amortization		400			3,304
Impairment of long lived assets held for sale		—			6,273
Stock-based compensation		1,529			3,030
Stock-based 401(k) plan employer match		147			332
Non-cash interest income		196			345
Non-cash interest income - Restricted cash		(144	)		(237	)
Gain on extinguishment of debt		(6,991	)		(169	)
Gain on sale of long-term marketable securities		—			(973	)
Gain on sale of intangible asset		(36,397	)		—
Changes in assets and liabilities:
Income taxes receivable		156			149
Accrued interest receivable		220			587
Accounts receivable		—			926
Prepaid expenses		1,537			1,254
Intangible and other assets, net		276			141
Accounts payable		574			136
Accrued expenses		(531	)		191
Accrued payroll and related items		(786	)		(393	)
Interest payable		(985	)		(2,759	)
Other current liabilities		(2,851	)		331
Net cash used in operating activities		(16,321	)		(34,990	)
Cash flows from investing activities:
Acquisitions of property and equipment		(3	)		(174	)
Proceeds from sale of fixed assets		95			29
Purchases of short-term investments		(42,199	)		(7,966	)
Proceeds from sales of short-term investments		9,360			1,401
Proceeds from maturities of short-term investments		11,450			15,900
Purchases of marketable securities		(4,021	)		(5,694	)
Proceeds from sales of marketable securities		17,518			26,543
Proceeds from maturities of marketable securities		18,800			11,090
Proceeds from sale of held for sale assets		—			2,217
Net proceeds from sale of intangible asset		24,583			—
Net cash provided by investing activities		35,583			43,346
Cash flows from financing activities:
Proceeds from exercise of stock options		—			72
Payment for extinguishment of debt		(43,247	)		—
Repayment of convertible debt		—			(66,228	)
Net cash used in financing activities		(43,247	)		(66,156	)
Cash flows from discontinued operations:
Net operating cash flows used in discontinued operations		—			(379	)
Net investing cash flows provided by discontinued operations		14,676			67,820
Net financing cash flows provided by discontinued operations		—			23
Net cash provided by discontinued operations		14,676			67,464
Plus decrease in cash and cash equivalents of discontinued operations, net of sale proceeds		—			430
Net (decrease) increase in cash and cash equivalents		(9,309	)		10,094
Cash and cash equivalents, beginning of period		16,730			58,486
Cash and cash equivalents, end of period	$	7,421		$	68,580
Supplemental cash flow information:
Interest paid	$	2,275		$	6,499
Income tax benefit payments received	$	247		$	407
Supplemental schedule of noncash investing transactions:
Fair value of marketable securities acquired	$	11,814		$	—

See accompanying notes to condensed consolidated financial statements

5

CURAGEN CORPORATION AND SUBSIDIARY

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

1. Basis of Presentation and Discontinued Operations

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of our management, the accompanying unaudited condensed consolidated financial statements include all adjustments, consisting of normal recurring accruals, necessary to present fairly our consolidated financial position, results of operations and cash flows. Interim results are not necessarily indicative of the results that may be expected for the entire year. The condensed consolidated financial statements of CuraGen Corporation and subsidiary (collectively, the “Company”) include CuraGen Corporation (“CuraGen”) and its former majority-owned subsidiary, 454 Life Sciences Corporation (“454”), and accordingly, all material intercompany balances and transactions have been eliminated. The prior period financial statements present the operating results of 454 as a discontinued operation on the condensed consolidated Statements of Operations as a result of the Agreement and Plan of Merger (the “Merger Agreement”) signed by 454 on March 28, 2007 with Roche Holdings, Inc., and 13 Acquisitions, Inc., an indirect wholly-owned subsidiary of Roche Holdings, Inc., each affiliates of F. Hoffman-La Roche Ltd (“Roche”) (see Note 4). The Merger Agreement was subsequently assigned by Roche Holdings, Inc. to its affiliate Roche Diagnostics Operations, Inc. (“RDO”), which is also an affiliate of Roche. The sale of 454 to RDO pursuant to the Merger Agreement closed on May 25, 2007. CuraGen has revised the condensed consolidated statements of cash flows for the nine months ended September 30, 2007 to reflect the proceeds from sale of held for sale assets within net investing cash flows provided by discontinued operations, instead of an investing activity. This revision had no effect on the Company’s net loss or the decrease in cash and cash equivalents reported.

The accompanying condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2007. All dollar amounts herein are shown in thousands, except par value and per share data.

2. Investments and Comprehensive (Loss) Income

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

	Three Months Ended September 30,						Nine Months Ended September 30,
	2008			2007			2008			2007
Net (loss) income	$	(3,982	)	$	(9,898	)	$	28,503		$	27,969
Other comprehensive (loss) income:
Unrealized losses on securities:
Unrealized losses arising during period		(369	)		(1,195	)		(26	)		(2,271	)
Reclassification adjustment for losses included in net (loss) income		(2	)		(968	)		(172	)		(928	)
Net unrealized loss on securities		(371	)		(2,163	)		(198	)		(3,199	)
Total comprehensive (loss) income	$	(4,353	)	$	(12,061	)	$	28,305		$	24,770

The Company had 9.5% of its cash and investment securities in mortgage-backed securities as of September 30, 2008. All of these mortgage-backed securities are sponsored by the United States Federal Government and are rated AAA by Moody’s. Additionally, the Company had 14.3% of its cash and investment securities in asset-backed securities which consist of auto, credit card and equipment loans as of September 30, 2008. The Company periodically reviews its investment portfolio to determine if there is an investment that is other than temporarily impaired. The Company believes that any individual unrealized loss as of September 30, 2008 represents only a temporary impairment, and no adjustment of carrying values is warranted at this time.

6

The asset-backed and mortgage-backed securities as of September 30, 2008 had a gross unrealized gain of $29 and a gross unrealized loss of $189, or a net unrealized loss of $160. The largest unrealized loss on any individual security is $55.

All of the securities in the Company’s investment portfolio are priced by the Company’s investment manager, an independent third party. On a quarterly basis, the Company obtains a second price for each security to compare to the price obtained from the Company’s investment manager. As of September 30, 2008 there were no material variances in the prices obtained from these two sources and as such have used the pricing provided by the Company’s investment manager.

3. 454 Life Sciences/Roche Holdings, Inc. Merger

On March 28, 2007, 454 entered into the Merger Agreement with Roche Holdings, Inc. and 13 Acquisitions, Inc., an indirect wholly-owned subsidiary of Roche Holdings, Inc. Roche Holdings, Inc. subsequently assigned the Merger Agreement to its affiliate RDO. Roche Holdings, Inc. and RDO are affiliates of Roche, a global research-based healthcare company. Under the Merger Agreement, 13 Acquisitions, Inc. was merged with and into 454 (the “Merger”), with 454 continuing after the Merger as the surviving corporation and an indirect wholly-owned subsidiary of Roche Holdings, Inc.

Under the terms of the Merger Agreement, upon the closing of the sale of 454 to RDO on May 25, 2007, the purchase price before transaction costs was $152,019, of which RDO paid $140,000 in cash and $12,019 was received from the exercise of 454 stock options following the signing of the Merger Agreement and prior to the closing of the sale. Of the $140,000 received from RDO, $25,000 was placed in escrow for a period of 15 months, or until August 25, 2008, to provide for certain post-closing adjustments based on 454’s net working capital and net debt on May 25, 2007, and to secure the indemnification rights of RDO and its affiliates. The Company’s portion of the purchase price after transaction costs, including the net working capital and net debt adjustment and the amount expected from the escrow, was $82,023. On August 25, 2008, the time period for submission of claims against the escrow expired and as such, $14,676 was released to the Company on that date by the escrow agent.

4. Discontinued Operations

The sale of 454 (see Note 3) on May 25, 2007 has been accounted for in accordance with Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”. In addition, 454’s operating results are reported as a discontinued operation for the period January 1, 2007 to May 25, 2007. The following table summarizes the financial information for the discontinued operations of 454 for the period January 1, 2007 to May 25, 2007:

	January 1 to May 25, 2007
Revenue:
Product revenue	$	14,210
Sequencing service revenue		3,825
Collaboration revenue		1,350
Grant revenue		444
Milestone revenue		3,707
Total revenue	$	23,536
Operating Expenses:
Cost of product revenue	$	9,015
Cost of sequencing service revenue		2,407
Grant research expenses		425
Research and development expenses		7,908
General and administrative expenses		7,075
Total operating expenses	$	26,830
Loss from discontinued operations before minority interest, net of tax of $18	$	(3,053	)
Minority interest in loss of discontinued consolidated subsidiary		62
Gain on sale of subsidiary		78,352
Income from discontinued operations	$	75,361

7

5. Stock-Based Compensation

The Company adopted SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”), effective January 1, 2006. SFAS 123R requires recognition of the fair value of stock-based compensation in net earnings.

Staff Accounting Bulletin 110, (“SAB 110”), was effective January 1, 2008 and allows companies to continue to utilize the simplified method in developing an estimate of the expected term of “plain vanilla” share options in accordance with SFAS 123R when there have been structural changes in a company’s business such that historical exercise data does not provide a reasonable basis upon which to estimate expected term. Due to the Company’s restructuring activities from 2003 through 2007, and the current market value of the Company’s common stock being below historical strike prices of share options, historical exercise patterns do not provide a reasonable basis to estimate expected term of current option grants. Accordingly, the Company will continue to utilize the simplified method to estimate expected term of stock options as allowed under SAB 110.

During the three and nine months ended September 30, 2008 and 2007, the Company recognized compensation expense in total operating expenses on the condensed consolidated statements of operations with respect to employee stock options and restricted stock grants as follows:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2008		2007		2008		2007
Compensation expense with respect to employee stock options	$	201	$	417	$	755	$	1,204
Compensation expense with respect to restricted stock grants	$	226	$	755	$	781	$	2,031

No tax benefit was recorded during the periods presented above as the Company has determined that it is more likely than not that the Company will not realize these deferred tax assets.

There were no stock option or restricted stock grants for the third quarter 2008 and 2007.

The 2007 Stock Incentive Plan (“2007 Stock Plan”) was approved by the Company’s stockholders as of May 2, 2007. The 2007 Stock Plan provides for the issuance of stock options and stock grants to employees, directors and consultants of CuraGen. A total of 3,000,000 shares of common stock were originally reserved for issuance under the 2007 Stock Plan. In May 2008, upon approval of the Company’s stockholders, the amount reserved under the 2007 Stock Plan was increased to 6,000,000.

A summary of the stock option activity under the 2007 Stock Plan, as of September 30, 2008, and changes during the three months ended September 30, 2008, are as follows:

	Number of Options		Weighted Average Exercise Price		Weighted Average Remaining Contractual Life (in years)	Aggregate Intrinsic Value
Outstanding July 1, 2008	2,266,940		$	0.99	9.62	$	159
Granted	—
Exercised	—
Canceled or lapsed	(52,500	)		1.37
Outstanding September 30, 2008	2,214,440			0.98	9.21		156
Exercisable September 30, 2008	430,950			1.46	9.11		10

There were no options exercised under the 2007 Stock Plan during the three months ended September 30, 2008 and 2007.

A summary of the stock option activity under the 1997 Employee, Director and Consultant Stock Plan (“1997 Stock Plan”) as of September 30, 2008, and changes during the three months ended September 30, 2008, are as follows:

8

	Number of Options		Weighted Average Exercise Price		Weighted Average Remaining Contractual Life (in years)	Aggregate Intrinsic Value
Outstanding July 1, 2008	2,594,352		$	5.93	4.92	$	0
Granted	—
Exercised	—
Canceled or lapsed	(533,620	)		4.67
Outstanding September 30, 2008	2,060,732			6.26	5.10		0
Exercisable September 30, 2008	1,711,418			6.65	4.73		0

There were no options exercised under the 1997 Stock Plan during the three months ended September 30, 2008 and 2007.

As of September 30, 2008 there was $1,385 of total unrecognized compensation expense related to unvested stock option grants under the 1997 Stock Plan and 2007 Stock Plan, and this expense is expected to be recognized over a weighted-average period of 1.44 years.

A summary of all restricted stock activity under the 2007 Stock Plan as of September 30, 2008, and changes during the three months ended September 30, 2008, are as follows:

	Number of Shares of Restricted Stock	Weighted Average Grant Date Fair Value
Outstanding July 1, 2008	537,500	$	1.23
Granted	—
Restrictions lapsed	—
Forfeited upon employee termination	—
Outstanding September 30, 2008	537,500		1.23

On May 25, 2007, the Compensation Committee of the Company’s Board of Directors approved the issuance of an aggregate of 975,000 shares of restricted common stock to five executive officers. During the quarter ended March 31, 2008, 525,000 of these shares were forfeited due to the termination of employment of three of these executive officers during the quarter. The 450,000 shares that remain outstanding will vest and become free from forfeiture on December 31, 2008, if the closing price of the common stock on the Nasdaq Global Market has equaled or exceeded $5.00 per share over a period of 20 consecutive trading days for any period ending on or before December 31, 2008.

The shares of common stock described above will only vest if the executive is an employee of the Company as of December 31, 2008. Therefore, pursuant to SFAS 123R, these restricted stock awards are deemed to contain a market condition which is reflected in the grant-date fair value of the awards, based on a valuation technique which considered all the possible outcomes of such market condition. Compensation cost is required to be recognized over the requisite service period for an award with a market condition provided that the requisite service is rendered, regardless of when, if ever, the market condition is satisfied. Accordingly, the Company will reverse previously recognized compensation cost for the above awards only if the requisite service is not rendered.

The total intrinsic value of restricted shares vested under the 2007 Stock Plan during the three months ended September 30, 2008 and 2007 was $0.

A summary of all restricted stock activity under the 1997 Stock Plan as of September 30, 2008, and changes during the three months ended September 30, 2008, are as follows:

	Number of Shares of Restricted Stock		Weighted Average Grant Date Fair Value
Outstanding July 1, 2008	189,370		$	3.53
Granted	—
Restrictions lapsed	37,500			2.95
Forfeited upon employee termination	(1,950	)		4.39
Outstanding September 30, 2008	149,920			3.67

9

The total intrinsic value of restricted shares vested under the 1997 Stock Plan during the three months ended September 30, 2008 and 2007 was $30 and $398, respectively. As of September 30, 2008, there was $444 of total unrecognized compensation expense related to unvested restricted stock grants under the 1997 Stock Plan and 2007 Stock Plan, and this expense is expected to be recognized over a weighted-average period of 0.64 years.

6. (Loss) Income Per Share from Continuing Operations

Basic (loss) income per share from continuing operations is computed by dividing (loss) income from continuing operations by the weighted average number of shares of common stock outstanding for the period, excluding unvested restricted stock. Diluted (loss) income per share from continuing operations reflects the potential dilution that could occur if options or other contracts to issue common stock were exercised or converted into common stock. Potential common shares consist of unvested restricted stock (using the treasury stock method) and the conversion of the Company’s convertible subordinated debt. For the three and nine months ended September 30, 2008, potentially dilutive securities representing 1,442,552 shares of common stock related to unvested stock options were excluded from the computation of diluted earnings per share because their effect would have been antidilutive. Due to the Company’s loss from continuing operations during the three and nine months ended September 30, 2007 and the three months ended September 30, 2008, no calculation of diluted income (loss) per share was necessary for those periods as all potential shares would have been antidilutive. The following table sets forth the computation of basic and diluted net (loss) income per share for the nine months ended September 30, 2008 (in thousands, except share and per share amounts):

	Nine Months Ended September 30, 2008
Basic:
Numerator:
Income from continuing operations	$	28,503
Denominator:
Weighted average common shares		56,693,176
Income from continuing operations per share - basic	$	0.50
Diluted:
Numerator:
Income from continuing operations	$	28,503
Interest expense		1,434
Income for diluted calculation	$	29,937
Denominator:
Denominator for basic calculation		56,693,176
Weighted average effect of dilutive securities:
Restricted stock awards		18,576
Convertible subordinated notes		4,528,511
Denominator for diluted calculation		61,240,263
Income from continuing operations per share - diluted	$	0.49

7. Restructuring Charge

During June and September 2007, the Company underwent corporate restructurings to reduce operating costs and to focus resources on the advancement of its therapeutic pipeline through clinical development, resulting in a restructuring charge of $11,274. This amount includes an asset impairment charge of $6,322 (associated with the closure of its pilot manufacturing plant, also known as the Biopharmaceutical Sciences Process facility, on July 27, 2007), $4,408 related to employee separation costs paid or payable in cash, $286 of non-cash employee separation costs and $258 of other asset write-offs.

The following table sets forth the cash payments and balance of the restructuring reserve as of and for the nine months ended September 30, 2008:

Reserve at December 31, 2007	Cash Payments in 2008		Change in Reserve 2008			Reserve at September 30, 2008
$2,791	$	2,699	$	(71	)	$	21

10

8. Fair Value Measurements

On January 1, 2008, the Company adopted SFAS No. 157 “Fair Value Measurements” (“SFAS 157”). SFAS 157 defines fair value, provides a consistent framework for measuring fair value under Generally Accepted Accounting Principles and expands fair value financial statement disclosure requirements. SFAS 157’s valuation techniques are based on observable and unobservable inputs. Observable inputs reflect readily obtainable data from independent sources, while unobservable inputs reflect our market assumptions. SFAS 157 classifies these inputs into the following hierarchy:

Level 1 Inputs– Quoted prices for identical instruments in active markets.

Level 2 Inputs– Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable.

Level 3 Inputs– Instruments with primarily unobservable value drivers.

The following table represents the fair value hierarchy for those financial assets and liabilities measured at fair value on a recurring basis as of September 30, 2008.

Fair Value Measurements on a Recurring Basis as of September 30, 2008
	Level I		Level II		Level III	Total
Assets
Cash and cash equivalents	$	5,864	$	1,028	—	$	6,892
Short-term investments		1,997		38,416	—		40,413
Marketable securities		9,160		34,434	—		43,594
Total Assets	$	17,021	$	73,878	—	$	90,899
Liabilities		—		—	—		—
Total Liabilities		—		—	—		—

Level I securities primarily consist of US Treasuries and Money Market accounts. Level II securities primarily consist of investment grade fixed income securities.

The Company’s investment portfolio has not been adversely materially impacted by the recent disruption in the credit markets. However, if there is continued and expanded disruption in the credit markets this may have a potential impact on the determination of the fair value of financial instruments. Additionally, there can be no assurance that the Company’s investment portfolio will not be adversely affected in the future.

9. Sale of Belinostat to TopoTarget

On April 21, 2008, the Company entered into a transfer and termination agreement (the “Transfer Agreement”) with TopoTarget A/S (“TopoTarget”) to transfer CuraGen’s ownership and development rights to belinostat, a Phase I/II histone deacetylase inhibitor (an “HDAC Inhibitor”), and any other HDAC Inhibitors. There was no book value for belinostat. In consideration for the transfer, the Company received $24,583 in net cash proceeds and 5 million shares of TopoTarget common stock, valued at $11,814 as of the date of the Transfer Agreement based on the closing price of TopoTarget common stock (in DKK on the Copenhagen Exchange) on the date of the sale, April 21, 2008, multiplied by the exchange rate for the same date. In addition, the Company is eligible to receive $6,000 in potential payments on future net sales and sublicenses of belinostat.

On June 3, 2008, the Company sold the 5 million shares of TopoTarget common stock for cash proceeds of $11,799. Additionally in June 2008, the Company recorded a $36,397 gain on sale of intangible asset, consisting of net cash proceeds of $24,583 and the fair value of 5 million shares of TopoTarget stock of $11,814 on the closing date, April 21, 2008.

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Under the Transfer Agreement, the Company assigned certain patents and granted a perpetual irrevocable license to the development and commercialization of the HDAC Inhibitors to TopoTarget and agreed for a period not to compete with TopoTarget in the HDAC Inhibitor market. The Transfer Agreement contains customary representations and warranties, indemnification obligations of the parties and a mutual release from most claims under the License Agreement (as defined below). The Transfer Agreement terminates the License and Collaboration Agreement between TopoTarget and CuraGen dated as of June 3, 2004 (the “License Agreement”) with the exception of provisions preserving certain of the parties’ rights, including confidentiality and indemnification under the License Agreement. CuraGen will no longer have funding requirements for belinostat as TopoTarget immediately assumed financial and operational responsibility for the ongoing clinical development at the time of signing the Transfer Agreement.

In connection with the Transfer Agreement, the Company and TopoTarget also entered into a Transition Services Agreement dated April 21, 2008 (the “TSA”), pursuant to which, for fees payable by TopoTarget, CuraGen provided certain regulatory and administrative services to TopoTarget. All services under the TSA will terminate by December 31, 2008 unless terminated earlier by TopoTarget on 30 days’ notice, by mutual written consent of the parties or by either party for non-performance, as provided in the TSA.

10. Extinguishment of Debt

During May 2008, the Company repurchased a total of $50,923 of its 4% convertible subordinated debentures due February 2011, for total consideration of $43,247, plus accrued interest of $498 at the date of repurchase. As a result of the transaction, for the nine months ended September 30, 2008, the Company recorded a gain of $6,991 in “Gain on extinguishment of debt,” which is net of the write-off of the ratable portion of unamortized deferred financing costs relating to the repurchased debt.

11. Income Taxes

As a result of the gain on the sale of belinostat to TopoTarget and the gain on extinguishment of debt recognized in the second quarter of 2008, the Company expects to have taxable income in 2008. The Company also expects to utilize approximately $26,000 of Federal net operating loss carryforwards in 2008. The income tax provision for the nine months ended September 30, 2008 was primarily a result of alternative minimum tax, partially offset by Connecticut research and development tax credits.

12. Recently Enacted Pronouncements

In June 2007, the FASB ratified the Emerging Issues Task Force, or EITF, consensus on Issue No. 07-3, “Accounting for Nonrefundable Advance Payments for Goods or Services to Be Used in Future Research and Development Activities”, or EITF 07-3. EITF 07-3 requires that nonrefundable advance payments for goods or services that will be used or rendered for future research and development activities should be deferred and capitalized. Such amounts should be recognized as an expense as the related goods are delivered or the services are performed, or when the goods or services are no longer expected to be provided. EITF 07-3 is effective for fiscal years beginning after December 15, 2007, and interim periods within those fiscal years. The adoption of EITF 07-3 did not have a material impact on the Company’s consolidated financial statements.

In December 2007, the FASB ratified the EITF consensus on Issue No. 07-1, “Accounting for Collaborative Arrangements”, or EITF 07-1. The EITF concluded that a collaborative arrangement is one in which the participants are actively involved and are exposed to significant risks and rewards that depend on the ultimate commercial success of the endeavor. Revenues and costs incurred with third parties in connection with collaborative arrangements would be presented gross or net based on the criteria in EITF 99-19, Reporting Revenue Gross as a Principal versus Net as an Agent, and other accounting literature. Payments to or from collaborators would be evaluated and presented based on the nature of the arrangement and its terms, the nature of the entity’s business, and whether those payments are within the scope of other accounting literature. EITF 07-1 is effective for fiscal years beginning after December 15, 2008. The Company does not believe the adoption of EITF 07-1 will have a material impact on its consolidated financial statements.

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In May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles (“SFAS No. 162”). SFAS 162 identifies a consistent framework, or hierarchy, for selecting accounting principles to be used in preparing financial statements that are presented in conformity with U.S. generally accepted accounting principles, or GAAP, for nongovernmental entities (the “Hierarchy”). The Hierarchy within SFAS 162 is consistent with that previously defined in the AICPA Statement on Auditing Standards No. 69, “The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles” (“SAS 69”). SFAS 162 is effective 60 days following the United States Securities and Exchange Commission’s (the “SEC”) approval of the Public Company Accounting Oversight Board amendments to AU Section 411, “The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles”. The Company does not believe the adoption of SFAS 162 will have a material effect on its consolidated financial statements.

In May 2008, FASB Staff Position (“FSP”) No. APB 14-1, “Accounting for Convertible Debt Instruments That May be Settled in Cash upon Conversion (Including Partial Cash Settlement)” was issued which specifies that issuers of such instruments should separately account for the liability and equity components in a manner that will reflect the issuer’s nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods. FSP No. APB 14-1 is effective for financial statements issued for fiscal years beginning after December 15, 2008. The Company has not yet determined the potential impact, if any, on its financial condition, results of operations and liquidity.

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CURAGEN CORPORATION AND SUBSIDIARY

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

Our management’s discussion and analysis of our financial condition and results of operations include the identification of certain trends and other statements that may predict or anticipate future business or financial results that are subject to important factors that could cause our actual results to differ materially from those indicated. See Part II, Item 1A, “Risk Factors.”

Overview

We are a biopharmaceutical development company dedicated to improving the lives of patients by developing novel therapeutics for the treatment of cancer. We have taken a systematic approach to identifying and validating promising therapeutics and are now focused on developing and advancing a potential drug candidate through clinical development. We are currently focusing the majority of our human and financial resources on our oncology therapeutic area.

Significant Recent Developments

On August 25, 2008, the escrow period for the escrow fund associated with the sale of 454 Life Sciences Corporation expired, and as such $14.7 million was released to us. The 454 sale and escrow are further discussed in Note 3 to our condensed consolidated financial statements.

On May 14, 2008, we announced that we completed a series of privately-negotiated transactions on May 12, 2008 with holders of our 4% convertible subordinated notes due February 2011, or the 2011 Notes, in which we repurchased a total of $50.9 million of the 2011 notes for an aggregate purchase price of $43.2 million plus accrued interest of $0.5 million. We recorded a $7.0 million gain on extinguishment of debt as a result of the repurchases.

On April 21, 2008, we entered into a Transfer Agreement with TopoTarget A.S. which effectively sold our rights to belinostat, a Phase I/II HDAC inhibitor and any other HDAC inhibitors, for $24.6 million in net cash proceeds, five million shares of TopoTarget common stock, valued at approximately $11.8 million as of the date of the Transfer Agreement (and which were subsequently sold on June 3, 2008 for $11.8 million) and $6.0 million in potential payments on future net sales and sublicenses of belinostat.

Under the Transfer Agreement, we assigned certain patents and granted a perpetual irrevocable license to the development and commercialization of the HDAC Inhibitors to TopoTarget and agreed for a period not to compete with TopoTarget in the HDAC Inhibitor market. The Transfer Agreement contains customary representations and warranties, indemnification obligations of the parties and a mutual release from most claims under the License Agreement. The Transfer Agreement terminates the License and Collaboration Agreement between TopoTarget and us dated as of June 3, 2004, or the License Agreement, with the exception of provisions preserving certain of the parties’ rights, including confidentiality and indemnification under the License Agreement.

CR011-vcMMAE for the Treatment of Cancer

CR011-vcMMAE consists of the fully-human monoclonal antibody, CR011, which results from our collaboration with Amgen Fremont and utilizes conjugation technology licensed from Seattle Genetics to attach monomethyl auristatin E, or MMAE, to the antibody. In June 2006, we initiated a Phase I/II open-label, multi-center, dose escalation study evaluating the safety, tolerability and pharmacokinetics of CR011-vcMMAE for patients with unresectable Stage III or Stage IV melanoma who have failed no more than one prior line of cytotoxic therapy. We are currently evaluating CR011-vcMMAE in clinical trials for the treatment of patients with advanced melanoma and for the treatment of patients with metastatic breast cancer.

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Melanoma

In June 2006, we initiated a Phase I/II open-label, multi-center, dose escalation study evaluating the safety, tolerability and pharmacokinetics of CR011-vcMMAE for patients with unresectable Stage III or Stage IV melanoma who have failed no more than one prior line of cytotoxic therapy.

On June 1, 2008, we announced the presentation of results from this ongoing study at the 2008 American Society of Clinical Oncology, or ASCO, Annual Meeting. As of April 4, 2008, forty patients were treated in this first-in-man Phase I/II study, including a total of 32 patients in the Phase I dose-escalation portion of the trial, that aimed to identify the safety and maximum tolerated dose, or MTD, of CR011-vcMMAE, and 8 patients in the ongoing Phase II portion of the study.

During Phase I, doses of CR011-vcMMAE between 0.03 mg/kg to 2.63 mg/kg were evaluated and generally well tolerated, with rash and neutropenia emerging at higher doses. Two dose-limiting toxicities, consisting of rash, were reported at the highest dose evaluated, and therefore the per-protocol MTD was determined to be 1.88 mg/kg administered intravenously (IV) once every three weeks. The activity of CR011-vcMMAE appeared dose dependent with 50% of those patients treated with doses at or above 1.34 mg/kg exhibiting tumor shrinkage and 64% progression-free at 12 weeks compared to 17% with tumor shrinkage and 28% progression-free at 12 weeks for patients treated at lower doses. One confirmed partial response was reported in Phase I. Based on the results of the Phase I portion of the trial, the dose selected for the Phase II portion was 1.88 mg/kg administered intravenously every three weeks.

On September 11, 2008, we announced the completion of enrollment into the Phase II portion of the melanoma clinical trial. Preliminary results from the trial were presented on November 1, 2008 at the 2008 International Society for Biologic Therapy of Cancer (iSBTc) Annual Meeting.

Thirty-six patients were enrolled into the Phase II portion of the trial. Of the patients enrolled, 94% had Stage IV disease, of which two-thirds were classified as M1c, the poorest risk group. At the time of the data cutoff for this analysis (19 Sept 2008), 31 patients had at least one efficacy assessment available, and 18 patients were continuing to receive ongoing treatment in the study. The overall median progression-free survival (PFS) to date was approximately 4.5 months. RECIST-defined partial responses were reported in 3 patients, 2 ongoing, and an unconfirmed partial response in 1 patient. Nineteen patients had stable disease, 14 ongoing, with tumor shrinkage observed in 12 of these patients. As expected based upon the expression of GPNMB and as observed in Phase I, dermatologic adverse events consisting of rash, alopecia, and pruritus were the most common toxicities in this study. A preliminary exploratory analysis assessing the relationship of rash and PFS was performed and showed a trend toward longer PFS in patients that developed Grade 2 or higher rash (n=13). Other adverse events included fatigue, diarrhea, anorexia and nausea. Grade 3 or 4 neutropenia was observed in 7 patients (22%).

We are also enrolling patients into the Phase I portion of the melanoma trial to evaluate more frequent dosing schedules of CR011-vcMMAE, including a weekly and a two out of every three-week regimen, to explore if more frequent administration can provide additional activity in patients with metastatic melanoma. We anticipate presenting updated results from both the Phase I and Phase II portions of the trial during the first half of 2009.

Breast Cancer

On June 25, 2008, we announced the initiation of patient dosing in an open-label, multi-center Phase II study of CR011-vcMMAE administered intravenously once every three weeks to patients with locally-advanced or metastatic breast cancer who have received prior therapy. We expect to enroll up to approximately 40 patients to confirm the MTD in this population and to assess efficacy using a Simon 2-Stage design with an endpoint of progression-free rate at 12 weeks. We anticipate presenting preliminary results from this study during the first half of 2009.

In addition, we have several potential preclinical protein, antibody, and antibody-drug conjugates that have been evaluated in animal studies. We will continue to evaluate strategic opportunities for these assets through partnerships, licensing, or the filing of investigational new drug, or IND, applications in the future.

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Summary

We expect to generate value for our shareholders by developing novel therapeutics and through strategic transactions. We seek to become profitable by commercializing a subset of therapeutics stemming from our development pipeline, establishing partnerships with pharmaceutical and biotechnology companies for the development and commercialization of other therapeutics from our development pipeline, and through successful strategic transactions. Additionally, we plan to continue to evaluate possible acquisitions or licensing of rights to additional products or technologies that fit within our growth strategy. Our failure to successfully develop and commercialize pharmaceutical products would materially and adversely affect our business, financial condition, cash and investments balances and results of operations. Royalties or other revenue generated from commercial sales of products developed through the application of our technologies or expertise is not expected for several years, if at all. We expect that our revenue or income sources for at least the next several years may be limited to potential milestones and other potential payments related to partnering one of our drug candidates, and interest income.

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

We expect to continue incurring expenses relating to our research and development efforts, as we focus on clinical trials required for the development of CR011-vcMMAE. Conducting clinical trials is a lengthy, time-consuming and expensive process and we expect to incur continued losses over the next several years. We are actively pursuing partnership opportunities regarding CR011-vcMMAE, and the nature of our future capital requirements and cash flow will be impacted positively or negatively based on the outcome of these discussions. Results of operations for any period may be unrelated to the results of operations for any other period. In addition, historical results should not be viewed as indicative of future operating results.

Critical Accounting Policies and Use of Estimates

Our discussion and analysis of our financial condition and results of operations are based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these condensed consolidated financial statements requires us to make estimates and judgments that affect the reported amount of assets and liabilities, revenues and expenses. On an on-going basis, we evaluate our estimates, including those related to prepaid expenses, accrued expenses, revenue recognition, the market value of our cash equivalents, short-term investments and marketable securities and stock based compensation. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Our significant accounting policies are more fully described in Note 1 to our consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2007.

All of the securities in our investment portfolio are priced by our investment manager, an independent third party. On a quarterly basis, we obtain a second price for each security to compare to the price obtained from our investment manager. As of September 30, 2008 there have been no material variances in the prices obtained from these two sources, and as such we have used the pricing provided by our investment manager. Our investment portfolio has not been adversely materially impacted by the recent disruption in the credit markets. However, if there is continued and expanded disruption in the credit markets this may have a potential impact on the determination of the fair value of financial instruments. Additionally, there can be no assurance that our investment portfolio will not be adversely affected in the future.

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Results of Operations

The following table sets forth a comparison of the components of our net loss for the three months ended September 30, 2008 and 2007 (in millions):

	Three Months Ended September 30,
	2008			2007			$ Change			% Change
Research and development expenses	$	3.4		$	8.1		$	(4.7	)	(58	)%
General and administrative expenses		1.1			2.6			(1.5	)	(58	)%
Restructuring charges		—			1.0			(1.0	)	(100	)%
Interest income		0.7			1.9			(1.1	)	(58	)%
Interest expense		0.2			1.3			(1.1	)	(85	)%
Gain on extinguishment of debt		—			0.2			(0.2	)	(100	)%
Gain on sale of long-term marketable securities		—			1.0			(1.0	)	(100	)%
Net loss	$	(4.0	)	$	(9.9	)

The following table sets forth a comparison of the components of our net income for the nine months ended September 30, 2008 and 2007 (in millions):

	Nine Months Ended September 30,
	2008			2007		$ Change			% Change
Collaboration revenue	$	1.2		$	—	$	1.2		*
Research and development expenses		12.5			30.5		(18.0	)	(59	)%
General and administrative expenses		4.2			9.6		(5.4	)	(56	)%
Restructuring charges		—			8.5		(8.5	)	(100	)%
Gain on sale of intangible asset		36.4			—		36.4		*
Interest income		2.5			4.0		(1.5	)	(38	)%
Interest expense		1.5			4.2		(2.7	)	(64	)%
Gain on extinguishment of debt		7.0			0.2		6.8		*
Gain on sale of long-term marketable securities		—			1.0		(1.0	)	(100	)%
Income tax (provision) benefit		(0.4	)		0.2		(0.6	)	*
Loss from discontinued operations		—			3.0		(3.0	)	(100	)%
Gain on sale of subsidiary		—			78.4		(78.4	)	(100	)%
Net income	$	28.5		$	28.0

* Based on prior year amounts, percentage change does not provide meaningful information.

Collaboration revenue. The increase in collaboration revenue for the nine months ended September 30, 2008, as compared to the nine months ended September 30, 2007 was due to the recognition of $1.2 million of the $1.3 million received during 2006 from TopoTarget’s licensing agreement with an unrelated third party. In January 2008, TopoTarget was informed by the third party that it had terminated the development of the preclinical compound pursuant to which we formerly received collaboration revenue. We do not expect any additional collaboration revenue in 2008.

Research and development expenses. Research and development expenses consist primarily of: contractual and manufacturing costs; salary and benefits; license fees and milestone payments; supplies; drug supply; depreciation and amortization; and allocated facility costs. Our research and development efforts are concentrated solely on clinical trials. We budget and monitor our research and development costs by expense category, rather than by project, because these costs often benefit multiple projects and/or our technology platform as a whole.

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Below is a summary that reconciles our total research and development expenses for the three and nine month periods ended September 30, 2008 and 2007 by the major categories (in millions):

	Three Months Ended September 30,
	2008		2007		$ Change			% Change
Contractual and manufacturing costs	$	1.5	$	5.0	$	(3.5	)	(68	)%
Salary and benefits		1.1		2.2		(1.1	)	(50	)%
Allocated facility costs		0.8		0.9		(0.1	)	(11	)%
Total research and development expenses	$	3.4	$	8.1

	Nine Months Ended September 30,
	2008		2007		$ Change			% Change
Contractual and manufacturing costs	$	5.7	$	16.7	$	(11.0	)	(66	)%
Salary and benefits		3.3		7.6		(4.3	)	(57	)%
Supplies and reagants		0.1		0.6		(0.5	)	(83	)%
License fees and milestone		1.6		0.1		1.5		*
Depreciation and amortization		0.0		1.1		(1.1	)	(100	)%
Allocated facility costs		1.8		4.4		(2.5	)	(57	)%
Total research and development expenses	$	12.5	$	30.5

* Based on prior year amounts, percentage change does not provide meaningful information.

The decrease in our research and development expenses for the three and nine months ended September 30, 2008 as compared to the three and nine months ended September 30, 2007 was due to our decision in the first quarter of 2007 to focus our resources exclusively on generating clinical trial results from our lead oncology drug development programs, as well as the closing of our Biopharmaceutical Sciences Process facility and personnel reductions in the third and fourth quarters of 2007. The reductions included a decrease in salary and benefits caused by a reduction in personnel, a decrease in depreciation and amortization from a reduction in lab equipment and a decrease in allocated facility costs due to our restructurings in 2007. We anticipate that our research and development expenses for the remainder of 2008 will be relatively consistent with the third quarter.

As soon as we advance a potential clinical candidate into clinical trials, we begin to track the direct research and development expenses associated with that potential clinical candidate. The following table shows the cumulative direct research and development expenses as of September 30, 2008, as well as the current direct research and development expenses for the three and nine month periods ended September 30, 2008 and 2007 for active programs which were incurred on or after we started conducting a Phase I clinical trial for our clinical candidate (in millions):

Therapeutic Area and Clinical Candidate	Class	Cumulative as of September 30, 2008 (since commencement of Phase I)		Indication	Trial Status
CR011-vcMMAE	Antibody-Drug Conjugate	$	12.7	Metastatic Melanoma/Breast Cancer	Phase II

Therapeutic Area and Clinical Candidate	Three Months Ended				Nine Months Ended
	September 30, 2008		September 30, 2007		September 30, 2008		September 30, 2007
CR011-vcMMAE	$	2.1	$	0.5	$	5.6	$	1.9

We expect that the direct research and development expenses incurred in connection with our development of CR011-vcMMAE will slightly increase in the remainder of 2008, related to higher enrollment of patients in our breast cancer Phase II trial and manufacturing costs of CR011-vcMMAE, which is partially offset by milestone expenses of $1.5 million incurred in the first quarter of 2008. We do not expect additional milestone expenses in 2008.

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In addition, we have two inactive programs for which we have incurred costs:

Velafermin—is a protein therapeutic we were investigating for the prevention of oral mucositis. We discontinued the development of this protein in the fourth quarter of 2007, after our Phase II dose-confirmatory clinical trial did not meet its primary endpoint. We incurred $0.4 million of costs for the three months ended September 30, 2008 and $1.3 million of costs for the nine months ended September 30, 2008. As of September 30, 2008, we have incurred cumulative costs of $51.6 million. As patients from this study were being followed for approximately one year post treatment for protocol-specified safety monitoring, the study was clinically complete at the end of September 2008. We do not anticipate incurring more than an additional $0.1 million of expenses for this program.

Belinostat—is a small molecule therapeutic, formerly referred to as PXD101, which inhibits the activity of the enzyme HDAC and is being evaluated for the treatment of solid and hematologic cancers either alone or in combination with other active chemotherapeutic drugs and newer targeted agents. As of September 30, 2008 we have incurred cumulative costs of $48.2 million. On April 21, 2008, we announced the sale of our ownership and development rights of belinostat to TopoTarget, and as such, we do not expect to incur any additional expenses associated with this program.

Currently, our potential pharmaceutical products require significant research and development efforts and preclinical testing, and will require extensive evaluation in clinical trials prior to submitting an application to regulatory agencies for their commercial use. Although we are conducting human studies with respect to CR011-vcMMAE, we may not be successful in developing or commercializing this or other products. Our product candidates are subject to the risks of failure inherent in the development and commercialization of pharmaceutical products and we cannot currently provide reliable estimates as to when, if ever, our product candidates will generate revenue and cash flows.

General and administrative expenses. The decrease in general and administrative expenses for the three and nine months ended September 30, 2008, as compared to the three and nine months ended September 30, 2007, was primarily a result of our restructuring activities during 2007 related to personnel reductions, a decrease in outsourcing of consultants and lower patent legal fees. We anticipate our general and administrative expenses for the remainder of 2008 will be consistent with the third quarter.

Restructuring charges. We incurred no restructuring charges for the three and nine months ended September 30, 2008. The restructuring charges for the three and nine months ended September 30, 2007 were due to the June 2007 restructuring.

Gain on sale of intangible asset. The gain on sale of intangible asset of $36.4 million for the nine months ended September 30, 2008 was a result of the sale of belinostat to TopoTarget in April 2008, which provided us with net cash proceeds of $24.6 million, and 5 million shares of TopoTarget stock valued at $11.8 million on the closing date, April 21, 2008.

Interest income. Interest income earned on our cash, restricted cash and investment portfolio for the three and nine month periods ended September 30, 2008 decreased as compared to the three and nine month periods ended September 30, 2007, primarily due to a lower average investment portfolio balance. We earned an average yield of 3.4% during the third quarter of 2008 as compared to 4.7% in the third quarter of 2007, and earned an average yield of 3.6% during the first nine months of 2008 as compared to 4.3% during the same period in 2007. We expect similar average yields in the fourth quarter of 2008 as in first three quarters of 2008; however, we anticipate interest income to slightly decrease in 2008 due to a lower average cash and investment portfolio balance.

Interest expense. Interest expense for the three and nine month periods ended September 30, 2008 decreased compared to the three and nine months ended September 30, 2007 due to the 2007 repurchases of $40.1 million and the 2008 repurchases of $50.9 million of our 4% convertible subordinated debentures due 2011. We expect interest expense, including interest paid to debt holders as well as amortization of deferred financing costs, to approximate $1.6 million for the full year 2008.

Gain on extinguishment of debt. The gain on extinguishment of debt for the nine month period ended September 30, 2008 was due to the repurchase of $50.9 million of our 4% convertible subordinated debentures due February 2011, for $43.2 million plus accrued interest of $0.5 million in May 2008. We recorded a gain of approximately $7.0 million which is net of the write-off of the ratable portion of unamortized deferred financing costs relating to the repurchased debt.

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Gain on sale of long-term marketable securities. During the three months ended September 30, 2007, we sold our investment in TopoTarget for proceeds of $6.3 million and realized a gain of $1.0.

Income tax benefit (provision). We recorded an income tax expense of $0.4 million for the nine month period ended September 30, 2008 related to Federal alternative minimum tax expense of $0.5 million partially offset by a research and development tax credit from the State of Connecticut of $0.1 million. The tax benefit for the nine month period is a result of Connecticut legislation, which allows companies to obtain cash refunds from the State of Connecticut at a rate of 65% of their annual research and development expense credit, in exchange for forgoing carryforward of the research and development credit. Income tax expense for the nine month period ended September 30, 2008 represents Federal alternative minimum tax expected in 2008. We are expecting to have taxable income in 2008, primarily related to the gain on the sale of belinostat to TopoTarget and the gain on extinguishment of debt both recognized in 2008.

Income from discontinued operations. Our statement of operations for the nine month period ended September 30, 2007 included income from discontinued operations as a result of the sale of our ownership in 454 in the second quarter of 2007. We had no income from discontinued operations in the three and nine month periods ended September 30, 2008.

Liquidity and Capital Resources

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

On April 21, 2008, we entered into a transfer and termination agreement with TopoTarget which effectively sold our rights to belinostat, a Phase I/II HDAC inhibitor and any other HDAC inhibitors, for $24.6 million in net cash proceeds, 5 million shares of TopoTarget common stock valued at approximately $11.8 million as of the date of the transfer agreement and $6 million in potential payments on future net sales and sublicenses of belinostat. On June 3, 2008, we sold the 5 million shares of TopoTarget common stock for cash proceeds of $11.8 million. Total net cash received related to the sale of belinostat was $36.4 million.

On May 12, 2008 we completed a series of privately-negotiated transactions with holders of our 4% convertible subordinated notes due February 2011 in which we repurchased a total of $50.9 million of the 2011 Notes for an aggregate purchase price of $43.2 million, reflecting an aggregate discount from the face value of such 2011 notes of approximately 15.1%.

On August 25, 2008, the escrow period for the escrow fund associated with the sale of 454 Life Sciences Corporation expired, and as such $14.7 million was released to us. The 454 sale and escrow are further discussed in Note 3 to our condensed consolidated financial statements.

Cash and investments. The following table depicts changes in cash, restricted cash and investments for the nine month periods ended September 30, 2008 and 2007, using the direct method (in millions):

	Nine months ended September 30,
	2008			2007
Cash paid to suppliers, employees and collaborators	$	(14.0	)	$	(32.1	)
Restructuring charges paid		(2.8	)		(1.6	)
Interest income received		2.7			4.1
Interest expense paid		(2.3	)		(6.5	)
Income tax provision (paid)/received		(0.3	)		0.4
Cash paid to acquire property and equipment		—			(0.1	)
Proceeds from sale of fixed assets		0.1			—
Proceeds from sale of held for sale assets		—			2.2
Proceeds from sale of long-term marketable securities		—			6.2
Proceeds from disposal of assets of discontinued operations		—			82.0
Gain on sale of intangible asset		36.4			—
Cash received from employee stock option exercises		—			0.1
Cash paid for extinguishment of debt		(43.2	)		(66.2	)
Net realized and unrealized gain on short-term investments and marketable securities		(0.2	)		0.7
Net decrease in cash, restricted cash and investments		(23.6	)		(10.8	)
Cash, restricted cash and investments, beginning of period		115.0			164.4
Cash, restricted cash and investments, end of period	$	91.4		$	153.6

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

Future Liquidity. We expect to continue to fund our operations by a combination of the following sources: cash and investment balances; interest income; potential public or private equity offerings; debt financing or additional collaborations and licensing arrangements. We plan to seek a partner to share the costs of our late stage oncology program CR011-vcMMAE. We intend to use the proceeds from the assets monetized in 2007 as well as the cash received in 2008 from the sale of belinostat to TopoTarget for the development costs of CR011-vcMMAE while we seek a developmental partner, and also for other uses which could include strategic transactions. We do not anticipate any material capital expenditures in the near future. Accordingly, we foresee the following as uses of short term liquidity: contractual services related to clinical trials and manufacturing; salary and benefits; and license fees. We will also continue to evaluate potential acquisitions, including complementary businesses, technologies and products.

We will continue to evaluate options to repurchase or refinance all or a portion of our outstanding 4% convertible debentures that mature on February 15, 2011. Repurchases might occur through cash purchases and/or exchange for equity securities, in open market purchases, privately negotiated transactions or otherwise. Such repurchases or exchanges, if any, will depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors. The amounts involved in any such transactions, individually or in the aggregate, may be material.

We may use sources of liquidity for working capital, general corporate purposes and potentially for future acquisitions of businesses, products or technologies. The amounts and timing of our actual expenditures will depend upon numerous factors, including the amount and extent of any acquisitions, our product development activities, our investments in technology and the amount of cash generated by our operations and may vary substantially from our estimates. Our failure to use sources of liquidity effectively could have a material adverse effect on our business, results of operations and financial condition.

We believe that our existing cash and investment balances and other sources of liquidity will be sufficient to meet our requirements through 2011. We consider our operating and capital expenditures to be crucial to our future success, and intend to continue to make strategic investments in our clinical drug pipeline. In appropriate situations, we may seek financing from other sources, and expect that we will need additional funds to meet our future operating and capital requirements. To the extent that we need to obtain additional funding, the amount of additional capital we would need to raise would depend on many factors, including: the number, breadth, progress and results of our research, product development and clinical programs; the costs and timing of obtaining regulatory approvals for any of our products; in-licensing and out-licensing of pharmaceutical products; acquisitions, including complementary technologies and products; costs incurred in enforcing and defending our patent claims and other intellectual property rights.

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

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Contractual Obligations

In the table below, we set forth our enforceable and legally binding obligations, along with future commitments related to all contracts that we are likely to continue, regardless of the fact that they are cancelable as of September 30, 2008. As compared to the Contractual Obligations disclosure in our Annual Report on Form 10-K for the year ended December 31, 2007, this table no longer includes belinostat obligations since all the obligations were transferred to TopoTarget in April 2008.

Some of the amounts included in this table under purchase commitments are based on management’s estimates and assumptions about these obligations, including their duration, anticipated actions by third parties, progress of our clinical programs and other factors. These amounts exclude items accrued for on the balance sheet.

	Payments Due Year Ended December 31,
	Total		2008		2009		2010		2011
Long-term debt obligations	$	19.0	$	—	$	—	$	—	$	19.0
Interest on convertible subordinated debt		2.0		—		0.8		0.8		0.4
Purchase commitments		3.9		1.4		2.3		0.2		—
Total	$	24.9	$	1.4	$	3.1	$	1.0	$	19.4

The expected timing of payment of the obligations discussed above is estimated based on current information. Timing of payments and actual amounts paid may be different depending on the time of receipt of goods or services or changes to agreed-upon amounts for some obligations.

We have unrecognized tax benefits of $0.8 million at September 30, 2008. This amount is excluded from the table above as we are unable to make a reasonable estimate of the period of cash settlement with the respective taxing authority.

Recently Enacted Pronouncements

In June 2007, the FASB ratified the Emerging Issues Task Force, or EITF, consensus on Issue No. 07-3, “Accounting for Nonrefundable Advance Payments for Goods or Services to Be Used in Future Research and Development Activities”, or EITF 07-3. EITF 07-3 requires that nonrefundable advance payments for goods or services that will be used or rendered for future research and development activities should be deferred and capitalized. Such amounts should be recognized as an expense as the related goods are delivered or the services are performed, or when the goods or services are no longer expected to be provided. EITF 07-3 is effective for fiscal years beginning after December 15, 2007, and interim periods within those fiscal years. The adoption of EITF 07-3 did not have a material impact on our consolidated financial statements.

In December 2007, the FASB ratified the EITF consensus on Issue No. 07-1, “Accounting for Collaborative Arrangements”, or EITF 07-1. The EITF concluded that a collaborative arrangement is one in which the participants are actively involved and are exposed to significant risks and rewards that depend on the ultimate commercial success of the endeavor. Revenues and costs incurred with third parties in connection with collaborative arrangements would be presented gross or net based on the criteria in EITF 99-19, Reporting Revenue Gross as a Principal versus Net as an Agent, and other accounting literature. Payments to or from collaborators would be evaluated and presented based on the nature of the arrangement and its terms, the nature of the entity’s business, and whether those payments are within the scope of other accounting literature EITF 07-1 is effective for fiscal years beginning after December 15, 2008. We do not believe the adoption of EITF 07-1 will have a material impact on our consolidated financial statements.

In May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles (“SFAS No. 162”). SFAS 162 identifies a consistent framework, or hierarchy, for selecting accounting principles to be used in preparing financial statements that are presented in conformity with U.S. generally accepted accounting principles, or GAAP, for nongovernmental entities (the “Hierarchy”). The Hierarchy within SFAS 162 is consistent with that previously defined in the AICPA Statement on Auditing Standards No. 69, “The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles” (“SAS 69”). SFAS 162 is effective 60 days following the United States Securities and Exchange Commission’s (the “SEC”) approval of the Public Company Accounting Oversight Board amendments to AU Section 411, “The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles”. We do not believe the adoption of SFAS 162 will have a material effect on our consolidated financial statements.

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In May 2008, FASB Staff Position (“FSP”) No. APB 14-1, “Accounting for Convertible Debt Instruments That May be Settled in Cash upon Conversion (Including Partial Cash Settlement)” was issued which specifies that issuers of such instruments should separately account for the liability and equity components in a manner that will reflect the issuer’s nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods. FSP No. APB 14-1 is effective for financial statements issued for fiscal years beginning after December 15, 2008. We have not yet determined the potential impact, if any, on our financial condition, results of operations and liquidity.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Our outstanding long-term liabilities as of September 30, 2008 included $19.0 million of our 4% convertible subordinated notes due February 15, 2011. As the debentures and notes bear interest at a fixed rate, our results of operations are not affected by interest rate changes. As of September 30, 2008, the market value of our $19.0 million 4% convertible subordinated notes due 2011, based on quoted market prices, was approximately $16.4 million.

We had 9.5% of our cash and investment securities in mortgage-backed securities as of September 30, 2008. All of these mortgage-backed securities are sponsored by the United States Federal Government and are rated AAA by Moody’s. Additionally, we had 14.3% of our cash and investment securities in asset-backed securities which consist of auto, credit card and equipment loans as of September 30, 2008. The asset-backed and mortgage-backed securities as of September 30, 2008 had a gross unrealized gain of $0.03 million and a gross unrealized loss of $0.19 million or a net unrealized loss of $0.16 million. The largest unrealized loss on any individual security is $0.06 million.

We review our investment portfolio on a regular basis to determine if there is an impairment that is other than temporary. We believe that any individual unrealized loss as of September 30, 2008, represents only a temporary impairment, and no adjustment of carrying values is warranted at this time. We continue to monitor our investment portfolio on a regular basis for any other potential impairment.

Item 4. Controls and Procedures

(a) Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures as of September 30, 2008. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, the “Exchange Act”), means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Our management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of September 30, 2008, our chief executive officer and chief financial officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.

(b) Changes in Internal Controls

No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the fiscal quarter ended September 30, 2008 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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Part II — Other Information

Item 1A. Risk Factors

Statements contained or incorporated by reference in this Quarterly Report on Form 10-Q that are not based on historical fact are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Exchange Act. These forward-looking statements regarding future events and our future results are based on current expectations, estimates, forecasts, projections, intentions, goals, strategies, plans, prospects and the beliefs and assumptions of our management including, without limitation, our expectations regarding results of operations, general and administrative expenses, research and development expenses, current and future development efforts, regulatory filings, clinical trial results and the sufficiency of our cash for future operations. Forward-looking statements can be identified by terminology such as “anticipate,” “believe,” “could,” “could increase the likelihood,” “hope,” “target,” “project,” “goals,” “potential,” “predict,” “might,” “estimate,” “expect,” “intend,” “is planned,” “may,” “should,” “will,” “will enable,” “would be expected,” “look forward,” “may provide,” “would” or similar terms, variations of such terms or the negative of those terms.

We cannot assure investors that our assumptions and expectations will prove to have been correct. Important factors could cause our actual results to differ materially from those indicated or implied by forward-looking statements. Such factors that could cause or contribute to such differences include those factors discussed below. We undertake no intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. If any of the following risks actually occur, our business, financial condition or results of operations would likely suffer.

The following discussion includes one revised risk factor (“Competition in our field is intense and likely to increase”) and two new risk factors (“Our common stock could be delisted from the NASDAQ Global Market if our stock price continues to trade below $1.00 per share” and “We may from time to time exceed the Federal Deposit Insurance Corporation limits in our bank accounts”) that reflect material developments subsequent to the discussion of risk factors included in our most recent Annual Report on Form 10-K, as well as updates to various risk factors in general. We also removed four risk factors as they were no longer relevant: (“Our debt service obligations may adversely affect our cash flow”; “Our ability to repurchase notes, if required, with cash upon a change in control or fundamental change may be limited”; “We have significant leverage as a result of the sale of our debt in 2004” and “If the proceeds we receive from the sale of our stake in 454 are less than anticipated due to indemnification claims against the escrow account, our liquidity may be impaired, and we may be forced to seek alternative sources of financing sooner than anticipated”).

Risks Related to Our Business

We have a history of operating losses and expect to incur operating losses in the foreseeable future. We do not expect to have a meaningful source of recurring revenue in the near future.

We have incurred losses since inception, principally as a result of research and development and general and administrative expenses in support of our operations. We generated net income of $28.5 million for the nine months ended September 30, 2008, net income of $25.4 million in 2007 principally resulting from the sale of 454, net losses of $59.8 million and $73.2 million in 2006 and 2005, respectively, and as of September 30, 2008 had an accumulated deficit of $459.0 million. We expect to continue to incur operating losses for the foreseeable future. We anticipate incurring additional losses related to investments in CR011-vcMMAE and do not expect to have a meaningful source of recurring revenue in the near future.

We can not ensure that our existing cash and investment balances will be sufficient to meet our requirements for the future.

We believe that our existing cash and investment balances and other sources of liquidity will be sufficient to meet our requirements through 2011. We consider our operating expenditures to be crucial to our future success, and by continuing to make strategic investments in our clinical drug pipeline, we believe that we are building substantial value for our stockholders. The adequacy of our available funds to meet our future operating and capital requirements will depend on many factors. These factors include: the number, breadth, progress and results of our research, product development and clinical programs; the costs and timing of obtaining regulatory approvals for any of our products; in-licensing and out-licensing of pharmaceutical products; and costs incurred in enforcing and defending our patent claims and other intellectual property rights.

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

Our drug candidates are still in development and remain subject to clinical testing and regulatory approval. If we are unable to successfully develop and test our drug candidates, we will not be successful.

To date, we have not marketed, distributed or sold any drug candidates. The success of our business depends primarily upon our ability to develop and commercialize our drug candidates successfully. Our most advanced drug candidate is CR011-vcMMAE, which is currently in Phase II clinical trials. Further development of our other preclinical candidates will be limited in the foreseeable future due to our decision to focus our resources on the development of our clinical development stage oncology therapeutic. Our drug candidates must satisfy rigorous standards of safety and efficacy before they can be approved for sale. To satisfy these standards, we must engage in expensive and lengthy testing and obtain regulatory approval of our drug candidates. Despite our efforts, our drug candidates may not:

• offer therapeutic or other improvement over existing comparable drugs;

• be proven safe and effective in clinical trials;

• meet applicable regulatory standards;

• be capable of being produced in commercial quantities at acceptable costs; or

• be successfully commercialized.

Positive results in preclinical studies of a drug candidate may not be predictive of similar results in humans during clinical trials, and promising results from early clinical trials of a drug candidate may not be replicated in later clinical trials. For example, in the fourth quarter of 2007, we decided to discontinue the development of velafermin after reviewing and evaluating the results of Phase II clinical trials. A number of companies in the pharmaceutical and biotechnology industries have suffered significant setbacks in late stage clinical trials even after achieving promising results in early stage development. Accordingly, the results from the completed preclinical studies and clinical trials and ongoing clinical trials for CR011-vcMMAE and our other future drug candidates may not be predictive of the safety, efficacy or dosing results we may obtain in later stage trials. We do not expect any of our drug candidates to be commercially available for at least several years.

We may not be able to execute our business strategy if we are unable to enter into alliances with other companies that can provide capabilities and funds for the development and commercialization of our drug candidates. If we are unsuccessful in forming or maintaining these alliances on favorable terms, our business may not succeed.

We have entered into collaboration arrangements with several companies for the research, development and commercialization of our drug candidates, and we may enter into additional collaborative arrangements in the future. For example, we may enter into alliances with major biotechnology or pharmaceutical companies to jointly develop specific drug candidates and to jointly commercialize them if they are approved. We may not be successful in entering into any such alliances on favorable terms. Even if we do succeed in securing such alliances, we may not be able to maintain them if, for example, development or approval of a drug candidate is delayed or sales of an approved drug are disappointing. Furthermore, any delay in entering into collaboration agreements could delay the development and commercialization of our drug candidates and reduce their competitiveness even if they reach the market. Any such delay related to our collaborations could adversely affect our business.

We may also depend on our alliances with other companies to provide substantial additional funding for development and potential commercialization of our drug candidates. We may not be able to obtain funding on favorable terms from these alliances, and if we are not successful in doing so, we may not have sufficient funds to develop a particular drug candidate internally, or to bring drug candidates to market. Failure to bring our drug candidates to market will prevent us from generating sales revenues, and this may substantially harm our business.

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We rely significantly on our collaborative partners to gain access to specified technologies and our business could be harmed if we are unable to maintain strategic alliances.

As part of our business strategy, we have strategic research and development alliances with companies to gain access to specific technologies. These alliances with other pharmaceutical and biotechnology companies may provide us with access to unique technologies, access to capital, near-term revenues, milestone and/or royalty payments, and potential profit sharing arrangements. In return, we provide access to unique technologies, expertise in genomics, and information on the molecular basis of disease, drug targets, and drug candidates. We currently have strategic alliances with Amgen Fremont and Seattle Genetics, in addition to numerous smaller agreements to facilitate these efforts. In these strategic alliances, either party can terminate the agreement at any time the alliance permits them to or if either party materially breaches the contract. We may not be able to maintain or expand existing alliances or establish any additional alliances. If any of our existing collaborators were to breach or terminate their agreements with us or otherwise fail to conduct activities successfully and in a timely manner, the preclinical or clinical development or commercialization of product candidates or research programs may be delayed or terminated, which may materially and adversely affect our business, financial condition, and results of operations.

We rely on third parties to conduct our clinical trials and provide other services, and those third parties may not perform satisfactorily, including failing to meet established deadlines for the completion of such services.

We do not have the ability to independently conduct some preclinical studies and the clinical trials for our drug candidates, and we rely on third parties such as contract laboratories, contract research organizations, medical institutions and clinical investigators to design and conduct these studies and our clinical trials. Our reliance on these third parties reduces our control over these activities. Accordingly, these third-party contractors may not complete activities on schedule, or may not conduct the studies of our clinical trials in accordance with regulatory requirements of our trial design. To date, we believe our contract research organizations and other similar entities with which we are working have performed well. However, if these third parties do not successfully carry out their contractual duties or meet expected deadlines, we may be required to replace them. Although we believe that there are a number of other third-party contractors we could engage to continue these activities, it may result in delays. Accordingly, our efforts to obtain regulatory approvals for and commercialize our drug candidates may be delayed.

In addition, our ability to bring our future products to market depends on the quality and integrity of the data we present to regulatory authorities in order to obtain marketing authorizations. We cannot guarantee the authenticity or accuracy of data compiled by third parties, nor can we be certain that such data has not been fraudulently generated. The failure of these third parties to carry out their obligations would materially adversely affect our ability to develop and market new products and implement our strategies.

We currently depend on third-party manufacturers to produce our clinical drug supplies and intend to rely upon third-party manufacturers to produce commercial supplies of any approved drug candidates. If in the future we manufacture any of our drug candidates, we will be required to incur significant costs and devote significant efforts to establish and maintain these capabilities.

We have relied upon third parties to produce material for clinical testing purposes and intend to continue to do so in the future. Although we believe that we will not have any material supply issues, we cannot be certain that we will be able to obtain long-term supplies of those materials on acceptable terms, if at all. We also expect to rely upon third parties to produce materials required for the commercial production of our drug candidates if we succeed in obtaining necessary regulatory approvals. If we are unable to arrange for third-party manufacturing, or to do so on commercially reasonable terms, we may not be able to complete development of our drug candidates or market them. Reliance on third-party manufacturers entails risks to which we would not be subject if we manufactured drug candidates ourselves, including reliance on the third party for regulatory compliance and quality assurance, the possibility of breach of a manufacturing agreement by the third party because of factors beyond our control and the possibility of termination or nonrenewal of the agreement by the third party, based on its own business priorities, at a time that is costly or damaging to us. In addition, the FDA and other regulatory authorities require that our drug candidates be manufactured according to current Good Manufacturing Practices, or cGMP, regulations. Any failure by us or our third-party manufacturers to comply with cGMP and/or our failure to scale up our manufacturing processes could lead to a delay in, or failure to obtain, regulatory approval of any of our drug candidates. In addition, such failure could be the basis for action by the FDA to withdraw approvals for drug candidates previously granted to us and for other regulatory action.

We currently rely on a limited number of manufacturers for the clinical supplies of our antibody, and antibody-drug conjugate, or ADC, drug candidates and do not currently have contractual relationships for redundant

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supply or a second source for any of these drug candidates. To date, our third-party manufacturers have met our manufacturing requirements, but we cannot assure that they will continue to do so. Any performance failure on the part of our existing or future manufacturers could delay clinical development or regulatory approval of our drug candidates or commercialization of any approved products. If for some reason our current contract manufacturers cannot perform as agreed, we may be required to replace them. Although we believe there are a number of potential replacements as our manufacturing processes are not manufacturer specific, we may incur added costs and delays in identifying and qualifying any such replacements. Furthermore, although we generally do not begin a clinical trial unless we believe we have a sufficient supply of a drug candidate to complete the trial, any significant delay in the supply of a drug candidate for an ongoing trial due to the need to replace a third-party manufacturer could delay completion of the trial.

We may in the future elect to manufacture certain of our drug candidates in our own manufacturing facilities. If we do so, we will require substantial additional funds and need to recruit qualified personnel in order to build or lease and operate any manufacturing facilities.

Because we have limited experience in developing, commercializing and marketing products, we may be unsuccessful in our efforts to do so.

Our products in development will require significant research and development and preclinical and clinical testing prior to our submitting any regulatory application for their commercial use. These activities, even if undertaken without the collaboration of others, will require us to expend significant funds and will be subject to the risks of failure inherent in the development of pharmaceutical products. We have limited experience conducting clinical trials. Even if we complete such studies, our ability to commercialize products will depend on our ability to:

• obtain and maintain necessary intellectual property rights to our products;

• enter into arrangements with third parties to manufacture our products on our behalf; and

• deploy sales and marketing resources effectively or enter into arrangements with third parties to provide these services.

As a result of these possibilities, we may not be able to develop any commercially viable products. In addition, should we choose to develop pharmaceutical products internally, we will have to make significant investments in pharmaceutical product development, marketing, sales, and regulatory compliance resources and we will have to establish or contract for the manufacture of products under the FDA cGMPs. Any potential products developed by our licensees will be subject to the same risks.

We do not currently have any marketed products. If we develop products that can be marketed, we intend to market the products either independently or together with collaborators or strategic partners. If we decide to market any products independently, we will incur significant additional expenditures and commit significant additional management resources to establish a sales force. For any products that we market together with partners, we will rely, in whole or in part, on the marketing capabilities of those parties. We may also contract with other third parties to market certain of our products. Ultimately, we and our partners may not be successful in marketing our products.

If clinical trials for our drug candidates are prolonged or delayed, we may be unable to commercialize our drug candidates on a timely basis, which would require us to incur additional costs and delay our receipt of any product revenue.

We cannot predict whether we will encounter problems with any of our completed, ongoing or planned clinical trials that will cause us or regulatory authorities to delay or suspend clinical trials, or delay the analysis of data from our completed or ongoing clinical trials. Any of the following could delay the clinical development of our drug candidates:

• ongoing discussions with the FDA or comparable foreign authorities regarding the scope or design of our clinical trials;

• delays in receiving or the inability to obtain required approvals from institutional review boards or other reviewing entities at clinical sites selected for participation in our clinical trials;

• delays in enrolling volunteers and patients into clinical trials;

• a lower than anticipated retention rate of volunteers and patients in clinical trials;

• the need to repeat clinical trials as a result of inconclusive or negative results or unforeseen complications in testing;

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• inadequate supply or deficient quality of drug candidate materials or other materials necessary for the conduct of our clinical trials;

• unfavorable FDA inspection and review of a clinical trial site or records of any clinical or preclinical investigation;

• serious and unexpected drug-related side effects experienced by participants in our clinical trials; or

• the placement by the FDA of a clinical hold on a trial.

Our ability to enroll patients in our clinical trials in sufficient numbers and on a timely basis will be subject to a number of factors, including the size of the patient population, the nature of the protocol, the proximity of patients to clinical sites, the availability of effective treatments for the relevant disease and the eligibility criteria for the clinical trial. Delays in patient enrollment may result in increased costs and longer development times. In addition, subjects may withdraw from our clinical trials, and thereby impair the validity or statistical significance of the trials.

We, the FDA or other applicable regulatory authorities may suspend clinical trials of a drug candidate at any time if we or they believe the subjects or patients participating in such clinical trials are being exposed to unacceptable health risks or for other reasons.

We cannot predict whether any of our drug candidates will encounter problems during clinical trials which will cause us or regulatory authorities to delay or suspend these trials, or which will delay the analysis of data from these trials. In addition, it is impossible to predict whether legislative changes will be enacted, or whether FDA regulations, guidance or interpretations will be changed, or what the impact of such changes, if any, may be. If we experience any such problems, we may not have the financial resources to continue development of the drug candidate that is affected or the development of any of our other drug candidates.

If a collaborative partner terminates or fails to perform its obligations under agreements with us, the development and commercialization of our drug candidates could be delayed or terminated.

If any current or future collaborative partner does not devote sufficient time and resources to collaboration arrangements with us, we may not realize the potential commercial benefits of the arrangement, and our results of operations may be adversely affected. In addition, if any existing or future collaboration partner were to breach or terminate its arrangements with us, the development and commercialization of the affected drug candidate could be delayed, curtailed or terminated because we may not have sufficient financial resources or capabilities to continue development and commercialization of the drug candidate on our own.

Much of the potential revenue from our existing and future collaborations will consist of contingent payments, such as payments for achieving development milestones and royalties payable on sales of drugs developed using our technologies. The milestone and royalty revenues that we may receive under these collaborations will depend upon our collaborator’s ability to successfully develop, introduce, market and sell new products. In addition, our collaborators may decide to enter into arrangements with third parties to commercialize products developed under our existing or future collaborations using our technologies, which could reduce the milestone and royalty revenue that we may receive, if any. In many cases we will not be involved in these processes and accordingly will depend entirely on our collaborators. Our collaboration partners may fail to develop or effectively commercialize products using our products or technologies because they:

• decide not to devote the necessary resources due to internal constraints, such as limited personnel with the requisite scientific expertise, limited cash resources or specialized equipment limitations, or the belief that other drug development programs may have a higher likelihood of obtaining regulatory approval or may potentially generate a greater return on investment;

• do not have sufficient resources necessary to carry the drug candidate through clinical development, regulatory approval and commercialization;

• decide to pursue a competitive drug candidate developed outside of the collaboration; or

• cannot obtain the necessary regulatory approvals.

If our collaboration partners fail to develop or effectively commercialize drug candidates or drugs for any of these reasons, we may not be able to replace the collaboration partner with another partner to develop and commercialize a drug candidate or drugs under the terms of the collaboration. We may also be unable to obtain a license from such collaboration partner on terms acceptable to us, or at all.

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Because neither we nor any of our collaborative partners have received marketing approval for any product resulting from our research and development efforts, and may never be able to obtain any such approval, we may not be able to generate any product revenue.

All of the products being developed by our collaborative partners will require additional research and development, extensive preclinical studies and clinical trials, and regulatory approval prior to any commercial sales. In some cases, the length of time that it takes for our collaborative partners to achieve various regulatory approval milestones may affect the payments that we are eligible to receive under our collaboration agreements. We and our collaborative partners may need to address a number of technical challenges successfully in order to complete development of our drug candidates. Moreover, these drug candidates may not be effective in treating any disease or may prove to have undesirable or unintended side effects, toxicities, or other characteristics that may preclude our obtaining regulatory approval or prevent or limit commercial use.

If we are unable to obtain U.S. and/or foreign regulatory approval, we will be unable to commercialize our drug candidates.

Our drug candidates are subject to extensive governmental regulations relating to development, clinical trials, manufacturing and commercialization. Rigorous preclinical testing and clinical trials and an extensive regulatory approval process are required in the United States and in many foreign jurisdictions prior to the commercial sale of our drug candidates. Satisfaction of these and other regulatory requirements is costly, time consuming, uncertain and subject to unanticipated delays. It is possible that none of the drug candidates we are developing will obtain marketing approval. In connection with the clinical trials for CR011-vcMMAE and any other drug candidate we may seek to develop in the future, we face risks that:

• the drug candidate may not prove to be efficacious;

• the drug may not prove to be safe;

• the results may not confirm the positive results from earlier preclinical studies or clinical trials; and

• the results may not meet the level of statistical significance required by the FDA or other regulatory authorities.

We have limited experience in conducting and managing the clinical trials necessary to obtain regulatory approvals, including approval by the FDA. The time required to complete clinical trials and for the FDA and other countries’ regulatory review processes is uncertain and typically takes many years. Our analysis of data obtained from preclinical and clinical activities is subject to confirmation and interpretation by regulatory authorities, which could delay, limit or prevent regulatory approval. We may also encounter unanticipated delays or increased costs due to government regulation from future legislation or administrative action or changes in FDA policy during the period of product development, clinical trials and FDA regulatory review.

Any delay in obtaining, or failure to obtain, required approvals could materially adversely affect our ability to generate revenues from the particular drug candidate. Furthermore, any regulatory approval to market a product may be subject to limitations on the indicated uses for which we may market the product. These limitations may limit the size of the market for the product. We are also subject to numerous foreign regulatory requirements governing the conduct of clinical trials, manufacturing and marketing authorization, pricing and third-party reimbursement. The foreign regulatory approval process includes all of the risks associated with FDA approval described above as well as risks attributable to the satisfaction of foreign requirements. Approval by the FDA does not ensure approval by regulatory authorities outside the United States. Foreign jurisdictions may have different approval procedures than those required by the FDA and may impose additional testing requirements for our drug candidates.

Even if we obtain regulatory approvals, our drug candidates will be subject to ongoing regulatory review. If we fail to comply with continuing U.S. and applicable foreign regulations, we could lose those approvals, and our business would be seriously harmed.

Even if we receive regulatory approval of any drugs we may develop, we will be subject to continuing regulatory review, including the review of clinical results which are reported after our drug candidates become commercially available approved drugs. Since drugs are more widely used by patients once approval has been obtained, side effects and other problems may be observed after approval that were not seen or anticipated during pre-approval clinical trials. In addition, the manufacturer, and the manufacturing facilities we use to make any of our drug candidates, will also be subject to periodic review and inspection by the FDA. The subsequent discovery of previously unknown problems with the drug, manufacturer or facility may result in restrictions on the drug, manufacturer or facility, including withdrawal of the drug from the market. If we fail to comply with applicable continuing regulatory requirements, we may be subject to fines, suspension or withdrawal of regulatory approval, product recalls and seizures, operating restrictions and criminal prosecutions.

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Our business has a substantial risk of product liability claims. If we are unable to obtain appropriate levels of insurance, a product liability claim could adversely affect our business.

Our business exposes us to significant potential product liability risks that are inherent in the development, manufacturing and sales and marketing of human therapeutic products. Although we do not currently commercialize any products, claims could be made against us based on the use of our drug candidates in clinical trials. We currently have clinical trial insurance and will seek to obtain product liability insurance prior to the sales and marketing of any of our drug candidates. However, our insurance may not provide adequate coverage against potential liabilities. Furthermore, clinical trial and product liability insurance is becoming increasingly expensive. As a result, we may be unable to maintain current amounts of insurance coverage or obtain additional or sufficient insurance at a reasonable cost to protect against losses that could have a material adverse effect on us. If a claim is brought against us, we might be required to pay legal and other expenses to defend the claim, as well as uncovered damages awards resulting from a claim brought successfully against us. Furthermore, whether or not we are ultimately successful in defending any such claims, we might be required to direct significant financial and managerial resources to such defense, and adverse publicity is likely to result.

If we are unable to establish sales and marketing capabilities or enter into agreements with third parties to market and sell our drug candidates, we may not generate product revenue.

We have no commercial products and we do not currently have an organization for the sales and marketing of pharmaceutical products. In order to successfully commercialize any drugs that may be approved in the future by the FDA or comparable foreign regulatory authorities, we must build our sales and marketing capabilities or make arrangements with third parties to perform these services. There are risks involved with establishing our own sales and marketing capabilities, as well as entering into arrangements with third parties to perform these services. For example, developing a sales force is expensive and time consuming and could delay any product launch. In addition, to the extent that we enter into arrangements with third parties to perform sales, marketing and distribution services, we will have less control over sales of our products, and our future revenues would depend heavily on the success of the efforts of these third parties. If we are unable to establish adequate sales, marketing and distribution capabilities, whether independently or with third parties, we may not be able to generate product revenue and may not become profitable.

If physicians, patients and third-party payors do not accept our future drugs, we may be unable to generate significant revenue, if any.

Even if CR011-vcMMAE or any other drug candidates we may develop or acquire in the future obtain regulatory approval, they may not gain market acceptance among physicians, patients and health care payers. Physicians may elect not to recommend these drugs for a variety of reasons including:

• timing of market introduction of competitive drugs;

• lower demonstrated clinical safety and efficacy compared to other drugs;

• lack of cost-effectiveness;

• lack of availability of reimbursement from third-party payors;

• convenience and ease of administration;

• prevalence and severity of adverse side effects;

• other potential advantages of alternative treatment methods; and

• ineffective marketing and distribution support.

If our approved drugs fail to achieve market acceptance, we would not be able to generate sufficient revenue from product sales to maintain or grow our business.

If third-party payors do not adequately reimburse customers for any of our product candidates that are approved for marketing, they might not be purchased or used, and our revenues and profits will not develop or increase.

Our revenues and profits will depend heavily upon the availability of adequate reimbursement for the use of our approved product candidates from governmental and other third-party payors, both in the United States and in foreign markets. Reimbursement by a third-party payor may depend upon a number of factors, including the third-party payor’s determination that use of a product is:

• a covered benefit under its health plan;

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• safe, effective and medically necessary;

• appropriate for the specific patient;

• cost-effective; and

• neither experimental nor investigational.

Obtaining reimbursement approval for a product from each government or other third-party payor is a time-consuming and costly process that could require us to provide supporting scientific, clinical and cost-effectiveness data for the use of our products to each payor. We may not be able to provide data sufficient to gain acceptance with respect to reimbursement. Even when a payor determines that a product is eligible for reimbursement, the payor may impose coverage limitations that preclude payment for some uses that are approved by the FDA or comparable authority. Moreover, eligibility for coverage does not imply that any product will be reimbursed in all cases or at a rate that allows us to make a profit or even cover our costs. Interim payments for new products, if applicable, may also not be sufficient to cover our costs and may not be made permanent. Reimbursement rates may vary according to the use of the product and the clinical setting in which it is used, may be based on payments allowed for lower-cost products that are already reimbursed, may be incorporated into existing payments for other products or services, and may reflect budgetary constraints and/or imperfections in Medicare, Medicaid or other data used to calculate these rates. Net prices for products may be reduced by mandatory discounts or rebates required by government health care programs or by any future relaxation of laws that restrict imports of certain medical products from countries where they may be sold at lower prices than in the United States.

There have been, and we expect that there will continue to be, federal and state proposals to constrain expenditures for medical products and services, which may affect payments for our products. The Centers for Medicare and Medicaid Services, or CMS, frequently change product descriptors, coverage policies, product and service codes, payment methodologies and reimbursement values. Third-party payors often follow Medicare coverage policy and payment limitations in setting their own reimbursement rates, and both CMS and other third-party payors may have sufficient market power to demand significant price reductions. Due in part to actions by third-party payors, the health care industry is experiencing a trend toward containing or reducing costs through various means, including lowering reimbursement rates, limiting therapeutic class coverage and negotiating reduced payment schedules with service providers for drug products.

Our inability to promptly obtain coverage and profitable reimbursement rates from government-funded and private payors for our products could have a material adverse effect on our operating results and our overall financial condition.

We depend on attracting and retaining key employees.

We are highly dependent on the principal members of our senior management and scientific staff. Our future success will depend in part on the continued services of our key management and scientific personnel. The loss of services of any of these personnel could materially adversely affect our business, financial condition, and results of operations. We have entered into employment agreements with all of the principal members of our senior management team. Our future success will also depend in part on our ability to attract, hire, and retain additional personnel. There is intense competition for qualified personnel and there can be no assurance that we will be able to continue to attract and retain such personnel. Failure to attract and retain key personnel could materially, adversely affect our business, financial condition, and results of operations.

We depend on academic collaborators, consultants, and scientific advisors.

We have relationships with collaborators, consultants, and scientific advisors at academic and other institutions that conduct research or provide consulting services at our request. These collaborators, consultants, and scientific advisors are not our employees. Substantially all of our collaborators, consultants, and scientific advisors are employed by employers other than us and may have commitments to, or collaboration, consulting, or advisory contracts with, other entities that may limit their availability to us. As a result, we have limited control over their activities and, except as otherwise required by our collaboration, consulting agreements, and advisory agreements, can expect only limited amounts of their time to be dedicated to our activities. Our ability to explore and validate biological activity of therapeutic candidates and commercialize products based on these discoveries may depend, in part, on continued collaborations with researchers at academic and other institutions. We may not be able to negotiate additional acceptable collaborations with collaborators, consultants, or scientific advisors at academic and other institutions.

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Our academic collaborators, consultants, and scientific advisors may have relationships with other commercial entities, some of which could compete with us. Our academic collaborators, consultants and scientific advisors sign agreements which provide for confidentiality of our proprietary information and of the results of studies. We may not be able to maintain the confidentiality of our technology and other confidential information in connection with every academic collaboration, consulting, or advisory arrangement, and any unauthorized dissemination of our confidential information could materially adversely affect our business, financial condition, and results of operations. Further, any such collaborator, consultant or advisor may enter into an employment agreement or consulting arrangement with one of our competitors.

Competition in our field is intense and likely to increase.

We are subject to significant competition in the development and commercialization of new drugs from organizations that are pursuing strategies, approaches, technologies and products that are similar to our own. Many of the organizations competing with us have greater capital resources, research and development staffs and facilities and marketing capabilities. We face competition from a number of biotechnology and pharmaceutical companies with products in preclinical development, clinical trials, or approved for conditions identical or similar to the ones we are pursuing. In addition, many other pharmaceutical and biotechnology companies are engaged in research and development for the treatment of cancer from which we may face intense competition.

If we do not obtain adequate intellectual property protection, we may not be able to prevent our competitors from commercializing our discoveries.

Our business and competitive position depends on our ability to protect our products and processes, including obtaining patent protection on genes and proteins for which we or our collaborators discover utility, and on products, methods and services based on such discoveries.

The patent positions of pharmaceutical, biopharmaceutical, and biotechnology companies, including us, are generally uncertain and involve complex legal and factual questions. The law relating to the scope of patent claims in the technology fields in which we operate is evolving, and the degree of future protection for our proprietary rights is uncertain. Furthermore, even if patents are issued to us, there can be no assurance that others will not develop alternative technologies or design around the patented technologies developed by us. Therefore, our patent applications may not protect our products, processes, and technologies for at least the following reasons:

• there is no guarantee that any of our pending patent applications will result in additional issued patents;

• there is no guarantee that any patents issued to us or our collaborative customers will provide a basis for commercially viable products;

• there is no guarantee that any patents issued to us or our collaborative customers will provide us with any competitive advantages;

• there is no guarantee that any patents issued to us or our collaborative customers will not be challenged or circumvented or invalidated by third parties; and

• there is no guarantee that any patents issued to others will not have an adverse effect on our ability to do business.

The issuance of a patent is not conclusive as to its validity or enforceability, nor does it provide the patent holder with freedom to operate without infringing the patent rights of others. A patent could be challenged by litigation and, if the outcome of such litigation were adverse to the patent holder, competitors could be free to use the subject matter covered by the patent. The invalidation of key patents owned by or licensed to us or the non-approval of pending patent applications could increase competition and materially adversely affect our business, financial condition, and results of operations.

Litigation, which could result in substantial cost to us, also may be necessary to enforce our patent and proprietary rights and/or to determine the scope and validity of others’ proprietary rights. We may participate in interference proceedings that may in the future be declared by the USPTO to determine priority of invention, which could result in substantial cost to us. The outcome of any such litigation or interference proceeding might not be favorable to us, and we might not be able to obtain licenses to technology that we require or, even if obtainable, such technology may not be available at a reasonable cost.

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If we infringe on the intellectual property rights of others, we may be required to obtain a license, pay damages, and/or cease the commercialization of our technology.

We believe that there may be significant litigation in the industry regarding patent and other intellectual property rights. It is possible that the commercialization of our technology could infringe the patents or other intellectual property rights of others. In addition, others may have filed, and in the future are likely to file, patent applications covering genes or gene products or antibodies against the gene products that are similar or identical to our products. Any such patent applications may have priority over our patent applications, and may result in the issuance of patents to others that could be infringed by our products or processes.

A number of competitors are producing proteins from genes and claiming both the proteins as potential therapeutics as well as the antibodies against these proteins. In many cases, generic antibody claims are being issued by the USPTO even though competitors have not actually made antibodies against the protein of interest, or do not have cellular, animal, or human data to support the use of these antibodies as therapeutics. These claims to proteins as therapeutics, to all antibodies against a protein, and to methods of use in broad human indications are being filed at a rapid rate, and patents including such claims have issued and may continue to issue. Such patents may prevent us from commercializing some products or processes or, if licenses under the patents are made available, may make the royalty burden on these products and processes so high as to prevent commercial success.

In addition, we have sought and intend to continue to seek patent protection for novel uses for genes and proteins and therapeutic antibodies that may have been patented by third parties. In such cases, we would need a license from the holder of the patent with respect to such gene or protein in order to make, use, or sell such gene or protein for such use. We may not be able to acquire such licenses on commercially reasonable terms, if at all.

Any legal action against us or our collaborators for patent infringement relating to our products and processes could, in addition to subjecting us to potential liability for damages, require us or our collaborators to obtain a license in order to continue to manufacture or market the affected products and processes, or could enjoin us from continuing to manufacture or market the affected products and processes. There can be no assurance that we or our collaborators would prevail in any such action or that any license required under any such patent would be made available on commercially acceptable terms, if at all. If we become involved in such litigation, it could consume a substantial portion of our managerial and financial resources.

We cannot be certain that our security measures will protect our confidential information and proprietary technologies.

We rely upon trade secret protection for some of our confidential and proprietary information that is not the subject matter for which patent protection is being sought. We have taken security measures to protect our proprietary technologies, processes, information systems, and data and continue to explore ways to enhance such security. Such measures, however, may not provide adequate protection for our trade secrets or other proprietary information. While we require employees, academic collaborators, consultants, and scientific advisors to enter into confidentiality and/or non-disclosure agreements where appropriate, any of the following could still occur:

• proprietary information could be disclosed;

• others may independently develop substantially equivalent proprietary information and techniques or otherwise gain access to our trade secrets, technology, or disclose such information; or

• we may not be able to meaningfully protect our trade secrets.

If the security of our confidential information is breached, our business could be materially adversely affected.

We depend upon our ability to license technologies.

We may have to acquire or license certain components of our technologies or products from third parties. We may not be able to acquire from third parties or develop new technologies, either alone or with others. We may not be able to acquire licenses on commercially reasonable terms, if at all. Failure to license or otherwise acquire necessary technologies could materially adversely affect our business, financial condition, and results of operations.

If we do not comply with laws regulating the protection of the environment and health and human safety, our business could be adversely affected.

Our research and development efforts involve the controlled use of hazardous materials, chemicals and various radioactive compounds. Although we believe that our safety procedures for handling and disposing of these materials comply with the standards prescribed by state and federal regulations, the risk of accidental contamination

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or injury from these materials cannot be eliminated. If an accident occurs, we could be held liable for resulting damages, which could be substantial. We are also subject to numerous environmental, health and workplace safety laws and regulations, including those governing laboratory procedures, exposure to blood-borne pathogens and the handling of biohazardous materials. Although we maintain workers’ compensation insurance to cover us for costs we may incur due to injuries to our employees resulting from the use of these materials, this insurance may not provide adequate coverage against potential liabilities. Due to the small amount of hazardous materials that we generate, we do not currently maintain any environmental liability or toxic tort claim insurance coverage to cover pollution conditions or other extraordinary or unanticipated events relating to our use and disposal of hazardous materials. Additional federal, state and local laws and regulations affecting our operations may be adopted in the future. We may incur substantial costs to comply with, and substantial fines or penalties if we violate, any of these laws or regulations.

Risks Related to Our Financial Results

We have convertible debt and our debt service obligations may prevent us from taking actions that we would otherwise consider to be in our best interests.

As of September 30, 2008, we had total outstanding convertible debt of $19.0 million which is due in February 2011; and for the year ended December 31, 2007, we had a deficiency of earnings available to cover fixed charges of $50.1 million. A variety of uncertainties and contingencies will affect our future performance, many of which are beyond our control. We may not generate sufficient cash flow in the future to enable us to meet our anticipated fixed charges, including our debt service requirements. The following table shows, as of September 30, 2008, the remaining aggregate amount of our interest payments due in each of the years listed (in millions):

Year	Aggregate Interest
2009		0.8
2010		0.8
2011		0.4
Total	$	2.0

Our leverage could have significant negative consequences for our future operations, including:

• increasing our vulnerability to general adverse economic and industry conditions;

• limiting our ability to obtain additional financing;

• requiring the dedication of a substantial portion of our expected cash flow to service our indebtedness, thereby reducing the amount of our expected cash flow available for other purposes, including working capital and capital expenditures;

• limiting our flexibility in planning for, or reacting to, changes in our business and the industry in which we compete; or

• placing us at a possible competitive disadvantage compared to less leveraged competitors and competitors that have better access to capital resources.

We will likely need to raise additional funding, which may not be available on favorable terms, if at all.

We believe that we have sufficient capital to satisfy our funding requirements through 2011. However, our future funding requirements will depend on many factors and we anticipate that we will likely need to raise additional capital to fund our business plan and research and development efforts on a going-forward basis. To the extent that we need to obtain additional funding, the amount of additional capital we would need to raise would depend on many factors, including:

• the number, breadth, and progress of our research, product development, and clinical programs;

• our ability to establish future potential strategic collaborations;

• the progress of our collaborators;

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• our costs incurred in enforcing and defending our patent claims and other intellectual property rights; and

• the costs and timing of obtaining regulatory approvals for any of our products.

We expect that we would raise any additional capital we require through public or private equity offerings, debt financings, or additional collaborations and licensing arrangements. We cannot be certain that in the future these sources of liquidity will be available when needed, particularly in light of the current economic environment, or that our actual cash requirements will not be greater than anticipated. In appropriate strategic situations, we may seek financing from other sources, including contributions by others to joint ventures and other collaborative or licensing arrangements for the development and testing of products under development. If we raise additional capital by issuing equity securities, the issuance of such securities would result in ownership dilution to our stockholders. If we raise additional funds through collaborations and licensing arrangements, we may be required to relinquish rights to certain of our technologies or product candidates, or to grant licenses on unfavorable terms. The relinquishing of rights or granting of licenses on unfavorable terms could materially adversely affect our business, financial condition, and results of operations. If adequate funds are not available, our business, financial condition, and results of operations would be materially adversely affected. However, should we be unable to obtain future financing either through the methods described above or through other means, we may be unable to meet the critical objective of our long-term business plan, which is to successfully develop and market pharmaceutical products. If we require additional capital at a time when investment in biotechnology companies such as ours, or in the marketplace in general, is limited due to the then prevailing market or other conditions, we may not be able to raise such funds at the time that we desire or any time thereafter.

Our quarterly operating results have fluctuated greatly and may continue to do so.

Our operating results have fluctuated on a quarterly basis. We expect that losses will continue to fluctuate from quarter to quarter and that these fluctuations may be substantial. Our results of operations are difficult to predict and may fluctuate significantly from period to period, which may cause our stock price to decline and result in losses to investors. Some of the factors that could cause our operating results to fluctuate include:

• the nature, pricing, and timing of products and services provided to our collaborators and customers;

• our ability to compete effectively in our therapeutic development efforts against competitors that have greater financial or other resources or drug candidates that are in further stages of development;

• acquisition, licensing, and other costs related to our operations;

• losses and expenses related to our investments;

• regulatory developments;

• regulatory actions and changes related to the development of drugs;

• changes in intellectual property laws that affect our patent rights;

• payments of milestones, license fees, or research payments under the terms of our external alliances and our ability to monitor and enforce such payments; and

• the timing of intellectual property licenses that we may enter.

We believe that quarterly comparisons of our financial results are not necessarily meaningful and should not be relied upon as an indication of future performance. In addition, fluctuations in quarterly results could affect the market price of our common stock in a manner unrelated to our long-term operating performance.

Our debt investments are impacted by the financial viability of the underlying companies or assets.

We have a diversified portfolio of investments, of which 34% of our debt investments at September 30, 2008 were invested in U.S. Treasuries and mortgage-backed securities that are sponsored by the U.S. Government. Our fixed-rate debt investments comply with our policy of investing in only investment-grade debt instruments. The ability for the debt to be repaid upon maturity or to have a viable resale market is dependent, in part, on the financial success of the underlying company or assets. Should the underlying company or assets suffer significant financial difficulty, the debt instrument could either be downgraded or, in the worst case, our investment could be worthless. This would result in our losing the cash value of the investment and incurring a charge to our statement of operations.

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The market price of our common stock is highly volatile.

The market price of our common stock has fluctuated widely and may continue to do so. For example, during the twelve months ended September 30, 2008 the closing price of our stock ranged from a high of $1.56 per share to a low of $0.63 per share. Many factors could cause the market price of our common stock to rise and fall. These factors include:

• the current credit crisis and associated turmoil in world financial markets;

• variations in our quarterly operating results;

• announcements of clinical results, technological innovations, or new products by us or our competitors;

• acquisitions or strategic alliances by us or others in our industry;

• announcement by the government or other agencies regarding the economic health of the United States and the rest of the world;

• the hiring or departure of key personnel;

• changes in market valuations of companies within the biotechnology industry; and

• changes in estimates of our performance or recommendations by financial analysts.

Our common stock could be delisted from the NASDAQ Global Market if our stock price continues to trade below $1.00 per share.

On September 23, 2008, we received notification from The NASDAQ Stock Market LLC, or NASDAQ, indicating that we are not in compliance with NASDAQ Marketplace Rule 4450(a)(5), or the Rule, because the closing bid price per share for the our common stock had been below $1.00 per share, or the Minimum Bid Price Requirement, for 30 consecutive business days. In accordance with NASDAQ Marketplace Rule 4450(e)(2), we were provided 180 calendar days, or until March 23, 2009, to regain compliance.

On October 22, 2008, we received written notification from NASDAQ that, effective October 16, 2008, NASDAQ suspended enforcement of the Minimum Bid Price Requirement through January 16, 2009 due to current conditions in U.S. and world financial markets. The Minimum Bid Price Requirement will be reinstated on January 19, 2009, and the first relevant trade date for determining compliance with the requirement will be January 20, 2009. The notification stated that since we had 158 calendar days remaining in our compliance period as of October 16, 2008, we will, upon reinstatement of the Minimum Bid Price Requirement, still have this number of days, or until June 26, 2009, to regain compliance.

To regain compliance with the Minimum Bid Price Requirement, the closing bid price of our common stock must remain at $1.00 per share or more for a minimum of ten consecutive business days, either during the suspension period or during the compliance period resuming after the suspension period. If we do not regain compliance with the Rule by June 26, 2009, we can apply to list our common stock on the NASDAQ Capital Market and NASDAQ will determine whether we meet the NASDAQ Capital Market initial listing criteria as set forth in NASDAQ Marketplace Rule 4310(c), except for the Minimum Bid Price Requirement. If we meet the NASDAQ Capital Market initial listing criteria, NASDAQ will notify us that we have been granted an additional 180 calendar days to come into compliance with the Minimum Bid Price Requirement. If we do not meet the initial listing criteria, NASDAQ will provide us with written notification that our common stock will be delisted. At that time we would be permitted to appeal NASDAQ’s determination to delist our common stock to a NASDAQ Listings Qualifications Panel.

We will seek to regain compliance with the Minimum Bid Price Requirement by June 26, 2009, and are considering alternatives to address compliance with the continued listing standards of the NASDAQ Global Market.

Delisting from the NASDAQ Global Market could have an adverse effect on our business and on the trading of our common stock. If a delisting of our common stock from the NASDAQ Stock Market were to occur, our common stock would trade on the OTC Bulletin Board or on the “pink sheets” maintained by the National Quotation Bureau, Inc. Such alternatives are generally considered to be less efficient markets, and our stock price, as well as the liquidity of our common stock, may be adversely impacted as a result.

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There are no restrictive covenants in our indentures relating to our ability to incur future indebtedness.

The indentures governing our convertible debt due in 2011 do not contain any financial or operating covenants or restrictions on the payment of dividends, the incurrence of indebtedness, transactions with affiliates, incurrence of liens, or the issuance or repurchase of securities by us or any of our subsidiaries. We may therefore incur additional debt, including secured indebtedness senior to these notes.

Securities we issue to fund our operations could cause dilution to our stockholders’ ownership.

We may decide to raise additional funds through a public or private debt or equity financing to fund our operations. If we raise funds by issuing equity securities, the percentage ownership of current stockholders will be reduced, and the new equity securities may have rights with priority over our common stock. We may not be able to obtain sufficient financing on terms that are favorable to us or our existing stockholders, if at all.

Any conversion of our convertible debt into shares of common stock will dilute the ownership interest of our current stockholders. The conversion price of our convertible debt due in February 2011 is approximately $9.69 per share.

We may effect future repurchases of our 4% convertible debentures due in February 2011, which may adversely affect our liquidity.

We may from time to time seek to repurchase or refinance all or a portion of our outstanding $19.0 million 4% convertible debentures that mature on February 15, 2011. Any repurchases might occur through cash purchases, privately negotiated transactions or otherwise. Such repurchases or exchanges, if any, will depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors. The amounts involved in any such transaction, individually or in the aggregate, may be material and could adversely affect our liquidity and ability to fund ongoing operations.

We may from time to time exceed the Federal Deposit Insurance Corporation limits in our bank accounts.

We may from time to time have a balance in our bank account which exceeds the $250,000 per depositor, per insured bank amount guaranteed by the Federal Deposit Insurance Corporation, or FDIC. The FDIC insures deposits in most banks and savings associations located in the United States. The FDIC protects depositors against the loss of their deposits if an FDIC-insured bank or savings association fails. FDIC insurance is backed by the full faith and credit of the United States government.

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Item 6. Exhibits

Exhibit 31.1	Certification by Chief Executive Officer pursuant to Rule 13a-14(a) and 15d-14(a) of the Exchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
Exhibit 31.2	Certification by Chief Financial Officer pursuant to Rule 13a-14(a) and 15d-14(a) of the Exchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
Exhibit 32	Certification by Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

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SIGNATURES

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

Dated: November 7, 2008	CuraGen Corporation
	By:	/s/ Timothy M. Shannon, M.D.
		Timothy M. Shannon, M.D.
		Chief Executive Officer and President
		(Principal Executive Officer of the Registrant)
Dated: November 7, 2008	By:	/s/ Sean A. Cassidy
		Sean A. Cassidy
		Vice-President and Chief Financial Officer
		(Principal Financial and Accounting Officer of the Registrant)

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CURAGEN CORPORATION

EXHIBIT INDEX

No.
Exhibit 31.1	Certification by Chief Executive Officer pursuant to Rule 13a-14(a) and 15d-14(a) of the Exchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
Exhibit 31.2	Certification by Chief Financial Officer pursuant to Rule 13a-14(a) and 15d-14(a) of the Exchange Act, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
Exhibit 32	Certification by Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

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EX-31.1

Exhibit 31.1

CERTIFICATIONS UNDER SECTION 302

I, Timothy M. Shannon, certify that:

1. I have reviewed this quarterly report on Form 10-Q of CuraGen Corporation;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)), for the registrant and have:

a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c) evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d) disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: November 7, 2008

/s/ Timothy M. Shannon, M.D.

Timothy M. Shannon, M.D.

Chief Executive Officer and President

(principal executive officer of the registrant)

EX-31.2

Exhibit 31.2

CERTIFICATIONS UNDER SECTION 302

I, Sean A. Cassidy, certify that:

1. I have reviewed this quarterly report on Form 10-Q of CuraGen Corporation;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)), for the registrant and have:

a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b) designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c) evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d) disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: November 7, 2008

/s/ Sean A. Cassidy

Sean A. Cassidy

Vice-President and Chief Financial Officer

(principal financial and accounting officer of the registrant)

EX-32

Exhibit 32

Certification

Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

(Subsections (a) and (b) of Section 1350, Chapter 63 of Title 18, United States Code)

In connection with the Quarterly Report on Form 10-Q of CuraGen Corporation (the “Company”) for the period ended September 30, 2008 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), the undersigned, Timothy M. Shannon, M.D., Chief Executive Officer and President of the Company, and Sean A. Cassidy, Vice-President and Chief Financial Officer of the Company, each hereby certifies, pursuant to 18 U.S.C. Section 1350, that:

(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Dated: November 7, 2008	By:	/s/ Timothy M. Shannon, M.D.
		Timothy M. Shannon, M.D.
		Chief Executive Officer and President
		(principal executive officer of the registrant)
Dated: November 7, 2008	By:	/s/ Sean A. Cassidy
		Sean A. Cassidy
		Vice-President and Chief Financial Officer
		(principal financial and accounting officer of the registrant)