UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

For the fiscal year ended December 31, 2003

OR

Commission file number 000-22171

KOS PHARMACEUTICALS, INC.

1001 Brickell Bay Drive, 25^th Floor, Miami, Florida 33131

Company’s Telephone Number, Including Area Code: (305) 577-3464

Securities registered pursuant to section 12(g) of the Act:
Common Stock, $.01 par value

     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 ü No o

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

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

     The aggregate market value of Kos Pharmaceuticals, Inc. Common Stock, $.01 par value, held by non-affiliates, computed by reference to the price at which the stock was sold as of February 23, 2004: $843,795,560.

     Number of shares of Common Stock of Kos Pharmaceuticals, Inc. issued and outstanding as of February 23, 2004: 36,909,431.

Documents Incorporated by Reference

Definitive Proxy Statement for the Company’s 2004 Annual Meeting of Shareholders
(incorporated in Part III to the extent provided in Items 10, 11, 12, 13 and 14 hereof).

Table of Contents

TABLE OF CONTENTS

PART II

ITEM 5. MARKET FOR THE COMPANY’S COMMON STOCK AND RELATED SHAREHOLDER MATTERS.

     The Company’s Common Stock, par value $.01 per share, commenced trading on March 7, 1997, on the Nasdaq National Market under the symbol “KOSP”. As of March 1, 2004, there were 437 registered shareholders of record of the Company’s Common Stock.

     The following table sets forth, for the fiscal periods indicated, the range of high and low prices for trades of the Company’s Common Stock on the Nasdaq National Market System.

     The Company has not declared or paid any cash dividends on its Common Stock. The Company currently anticipates that it will retain future earnings, if any, to fund the development and growth of its business and does not intend to pay dividends on its Common Stock in the foreseeable future.

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ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA.

     The following consolidated selected financial data of the Company for the five years ended December 31, 2003 should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and related notes thereto. See “Item 8. Consolidated Financial Statements and Supplementary Data.”

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

Executive Overview

     Kos is a fully-integrated specialty pharmaceutical company engaged in the development and commercialization of proprietary prescription products for the treatment of chronic cardiovascular and respiratory diseases. Kos manufactures its lead products, Niaspan and Advicor, and currently markets them directly through its own specialty sales force and co-promotion partner. The Company’s products under development directed to cardiovascular disease consist of controlled-release, once-a-day, oral dosage formulations, and the Company’s respiratory products under development consist of aerosolized inhalation formulations to be used primarily with Kos’ proprietary inhalation devices.

     The Company’s current business strategy is based upon developing drugs that are reformulations of existing approved prescription pharmaceutical products, but which offer certain safety advantages or patient compliance advantages compared with existing formulations of such products.

     The principal elements of Kos’ current business strategy are as follows:

(i)		develop or acquire products with unrealized commercial potential where safety or patient compliance may be improved;
(ii)		focus on the large, rapidly growing cardiovascular and respiratory markets, which include many chronic diseases requiring long-term therapy;
(iii)		develop proprietary formulations of currently approved pharmaceutical compounds;
(iv)		manage internally the clinical development of its products;
(v)		manufacture its products internally, or where necessary or prudent, using a contract manufacturer;
(vi)		market its products directly through the Company’s specialty sales force, which Kos may supplement with a contract sales organization or other partners; and
(vii)		leverage its core competencies through corporate and academic alliances.

     On July 28, 1997, Kos received clearance from the FDA to market the Niaspan product for the treatment of mixed lipid disorders. Niaspan is the only once-a-day prescription formulation of a niacin product ever approved by the FDA for the treatment of mixed lipid disorders. Kos currently markets the Niaspan product directly to specialist physicians within the cardiovascular market who specialize in treating patients with coronary heart disease and who are among the leading prescribers of lipid-altering medications. Such “lipid-management specialists”, whose primary focus is on treating the 14 million Americans who are estimated by the American Heart Association to have coronary heart disease, consist principally of cardiologists, endocrinologists, and internists.

     On December 17, 2001, Kos received clearance from the FDA to market the Advicor product (extended-release niacin/lovastatin tablets). The approval of the Advicor product marks the first time that the FDA has approved a combination product for the safe and efficacious treatment of cholesterol disorders. The Company began detailing the Advicor product to physicians on January 28, 2002. As with the Niaspan product, the Company currently markets the Advicor product directly to specialist and primary care physicians within the cardiovascular market who specialize in treating patients with coronary heart disease and who are among the leading prescribers of lipid-altering medications.

     In measuring the Company’s results of operations, management’s primary focus is on revenue growth of the Niaspan and Advicor products and net income growth. Net sales of the Company’s Niaspan and

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Advicor products increased to $293.9 million for the year ended December 31, 2003, from $172.7 million for the same period in 2002. This increase in revenue was primarily attributable to increases in unit volume and prices for the Company’s products during the 2003 period, and to a change in product return estimates (as described below in this Management’s Discussion and Analysis of Financial Condition and Results of Operations). Net income for the year ended December 31, 2003 increased to $59.4 million from a net loss of $20.8 million for the same period in 2002. This dramatic turnaround in net income generation was primarily attributable to the revenue growth experienced by the Company’s Niaspan and Advicor products, including, as previously mentioned, the effect of a change in accounting estimate.

     Because Kos’ current business strategy is mostly dependent on the reformulation of existing compounds, the Company’s business could be subject to significant competitive pressures. As such, Kos’ critical success factors include its ability to continue to increase the amount of revenue generated by the Niaspan and Advicor products and its ability to successfully develop and/or acquire new products or drugs. The Company’s ability to continue to increase revenue is primarily dependent on its ability to increase prescriptions for its marketed products, and to maintain a competitive product pricing and differentiation strategy. The Company intends to utilize proceeds derived from the Company’s public offering of Common Stock in the fourth quarter of 2003 to acquire other products or companies, to in-license complimentary products, and to fund working capital needs for general corporate purposes. The Company’s ability to complete new drug and product acquisitions on favorable terms will be a critical factor in the Company’s ability to increase revenues in future periods. Protection of the Company’s intellectual property rights will also be critical to the Company’s success in future periods, including its ability to obtain and maintain patents, enforce those patents, preserve trade secrets, and operate without infringing the proprietary rights of third parties.

General

     A predecessor corporation to the Company was formed in July 1988 under the name of Kos Pharmaceuticals, Inc. principally to conduct research and development on new formulations of existing prescription pharmaceutical products. In June 1993, Aeropharm Technology, Inc. (“Aeropharm”), a then majority-owned subsidiary of the Company, was formed to conduct research and development activities on aerosolized products, dispensed in metered-dosed inhalers, for the treatment of respiratory diseases. During June 1996, this predecessor corporation acquired the outstanding minority interest in Aeropharm; changed its name to Kos Holdings, Inc. (“Holdings”); established the Company as a wholly-owned subsidiary under the name of Kos Pharmaceuticals, Inc.; and, effective as of June 30, 1996, transferred all of its existing assets, liabilities, and intellectual property, other than certain net operating loss carryforwards, to the Company. Accordingly, all references in this Form 10-K filing to the Company’s business include the business and operations of Holdings until June 30, 1996.

     On March 12, 1997, the Company completed an initial public offering (“IPO”) of its Common Stock. From inception through the IPO, the Company had not recorded any significant revenues; and the Company had funded its operations exclusively through equity contributions and a loan from its majority shareholder. Through December 31, 2003, the Company had accumulated a deficit from operations of approximately $233.9 million. In connection with the transfer of operations from Holdings to the Company on June 30, 1996, net operating loss carryforwards amounting to approximately $51.0 million and related tax benefits were retained by Holdings and not transferred to the Company. Consequently, as of December 31, 2003, the Company had approximately $146.7 million of net operating loss carryforwards and $41.2 million of other deductible temporary differences between the book and tax bases of assets and liabilities which may be used to offset future taxable net income, if any.

Recent Developments

     On March 8, 2004, the Company announced that it had entered into a product acquisition agreement with Aventis Pharmaceuticals Holdings Inc. and a supply agreement with Aventis Pharmaceuticals, Inc. (collectively “Aventis”) to acquire global rights to the Azmacort (triamcinolone acetonide) inhalation aerosol franchise (collectively the “Aventis Agreement”). Azmacort is an inhaled corticosteroid that alleviates inflammation in the lungs and is used as prophylactic therapy for the maintenance treatment of asthma. Under the terms of the Aventis Agreement, Kos will pay Aventis $200 million in cash and has agreed to pay a royalty on future sales of another version of the product to be developed. Under the terms of the supply agreement, Aventis has agreed to supply finished product to Kos for a period of five years. The Company expects to close this transaction by the end of the first quarter 2004, pending the completion of the Federal Trade Commission’s Hart-Scott-Rodino review and approval process.

     On November 25, 2003, the Company sold 3,750,000 shares of Common Stock pursuant to a registration statement filed with the Securities and Exchange Commission. On December 22, 2003, the

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Company sold an additional 650,000 shares to cover over allotments. Net proceeds to the Company resulting from the sale of these 4,400,000 shares of Common Stock totaled $184,277,000. See “Liquidity and Capital Resources” for additional discussion regarding this issuance of shares of Common Stock.

     On November 4, 2003, the Company and Takeda Pharmaceuticals North America, Inc. (“Takeda”) announced a three-year agreement to co-promote Niaspan and Advicor in the United States. Pursuant to this agreement, Takeda will utilize its U.S.-based sales force to promote Niaspan and Advicor in addition to its own product. Takeda is responsible for providing a promotional effort that is expected to significantly increase the amount of product details for Niaspan and Advicor performed per year, and for all costs associated with its sales force, including promotional materials and samples. The Company is responsible for manufacturing and supplying both products and will collect and record all sales associated with its products. Takeda will receive a royalty on incremental net sales of the products in the United States above a certain baseline amount. This co-promotion arrangement has a three-year term commencing January 2004 and provides for residual payments to Takeda after the three years, if the parties do not renew the agreement.

     On August 20, 2003, the Company announced an exclusive development and commercialization agreement with Oryx Pharmaceuticals, Inc. (“Oryx”) for the commercialization of Niaspan and Advicor in Canada. Under the agreement, Oryx is responsible for obtaining marketing authorization for Niaspan and Advicor in Canada and for all promotional investments, and the Company will be responsible for manufacturing and supplying Niaspan and Advicor following receipt of marketing authorization for such products in Canada. In December 2003, Oryx filed New Drug Submissions with Health Canada for regulatory clearance to market Niaspan and Advicor in Canada. Market clearance is expected in Canada during the second half of 2005. If and when marketing approval is obtained, the Company will share the revenues from sales of Niaspan and Advicor in Canada with Oryx.

     On October 23, 2002, the Company signed an exclusive international commercialization agreement with Merck KGaA (“Merck”) to market the Niaspan and Advicor products outside the United States, Canada and Japan (the “Merck Agreement”). Under the terms of the Merck Agreement, Merck will provide Kos up to $61 million in licensing, milestone and reimbursement payments, including $15 million of upfront payments, of which $12.5 million are refundable to Merck by Kos if it fails to achieve certain regulatory milestones. The milestone payments are dependent on the achievement of certain regulatory approvals and sales thresholds. Kos will also receive 25% of net sales of the products in the territory, which includes the cost of goods sold. Merck will be responsible for conducting Phase IV clinical studies and commercialization activities while Kos is responsible for obtaining initial marketing authorization in all major European countries and for the supply and manufacturing of the products. As of December 31, 2003, Kos had received $15 million in upfront and reimbursement payments from Merck. Of this amount, $0.2 million was offset against research and development expenses during the year ended December 31, 2003. The majority of these payments, however, will begin to be recognized as revenue in future periods upon Kos achieving certain regulatory milestones. On November 3, 2003, Merck launched the sale of Niaspan in the United Kingdom. In January 2004, the Company received tentative approval to market Niaspan in thirteen European countries.

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Results of Operations

Critical Accounting Policies

     The Company’s significant accounting policies are described in Note 2 to Consolidated Financial Statements. The Company believes that its most critical accounting policies include revenue recognition and the estimation of allowances principally related to product returns, managed care rebates, chargebacks, reimbursements relating to Medicaid and Medicare, and accounting for income taxes. The allowances are based upon consideration of a variety of factors, including but not limited to actual return experience by product type, the market for the product, estimated customer inventory levels by product, and other current and projected economic conditions. Actual product returns, managed care rebates, chargebacks, reimbursements relating to Medicaid and Medicare, other allowances incurred, and management’s expectations regarding the continuing need for a valuation allowance on deferred income tax assets are dependent upon future events. The Company’s management periodically reviews these policies and estimates, the effect of which is reflected as a component of net income in the period in which the change is known. Other than the change described below associated with the Company’s estimate of its product return exposure, such changes to these estimates have not been material to the Company’s results of operations during the years ended December 31, 2003, 2002 and 2001.

     The Company periodically evaluates the volume of its Niaspan and Advicor products that are in customer inventories or elsewhere in the distribution channel to determine whether increased risk of product returns exists. For the period from the introduction of its products through December 31, 2002, Kos’ return risk expectations were consistently based on its limited product return experience given the early stage nature of its products and of the Company. Accordingly, Kos established a specific return risk estimate based on estimated inventory levels in the distribution channel that was used to determine the amount of revenue that could be recorded during a given period. During the year ended December 31, 2003, as a result of the significant history of minimal returns for both products since their introduction, Kos revised its return risk estimates to reflect the historically low product return patterns. This change in accounting estimate resulted in the Company recognizing as revenue all product shipments made during the year ended December 31, 2003, as well as $11.1 million of its prior period product shipments not recognized as revenue because of its previous product return risk exposure estimates. The impact of this change in estimate increased the Company’s reported revenues, net income, and basic and diluted earnings per share by $11.1 million, $9.9 million, and $0.45 per share and $0.24 per share, respectively, for the year ended December 31, 2003. The Company will continue to monitor wholesaler inventory levels, and, if the Company’s product return risk exceeds acceptable levels, the Company may be required to not recognize the revenue and related costs associated with the excess inventory until such return risk is mitigated.

     The Company follows Statement of Financial Accounting Standards (“SFAS”) No. 109, “Accounting for Income Taxes,” which requires, among other things, recognition of future tax benefits and liabilities measured at enacted rates attributable to temporary differences between financial statement and income tax bases of assets and liabilities and to tax net operating loss carryforwards to the extent that realization of said benefits is more likely than not. The Company has generated an accumulated deficit since inception of approximately $233.9 million. Excluding the impact of the BMS Payment, as discussed below, the Company generated full-year income before provision for income taxes for the first time in 2003. As of December 31, 2003, the Company had approximately $146.7 million of net operating loss carryforwards and $41.2 million of other deductible temporary differences between the book and tax bases of assets and liabilities. These items result in a net deferred tax asset of approximately $73.8 million as of December 31, 2003. The net deferred tax asset has been fully reserved by establishing a valuation allowance as of December 31, 2003. Management has re-evaluated the continuing need for a valuation

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allowance against deferred tax assets and, based on the history of net losses, concluded that there is not sufficient evidence as of December 31, 2003 to determine that the Company will “more likely than not” realize all or a portion of its deferred tax assets. However, if in the future management concludes that some or all of its deferred tax assets will “more likely than not” be realized, then the Company will be required to recognize such assets by reversing the applicable portion of the valuation allowance. The Company recorded a provision for income taxes of $2.9 million for the year ended December 31, 2003, to reflect $1.3 million in federal alternative minimum tax and $1.6 million in state income tax liabilities that cannot be offset by utilizing the Company’s net operating loss carryforwards.

Years Ended December 31, 2003 and 2002

     The Company’s reported revenue increased to $293.9 million for the year ended December 31, 2003, from $172.7 million for the same period in 2002. This increase in revenue was principally attributable to increases in unit volume and price for the Company’s products during the 2003 period as compared to the 2002 period, and to the change in product return estimates (as described above).

     Gross profit (reported product sales less cost of product sold) for the year ended December 31, 2003, was $273.9 million, compared with $157.3 million for the 2002 period.

     The Company’s research and development expenses increased to $52.2 million for the year ended December 31, 2003, from $44.0 million for the same period in 2002. The increased expenses related primarily to an increase of $4.2 million in personnel and personnel-related costs, and to a $3.1 million increase principally associated with expenses related to Advicor clinical studies. These increases were partially offset by decreases of $0.9 million in medical education costs which were greater during the 2002 period in support of the commercial launch of the Advicor product, of $0.9 million associated with formulation costs for products under development, and of $0.2 million in offset expenses resulting from Merck reimbursement payments.

     Selling, general and administrative expenses increased to $156.5 million for the year ended December 31, 2003, from $130.1 million for the same period in 2002. Within this category, selling expenses increased to $124.3 million for the 2003 period from $108.5 million for the comparable 2002 period. The growth in selling expenses was primarily related to increases of $13.9 million in sales force operating costs in support of the Niaspan and Advicor products, and of $2.3 million in royalty expenses. General and administrative expenses increased to $32.2 million for the year ended December 31, 2003, from $21.6 million for the year ended December 31, 2002. This increase in general and administrative expenses was primarily related to increases of $3.7 million in personnel and personnel related costs, of $3.2 million in professional fees, of $2.5 million associated with a warrant award and with a modification made to a stock option grant previously made to a former employee, and of $1.2 million in other costs associated with the expanded activities of the Company.

     As of December 31, 2003, the Company was subject to the terms of the December 19, 2002, $30 million credit facility (the “Additional Standby Facility”), and the December 21, 1999, $50 million credit facility (the “Standby Facility”), with Michael Jaharis, Chairman Emeritus of the Company’s Board of Directors and its principal shareholder. During 2003, the Company was also subject to the terms of the September 1, 1999, $50 million credit facility (the “Supplemental Credit Facility”) with Mr. Jaharis and with a transferee of Mr. Jaharis’ wife until its conversion into Common Stock during the fourth quarter of 2003. See “Liquidity and Capital Resources” for additional discussion regarding this debt conversion. Interest expense under the Company’s credit facilities totaled $3.3 million and $4.0 million for the years ended December 31, 2003 and 2002, respectively. The decrease in interest expense is mostly attributable to a decrease in outstanding borrowings, and to a decrease in the Company’s borrowing rate, which is based on the prime rate.

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     The Company recorded a $2.9 million income tax provision for the year ended December 31, 2003 to reflect $1.3 million of federal alternative minimum tax and $1.6 million of state income tax liabilities that cannot be offset by utilizing the Company’s net operating loss carryforwards.

     The Company recorded net income of $59.4 million for the year ended December 31, 2003, compared with a net loss of $20.8 million for the year ended December 31, 2002.

Years Ended December 31, 2002 and 2001

     The Company’s reported revenue, including the effect of Niaspan and Advicor shipments not recognized as revenue during the period resulting from the Company’s product return risk expectations described above, increased to $172.7 million for the year ended December 31, 2002, from $91.4 million for 2001. This increase in revenue was mostly related to increases in prescription volume for the Company’s Niaspan product during 2002 as compared to 2001, as well as to the market introduction, during late January 2002, of the Company’s Advicor product. More specifically, Niaspan and Advicor revenue for the years ended December 31, 2002 and 2001, were as follows:

     The increase in Niaspan and Advicor product sales during the year ended December 31, 2002, were partially offset by the absence, during the 2002 period, of $7.2 million in co-promotion revenue associated with the terms of a co-promotion agreement with Abbott Laboratories, Inc. (“Abbott”), for the promotion and marketing of Abbott’s Mavik and Tarka products within the United States (the “Abbott Agreement”). Under the terms of the Abbott Agreement, the Company received an increasing percentage of revenue based on sales thresholds. Kos and Abbott agreed to terminate the Abbott Agreement effective January 1, 2002. Accordingly, revenue for the year ended December 31, 2002, does not reflect co-promotion revenue associated with the Abbott Agreement.

     Gross profit (reported product sales less cost of product sold) for the year ended December 31, 2002, was $157.3 million, compared with $76.6 million for the 2001 period (before the $7.2 million of co-promotion revenue discussed above).

     Through December 17, 2001, the Company was subject to an agreement with DuPont Pharmaceuticals Company (“DuPont”) for the purpose of co-promoting the Company’s Advicor product in the United States and Canada (the “DuPont Agreement”). Under the terms of the DuPont Agreement, the Company and DuPont would have shared in the future development and commercialization of the Advicor product. Specifically, DuPont had agreed (i) to make equity investments in the Company up to $30 million through the date of FDA approval of the Advicor product; (ii) to pay the Company $17.5 million in milestone payments upon FDA approval of the Advicor product; (iii) to fund up to $32.5 million for future clinical development of the Advicor product; and (iv) to share equally in the costs associated with promoting the Advicor product and share equally in product profits after deducting a royalty to the Company. On May 31, 2000, DuPont made a $20-million equity investment in the

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Company in exchange for 1,250,000 shares of the Company’s Common Stock. On June 7, 2001, DuPont’s parent company, E.I. du Pont Nemours, announced that it had entered into an agreement to sell DuPont to Bristol-Myers Squibb Company (“BMS”) and on October 1, 2001, BMS completed its acquisition of DuPont. On December 17, 2001, the Company entered into an agreement with BMS pursuant to which the DuPont Agreement was terminated and BMS paid Kos $45 million (the “BMS Payment”). Of the total settlement received from BMS, approximately $6 million pertained to co-promotion expenses due and unpaid by DuPont prior to the termination of the DuPont Agreement. The remaining settlement amount, or approximately $39 million, was recorded as other income for the year ended December 31, 2001.

     On January 28, 2002, following the termination of the DuPont Agreement, the Company began commercializing its Advicor product. Accordingly, results of operations for the year ended December 31, 2002, reflect the Company’s significant efforts in connection with the commercial launch of this new product.

     The Company’s research and development expenses increased to $44.0 million for the year ended December 31, 2002, from $31.0 million for the year ended December 31, 2001. The increased expense related primarily to increases of $3.6 million in personnel and personnel related costs, $3.3 million in medical education costs in support of the Niaspan and Advicor products, and of $2.5 million in formulation development costs for products under development. Research and development expenses were also affected by the absence, during the 2002 period, of a $3.9 million contribution made by DuPont during the 2001 period pursuant to the DuPont Agreement, which agreement was terminated on December 17, 2001. Under the terms of the DuPont Agreement, DuPont shared equally with the Company in costs associated with the clinical development, medical education, and promotional efforts of the Company’s Advicor product. This growth in research and development expenses was partially offset by a decrease of $1.5 million in clinical study costs as a result of the substantial completion, during the 2002 period, of an Advicor clinical trial.

     Selling, general and administrative expenses increased to $130.1 million for the year ended December 31, 2002, from $83.6 million for the year ended December 31, 2001. Within this category, selling expenses increased to $108.5 million for the 2002 period from $69.6 million for the comparable 2001 period. The growth in selling expenses was primarily related to increases of $21.2 million in sales force operating costs, of $13.5 million in marketing costs, of $4.1 million in royalty expenses, of $1.5 million in fees associated with a contract sales organization’s assistance in the promotion of the Company’s Niaspan and Advicor products, of $0.8 million in medical education grants, and by the absence, during the 2002 period, of a $4.2 million contribution made by DuPont during the 2001 period pursuant to the DuPont Agreement. Because of the termination of the Abbott Agreement, selling expenses for the year ended December 31, 2002, also exclude the effect of co-promotion expenses associated with such co-promotion arrangement, which totaled $7.0 million for the year ended December 31, 2001. General and administrative expenses increased to $21.6 million for the 2002 period, from $14.0 million for the 2001 period. This increase in general and administrative expenses related primarily to an increase of $2.7 million in personnel and personnel related costs, of $2.2 million in patent costs, and $2.7 million in other costs associated with the expanded activities of the Company.

     Interest expense under the Company’s credit facilities totaled $4.0 million and $6.1 million for the years ended December 31, 2002 and 2001, respectively.

     The Company incurred a net loss of $20.8 million for the year ended December 31, 2002, compared with net income of $2.4 million for the year ended December 31, 2001.

Liquidity and Capital Resources

     At December 31, 2003, the Company had cash and cash equivalents of $260 million (of which $17.8 million was pledged as collateral for the Company’s letters of credit facility with a major institutional

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bank) and working capital of $248.1 million. The Company’s primary uses of cash to date have been to fund selling, general and administrative expenses, and research and development expenses, including clinical trials.

     Net cash provided by operating activities was $55.6 million in 2003, compared to net cash used in operating activities of $1.2 million in 2002, and $7.1 million of net cash provided by operations in 2001. The increase in net cash provided by operations in 2003 was primarily a result of the increase in net income as adjusted for non-cash items. Working capital uses of cash during 2003 included increases in trade accounts receivable, inventories, prepaid expenses and other current assets, and advance payments from customers, partially offset by increases in accounts payable, accrued expenses and advance payments received on a license agreement. The increase in net cash used in operating activities in 2002 was primarily a result of the net loss associated with the absence during 2002 of the BMS payment, which was received in late 2001. Working capital sources of cash in 2002 included decreases in the Company’s current non-cash assets, except for trade accounts receivable which increased in line with the Company’s historical growth in net sales, as well as increases in the Company’s current liabilities.

     Net cash used in investing activities was $11.0 million in 2003, compared to $6.7 million in 2002, and $4.3 million in 2001. The increases in net cash used in investing activities were a result of the Company’s expansion of its production capacity and its overall infrastructure throughout 2003, 2002 and 2001. As of December 31, 2003, the Company’s investment in equipment and leasehold improvements, net of depreciation and amortization, was $17.8 million. The Company expects to increase the level of capital expenditures during 2004 mostly to provide increased production capacity and to accommodate the Company’s increasing operational needs.

     In 2003, net cash provided by financing activities was $195.8 million, compared to cash used in financing activities of $17.8 million in 2002, and to net cash provided by financing activities of $36.4 million in 2001. The increase in 2003 was primarily related to the net proceeds from the Company’s stock offering (as described below) and to shares of Common Stock issued from the exercise of stock options and employee participation in the employee stock purchase plan. These amounts were offset by a payment against borrowings previously made under the Standby Facility. In 2002, the $17.8 million used in financing activities was primarily associated with net payments of $21 million against borrowings previously made under the Standby Facility and Additional Standby Facility.

     On December 19, 2002, the Company entered into an agreement with Michael Jaharis, Chairman Emeritus of the Company’s Board of Directors and its principal shareholder, whereby Mr. Jaharis agreed to replace the previous $30-million credit facility extended to the Company on July 1, 1998 (which was to expire on December 31, 2002), with a new facility expiring on June 30, 2008 (the “Additional Standby Facility”). In connection with this new credit arrangement, the Company granted to Mr. Jaharis non-detachable warrants to purchase 1,000,000 shares of the Company’s Common Stock at an exercise price based on the market price of the Company’s Common Stock on the date that the first draw under this facility occurs. The Company had no borrowings outstanding under the Additional Standby Facility as of December 31, 2003. Borrowings, when outstanding, will bear interest at the prime rate (4.0% as of December 31, 2003), and will be subject to the terms and conditions of borrowings made under the Supplemental Credit Facility, which in addition to including standard and customary loan covenants and conditions, also includes the condition that the death of the lender shall not have occurred, that lender, his spouse, children and entities they control continue to own at least 40% of the Common Stock of the Company, and that no material adverse change shall have occurred to the Company or its financial operations.

     On September 1, 1999, the Company formally agreed to the terms of an additional $50-million funding arrangement initially entered into with Mr. Jaharis on October 7, 1998 (the “Supplemental Credit Facility”). On July 21, 2001, the Company replaced its existing $50 million promissory note payable to Mr. Jaharis with two, $25 million, promissory notes, one payable in the name of Mr. Jaharis and the other

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payable in the name of Mr. Jaharis’ wife. With this promissory note replacement, all of Mr. Jaharis’ existing rights and obligations under the Supplemental Credit Facility, with respect to one-half of the outstanding amount, were transferred to Mrs. Jaharis, and were subsequently transferred by Mrs. Jaharis to a limited partnership (the “Limited Partnership”) that she controls. All other terms and conditions of the Supplemental Credit Facility remained unchanged. Borrowings under the Supplemental Credit Facility were convertible at $4.91 per share and accrued interest at the prime rate. On November 25, 2003, $6.1 million of the Supplemental Credit Facility was converted into 1,250,000 shares of Common Stock and subsequently sold pursuant to the equity offering described below. On December 31, 2003, the remaining $43.9 million balance was converted into 8,933,299 shares of the Common Stock. The Supplemental Credit Facility terminated as of December 31, 2003.

     On December 21, 1999, Mr. Jaharis agreed to extend another $50-million loan to the Company (the “Standby Facility”). Borrowings made under the Standby Facility totaled $30 million as of December 31, 2003, are due June 30, 2005, and are also subject to most of the terms and conditions of borrowings made under the Supplemental Credit Facility. In addition to including standard and customary loan covenants and conditions, the Standby Facility includes the conditions that the death of lender shall not have occurred, that lender, his spouse and children, and entities they control continue to own at least 40% of the Common Stock of the Company, and that no material adverse change shall have occurred to the Company or its financial operations. Borrowings made under the Standby Facility are not, however, convertible into shares of the Company’s Common Stock. In lieu of a conversion feature, the Company has granted to Mr. Jaharis non-detachable warrants to purchase 6,000,000 shares of the Company’s Common Stock at $5.00 per share, which approximated the market value of the Company’s Common Stock on the effective date of the Standby Facility. The warrants are exercisable at any time until June 30, 2006. The exercise of a significant number of the warrants issued under the Standby Facility will cause material dilution to existing shareholders of the Company.

     The Company recorded $3.3 million and $4.0 million of interest expense for the years ended December 31, 2003 and 2002, respectively, related to its credit facilities with Mr. Jaharis and his transferees.

     In January 2002, the Securities and Exchange Commission declared effective a shelf registration statement (the “Shelf Registration”) filed by the Company for the sale, from time to time, of up to $200 million of its Common Stock, Preferred Stock, stock options, warrants and other rights to purchase Common Stock or Preferred Stock. On October 10, 2003, the Company filed a new shelf registration statement that covered the shares of the earlier Shelf Registration (the “Amended Shelf Registration”) and which allowed the Limited Partnership to sell up to 1,500,000 shares of the Company’s Common Stock in a public offering; and on October 31, 2003, the Company further amended the Amended Shelf Registration to register an aggregate of 1,350,000 shares of Company Common Stock held by BMS and the Company’s Chairman. The Amended Shelf Registration was declared effective by the Securities and Exchange Commission on October 31, 2003. On November 25, 2003, the Company sold 3,750,000 shares of Common Stock and the Limited Partnership sold 1,250,000 shares of Common Stock (converted from the Supplemental Credit Facility) pursuant to the Amended Shelf Registration. On December 22, 2003, the Company sold an additional 650,000 shares of Common Stock and the Company’s Chairman sold 100,000 shares of Common Stock to cover over-allotments as permitted in the Amended Shelf Registration. Net proceeds to the Company resulting from the sale of the 4,400,000 shares of Common Stock totaled $184.3 million. Proceeds from the offerings, other than the proceeds pertaining to the selling shareholders, are expected to be used to acquire other products or companies, to in-license complimentary products, and to fund working capital needs for general corporate purposes.

     Although the Company currently anticipates that, including the capital available to the Company under the Additional Standby Facility and the Standby Facility, it has or has access to an amount of working capital that will be sufficient to fund the Company’s operations for the next twelve months, the

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Company’s cash requirements during this period will be substantial and may exceed the amount of working capital available to the Company. The Company’s ability to fund its operating requirements and maintain an adequate level of working capital will depend primarily on its ability to continue to generate substantial growth in sales of its Niaspan and Advicor products, its ability to continue to access its credit facilities, and on its ability to control operating expenses. The Company’s failure to generate substantial growth in the sales of Niaspan and Advicor, control operating expenses, or meet the conditions necessary for the Company to obtain funding under the Additional Standby Facility and the Standby Facility, and other events – including the progress of the Company’s research and development programs; the costs and timing of seeking regulatory approvals of the Company’s products under development; the Company’s ability to obtain regulatory approvals in the United States and abroad; the Company’s ability to manufacture products at an economically feasible cost; costs in filing, prosecuting, defending, and enforcing patent claims and other intellectual property rights; the extent and terms of any collaborative research, manufacturing, marketing, joint venture, or other arrangements; and changes in economic, regulatory, or competitive conditions or the Company’s planned business – could cause the Company to require additional capital. In the event that the Company must raise additional capital to fund its working capital needs, it may seek to raise such capital through loans, the issuance of debt securities or equity securities, each of which would require the consent of the Company’s current lender. To the extent the Company raises additional capital by issuing equity securities or obtaining borrowings convertible into equity, ownership dilution to existing shareholders will result, and future investors may be granted rights superior to those of existing shareholders. Moreover, additional capital may not be available to the Company on acceptable terms, or at all.

Contractual Obligations

     The following table summarizes our significant contractual obligations at December 31, 2003, and the effect such obligations are expected to have on our liquidity and cash flows in future periods. This table excludes amounts already recorded on our balance sheet as current liabilities as of December 31, 2003.

     Purchase orders or contracts for the purchase of raw materials and other goods and services are not included in the table above. The Company’s purchase orders are based on its current manufacturing needs and are fulfilled by its vendors within a short period of time. The Company does not have any significant agreements for the purchase of raw materials or other goods specifying minimum quantities or set prices.

     Contractual obligations such as sponsored research and licensing agreements that are contingent upon the achievement of certain milestones are not included in the table above. Such arrangements are not considered contractual obligations until the milestone is met by the third party, and in most cases, are cancelable at the option of the Company. As of December 31, 2003, assuming all future milestones were met, additional required payments related to sponsored research and licensing agreements would be approximately $1.8 million.

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     Obligations associated with Takeda and with a contract sales organization (“CSO”) are based upon net sales of the Company and are not included in the table above. The Company will pay Takeda a royalty on incremental net sales of the Company’s Niaspan and Advicor products in the United States above a certain baseline amount. This co-promotion arrangement has a three-year term commencing January 2004 and provides for residual payments to Takeda after the three years, if the parties do not renew the agreement. The Company will pay the CSO a royalty based on net sales of the Company’s Niaspan and Advicor products during a five-year period beginning January 1, 2002. The royalty amounts payable to the CSO are subject to a cumulative minimum of $50 million over the term of the Contract Sales Force Agreement, not to exceed $65 million over such contract term.

     As of December 31, 2003, in connection with the Merck Agreement, Kos had received $15 million of upfront payments of which $12.5 million are refundable to Merck by Kos if it fails to achieve certain regulatory milestones. Refundable amounts under the Merck Agreement are not included in the table above.

     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 changes to agreed-upon amounts for some obligations. Amounts disclosed as contingent or milestone-based obligations are dependent on the achievement of the milestones or the occurrence of the contingent events and can vary significantly.

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FORWARD-LOOKING INFORMATION: CERTAIN CAUTIONARY STATEMENTS

     Statements contained in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this report may contain information that includes or is based upon forward-looking statements within the meaning of the Securities Litigation Reform Act of 1995. Forward-looking statements present the Company’s expectations or forecasts of future events. These statements can be identified by the fact that they do not relate strictly to historical or current facts. They frequently are accompanied by words such as “anticipate,” “estimate,” “expect,” “project,” “intend,” “plan,” “believe,” and other words and terms of similar meaning. In particular, these include statements relating to the Company’s ability to: increase the amount of the sales of its products, including the success of its relationship with Takeda; successfully develop and commercialize new products under development and within expected timeframes; continue its strong financial performance and that of its products; increase its stock price; protect the strength of its patents; achieve a successful conclusion to the ongoing litigation with Barr Laboratories, Inc. and Andrx Laboratories, Inc.; commercialize its products outside the United States and the success of its relationship with Merck; achieve its goals for future sales levels, operating margins, earnings growth, and shareholder value; meet the conditions necessary to obtain funding under its funding arrangements; increase the level of capital expenditures in future periods; and meet its expectations regarding future capital needs. These forward-looking statements are subject to risks and uncertainties which may cause actual results to differ materially from those projected in a forward-looking statement. These risks and uncertainties include the continued market acceptance of the Advicor product, the expected continued growth in sales of the Niaspan product, the ability of Kos to continue to build awareness for Advicor within the medical community, the ability of the Company to generate increasing sales of Advicor without diminishing the sales of Niaspan, the success of the Company’s relationship with Takeda, the Company’s ability to commercialize its products outside the United States and the success of its relationship with Merck, the Company’s ability to attract and retain sales professionals, the Company’s ability to successfully develop and commercialize new products under development and within expected timeframes, the Company’s ability to increase its stock price, grow revenue, control expenses, and grow earnings and shareholder value, the Company’s ability to meet the conditions necessary to obtain funding under its funding arrangements, the Company’s ability to retain sufficient cash, available credit, and access to capital from third parties to be able to repay its credit obligations on a timely basis and meet its expectations regarding future capital needs, the protection afforded by the Company’s patents, the effect of conditions in the pharmaceutical industry and the economy in general, as well as certain other risks including those set forth below and elsewhere in this report and in other reports filed by the Company with the Securities and Exchange Commission. Further, certain forward-looking statements are based upon assumptions of future events, which may not prove to be accurate. All forward-looking statements included herein are made only as of the date such statements are made, and the Company does not undertake any obligation to publicly update or correct any forward-looking statements to reflect events or circumstances that subsequently occur or which the Company hereafter becomes aware of. Subsequent written and oral forward looking-statements attributable to the Company or to persons acting on its behalf are expressly qualified in their entirety by the cautionary statements set forth below and elsewhere in this report and in other reports filed by the Company with the Securities and Exchange Commission.

Market Acceptance and Sales Growth of Niaspan and Advicor

     The Company’s success depends primarily upon its ability to successfully market and sell increasing quantities of the Niaspan and Advicor products. The Company’s ability to successfully sell increasing quantities of the Niaspan and Advicor products will depend significantly on the continued acceptance of the Niaspan product by physicians and their patients despite the introduction of Advicor. As a consequence of the on-going commercialization of the Advicor product, which is a combination product including Niaspan and a statin, prescription levels for Niaspan may be adversely affected to the extent a significant number of physicians prescribe Advicor as a substitute product for their patients who are

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currently taking Niaspan. Such substitution could have an adverse effect on the growth of the combined revenue generated from the sale of the Company’s products. The Company believes that intolerable flushing and potential liver toxicity associated with other currently available formulations of niacin are the principal reasons why physicians generally have been reluctant to prescribe or recommend such formulations. Flushing episodes are often characterized by facial redness, tingling or rash, and are a side effect that often occurs when humans ingest niacin. Currently available formulations of niacin generally either require, in the case of immediate-release niacin, the patient to take niacin several times per day, resulting in multiple flushing episodes, or result, in the case of sustained-release niacin, in liver toxicity. Although most patients taking the Niaspan and Advicor products will sometimes flush, the formulation and dosing regimen for Niaspan and Advicor have been designed to maximize patient acceptance and minimize the occurrence of flushing and liver toxicity. If, however, a significant number of patients using the Niaspan and Advicor products were to suffer episodes of flushing that they consider intolerable or to suffer other side effects, physicians may discontinue prescribing the Niaspan and Advicor products or patients may stop taking Niaspan and Advicor, which would have a material adverse effect on the Company. Unanticipated side effects or unfavorable publicity concerning the Niaspan or Advicor products or any other product incorporating technology similar to that used in the Niaspan or Advicor products also could have an adverse effect on the Company’s ability to obtain regulatory approvals or to achieve acceptance by prescribing physicians, managed care providers, or patients, any of which would have a material adverse effect on the Company.

     On January 28, 2002, the Company began commercializing the Advicor product. The Company’s ability to successfully sell increasing quantities of the Advicor product will depend significantly on the increasing acceptance of the Advicor product by physicians and their patients. If a significant number of patients using the Advicor product were to suffer episodes of flushing that they consider intolerable or to suffer more serious side effects, such as rhabdomyolysis or myopathy, physicians may discontinue prescribing the Advicor product or patients may stop taking Advicor, which would have a material adverse effect on the Company. Rhabdomyolysis is a rare disease in which serious muscle damage results in release of muscle cell contents into the bloodstream, which may be fatal. Myopathy is a disorder of muscle tissue or muscles that can result from endocrine disorders, metabolic disorders, infection or inflammation of the muscles, and from certain drugs. There have been several cases where Niaspan (one of the principal ingredients in Advicor) or Advicor have been identified as possible causes of myopathy. Unanticipated side effects or unfavorable publicity concerning the Advicor product or any other product incorporating technology similar to that used in the Advicor product also could have an adverse effect on the Company’s ability to maintain regulatory approvals or to achieve acceptance by prescribing physicians, managed care providers, or patients, any of which would have a material adverse effect on the Company.

     In addition, Advicor may prove to be difficult to successfully sell because the cholesterol market is dominated by competitors with significantly larger sales forces and with significantly greater marketing resources than those available to the Company. Further, Advicor is a combination of two well-known cholesterol drugs, niacin and lovastatin, that have been available for a significant period of time. Although the combination of these drugs is highly effective in improving all of the major components of cholesterol, it is possible that physicians may not prescribe Advicor because it is not as new as more recently introduced compounds, such as the potent statin products marketed by the Company’s competitors. Also, because Advicor is a combination of two currently available drugs, Advicor has been approved by the FDA for the improvement of cholesterol disorders in patients who were not able to achieve desired cholesterol improvements by taking either Niaspan or lovastatin alone. Consequently, although such an approved treatment indication is standard for combination drugs such as Advicor, it is possible that physicians will not prescribe Advicor until they have first prescribed either Niaspan, lovastatin, or another statin alone and subsequently determined that their patients need Advicor to achieve desired cholesterol improvements. Similarly the Company’s ability to successfully sell increasing

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quantities of the Advicor product may be adversely affected by the November 2002 release of Zetia, part of a new class of cholesterol-lowering agents, and by the September 2003 release of Crestor, a new, highly powerful statin product. Zetia is being marketed by Merck/Schering-Plough Pharmaceuticals, which is a joint venture between Merck & Co., Inc. and Schering-Plough Corporation, and Crestor is marketed by AstraZeneca. Merck/Schering-Plough Pharmaceuticals and AstraZeneca are competitors with substantially greater resources than Kos. Zetia is part of a new class of cholesterol-lowering agents that inhibit the intestinal absorption of cholesterol. Crestor is a type of statin drug that is highly effective in reducing LDL cholesterol, but is less effective in modifying HDL cholesterol, triglycerides and other forms of cholesterol. The Company’s future sales of Advicor may also be affected by the potential release of several other new combination statin drugs in the future. Further, there are at least nine versions of generic lovastatin, one of the components of Advicor, that have been launched into the cholesterol market, which could adversely affect demand for Advicor. Consequently, the Company’s effort to sell increasing quantities of the Advicor product may be unsuccessful.

History of Operating Losses; Uncertainty of Future Profitability

     To date, the Company has dedicated most of its financial resources to the development and commercialization of the Niaspan and Advicor products, the development of other products, and general and administrative expenses. The Company has generated an accumulated deficit as of December 31, 2003, of approximately $233.9 million. Excluding the impact of the BMS Payment, the Company generated full-year income before provision for income taxes for the first time in 2003. The Company’s ability to achieve and maintain profitability will depend, among other things, on the commercial success of the Niaspan and Advicor products; on the Company’s ability to successfully exploit the Company’s manufacturing and sales and marketing capabilities; on the Company’s ability to complete the development of, and obtain regulatory approvals for, and achieve market acceptance for the Company’s products under development; and on the Company’s ability to maintain sufficient funds to finance the Company’s activities. As of December 31, 2003, the Company had approximately $146.7 million of net operating loss carryforwards and $41.2 million of other deductible temporary differences between the book and tax bases of assets and liabilities. If the Company is unable to achieve or sustain profitability, however, its carryforwards may not be utilized.

Barr Laboratories Litigation

     On January 23, 2002, the Company received notice from Barr Laboratories, Inc. (“Barr”) that it had filed with the FDA an Abbreviated New Drug Application (“ANDA”) that, if approved, would allow Barr to market a generic version of the Company’s 1000 mg Niaspan product. As a result, on March 4, 2002, the Company filed a patent infringement lawsuit against Barr in the Southern District of New York (“SDNY”). On March 11, 2002, the Company filed an amended complaint (the “Amended Complaint”). In this lawsuit, the Company asserted that Barr has infringed Kos’ 6,080,428 and 6,129,930 patents. On March 25, 2002, Barr answered the Amended Complaint (the “Answer”) by denying that the ‘428 and ‘930 patents are valid and infringed, and seeking a declaratory judgment to that effect. On August 19, 2002, Barr amended its Answer to add counterclaims requesting a declaratory judgment that two other patents owned by Kos, U.S. Patent Numbers 5,126,145 and 5,268,181, are not infringed, and that the ‘181 patent is invalid.

     On July 9, 2002, the Company received notice from Barr that it had filed an ANDA with the FDA that would, if approved, allow Barr to market generic versions of the Company’s 500 mg and 750 mg Niaspan products. On August 13, 2002, the Company filed a second patent infringement lawsuit against Barr also in the SDNY. Again, the Company asserted that Barr has infringed the ‘428 and ‘930 patents. On September 3, 2002, Barr answered the complaint by denying infringement and alleging that the patents are invalid. Barr also sought a declaratory judgment that the ‘428, ‘930, ‘145, and ‘181 patents are not infringed, and that the ‘428, ‘930, and ‘181 patents are invalid. The two cases were consolidated on September 23, 2002.

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     On September 30, 2002, the Company received notice from Barr that it had filed a Supplemental Paragraph IV Certification relating to Kos’ 6,406,715 patent. The Company filed a third lawsuit on November 12, 2002, against Barr in the SDNY asserting infringement of this patent. On December 3, 2002, Barr answered the complaint by denying that the ‘715 patent is valid and infringed, and seeking a declaratory judgment of invalidity. Barr also sought a declaratory judgment that the ‘428, ‘930, ‘145, and ‘181 patents are not infringed, and that the ‘428, ‘930 and ‘181 patents are invalid.

     The third case was consolidated with the first two on January 23, 2003. On March 4, 2003, Kos replied to Barr’s declaratory judgment counterclaims by denying that Kos’ patents are invalid or not infringed. Kos also sought a declaratory judgment that one or more of Barr’s products will infringe the ‘145 and ‘181 patents. During the course of the litigation, Barr has also suggested claims of anti trust and unenforceability. Kos has received several notices from Barr Laboratories that Barr has filed a Supplemental Paragraph IV Certification to each ANDA to provide for U.S. Patent No. 6,676,967. The first notice was received by Kos on January 21, 2004 and the latest on February 23, 2004. Kos is currently evaluating its options.

     This current litigation is costly and time consuming, and the Company cannot assure that it will be successful. In addition, such litigation may result in financial losses or harm to the Company’s reputation, and may divert management resources and attention from its operations. If Barr is successful in this litigation, the Company’s ‘428, ‘930 and ‘181 and ‘715 patents could be found to be invalid, unenforceable or not infringed. If such patents are invalid, unenforceable or not infringed, the Company would be unable to prevent Barr from marketing a generic version of the Niaspan product, which would have a material adverse effect on the Company. The Company would also be unable to prevent other companies from introducing generic and other competing products into the market place. Furthermore, there could be an increased risk that other companies would challenge the Company’s proprietary rights or claim that the Company’s products infringe on their patents.

Future Capital Needs; Uncertainty of Additional Funding.

     In order to finance the Company’s operations, as of December 31, 2003, the Company had $30 million in outstanding borrowings from Michael Jaharis, the Company’s principal shareholder, director, and Chairman Emeritus. The Company can borrow up to an additional $50 million from Mr. Jaharis under agreements currently in place; provided that the conditions of borrowings have been satisfied including, without limitation, that the death of lender shall not have occurred, the lender, his spouse, children and entities they control continue to own at least 40% of the Common Stock of the Company, and no material adverse change shall have occurred to the Company or its financial condition. The repayment of funds borrowed from Mr. Jaharis are secured by the pledge of all of the Company’s assets to him. As a result, if the Company is unable to repay the loans as they become due, the Company could be forced to liquidate the Company’s assets or transfer all of such assets to Mr. Jaharis. The Company has spent, and will continue to be required to spend, substantial funds to continue research and development activities, including clinical trials of the Company’s products under development, and to commercialize the Niaspan and Advicor products and the Company’s other products under development, if regulatory approvals are obtained for such products under development.

     The Company believes that it has sufficient resources, including funds available to it under loans from Mr. Jaharis and the proceeds of the public offering completed in the last quarter of 2003, to fund the Company’s operations through at least the next twelve months. Even with the proceeds from these sources, however, the Company may need or elect to raise additional capital prior to such date. The Company’s ability to fund its operating requirements and maintain an adequate level of working capital for the next twelve months will depend primarily on: the near-term commercial success of Niaspan and Advicor; its ability to meet the conditions necessary to obtain funding under its lines of credit, including, without limitation, that the death of the lender shall not have occurred, the lender, his spouse, children and entities they control continue to own at least 40% of the Common Stock of the Company, and no material adverse change shall have occurred to the Company or its financial condition; the problems, delays, expenses and complications frequently encountered by companies at this stage of development; the progress of the Company’s research, development, and clinical trial programs; the costs and timing of seeking regulatory approvals of the Company’s products under development; the Company’s ability to obtain such

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regulatory approvals; costs in filing, prosecuting, defending, and enforcing patent claims and other intellectual property rights; the extent and terms of any collaborative research, manufacturing, marketing, or other arrangements; and changes in economic, regulatory, or competitive conditions or the Company’s planned business. Estimates about the adequacy of funding for the Company’s activities are based on certain assumptions, including assumptions regarding the marketing and sales success of the Niaspan and Advicor products, the regulatory and commercial success of the Advicor product, and that testing and regulatory procedures relating to the Company’s other products under development can be conducted at projected costs and within projected time frames. To the extent these assumptions prove to be inaccurate, the Company may have insufficient resources to fund its operations as currently planned.

     To satisfy the Company’s capital requirements, it may seek to raise funds in the public or private capital markets. The Company’s ability to raise additional funds in the public markets may be adversely affected if sales of the Niaspan and Advicor products do not increase rapidly; if the results of the clinical trials for the Company’s products under development are not favorable; or if regulatory approval for any of the Company’s products under development is not obtained. The Company may seek additional funding through corporate collaborations and other financing vehicles. If adequate funds are not available to the Company, or if available, their terms are unacceptable, the Company may be required to significantly reduce its marketing activities for the Niaspan and Advicor products or curtail significantly one or more of the Company’s research or development programs or the Company may be required to obtain funds through arrangements with future collaborative partners or others that may require the Company to relinquish rights to the Niaspan or Advicor products or to some or all of the Company’s technologies or products under development or take significant cost-reducing actions or both. If the Company is successful in obtaining additional financing, the terms of the financing may have the effect of diluting or adversely affecting the holdings or the rights of the holders of the Company’s securities.

Registration Rights

     The Company has granted certain registration rights to its controlling shareholder, Mr. Jaharis, his spouse, and their transferees, and to Kos Investments, Inc. and Kos Holdings, Inc., which entitle such persons and entities to cause the Company to effect an unlimited number of registrations under the Securities Act of 1933 of sales of up to an aggregate of 24,503,368 shares of the Company’s common stock owned or controlled by such persons or entities or that could be acquired by such person or entities upon exercise or conversion of securities they currently hold. These registration rights generally would also permit the holders of such rights to include shares in any registration statement otherwise filed by the Company. By exercising these registration rights, these persons and entities could cause a large number of shares to be registered and become freely tradeable without restrictions under the Securities Act (except for those purchased in the offering by the Company’s affiliates) immediately upon the effectiveness of such registration. Such sales may have an adverse effect on the market price of the Company’s common stock and could impair the Company’s ability to raise additional capital.

Limited Sales and Marketing Resources

     Although the Company and Takeda currently market the Niaspan and Advicor products and the Company intends to market its products under development primarily through the Company’s own specialty sales force or through co-promotion partners, substantial resources will continue to be required for Kos to promote the sale of its products. Because its current marketing resources are limited, the Company may be unable to devote sufficient resources to the Niaspan and Advicor products, or to the Company’s products under development or to be acquired or licensed, or to achieve increasing market acceptance of such products. The Company’s failure to expend the resources to adequately promote the Niaspan and Advicor products or its other products under development would have a material adverse effect on the Company’s business and results of operations.

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     Moreover, because the Company has fewer sales persons than its competitors, the Company’s sales force may be unable to detail successfully physicians who prescribe lipid-altering or other medications. The Company may not be able to retain its current sales representatives. Even if the Company hires additional representatives, they may not be immediately effective in promoting the sale of the Niaspan and Advicor products. As a result, Kos may be unable to generate significantly increased sales of the Niaspan or Advicor products. The failure of the Company’s sales representatives to generate increased sales of the Niaspan and Advicor products would have a material adverse effect on operating results.

Control by Existing Shareholder

     Michael Jaharis, the Company’s principal shareholder and a director, owns, directly or indirectly, 13,681,720 shares of the Company’s Common Stock as of December 31, 2003, or approximately 37.2% of the common stock outstanding. Accordingly, Mr. Jaharis can control the outcome of certain shareholder votes, including votes concerning the election of directors, the adoption or amendment of provisions in the Company’s Articles of Incorporation, and the approval of mergers and other significant corporate transactions. This level of concentrated ownership by one person may have the effect of delaying or preventing a change in the management or voting control of Kos. In addition, a line of credit gives Mr. Jaharis the right to exercise warrants to purchase six million shares of the Company’s Common Stock at $5.00 per share. The warrants are non-detachable and can be exercised only through the conversion of principal and interest accumulated under the line of credit. If this warrant exercise was to occur, Mr. Jaharis’ direct or indirect ownership of the Company’s Common Stock would increase to 19,681,720 shares, or approximately 46.0% of the common stock outstanding, assuming the warrant exercise had occurred as of December 31, 2003.

Competition and Technological Change

     Many products are commercially available for the treatment of elevated LDL cholesterol, and the manufacturers of such products, individually and collectively, have significantly greater financial resources and sales and manufacturing capabilities than those available to Kos, including combined field sales forces exceeding 18,000 persons, compared with the Company’s approximately 440 person field sales force and the sales force of its co-promotion partners. The Company’s direct competitors and their respective competitive products include, among others:

•		Abbott (Tricor)
•		Bristol-Myers Squibb (Pravachol)
•		Merck (Zocor and Mevacor)
•		Novartis (Lescol)
•		Pfizer (Lipitor and Lopid)
•		Sankyo (Welchol)
•		Merck/Schering-Plough (Zetia)
•		AstraZeneca (Crestor)

     The Company estimates that the existing Niaspan and Advicor prescriptions account for slightly more than 3.2% of the total prescriptions currently being written in the United States for cholesterol-lowering pharmaceutical compounds. In addition, Zetia, part of a new class of cholesterol-lowering agents that inhibit the intestinal absorption of cholesterol, was launched in November 2002 by Merck/Schering-Plough Pharmaceuticals, and Crestor, a new highly powerful statin product, was launched during September 2003 by AstraZeneca. Both Merck/Schering-Plough Pharmaceuticals and AstraZeneca are competitors who have substantially greater resources than those available to Kos. Further, other new combination statin drugs may be marketed during succeeding years. Finally, there are at least nine versions of generic lovastatin, one of the components of Advicor, currently being marketed in the cholesterol market. The existence of distributors of generic lovastatin and the competitive environment

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they create may inhibit the Niaspan and Advicor products from competing successfully or from achieving increased sales. Moreover, the active ingredient in Niaspan, niacin, is available in several other formulations, most of which do not require a prescription. Although the Company believes that there are no other currently available niacin formulations that have been approved by the FDA specifically for once-a-day dosing, physicians may decide to prescribe or recommend some of these unapproved niacin formulations, using the Niaspan product’s dosing regimen, to try to achieve the same results as Niaspan. Substitution of other niacin formulations for the Niaspan product could have a material adverse effect on the Company’s business and results of operations. Moreover, manufacturers of other niacin formulations could promote their products using the Niaspan product’s dosing regimen and could promote the sale of their products to treat the indications for which the Company has received clearance to market Niaspan. Although such promotion would be a violation of FDA regulations, the significant occurrence of such practices would have a material adverse effect on the Company. Moreover, many established pharmaceutical and biotechnology companies, universities, and other research institutions with resources significantly greater than Kos’ may develop products that directly compete with the Company’s products. Even if the Company’s products under development prove to be more effective than those developed by other entities, such other entities may be more successful in marketing their products than Kos because of greater financial resources, stronger sales and marketing efforts, and other factors. If these entities are successful in developing products that are safer, more effective, or less costly than the products developed by Kos, the Company’s products may be unable to compete successfully with any of those products.

International Commercialization Agreement with Merck KGaA

     On October 23, 2002, the Company signed an exclusive international commercialization agreement with Merck to market the Niaspan and Advicor products outside the United States, Canada and Japan. Under terms of the Merck Agreement, Merck will provide Kos up to $61 million in licensing, milestone and reimbursement payments, including $15 million in upfront payments. Kos is responsible for obtaining initial marketing authorization in all European countries and the supply and manufacturing of the products.

     Pursuant to the Merck Agreement, if marketing authorization is not obtained for Niaspan or Advicor in certain countries and within certain timeframes, Merck will have the right to terminate the agreement, and Kos will be required to refund to Merck up to $12.5 million of the upfront payments. In addition, other milestone payments payable to Kos under the Merck Agreement are dependent on the achievement of marketing authorization of Niaspan in certain countries, the achievement of marketing authorization of Advicor in certain countries, and achieving certain net sales thresholds of Niaspan and Advicor.

     In 1999, Kos received marketing approval for Niaspan in the United Kingdom, and in 2002, submitted Advicor for marketing approval in the United Kingdom. We entered Niaspan into the European Union’s Mutual Recognition Procedure (“MRP”) in September 2003. In January 2004, the MRP for Niaspan was successfully completed with the Company receiving tentative approval to market Niaspan in thirteen European countries. There is no certainty that final marketing authorization for the Niaspan and Advicor products will be obtained under the MRP, or, with respect to Advicor, at all, and there could be delays in the granting of such authorizations. Consequently, Kos may be required to reimburse Merck for up to $12.5 million of the upfront payments and may not receive any of the milestone payments under the Merck Agreement.

No Assurance of Adequate Third-Party Reimbursement

     The Company’s ability to commercialize successfully its products under development is dependent in part on the extent to which appropriate levels of reimbursement for the Niaspan and Advicor products, or for the other products it sells are obtained from government authorities, private health insurers, and managed care organizations such as health maintenance organizations or HMOs. The Company estimates that, through December 31, 2003, approximately $471.9 million, or 72%, of the Company’s cumulative

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Niaspan and Advicor revenue has been subjected to the reimbursement rules of such organizations. Managed care organizations and other third-party payors are increasingly challenging the pricing of pharmaceutical products. The trend toward managed healthcare in the United States, the growth of organizations such as HMOs, and legislative proposals to reform healthcare and government insurance programs could significantly influence the purchase of pharmaceutical products, resulting in lower prices and reduced demand for Niaspan, the Advicor product, or the Company’s products under development. Such cost containment measures and potential legislative reform could affect the Company’s ability to sell Niaspan, Advicor, or its products under development and may have a material adverse effect on the Company. Significant uncertainty exists about the reimbursement status of newly approved pharmaceutical products. Although the Company has obtained approvals for reimbursement for the cost of Niaspan and Advicor from many third-party payors, such approvals, in the United States and in foreign countries, may be discontinued for Niaspan, or unavailable for Advicor or any of the Company’s products under development. The unavailability or inadequacy of third-party reimbursement for Niaspan, Advicor, or the Company’s products under development or to be acquired or licensed, may reduce the demand for, or negatively affect the price of, these products, which would have a material adverse effect on the Company.

Dependence on Collaborators

     The Company relies on various third parties for certain aspects of the development, manufacture and promotion of the Company’s present and planned products. There can be no assurance that the Company will be able to enter into future collaborative arrangements on favorable terms, or at all. Even if the Company is successful in entering into such collaborative agreements, there can be no assurance that any such arrangement will be successful. The success of any such arrangement is dependent on, among other things, the skills, experience and efforts of the third party’s employees responsible for the project, the third party’s commitment to the arrangement, and the financial condition of the third party, all of which are beyond the control of the Company.

Dependence on Key Personnel

     The Company’s success is dependent on the Company’s ability to attract and retain highly qualified scientific, management, and sales personnel. In April 2001, the Company hired its current President and Chief Executive Officer, Adrian Adams. The loss of Mr. Adams as the Company’s President and Chief Executive Officer could have a material adverse effect on its operations and business. Due to intense competition for personnel from other companies, academic institutions, government entities, and other organizations, the Company may be unsuccessful in attracting and retaining key personnel. The loss of key personnel, or the inability to attract and retain the additional, highly-skilled employees required for the expansion of Kos’ activities, could adversely affect its business and operating results.

Products Under Development

     Although the Company has obtained clearance from the FDA to market the Niaspan and Advicor products, the Company may be unsuccessful in effectively formulating any of its other products as planned. Further, the Company may not be successful in demonstrating the safety and efficacy of such products in human clinical trials. These trials may be costly and time-consuming. The administration of any product the Company develops may produce undesirable side effects that could result in the interruption, delay or suspension of clinical trials, or the failure to obtain FDA or other regulatory approval for any or all targeted indications. Even if regulatory approval is secured, the Company’s products under development may later produce adverse effects that limit or prevent their widespread use or that necessitate their withdrawal from the market. The Company may discontinue the development of any of its products under development at any time.

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Acquisition of Products

     As part of the Company’s growth strategy, the Company intends to acquire and develop additional product candidates or approved products. The success of this strategy depends upon Kos’ ability to identify, select and acquire pharmaceutical products that meet the criteria it has established. Any product candidate the Company acquires will require additional research and development efforts prior to commercial sale, including extensive pre-clinical and/or clinical testing and approval by the FDA and corresponding foreign regulatory authorities. All product candidates are prone to the risks of failure inherent in pharmaceutical product development, including the possibility that the product candidate will not be safe, non-toxic and effective or approved by regulatory authorities. In addition, the Company cannot assure that any approved products that the Company develops or acquires will be: manufactured or produced economically; successfully commercialized; widely accepted in the marketplace or that the Company will be able to recover its significant expenditures in connection with the development or acquisition of such products. In addition, proposing, negotiating and implementing an economically viable acquisition is a lengthy and complex process. Other companies, including those with substantially greater financial, marketing and sales resources, may compete with the Company for the acquisition of product candidates and approved products. The Company may not be able to acquire the rights to additional product candidates and approved products on terms that it finds acceptable, or at all. In addition, if the Company acquires product candidates from third parties, the Company will be dependent on third parties to supply such products to the Company for sale. The Company could be materially adversely affected by the failure or inability of such suppliers to meet performance, reliability and quality standards.

Patents and Trademarks; Interference

     The Company’s ability to commercialize any of its products under development will depend, in part, on the Company’s or on its licensors’ ability to obtain patents, enforce those patents, preserve trade secrets, and operate without infringing on the proprietary rights of third parties. In addition, the patents that the Company has been issued or for which Kos has applied relating to Niaspan, Advicor and certain of the Company’s products under development are based on, among other things, the extended-release nature of the niacin active ingredient. If the indications treated by Niaspan, Advicor and such other products under development could be treated using drugs without such extended-release properties, such patents and patent applications may not prevent the use of other niacin-based drugs for the treatment of such indications, which would have a material adverse effect on the Company. Further, the Company would be adversely affected if:

•		The patent applications licensed to or owned by Kos do not result in issued patents;
•		Meaningful patent protection is not secured for any particular technology; or
•		Any patents that have been or may be issued to Kos or the Company’s licensors, including the patents covering the Company’s Niaspan product, are invalid, unenforceable or not infringed.

     In general, the U.S. patents and patent applications owned by or licensed to Kos are directed to compositions and their methods of use. Protection of the chemical entity is not available for the active ingredient in Niaspan, or either of the active ingredients in Advicor. Moreover, the active ingredient in Niaspan, niacin, is currently sold in the United States and other markets for lipid altering indications and for other uses. The additional active ingredient in Advicor, lovastatin, is also currently sold in the United States and other markets for lipid altering indications. Even in jurisdictions where the use of the active ingredients in Niaspan and Advicor for lipid altering and other indications may be covered by the claims of method-of-use or composition patents owned by or licensed to Kos, off-label sales might occur, especially if another company markets the active ingredient at a price that is less than the price of Niaspan or Advicor, thereby potentially reducing the sales of such products.

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     The U.S. Patent and Trademark Office (the “PTO”) has issued U.S. Patent numbers 6,129,930, 6,080,428, 6,406,715 and 6,676,967 to the Company with claims related to Niaspan’s and Advicor’s composition and method-of-use consistent with the recommended once-a-day regime. On February 7, 1997, the Company entered into an agreement with a generic manufacturer pursuant to which the Company and the manufacturer granted cross-licenses to each other under their respective patents. The Company has subsequently purchased the patents that were the subject of the cross-license agreement and agreed to continue paying a royalty to the manufacturer on terms similar to those contained in the cross-license agreement.

     The Company has received patents and has filed patent applications covering technologies pertaining to propellant-driven aerosol formulations that do not contain chlorofluorocarbons. The Company is aware that certain European and U.S. patents have been issued with claims covering products that contain certain propellant-driven aerosol formulations that do not contain chlorofluorocarbons. It may be argued that certain or all of the Company’s aerosol products under development may use a formulation covered by such European or U.S. patents. If that is shown to be the case, the Company would be prevented from making, using or selling such products unless Kos obtains a license under such patents, which license may not be available on commercially reasonable terms, or at all, or unless such patents are determined to be invalid in Europe or invalid or unenforceable in the United States. The Company’s development of products that may be covered by such patents and its failure to obtain licenses under such patents in the event such patents are determined to be valid and enforceable could have an adverse effect on the Company’s business.

     On January 23, 2002, the Company received notice from Barr Laboratories, Inc. (“Barr”) that it had filed with the FDA an Abbreviated New Drug Application (“ANDA”) that would, if approved, allow Barr to market a generic version of the Company’s 1000 mg Niaspan product. As a result, on March 4, 2002, the Company filed a patent infringement lawsuit against Barr in the Southern District of New York (“SDNY”). On March 11, 2002, the Company filed an amended complaint (the “Amended Complaint”). In this lawsuit, the Company asserted that Barr has infringed the ‘428 and ‘930 patents. On March 25, 2002, Barr answered the Amended Complaint by denying that the ‘428 and ‘930 patents are valid and infringed, and seeking a declaratory judgment to that effect. On August 19, 2002, Barr amended its answer to add counterclaims requesting a declaratory judgment that two other patents owned by Kos, U.S. Patent Numbers 5,126,145 and 5,268,181, are not infringed, and that the ‘181 patent is invalid.

     On July 9, 2002, the Company received notice from Barr that it had filed an ANDA with the FDA that would, if approved, allow Barr to market generic versions of the Company’s 500 mg and 750 mg Niaspan products. On August 13, 2002, the Company filed a second patent infringement lawsuit against Barr also in the SDNY. Again, the Company asserted that Barr has infringed the ‘428 and ‘930 patents. On September 3, 2002, Barr answered the complaint by denying infringement and alleging that the patents are invalid. Barr also sought a declaratory judgment that the ‘428, ‘930, ‘145, and ‘181 patents are not infringed, and that the ‘428, ‘930, and ‘181 patents are invalid. The two cases were consolidated on September 23, 2002.

     On September 30, 2002, the Company received notice from Barr that it had filed a Supplemental Paragraph IV Certification relating to Kos’ ‘715 patent. The Company filed a third lawsuit on November 12, 2002, against Barr in the SDNY asserting infringement of this patent. On December 3, 2002, Barr answered the complaint by denying that the ‘715 patent is valid and infringed, and seeking a declaratory judgment of invalidity. Barr also sought a declaratory judgment that the ‘428, ‘930, ‘145, and ‘181 patents are not infringed, and that the ‘428, ‘930 and ‘181 patents are invalid.

     The third case was consolidated with the first two on January 23, 2003. On March 4, 2003, Kos replied to Barr’s declaratory judgment counterclaims by denying that Kos’ patents are invalid or not infringed. Kos also sought a declaratory judgment that one or more of Barr’s products will infringe the ‘145 and ‘181 patents. During the course of the litigation, Barr has also suggested claims of anti trust and

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unenforceability. Kos has received several notices from Barr Laboratories that Barr has filed a Supplemental Paragraph IV Certification to each ANDA to provide for U.S. Patent No. 6,676,967. The first notice was received by Kos on January 21, 2004 and the latest on February 23, 2004. Kos is currently evaluating its options.

     On August 6, 2003, the Company filed a trademark infringement lawsuit against Andrx Corporation and Andrx Laboratories, Inc. (“Andrx”) in the U.S. District Court for the District of New Jersey based on Andrx’s use of the mark Altocor for its cholesterol product. In conjunction with its complaint, the Company also filed a Motion for Preliminary Injunction the same day. Andrx filed an Opposition to the Motion for Preliminary Injunction on August 28, 2003. Andrx answered the Company’s Complaint on September 2, 2003. The Company filed its Reply in support of its Motion for Preliminary Injunction on September 8, 2003. Oral argument on the Motion for Preliminary Injunction was held on September 17, 2003. An Order denying the Motion for Preliminary Injunction was entered September 23, 2003. The Company filed a Notice of Appeal to the Order denying the Preliminary Injunction on September 30, 2003, and a Motion for Expedited Consideration of the Appeal on October 3, 2003, in the Third Circuit. Andrx filed a Motion in Opposition of Expedited Consideration on October 10, 2003, and the Company replied October 15, 2003. The Company’s Motion for Expedited Review of the Appeal was granted on October 31, 2003. On November 24, 2003, the Company filed its Third Circuit Appellate Brief, Andrx filed a Brief in Opposition December 5, 2003, and the Company filed its Reply Brief December 15, 2003.

     There can be no assurance that the Company will be successful in defending its patents in the Barr litigation. If the Company is not successful in defending its patents, Barr and other competitors may be able to produce and market generic version of its Niaspan products, which could be sold at prices lower than those charged by the Company. This would have a material adverse effect on the Company’s business and financial results. The Company is unable to estimate the economic impact if it is not successful in defending its patents.

     Because the patent positions of pharmaceutical and biotechnology companies are highly uncertain and involve complex legal and factual questions, the patents owned and licensed by Kos, or any future patents, may not prevent other companies from developing competing products or ensure that others will not be issued patents that may prevent the sale of the Company’s products or require licensing and the payment of significant fees or royalties. Furthermore, to the extent that (1) any of the Company’s future products or methods are not patentable, (2) such products or methods infringe upon the patents of third parties, or (3) the Company’s patents or future patents fail to give Kos an exclusive position in the subject matter to which those patents relate, the Company will be adversely affected. The Company may be unable to avoid infringement of third party patents and may have to obtain a license, or defend an infringement action and challenge the validity of the patents in court. A license may be unavailable on terms and conditions acceptable to the Company, if at all. Patent litigation is costly and time consuming, and the Company may be unable to prevail in any such patent litigation or devote sufficient resources to even pursue such litigation. If the Company does not obtain a license under such patents, or if it is found liable for infringement and if it is not able to have such patents declared invalid, the Company may be liable for significant money damages, may encounter significant delays in bringing products to market, or may be precluded from participating in the manufacture, use, or sale of products or methods of treatment requiring such licenses.

Government Regulation; No Assurances of Regulatory Approval

     The Company’s research and development activities, preclinical studies, clinical trials, and the manufacturing and marketing of the Company’s products are subject to extensive regulation by the FDA. The drug development and approval process takes many years and requires the expenditure of substantial resources. Data obtained from preclinical and clinical activities are susceptible to varying interpretations that could delay, limit, or prevent regulatory approval. Although the Company may consult the FDA for

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guidance in developing protocols for clinical trials, despite such consultation, the FDA may find the clinical trials inadequate or not well-controlled. They may also reject the results of those trials altogether. In addition, delays or rejections of applications for regulatory approval may result from changes in or additions to FDA regulations concerning the drug approval process. Thus, regulatory reviews may be untimely and regulatory approvals could be denied for products developed by the Company. Even if regulatory approval of a product is obtained, the approval will be limited as to the indicated uses for which it may be promoted or marketed. In addition, a marketed drug, its bulk chemical supplier, its manufacturer, and its manufacturing facilities are subject to continual regulatory review and periodic inspections, and later discovery of previously unknown problems with a product, supplier, manufacturer, or facility may result in restrictions on such products or manufacturers, which may require a withdrawal of the product from the market. Failure to comply with the applicable regulatory requirements in the United States or abroad can, among other things, result in fines, suspensions of regulatory approvals, seizure of products, product recalls, operating restrictions, and criminal prosecution, any of which could have a material adverse effect on Kos.

     Outside the United States, the Company’s research and development activities, preclinical studies, clinical trials, and the manufacturing and marketing of the Company’s products are subject to extensive foreign regulation. In the European Union, the approval of new drugs is governed by the central approval or mutual recognition procedures of the European Medicines Evaluation Agency (“EMEA”). In 1999, the Company received marketing approval for Niaspan in the United Kingdom, and in 2002, submitted Advicor for marketing approval in the United Kingdom. Pursuant to the Merck Agreement, the Company is responsible for obtaining initial marketing authorization for the Niaspan or Advicor products in all countries in the European Union. There could be delays or rejections in applications for regulatory approval in Europe and in other countries, as well a requirement of completion of additional preclinical and clinical studies. The process of obtaining regulatory approval could be costly. In addition, competitors of the Company may obtain regulatory approval for similar products. Even if regulatory approval of a product is obtained, the approval will be limited as to the indicated uses for which it may be promoted or marketed, and the product will be subject to a continual regulatory review and inspections, which, if previously unknown problems are discovered, may result in restrictions on the products and manufacturers, which may require a withdrawal of the product from the market. In addition, individual countries will have pricing, third party reimbursement and labeling approvals necessary for the manufacture, distribution, use and sale of products with which the Company must comply. Moreover, because the legislative and regulatory environment continues to evolve in the U.S. and abroad, it is difficult to predict the impact of legislation and regulations on the Company and its products.

     In July 2001, the Division of Drug Marketing, Advertising, and Communication at the FDA issued a warning letter to Kos related to an advertisement the Company ran in a healthcare section of TIME magazine. The advertisement, which the Company intended to run only one time, was designed to increase awareness of the Company’s Niaspan product. In its warning letter, the FDA objected to the advertisement on the grounds that the advertisement failed to reflect a fair balance of the contraindications, warnings, precautions, and side effects of the Company’s Niaspan product. The FDA also objected to the advertisement on the grounds that the advertisement overstated the efficacy of the Niaspan product in light of its approved labeling. Subsequent to this event, the Company reached agreement with the FDA to remedy their objections by placing a new advertisement with content that adequately characterizes the risks and other safety implications for the product.

     The Company’s business is also subject to regulation under state, federal and local laws, rules, regulations, and policies relating to the protection of the environment and health and safety, including those governing the use, generation, manufacture, storage, air emission, effluent discharge, handling, and disposal of certain materials. The Company believes that it is in compliance in all material respects with all such laws, rules, regulations, and policies applicable to Kos. However, non-compliance with such environmental and health and safety laws and regulations in the future would require Kos to incur

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significant costs to comply. The Company’s research and development involves the controlled use of hazardous materials. Although the Company believes that its safety procedures for handling and disposing of such materials comply with the standards prescribed by applicable state, federal, and local regulations, the risk of contamination or injury from these materials cannot be completely eliminated. In the event of such contamination or injury, the Company could be held liable for any damages that result and any such liability could exceed its resources and materially adversely affect the Company’s business, financial condition and results of operations.

Manufacturing

     On December 29, 2003, the FDA issued the Company a warning letter related to a routine, unannounced inspection of the Company’s principal manufacturing facility located in Edison, New Jersey. The letter cited four deficiencies in the Company’s quality systems. The Company is working diligently to remedy these deficiencies, and plans to cooperate fully with the FDA to take any corrective action that may be required to further assure the quality of the Company’s products. Based upon the observations noted in the December warning letter, the Company is not currently in compliance with cGMP. Although such status does not prohibit Kos from producing product for commercial sale, this status may result in a delay in the approval by the FDA of any pending Company sponsored regulatory applications. It may also contribute to a delay in the Company’s marketing partner’s receipt of final product approval in certain foreign countries. Further, if appropriate corrective actions are not taken in response to the issues raised in the December warning letter, the FDA, upon re-inspection of the Company’s Edison manufacturing facility, may impose additional regulatory sanctions that may include withdrawal or seizure from the market of Kos’ products.

     The Company’s manufacturing facilities are and will continue to be subject to ongoing, periodic inspection by the FDA and state agencies to ensure compliance with cGMP. The Company’s failure to follow and document the Company’s adherence to such cGMP regulations or other regulatory requirements may lead to significant delays in the availability of the Company’s products, including the Niaspan and Advicor products, for commercial use or clinical study, may result in the termination or hold of a clinical study, or may delay or prevent filing or approval of marketing applications for Kos’ products.

     The Company also may encounter problems with, among other things, the following:

•		achieving consistent and acceptable production yield and costs;
•		meeting product release specifications;
•		quality control and assurance;
•		shortages of qualified manufacturing personnel;
•		shortages of raw materials;
•		shortages of key contractors; and
•		ongoing compliance with FDA and other regulations.

     Any of the foregoing could result in the Company being unable to manufacture and supply sufficient quantities of its Niaspan and Advicor products to meet the demands of its customers, or to fulfill orders from its international marketing partner. In addition, the resolution of the concerns raised by the FDA in its recent warning letter could result in the Company being required to implement manufacturing, testing or other procedures that could materially reduce the efficiency of the Company’s manufacturing and supply capability and could reduce the amount of quantities of the Company’s products that the Company has available for sale. The Company’s failure for any reason to manufacture and supply sufficient quantities of the Niaspan and Advicor products would have a material adverse impact on the Company and its financial condition. The extent of such adverse effect would depend on the nature, timing, scope

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and duration of the manufacturing issues. Although the Company is currently in discussions with a contract manufacturer, the Company does not currently have a qualified backup manufacturing capability with a third party.

     Failure to comply with applicable manufacturing regulations could also result in sanctions being imposed on the Company, including fines, injunctions, civil penalties, failure of regulatory authorities to grant marketing approval of the Company’s products, delays, suspension or withdrawal of approvals, license revocation, seizures or recalls of products, operating restrictions and criminal prosecutions, any of which could harm the Company’s business. If the Company is unable to manufacture its products for any reason, the Company’s options for outsourcing manufacturing are currently limited. It would take a substantial period of time for a contract manufacturing facility that has not been producing the Company’s particular products to begin producing them under cGMP regulations.

Limited Manufacturing Experience; Risk of Scale-Up

     The Company currently manufactures the Niaspan and Advicor products in one manufacturing plant in Edison, New Jersey that has been inspected and approved by the FDA for both Niaspan and Advicor. Although both products have been approved for manufacture in the Edison facility, the Company has limited experience in manufacturing products for commercial sale in the Edison facility and inefficiencies may exist in the manufacturing process. The Company may need to further scale-up certain of the Company’s current manufacturing processes to achieve production levels consistent with the commercial sale of its products for both the U.S. and international use. Further, modifications to the facilities, systems, and procedures may be necessary to maintain capacity at a level sufficient to meet market demand or to maintain compliance with current good manufacturing practices regulations and other regulations prescribed by various regulatory agencies including the Occupational Safety and Health Administration and the Environmental Protection Agency. The Company’s failure to successfully further scale-up, expand in connection with manufacture for commercial sale, or modify the Company’s manufacturing process or to comply with current good manufacturing practices regulations and other regulations could delay the approval of its products under development or limit its ability to meet the demand for its products, any of which would have a material adverse effect on Kos. Such occurrences may require Kos to acquire alternative means of manufacturing the Company’s products, which may not be available on a timely basis, on commercially practicable terms, or at all.

Dependence on Single Sources of Supply

     Some materials used in the Company’s products, including the active ingredients in Niaspan and Advicor, are currently sourced from single qualified suppliers. The Company has not established arrangements with alternative suppliers for these ingredients, although the Company believes that it can obtain an alternative supply of lovastatin, one of the two active ingredients in Advicor, if necessary. Although the Company has maintained a business relationship with its niacin supplier since 1993, and has not experienced difficulty to date in acquiring niacin, or other materials for product development, additional product validations and regulatory submissions would be required if supply interruptions were to occur in the future or if the Company had to obtain substitute materials. Similarly, the Company’s source for lovastatin is relatively inexperienced as a supplier of such ingredient. Although the Company has maintained a business relationship with its lovastatin supplier since 1997, and this supplier is experienced as a supplier of other pharmaceutical grade active ingredients, this supplier may be unable to meet the Company’s requirements for lovastatin on a sustained basis, at an acceptable quality standard, or at a commercially viable price. In such an event, the Company would be forced to obtain an alternative supplier of lovastatin. Any interruption of raw material supply, for any reason, in any of the required ingredients for the Company’s products could have a material adverse effect on Kos’ ability to manufacture its products or to obtain or maintain regulatory approval of such products.

     In the event that the Company consummates its transaction with Aventis and acquires the Azmacort product, the Company will rely on Aventis to manufacture and supply adequate quantities of the finished

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Azmacort product. Although there is one other company that is currently qualified to manufacture and supply the Azmacort product, the Company does not have any contractual arrangement with such other entity. As a result, the Company will rely solely on Aventis to supply the Company with the Azmacort product, and the Company cannot provide any assurances that Aventis will be able to produce sufficient quantities of the Azmacort product to meet the Company’s requirements. The Azmacort product can be difficult to produce and requires the assembly of several different components, the unavailability of any of which can result in an interruption in the supply of finished Azmacort products to the Company. The manufacture and assembly of each of the components, in addition to the qualification of the raw materials used in the finished Azmacort product, is subject to regulatory approval. If Kos, Aventis or Aventis’ suppliers are unable to maintain the regulatory approval for such components, raw materials or finished product, or are unable to manufacture and store them in compliance with applicable regulatory requirements, Aventis may not be able to supply the Company with sufficient quantities of the finished Azmacort product. The Company is dependent on the performance by Aventis and its suppliers for the manufacture and supply of the finished Azmacort products, and the Company cannot provide any assurance of their willingness or ability to perform their manufacturing responsibilities in the future. Any interruption of supply, for any reason, of the finished Azmacort product to the Company would have a material adverse effect on the Company’s financial condition and results of operations.

Risk of Product Liability Claims; No Assurance of Adequate Insurance

     Manufacturing, marketing, selling, and testing Niaspan, Advicor, and the Company’s products under development or to be acquired or licensed, entails a risk of product liability. On August 8, 2001, Bayer AG, removed its statin product, Baycol, from the market because of multiple deaths attributed to a rare form of a muscle disorder called rhabdomyolysis. As a result of the removal of Baycol from the market, however, the side affects of statin products have been subject to increased scrutiny. Although the statin component of Advicor has been approved by the FDA and marketed for nearly 16 years and is a different drug compound than that which was used in Baycol, to the extent that patients who take Advicor develop serious adverse side affects, such as rhabdomyolysis, or associate the adverse events experienced by some Baycol patients with all other statin products, including the Company’s Advicor product, it would have a material adverse effect on the Company’s business. The Company could be subject to product liability claims in the event that its products or products under development fail to perform as intended. Even unsuccessful claims could result in the expenditure of funds in litigation and the diversion of management time and resources and could damage the Company’s reputation and impair the marketability of its products. While the Company currently maintains liability insurance, the Company may not be able to maintain such insurance at a commercially reasonable cost. If a successful claim were made against the Company, and the amount of insurance were inadequate to cover the costs of defending against or paying such a claim, or the damages payable by Kos, the Company would experience a material adverse effect on its business, financial condition, and results of operations and on the price of the Company’s Common Stock.

Possible Stock Price Volatility

     The stock market, including the Nasdaq National Market, on which the Company’s shares are listed, has from time to time experienced significant price and volume fluctuations that may be unrelated to the operating performance of particular companies. In addition, the market price of the Company’s Common Stock, like the stock prices of many publicly traded pharmaceutical and biotechnology companies, has been and may continue to be highly volatile.

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     The following table sets forth, for the fiscal periods indicated, the range of high and low prices for trades of the Company’s Common Stock on the Nasdaq National Market System.

     The sale by the Company’s controlling shareholder or members of the Company’s management of shares of Common Stock, announcements of technological innovations or new commercial products by the Company or its competitors, developments or disputes concerning patent or proprietary rights, publicity regarding actual or potential medical results relating to the Niaspan and Advicor products or to products under development by Kos or its competitors, regulatory developments in either the United States or foreign countries, public concern as to the safety of pharmaceutical and biotechnology products, and economic and other external factors, as well as the trend of prescriptions for the Niaspan product and the Advicor product after its launch and the period-to-period fluctuations in sales or other financial results, among other factors, may have a significant impact on the market price of the Company’s Common Stock.

Anti-Takeover Provisions

     Certain provisions of the Company’s Articles of Incorporation and Bylaws generally permit removal of directors only for cause by a 60% vote of the shareholders, require a 60% vote of the shareholders to amend the Company’s Articles of Incorporation and Bylaws, require a demand of at least 50% of the Company’s shareholders to call a special meeting of shareholders, and prohibit shareholder actions by written consent. Certain of such provisions also allow the Board of Directors to authorize the issuance of Preferred Stock with rights superior to those of the Common Stock. Moreover, provisions of the Florida Business Corporation Act, to which the Company is subject, prohibit the voting of shares that are acquired in certain takeovers without the approval of the Board of Directors or the approval by a majority

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of the corporation’s voting shares. Accordingly, the forgoing provisions could prevent the removal of the Company’s current directors and management, or discourage a third party from attempting to acquire, or make it more difficult for a third party to acquire, control of Kos.

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REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS

To the Shareholders of Kos Pharmaceuticals, Inc.

     We have audited the accompanying consolidated balance sheets of Kos Pharmaceuticals, Inc. (a Florida corporation) and subsidiaries as of December 31, 2003 and 2002, and the related consolidated statements of operations, shareholders’ equity (deficit) and cash flows for the years then ended. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. The financial statements of Kos Pharmaceuticals, Inc. for the year ended December 31, 2001 were audited by other auditors who have ceased operations and whose report dated February 7, 2002, expressed an unqualified opinion on those statements.

     We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

     In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Kos Pharmaceuticals, Inc. and subsidiaries as of December 31, 2003 and 2002, and the consolidated results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States.

/s/ Ernst & Young LLP

Miami, Florida,
February 10, 2004,
except for Note 14, as to which the date is March 8, 2004

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     The following audit report of Arthur Andersen LLP is a copy of the original report dated February 7, 2002 included in our Annual Report on Form 10-K for the year ended December 31, 2001, and has not been reissued by Arthur Andersen LLP. We are including this copy of the Arthur Andersen LLP audit report pursuant to Rule 2-02(e) of Regulation S-X under the Securities Act of 1933.

REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS

To the Shareholders of Kos Pharmaceuticals, Inc.:

     We have audited the accompanying consolidated balance sheets of Kos Pharmaceuticals, Inc. (a Florida corporation) and subsidiary as of December 31, 2001 and 2000, and the related consolidated statements of operations, shareholders’ deficit and cash flows for each of the three years in the period ended December 31, 2001. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

     We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

     In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Kos Pharmaceuticals, Inc. and subsidiary as of December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States.

ARTHUR ANDERSEN LLP

Miami, Florida,
February 7, 2002.

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KOS PHARMACEUTICALS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

The accompanying notes are an integral part of these financial statements.

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KOS PHARMACEUTICALS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

The accompanying notes are an integral part of these financial statements.

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KOS PHARMACEUTICALS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (DEFICIT)

The accompanying notes are an integral part of these financial statements.

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KOS PHARMACEUTICALS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

The accompanying notes are an integral part of these financial statements.

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KOS PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. General

     Kos Pharmaceuticals, Inc. (“Kos” or the “Company”) develops prescription pharmaceutical products principally for the cardiovascular and respiratory markets.

     On July 28, 1997, the Company received clearance from the U.S. Food and Drug Administration (“FDA”) to market Niaspan® for the treatment of mixed lipid disorders, a condition in which a patient is observed to have several abnormalities in the levels of the fatlike substances, called lipids, that contribute to heart disease. Niaspan is the only once-a-day prescription and the first extended-release formulation of any type of product with niacin as the active ingredient ever approved by the FDA for the treatment of mixed lipid disorders. Niaspan is indicated for the following: (i) reduce elevated total cholesterol, low-density lipoprotein cholesterol, commonly referred to as LDL or “bad cholesterol,” and apolipoprotein B, another lipid particle, and increase low high-density lipoprotein cholesterol, commonly referred to as HDL or “good cholesterol;” (ii) reduce very high serum triglycerides, which are fatty substances in the blood that contribute to heart disease; (iii) reduce elevated total and LDL cholesterol when used in combination with a bile-binding resin, which is a different class of drugs that reduces bad cholesterol; (iv) reduce recurrent nonfatal myocardial infarction, or the recurrence of nonfatal heart attacks; and (v) promote the regression or slow the progression of atherosclerosis, which is a medical condition involving the narrowing of the arteries to the heart, when combined with bile-binding resins. Additionally, Niaspan’s prescribing information references its ability to significantly reduce lipoprotein (a), which is referred to as the “very bad cholesterol” and is an independent risk factor for coronary heart disease.

     On January 28, 2002, the Company launched Advicor®, a new solid-dose drug containing Niaspan and lovastatin, which is a currently marketed cholesterol-lowering drug, for the treatment of mixed lipid disorders. The Company believes that a once-a-night tablet with the combined complementary properties of its Niaspan product and lovastatin represents an effective method for treating patients with mixed lipid disorders.

     The Company is currently developing several other products in solid-dose and inhaled dosage forms.

     No assurance can be given that the Company’s products can be successfully marketed, that products under development can be successfully formulated or manufactured at acceptable cost and with appropriate quality, or that required regulatory approvals will be obtained. The Company is subject to a number of other risks including, but not limited to, uncertainties related to market acceptance, future capital needs and uncertainty of additional funding, including its ability to meet all of the conditions necessary to obtain funding under its credit facilities with Michael Jaharis; uncertainties related to the protection afforded by the Company’s patents and patent applications; uncertainties related to foreign regulatory approvals; uncertainties related to patents and trademarks, including interference and risk of infringement; uncertainties related to competition and technological changes, government regulation, dependence on product development collaborators, limited manufacturing experience and risk of scale-up, dependence on single sources of supply; and no assurances of adequate third party reimbursement. The likelihood of the success of the Company also must be considered in light of the uncertainty caused by problems, expenses, complications, and delays frequently encountered in connection with the development of new business ventures.

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2. Summary of Significant Accounting Policies

Basis of Presentation

     The consolidated financial statements include the results of the Company and its subsidiaries, Aeropharm Technology, Inc. and Kos Life Sciences, Inc. All intercompany accounts and transactions have been eliminated in consolidation.

Use of Estimates

     The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Significant estimates and assumptions made by management in the preparation of the accompanying financial statements include the allowance for doubtful accounts; reserves for inventory obsolescence, product returns, chargebacks, rebates, discounts and other sales allowances; estimation of customer inventory levels; and the valuation allowance on deferred income taxes. Actual results could differ from those estimates.

Cash and Cash Equivalents

     The Company considers all highly liquid investments purchased with an original maturity of 90 days or less to be cash equivalents. As of December 31, 2003, $17,800,000 of cash and cash equivalents were pledged as collateral on outstanding letters of credit.

Allowance for Doubtful Accounts

     The Company specifically analyzes its trade receivables and provides reserves for items determined not to be collectable. In addition, the Company provides general reserves for a portion of receivables where items, generally based on age, are deemed to represent a significant risk of loss. Historically, the Company has not had significant write-offs.

Inventories

     Inventories are stated at the lower of cost or market. Cost is determined using the first-in, first-out method. Components of inventory cost include raw materials, labor, and manufacturing overhead. The Company considers factors such as the amount of inventory on hand, estimated time required to sell such inventories, remaining shelf life, and current market conditions to determine whether inventories are stated at the lower of cost or market.

     Certain raw materials used by the Company in the manufacture of its Niaspan and Advicor products are available from a limited number of suppliers. The Company is dependent on its suppliers to allocate a sufficient portion of their capacity to meet the Company’s needs.

Long-Lived Assets

     The Company evaluates the recoverability of long-lived assets whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by the comparison of the carrying amount of the assets to the estimated undiscounted future cash flows associated with them. At the time such evaluations indicate that the future undiscounted cash flows of certain long-lived assets are not sufficient to recover the carrying value of such assets, the assets are adjusted to their fair values.

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     The Company evaluates the recoverability of long-lived assets held for sale by comparing the asset’s carrying amount with its fair value less cost to sell. No assets were held for sale as of December 31, 2003 or 2002.

Fair Value of Financial Instruments

     As of December 31, 2003 and 2002, the carrying amount of cash and cash equivalents, trade accounts receivable, and accounts payable approximates fair value due to the short term nature of these accounts. The fair value of notes payable to shareholder is determined using interest rates in effect as of the balance sheet date and, because interest expense is payable utilizing variable rates that re-price frequently, the carrying value approximates fair value.

Concentration of Credit Risk

     The Company maintains its cash and cash equivalents with a major financial institution. The Company performs periodic evaluations of the relative credit standing of this institution to limit its credit risk exposure.

     The Company conducts a significant amount of its sales with a limited number of large pharmaceutical wholesalers and warehousing chains. Accordingly, 86% of the trade accounts receivable before allowances at December 31, 2003, were represented by five of these customers. The Company performs periodic evaluations of the financial condition of all customers to limit its credit risk exposure, but does not obtain collateral. The Company has no significant off-balance-sheet concentrations of credit risk.

Revenue Recognition

     Sales and the related cost of sales are recognized at the time product arrives at the customer’s location. The Company’s largest customers are distributors who warehouse product and, in turn, sell that product to retailers and others. Net sales consist of gross sales to the Company’s customers less provisions for expected returns from customers, customer discounts, and rebates and chargebacks to managed care organizations with whom the Company has contracts. These provisions totaled $82,967,000, $44,369,000, and $19,542,000 for the years ended December 31, 2003, 2002, and 2001, respectively. Included in “Accrued expenses” in the accompanying consolidated balance sheets are $20,283,000 and $11,070,000, at December 31, 2003 and 2002, respectively, related to these provisions.

     Accounting for Product Returns — Impact on Revenue Recognition

     The Company periodically evaluates the volume of its Niaspan and Advicor products that are in customer inventories or elsewhere in the distribution channel to determine whether increased risk of product returns exists. For the period from the introduction of its products through December 31, 2002, Kos’ return risk expectations were consistently based on its limited product return experience given the early stage nature of its products and of the Company. Accordingly, Kos established a specific return risk estimate based on estimated inventory levels in the distribution channel that was used to determine the amount of revenue that could be recorded during a given period. During the quarter ended March 31, 2003, as a result of the significant history of minimal returns for both products since their introduction, Kos revised its return risk estimates to reflect the historically low product return patterns. This change in accounting estimate resulted in the Company recognizing as revenue all product shipments made during the year ended December 31, 2003, as well as $11.1 million of its prior period product shipments not previously recognized as revenue because of its previous product return risk exposure estimates. The impact of this change in estimate increased the Company’s reported revenues, net income, and basic and diluted earnings per share by $11.1 million, $9.9 million, and $0.45 per share and $0.24 per share, respectively, for the year ended December 31, 2003. The Company will continue to monitor wholesaler inventory levels, and, if the Company’s product return risk exceeds acceptable levels, the Company may

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be required to not recognize the revenue and related costs associated with the excess inventory until such return risk is mitigated.

Advance Payment Received on License Agreement

     On October 23, 2002, the Company signed an exclusive international commercialization agreement with Merck KGaA (“Merck”) to market the Company’s Niaspan and Advicor products outside the United States, Canada and Japan. Under terms of the agreement, Merck will provide Kos up to $61 million in licensing, milestone and reimbursement payments, including $15 million of upfront payments, of which $12.5 million are refundable to Merck by Kos if it fails to achieve certain regulatory milestones. The milestone payments are dependent on the achievement of certain regulatory approvals and sales thresholds. Kos will also receive 25% of net sales of the products in the territory, which includes the cost of goods sold. Merck will be responsible for conducting Phase IV clinical studies and commercialization activities while Kos is responsible for obtaining initial marketing authorization in all major European countries and for the supply and manufacturing of the products. Through December 31, 2003, Kos has received $15 million in upfront and reimbursement payments from Merck. Of this amount, $229,000 was offset against research and development expenses during the year ended December 31, 2003. The majority of these payments, however, will be recognized as revenue in future periods upon Kos achieving certain regulatory milestones.

Co-Promotion and Strategic Alliance Arrangements

     During 1999, the Company entered into a co-promotion collaboration agreement with Knoll Pharmaceutical Company (“Knoll”), for the promotion and marketing of Knoll’s Mavik and Tarka products (Mavik® and Tarka® are registered trademarks of Abbott Laboratories) within the United States (the “Knoll Agreement”). Under the terms of the Knoll Agreement, the Company was to receive an increasing percentage of revenue based on sales thresholds. The Company recorded $7.2 million of co-promotion revenue as a result of the Knoll Agreement for the year ended December 31, 2001. On March 2, 2001, Abbott Laboratories (“Abbott”) announced that it had finalized its acquisition of BASF’s pharmaceutical business, which included the global operations of Knoll. The Company and Abbott agreed to terminate the Knoll Agreement effective January 1, 2002.

     The Company entered into an agreement, effective May 3, 2000, with DuPont Pharmaceuticals Company (“DuPont”) to form a strategic alliance for the purpose of co-promoting the Company’s Advicor product in the United States and Canada (the “DuPont Agreement”). Under the terms of the DuPont Agreement, the Company and DuPont would have shared in the future development and commercialization of the Advicor product. Specifically, DuPont had agreed (i) to make equity investments in the Company of up to $30 million through the date of FDA approval of the Advicor product; (ii) to pay the Company $17.5 million in milestone payments upon FDA approval of the Advicor product; (iii) to fund up to $32.5 million for future clinical development of the Advicor product; and (iv) to share equally in the costs associated with promoting the Advicor product and share equally in product profits after deducting a royalty to the Company. On May 31, 2000, DuPont made a $20-million equity investment in the Company in exchange for 1,250,000 shares of the Company’s Common Stock. On June 7, 2001, DuPont’s parent company, E.I. du Pont Nemours, announced that it had entered into an agreement to sell DuPont to Bristol-Myers Squibb Company (“BMS”) and on October 1, 2001, BMS completed its acquisition of DuPont. On December 17, 2001, the Company entered into an agreement with BMS pursuant to which the DuPont Agreement was terminated and BMS paid Kos $45 million (the “BMS Payment”). The BMS Payment, offset by approximately $6 million of promotional expenses due to Kos by BMS at the time of termination, was recorded as “Other Income” in the accompanying consolidated statements of operations for the year ended December 31, 2001.

     On October 17, 2003, the Company entered into a three-year agreement with Takeda Pharmaceuticals North America, Inc. (“Takeda”) to co-promote Niaspan and Advicor in the United States. Pursuant to this

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agreement, Takeda will utilize its U.S.-based sales force to promote Niaspan and Advicor in addition to its own product. Takeda is responsible for providing a promotional effort that is expected to significantly increase the amount of product details performed per year, and for all costs associated with its sales force, including promotional materials and samples. The Company is responsible for manufacturing and supplying both products and will collect and record all sales associated with its products. Takeda will receive a royalty on incremental net sales of the products in the United States above a certain baseline amount. This co-promotion arrangement has a three-year term commencing January 2004 and provides for residual payments to Takeda after the three years, if the parties do not renew the agreement.

Fixed Assets

     Fixed assets are stated at cost, less accumulated depreciation and amortization. Depreciation and amortization are provided using the straight-line method over the estimated useful lives of the assets or lease terms as follows:

     Effective January 1, 2002, the Company made certain prospective changes in the estimated useful lives of most of its fixed assets. This change was made to better reflect how the assets are expected to be used over time and to provide a better matching of revenues and expenses. The effect of this change on net loss for 2002 was not material.

Research and Development Expenses

     All research and development expenses are reflected in the Company’s consolidated statements of operations as incurred.

Advertising Expense

     The Company records the cost of its advertising efforts when services are performed or goods are delivered. The Company recorded $6,829,000, $7,279,000, and $6,781,000 in advertising expense for the years ended December 31, 2003, 2002, and 2001, respectively.

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Net Income (Loss) Per Share

     Basic earnings (loss) per share is determined by dividing the Company’s net income (loss) by the weighted average number of shares of Common Stock outstanding. Diluted income (loss) per share also includes dilutive Common Stock equivalents outstanding after applying the “treasury stock” method to outstanding stock options and warrants and the “if converted” method to convertible debt. A reconciliation of the numerator and denominator of the basic and diluted earnings per share computation is as follows:

     The following Common Stock equivalents have been excluded from the calculation of weighted average shares outstanding because their impact is antidilutive:

Income Taxes

     The Company follows Statement of Financial Accounting Standards (“SFAS”) No. 109, “Accounting for Income Taxes”, which requires, among other things, recognition of future tax benefits measured at enacted rates attributable to deductible temporary differences between financial statement and income tax bases of assets and liabilities and to tax net operating loss carryforwards to the extent that realization of said benefits is more likely than not. As of December 31, 2003, the Company had available approximately $146.7 million of net operating loss carryforwards that expire between 2004 and 2021.

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     The composition of the net deferred tax assets is as follows:

     The Company has an accumulated deficit as of December 31, 2003, of approximately $233.9 million. Excluding the impact of the BMS Payment, the Company generated full-year income before provision for income taxes for the first time in 2003. Management has re-evaluated the continuing need for a valuation allowance against deferred tax assets and, based on the history of net losses, concluded that there is not sufficient evidence as of December 31, 2003, to conclude that the Company will “more likely than not” realize all or a portion of its deferred tax assets. However, if in the future management concludes that some or all of its deferred tax assets will “more likely than not” be realized, then the Company will be required to recognize such assets by reversing all or the applicable portion of the valuation allowance.

     There was no provision for income taxes for the years ended December 31, 2002 and 2001. Although the Company has sufficient net operating losses to offset taxable income, the use of net operating losses is limited under federal alternative minimum tax rules to 90% of taxable income. Similar rules apply to state taxing jurisdictions where state income tax is based on an apportionment of federal taxable income. Consequently, the Company recorded a provision for income taxes of $2,878,821 for the year ended December 31, 2003 to reflect $1,259,368 in federal alternative minimum tax and $1,619,453 in state income tax liabilities that cannot be offset by utilizing the Company’s net operating loss carryforwards. A reconciliation between the statutory federal income tax expense and the income tax expense at the Company’s effective rate for the years ended December 31, 2003, 2002 and 2001 is set forth below:

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Reporting of Comprehensive Income or Loss

     SFAS No. 130 “Reporting Comprehensive Income”, establishes standards for reporting and display of comprehensive income and its components in a full set of financial statements. Comprehensive income or loss refers to revenues, expenses, gains and losses that are not included in net income or loss but rather are recorded directly in stockholders’ equity, such as certain unrealized gain or loss items. The Company’s reported net income (loss) equals comprehensive income (loss) for all periods presented.

Accounting for Stock-Based Compensation

     As permitted by SFAS No. 148, “Accounting for Stock-Based Compensation” (“SFAS 148”), which amended SFAS No. 123, “Accounting for Stock-Based Compensation”, the Company accounts for options issued to employees and to outside directors (after June 30, 2000) under Accounting Principles Board (“APB”) Opinion No. 25 “Accounting for Stock Issued to Employees” (“APB 25”). Except for compensation cost of $774,000, included in “Selling, general and administrative” in the accompanying consolidated statements of operations, related to the modification of a terminated employee’s options in 2003, no compensation cost has been recognized on options issued to employees because the exercise price of such options was not less than the market value of the Common Stock on the date of grant. Had compensation cost for options issued to employees been determined consistent with SFAS 148, the Company’s net income (loss) and net income (loss) per share would have been the “Pro forma” amounts shown in the following table: