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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark one)

For the Fiscal Year Ended December 31, 2003.

Or

For the Transition Period from              to             .

Commission File Number:

000-31633

Kosan Biosciences Incorporated

(Exact name of registrant as specified in its charter)

3832 Bay Center Place, Hayward, California 94545

(address of principal executive offices)

(510) 732-8400

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, $.001 par value per share

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

Indicate by check mark if disclosure 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 Exchange Act Rule 12b-2).    Yes  x    No  ¨

State the aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter: $95,022,879. ⁽¹⁾

The aggregate market value of the common stock of the registrant held by non-affiliates as of February 29, 2004, based upon the closing sale price of the registrant’s common stock listed on the Nasdaq National Market on February 27, 2004, was $212,035,663. ⁽²⁾

The number of shares of common stock of the registrant outstanding at February 29, 2004 was 28,809,778 shares.

DOCUMENTS INCORPORATED BY REFERENCE

Certain portions of the registrant’s Proxy Statement in connection with the registrant’s 2004 Annual Meeting of Stockholders, to be filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the end of the fiscal year covered by this report on Form 10-K, are incorporated by reference into Part II and Part III of this report.

Table of Contents

Kosan Biosciences Incorporated

Form 10-K

For the Fiscal Year Ended December 31, 2003

TABLE OF CONTENTS

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PART I

Forward-Looking Statements and Risk Factors

This annual report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, which are subject to the “safe harbor” created by those sections. These forward-looking statements include, but are not limited to, statements about:

These forward-looking statements are generally identified by words such as “expect,” “anticipate,” “intend,” “believe,” “hope,” “assume,” “estimate,” “plan,” “will” and other similar words and expressions. In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances are forward-looking statements. Discussions containing these forward-looking statements may be found in “Business” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” These forward-looking statements involve risks and uncertainties, including the risks discussed in “Item 1. Business—Risks Factors That May Affect Results of Operations and Financial Condition,” that could cause our actual results to differ materially from those in the forward-looking statements. We undertake no obligation to publicly release any revisions to the forward-looking statements or reflect events or circumstances after the date of this document. The risks discussed in “Item 1. Business—Risks Factors That May Affect Results of Operations and Financial Condition” and elsewhere in this report should be considered in evaluating our prospects and future financial performance.

Item 1. Business

Overview

We are a biotechnology company developing drug candidates from an important class of natural product compounds known as polyketides. Polyketides are naturally made in very small amounts in certain microorganisms and are difficult to make or modify chemically. Using our expertise and proprietary technologies, we are able to create, modify and produce polyketides in a variety of ways. Because polyketides have been a rich source of marketed drugs, creating novel polyketides and having the capability to more cost-effectively produce polyketides should provide us with a pipeline of potential drug candidates that address existing or potential large markets.

We can make improved versions of a known polyketide pharmaceutical product or product candidate and are able to change a polyketide used in one therapeutic area to create a new polyketide to be used for another therapeutic area. We can also take the genetic instructions for making a polyketide out of one microorganism and put them into another that provides a more favorable environment to produce more of the polyketide. We can otherwise manipulate the genetic instructions for a polyketide in order to improve production.

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Our strategy is to use our technologies to create new polyketides, to make improved versions of known polyketide pharmaceuticals, to cost-effectively produce them and to advance selected drug candidates into clinical trials. We are co-developing epothilones, a class of polyketides, for the treatment of cancer with Hoffmann-La Roche, Inc. and F. Hoffmann-La Roche Ltd., collectively Roche, and have U.S. co-promotion rights to any resulting epothilones that receive regulatory approval for marketing. Our lead epothilone candidate, KOS-862 (Epothilone D), is in Phase II and Phase Ib clinical trials. In collaboration with the National Cancer Institute, or NCI, a component of the National Institutes of Health, or NIH, we are developing derivatives of geldanamycin, a polyketide, for the treatment of cancer. Our lead geldanamycin candidate, 17-AAG, a derivative of geldanamycin, is in Phase I and Phase Ib combination clinical trials being conducted by us and the NCI. We also have additional product candidates in the areas of cancer, infectious disease and gastrointestinal motility that are undergoing preclinical evaluation, and several early stage product research and technology development programs.

We were incorporated under the laws of the state of California in January 1995 and commenced operations in 1996. In July 2000, we were reincorporated under the laws of the state of Delaware.

Overview of Polyketides

Polyketides are complex natural products produced by certain microorganisms. There are about 10,000 known polyketides, from which numerous pharmaceutical products in many therapeutic areas have been derived. We focus on polyketides because of their demonstrated ability to address large markets and to treat many different disease conditions. The following table lists some of the important polyketides and their uses.

Selected Polyketide Products and Their Uses

Unlike most classes of compounds, different polyketides often have unrelated structures. The common features that link the polyketides as a class are the sequence of reactions by which they are formed, and the intermediate compounds made in these reactions. Each polyketide is produced by a unique polyketide synthase, or PKS, which is a large enzyme composed of many component enzymes. There are two types of PKSs, modular and iterative. We focus primarily on modular PKSs. Modular PKSs contain many enzymes, each of which is used only once during polyketide production, while iterative PKSs may use some enzymes several times. Erythromycin is an example of a polyketide made by a modular PKS. Erythromycin is not only a valuable antibiotic product, but it is also used in the production of the antibiotics azithromycin and clarithromycin.

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A modular PKS is composed of multiple proteins. The instructions for making these proteins are contained in the DNA, or genome, of the microorganism that produces the modular PKS. Each protein has its own set of instructions, which is called the gene for the protein. The complete set of genes for a modular PKS that produces a polyketide is called a gene cluster. When any gene of a polyketide gene cluster is identified, the entire cluster can usually be easily obtained. We accomplish this by using recombinant DNA technology, which is a set of techniques that enables scientists to combine or alter DNA from different organisms.

The synthesis of a polyketide essentially involves the linking of a number of small building block compounds to form the larger polyketide. A modular PKS can be functionally subdivided into units called modules, each of which is responsible for a single building block used in the synthesis. Synthesis begins at the first module, called the loading module, located at one end of the PKS, and continues to the end through multiple extender modules, each of which adds and modifies another building block. This process creates a chain of building blocks that forms the polyketide; in many instances, the chain is linked to itself to form a ring. Because each module codes for one building block, the number of modules in a PKS codes for the size of the polyketide. Each module contains three essential enzyme activities responsible for connecting the polyketide building blocks. One of these activities selects which building block (there are at least four different building blocks) is used, and the other two are involved in linking the building block to the growing chain and passing the chain to the next module. A module may also have one, two or three additional enzymes that modify the building blocks once they are incorporated into the chain.

The structure of a polyketide can therefore be viewed as being determined by the types, order and number of modules in a modular PKS. The types of modules dictate which building blocks are used, the order of the modules dictates the sequence of building blocks and the number of modules dictates the number of building blocks in, or size of, the polyketide. Modifying, adding or deleting modules results in specific and predictable changes to the structure of the polyketide. Polyketides may also be made by sophisticated duplicate synthesis techniques, or by a combination of chemical and biological techniques.

Our Strategy

Our goal is to create a pipeline of drug candidates that can be advanced into clinical trials and developed into commercialized drugs. Our focus is on drug candidates that address existing or potential large markets. Our strategy includes the following components:

Maximize Value, Minimize Risk. Our principal programs are focused on the development of improved versions of known compounds or drugs and increasing the efficiency of large-scale production of polyketides. By improving the properties of known compounds, we believe we can create novel products that take advantage of the known utility, safety, development path and market for existing drugs to reduce the risk and time required for development. By improving the efficiency of large-scale production, we can more cost-effectively access promising compounds that cannot be obtained from nature in sufficient quantities to permit development and commercialization.

Establish Collaborative Relationships. We have a collaboration with Roche to co-develop and to commercialize our anticancer product candidate, KOS-862, and other epothilone analogs for the treatment of cancer. We have a collaboration with the NCI to clinically develop 17-AAG and other geldanamycin derivatives for the treatment of cancer. We plan to establish additional collaborative relationships with large pharmaceutical companies and other research and development organizations to help us obtain our drug candidates or advance them into or through clinical trials and to the market, apply our technologies to create new polyketides and develop large-scale production systems.

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Acquire Complementary Technologies and Products. We have license agreements with Stanford University in the area of polyketide genetic engineering, the Sloan-Kettering Institute for Cancer Research, or Sloan-Kettering, in the area of epothilones and with the NCI in the area of geldanamycin analogs. We may acquire or license additional complementary technologies or product candidates from others.

Enhance Leadership Position of Our Technology Platform. We intend to expand and enhance our technologies by continuing in-house research activities on polyketide biosynthesis and chemical synthesis. We plan to continue to extend the reach of our technologies through strategic alliances or acquisitions. We plan to broaden and protect our intellectual property portfolio and in-license patents that complement our core technologies.

Product Development Opportunities

Our primary programs are currently directed at discovery and development of polyketides for cancer, infectious disease and gastrointestinal motility disorders. These programs were selected because they represent opportunities where our technologies could improve upon existing products or fill unmet needs, and because each addresses existing or potential large markets.

Cancer

Epothilones

Epothilones are polyketides that inhibit cancer cells by the same mechanism as a class of cytotoxic drugs known as taxanes, including paclitaxel, marketed as Taxol^® by Bristol-Myers Squibb Company, and docetaxel, marketed as Taxotere^® by Aventis Pharmaceuticals, Inc. In 2002, sales of taxanes were approximately $1.4 billion. The epothilones may address a key limitation of the taxane class because they are active against taxane-resistant human tumor cell lines in in vitro and in vivo animal models, as well as being active against taxane-sensitive human tumors cells in these models.

KOS-862 is our lead epothilone. KOS-862 is being evaluated in Phase II in advanced non-small cell lung, colorectal and breast cancers with Roche. We are conducting the lung cancer trial at multiple centers in North America, and Roche is conducting the other two multiple center trials. In addition to the Phase II monotherapy trials, Kosan and Roche are advancing KOS-862 into Phase Ib clinical trials in which KOS-862 is being evaluated in combination with Gemzar^®, Paraplatin^®, Herceptin^® and Xeloda^®, four standard-of-care anticancer chemotherapeutics. We and Roche are exploring additional epothilone analogs for development, with the objective of initiating clinical trials of a novel epothilone analog during 2004. Competing epothilones in clinical development include those being developed by Bristol-Myers Squibb (reported to be in Phase III clinical trials) and Novartis AG (reported to be in Phase II clinical trials).

In September 2002, we entered into an agreement with Roche to jointly develop KOS-862 and other epothilones.

Geldanamycin

We are developing analogs of the polyketide geldanamycin that have been shown to cause the degradation of numerous proteins involved in the growth and survival of cancer cells. These compounds bind to and disrupt the function of Hsp90 (heat shock protein 90). Hsp90 is a molecular “chaperone” in cells that maintains the stability and function of “client proteins” implicated in signal transduction as well as the proliferation, angiogenesis and metastasis of tumors. By preventing Hsp90 from protecting its “clients,” geldanamycin analogs cause their degradation. By simultaneously depleting multiple proteins involved in the genesis and maintenance of cancer cells, geldanamycin derivatives may serve as chemotherapeutic agents in a number of cancers. Moreover, preclinical studies suggest that these compounds are synergistic with certain other inhibitors of the signal transduction client proteins, as well as several conventional anticancer agents.

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In October 2002, we entered into two Cooperative Research and Development Agreements (CRADAs) with the NIH to collaborate with the NCI on the clinical development of 17-AAG and the development of geldanamycin derivatives. We are collaborating with the NCI to complete five ongoing Phase I 17-AAG clinical trials, in which over 180 patients have been treated, and three ongoing Phase Ib trials in which patients are treated with 17-AAG in combination with Taxotere^®, Gemzar^®/Platinol^® and Gleevec^®. In addition, we are collaborating with the NCI to initiate Phase II clinical trials of 17-AAG as a monotherapy and to initiate additional Phase Ib clinical trials of 17-AAG in combination with other anticancer drugs. Under the terms of the CRADAs, we are responsible for the provision of sufficient quantities of clinical materials necessary to conduct the clinical development of 17-AAG clinical trials funded by the NCI, and we have the option, at our expense, to conduct our own clinical trials of 17-AAG and geldanamycin derivatives in addition to those funded by the NCI. We have developed a new formulation of 17-AAG (KOS-953) that addresses a limitation of the first generation formulation. In December 2003, we filed an Investigational New Drug, or IND, application for KOS-953 and plan to initiate self-funded Phase I/II and Phase Ib clinical trials of this newly formulated product candidate during 2004. We also are collaborating with the NCI on initiating clinical trials of 17-DMAG, a highly potent, water-soluble and orally active derivative of geldanamycin.

Discodermolide

Discodermolide is a polyketide with a mechanism of action similar to both the taxanes and the epothilones. Discodermolide has broad-spectrum activity against cancer cells and is a potent inhibitor of taxane- and epothilone-resistant tumors in cell culture and in animal models. We have generated analogs with improved properties over the natural polyketide and are seeking to develop cost-effective production processes. Several of these compounds are undergoing preclinical evaluation.

Infectious Disease

Macrolides are clinically important antibiotics that have been used for the treatment of respiratory infections for more than 40 years.

Currently, the leading macrolides are clarithromycin, marketed as Biaxin^® by Abbott Laboratories, and azithromycin, marketed as Zithromax^® by Pfizer Inc. These are polyketide-derived antibiotics that show high potency, a broad spectrum of activity and few side effects. In 2002, these products had combined revenues of approximately $2.0 billion. In recent years, there has been increasing bacterial resistance to macrolides, driving the need to develop new and more effective drugs. Ketolides, derivatives of the polyketide erythromycin, possess the potency and spectrum of activity shown by clarithromycin and azithromycin, but are effective against some of these resistant organisms. Aventis has received regulatory approval in Europe and major Latin American markets and has received an approvable letter by the U.S. Food and Drug Administration, or FDA, to market a ketolide antibiotic called Ketek^®.

We have generated several proprietary ketolides with in vitro activity comparable or superior to other ketolides. Several of these compounds are currently undergoing preclinical evaluation by us.

Several compounds in this program resulted from a multi-year research collaboration between us and affiliates of Johnson & Johnson. Rights to these compounds reverted to us without any further obligation to Johnson & Johnson and its affiliates when the agreement expired in December 2003.

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Gastrointestinal Motility

One of the actions of erythromycin is stimulation of gastrointestinal movement, or GI motility. Erythromycin-derived compounds called motilides may be useful to treat diseases such as gastroparesis and other conditions in which GI motility is impaired or needs to be increased. We have made several series of motilides that stimulate GI motility in preclinical models and from which the unnecessary antibiotic activity of erythromycin has been eliminated. Several of these compounds are being evaluated in preclinical studies.

Our Technology Platform

Our technology platform has four components: polyketide gene alteration, chemo-biosynthesis, heterologous over-expression and polyketide chemical synthesis. Together, our technologies enable us to modify, create and produce proprietary polyketides with potential for development as valuable pharmaceutical products.

Polyketide Gene Alteration

The structure of a polyketide is primarily determined by variation in the number, order and type of modules in the PKS. Our technologies enable us to alter modules in a specific, directed manner, and thus we can make specific and predictable changes to the structure of a polyketide.

Polyketides are structurally complex compounds that are difficult to make or modify chemically. Because each building block of a polyketide is selected by a specific module of the PKS, we use our technologies to make precise structural changes by altering the module that specifies the targeted building block. We use our technologies to improve properties of known, biologically active molecules. This can be done by using our technology to change a portion of the polyketide that cannot be chemically modified to one that can, allowing us to make subsequent chemical modifications not otherwise practicable. We can also make changes in the structure of existing proprietary polyketide products to create a new polyketide proprietary to us.

We also are developing the capability to synthesize polyketide genes to facilitate biosynthetic production and to avoid the need to isolate polyketide synthase genes, or DNA, from nature.

Chemo-Biosynthesis

We incorporate chemically synthesized fragments into complicated polyketide structures, permitting changes in the polyketide structures and properties in ways that have not been achieved by any other process.

First, we disable the loading and first extender modules in a PKS by altering the gene that contains the instructions for these modules. This prevents formation of the two-building-block intermediate that feeds the second extender module, but leaves the remainder of the PKS fully functional. Then, microorganisms containing this modified PKS are fed our chemically synthesized fragments that substitute for the natural building-block intermediate.

Heterologous Over-Expression

We can isolate a polyketide gene cluster from one organism and transfer it to another. This is important because many polyketides are produced by microorganisms that are difficult or slow to grow, or in which recombinant DNA methods have not been developed. In addition, polyketides are often produced in small amounts in organisms that naturally produce them, which can limit their commercial development. We have created microorganisms for efficient polyketide manipulation and production. Our proprietary technologies allow us to transfer polyketide genes to these microorganisms to enable easier manipulation and increased production of polyketides necessary for commercialization.

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Polyketide Chemical Synthesis

We have developed state-of-the-art capabilities to chemically synthesize polyketides and to generate chemical derivatives of polyketide structures. This enables us to use total chemical synthesis as an alternative to polyketide gene alteration in order to obtain novel compounds and to combine chemical and biosynthetic approaches for production when appropriate.

Research and Development Expenses

Our research and development expenses were approximately $36.8 million in 2003, $28.4 million in 2002 and $25.5 million in 2001.

Intellectual Property

Our intellectual property consists of patents, copyrights, trade secrets and know-how. Our ability to compete effectively depends in large part on our ability to obtain patents for our technologies and products, maintain trade secrets and operate without infringing the rights of others and prevent others from infringing our proprietary rights. We will be able to protect our technologies from unauthorized use by third parties only to the extent that they are covered by valid and enforceable patents, or are effectively maintained as trade secrets. Accordingly, patents or other proprietary rights are an essential element of our business. As of December 31, 2003, we owned or were exclusively licensed under over 80 patents and 130 patent applications in the U.S., over 20 patents and 50 patent applications in Europe and 2 patents and over 40 patent applications in Japan. We also own or are exclusively licensed under patents and patent applications in other countries, and pursue patent protection for each case in countries where we believe it is commercially reasonable and advantageous to do so.

Our policy is to file patent applications to protect technology and compounds commercially important to our business. We also rely on trade secrets to protect our technology where patent protection is deemed inappropriate or unobtainable. We protect our proprietary technology and processes, in part, by confidentiality agreements with our employees, consultants, collaborators and certain contractors. There can be no assurance that our confidential trade secret information will not be disclosed, that others will not independently develop substantially equivalent proprietary information and techniques or that we can meaningfully protect our proprietary information.

Collaborative Research, Development and License Agreements

Roche

In September 2002, we signed a research and collaboration agreement with Roche. Under the terms of the agreement, Roche has worldwide exclusive rights to market and sell KOS-862 and other epothilones in the field of oncology, and we will co-develop and have the right to co-promote the products in the United States. The principal focus of the collaboration is the clinical development and marketing of KOS-862 and eventual back-up compounds. Any such back-up candidates would be collaboratively developed by Roche and us, and would be exclusively licensed to and marketed by Roche, and could, at our option, be co-promoted by us with Roche, all for the treatment of cancer.

Under the agreement, we are entitled to receive clinical development funding for our activities under the collaboration, process and back-up development program funding at specified levels, and milestone payments based upon achievement of clinical, regulatory and commercial events. We estimate that these types of cash payments could total up to $220 million, based upon our current expectations for program

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expenses and assuming successful development and commercialization of one product that achieves each milestone event. As of December 31, 2003, we have received approximately $42.9 million related to this collaboration. In addition, we are entitled to receive royalties on any sales of collaboration products. We have the option to increase our royalties by contributing to development costs and by co-promotion of products resulting from the collaboration.

Pursuant to this agreement, we recognized approximately $26.9 million and $3.4 million of contract revenue in 2003 and 2002, respectively. Such amounts, excluding the ratable portion of an initial fee and milestones, approximated research and development expenses under this collaboration agreement. Included in 2003 revenue was the ratable portion of the $25 million initial fee that is being recognized through the second half of 2007, the estimated clinical development period, and $6.0 million in non-recurring milestones achieved under the agreement.

Either party may terminate the agreement at any time for the other party’s uncured material breach of the agreement. In addition, Roche may terminate the agreement as a whole during an initial period solely for cause relating to the success of the program (not needing to relate to any breach by us), or after this initial period for convenience entirely or in part. Upon such a termination by Roche for cause or convenience, the licensed rights would revert to us and Roche would provide us with other assistance to take over the previously licensed products. Unless earlier terminated, the agreement will remain in effect for the life of the relevant patents or a specified number of years from product launch.

Sloan-Kettering Institute for Cancer Research

Effective August 2000, we signed a research and license agreement with Sloan-Kettering relating to epothilones. Under the agreement, we use our technologies to produce KOS-862, work collaboratively with Sloan-Kettering to develop compounds and production methods. Under the agreement, each party licenses the other party for activities as part of the collaborative program. In addition, Sloan-Kettering exclusively licenses us for all further development and commercialization of compounds selected by us in accordance with the agreement.

Under the agreement, we paid Sloan-Kettering an initial license fee and will pay annual maintenance fees as well as payments for research and development costs (including the costs of clinical trials). In addition, we must pay Sloan-Kettering milestone payments if clinical development milestones are reached, royalty payments based on net sales of products covered by the collaboration, and a share of some sublicensing revenues.

If we and Sloan-Kettering jointly determine that the objectives of the research plan cannot be met, then the agreement terminates. Upon termination, all licenses granted by one party to the other revert to the granting party. Otherwise, so long as we are actively developing or commercializing a product under the agreement, the agreement and our license do not terminate until our royalty obligations expire, in most cases, with the last patent covering the last product, or, if later, a specified number of years after the first commercial sale of unpatented products. Effective September 2002, we received a consent from Sloan-Kettering to enter into a sublicense agreement with Roche and amended the research and license agreement with Sloan-Kettering to harmonize it with the collaboration agreement with Roche.

In 2003 we were in a dispute and litigation with Sloan-Kettering regarding whether certain epothilone analogs developed in Sloan-Kettering laboratories during our collaboration were exclusively licensed to us, and the amount of research funding due Sloan-Kettering under the contract and Sloan-Kettering’s right to terminate it. Effective September 2003, we settled the dispute and litigation. Under the terms of the settlement, we and Sloan-Kettering agreed that rights to the disputed epothilone analogs are included in the exclusive license to us under the August 2000 research and license agreement, and that so long as we make the payments required under the settlement, Sloan-Kettering will not have the right to terminate

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that agreement (including our exclusive license to KOS-862) on the basis of any alleged breach prior to the settlement. We are obliged under the settlement to make contingent and non-contingent payments to Sloan-Kettering, and to undertake certain development activities with the previously disputed analogs.

Stanford University

Effective March 1996, we entered into an exclusive license agreement with the Board of Trustees of the Leland Stanford Junior University, or Stanford University, for certain technology and related patent rights, and materials for the recombinant production of novel polyketides. Under the terms of the agreement, we paid a license issue fee to Stanford University, and we pay annual maintenance fees, make milestone payments based on achievement of specified events with licensed products, pay royalties on net sales of products claimed in or originating from the licensed technology, and pay a share of some sublicensing fees. In March 2000, we amended the agreement to provide us an exclusive option to acquire an exclusive or non-exclusive license to future patents or patent applications that are related to certain technology developed by one of our founders, Chaitan S. Khosla, Ph.D., related to polyketides and their production, and chosen by Stanford University in its discretion. Effective September 2002, we received a consent from Stanford University to enter into a sublicense agreement with Roche and amended the research and license agreement to grant a sublicense to Roche and to harmonize it with the collaboration agreement with Roche.

National Institutes of Health/NCI

Effective October 2002, we entered into two CRADAs with the NIH. Under these agreements, we will collaborate with the NCI in the clinical development of 17-AAG and the development of geldanamycin derivatives. We have the option to obtain exclusive licenses under patents claiming inventions made in the collaborations under standard NIH licensing terms. Under the CRADAs, we must conduct various activities, including providing quantities of the drugs for the preclinical studies and clinical trials, and a specified number of personnel to the programs. The clinical trials of 17-AAG and other derivatives are or will be sponsored by the NCI in collaboration with us or by us solely. The term of the collaborative programs is currently scheduled for four years in total, but may be adjusted as the programs proceed.

Under a November 2002 license agreement with the NIH, we obtained exclusive commercial rights under pending patent applications relating to the geldanamycin derivatives being developed under the CRADAs. Initially, our license is limited to specified medical fields of use, including treatment of cancer, restenosis and neurodegenerative diseases relating to undesired cell growth. We may include additional fields of use to the license as we go along. We have paid the NIH an up-front fee and will owe annual minimum royalties, patent fees, royalties based on net sales of licensed products, milestone payments if clinical development milestones are reached, and a portion of our sublicensing revenues. Our license could terminate if we are not diligent or otherwise default in performing our material obligations under the agreement, and fail to cure the deficiency. The agreement contains standard NIH licensing terms. Unless the agreement is earlier terminated, our license will endure for the life of the licensed patents.

In connection with our collaboration and license agreements for the years ended December 31, 2003, 2002 and 2001, we have expensed approximately $2.5 million, $1.5 million and $721,000, respectively.

Competition

The pharmaceutical and biotechnology industries are intensely competitive. Many companies, including biotechnology, chemical and pharmaceutical companies, are actively engaged in research and development of drugs for the treatment of the same diseases and conditions as our potential product candidates. Many of these companies have substantially greater financial and other resources, larger research and development staffs and more extensive marketing and manufacturing organizations than we

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do. In addition, some of them have considerable experience in preclinical testing, clinical trials and other regulatory approval procedures. There are also academic institutions, governmental agencies and other research organizations that are conducting research in areas in which we are working. They may also market commercial products, either on their own or through collaborative efforts.

We face significant competition from large pharmaceutical companies that are pursuing the same or similar technologies, including polyketide manipulation, as the technologies used by us in our drug discovery and production efforts. For example, a number of companies have cloned polyketide synthase genes and claimed or described in patents or publications those genes or technology to modify them or express them in heterologous hosts using recombinant DNA technology. Such companies include, for example, Abbott Laboratories (erythromycin, niddamycin); Dow Agrosciences (spinosyn); Eli Lilly and Company (tylosin, spiramycin); Novartis (soraphen, epothilone); and Merck (avermectin, lovastatin). We also face competition from biotechnology companies and academic researchers that engage in research similar to our own. For example, Biotica Ltd. is a biotechnology company that has published patent applications, issued patents and entered into collaborations with pharmaceutical companies relating to efforts to modify polyketide synthase genes using recombinant DNA technology.

We expect to encounter significant competition for any of the pharmaceutical products we develop. Companies that complete clinical trials, obtain required regulatory approvals and commence commercial sales of their products before their competitors may achieve a significant competitive advantage. We are aware that many other companies or institutions are pursuing the development of drugs and technologies directly targeted at applications for which we are developing our drug compounds. Aventis Pharmaceuticals has received regulatory approval in Europe and major Latin American markets and has received an approvable letter from the FDA to market a ketolide antibiotic called Ketek^®. Chugai Pharmaceuticals has a motilide compound in clinical trials. Competing epothilones in clinical development include those being developed by Bristol-Myers Squibb (reported to be in Phase III clinical trials) and Novartis AG (reported to be in Phase II clinical trials). Novartis has initiated clinical trials of discodermolide. Thus, it is likely that, even if we are successful in developing any of our product candidates, one or more of these compounds of our competitors will be approved and marketed as products before our own. This could place us and our collaborators at a significant disadvantage, especially if our compounds do not have superior properties or cost advantages, and could prevent us from realizing significant commercial benefit from such products.

Developments by others may render our drug candidates or technologies obsolete or noncompetitive. We face and will continue to face intense competition from other companies for collaborative arrangements with pharmaceutical and biotechnology companies, for establishing relationships with academic and research institutions and for licenses to additional technologies. These competitors, either alone or with their collaborative partners, may succeed in developing technologies or products that are more effective than ours.

To compete successfully, we must develop proprietary positions and patented drugs for therapeutic markets that have not been satisfactorily addressed by conventional research strategies and, in the process, expand our technical expertise. We must also successfully pursue our technologies and product candidates outside the scope of proprietary rights of others, or succeed in obtaining licenses under proprietary rights that we are unable to avoid. Our potential products, even if successfully tested and developed, may not be adopted by physicians over other products and may not offer economically feasible alternatives to other therapies.

Government Regulation

The FDA and comparable regulatory agencies in state and local jurisdictions and in foreign countries impose substantial requirements upon the clinical development, manufacture and marketing of

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pharmaceutical products. These agencies and other federal, state and local entities regulate research and development activities and the testing, manufacture, quality control, safety, effectiveness, labeling, storage, record keeping, approval, advertising and promotion of our potential products.

The process required by the FDA before our products may be marketed in the United States generally involves the following:

The testing and approval process requires substantial time, effort and financial resources, and we cannot be certain that any approvals for any of our potential products will be granted on a timely basis, if at all.

Prior to commencing clinical trials, which are typically conducted in three sequential phases, we must submit an IND application to the FDA. The IND automatically becomes effective 30 days after receipt by the FDA, unless the FDA, within the 30-day time period, raises concerns or questions about the conduct of the trial. In such a case, the IND sponsor and the FDA must resolve any outstanding concerns before the clinical trial can begin. Our submission of an IND may not result in FDA authorization to commence a clinical trial. Further, an independent institutional review board at the medical center proposing to conduct a clinical trial must review and approve the plan for the clinical trial before it commences.

We may not successfully complete any of the three phases of testing of any of our potential products within any specific time period, if at all. Furthermore, the FDA, an institutional review board or the trial sponsor may suspend a clinical trial at any time on various grounds, including a finding that the subjects or patients are being exposed to an unacceptable health risk.

The results of product development, preclinical studies and clinical trials are submitted to the FDA as part of an NDA or BLA. The FDA may deny an NDA or BLA if the applicable regulatory criteria are not satisfied or may require additional clinical data. Even if such data are submitted, the FDA may ultimately decide that the NDA or BLA does not satisfy the criteria for approval. Once issued, the FDA may withdraw product approval if compliance with regulatory standards is not maintained or if problems occur after the product reaches the market. In addition, the FDA may require testing and surveillance programs to monitor the effect of approved products that have been commercialized, and the FDA has the power to prevent or limit further marketing of a product based on the results of these post-marketing programs.

Satisfaction of FDA requirements or similar requirements of state, local and foreign regulatory agencies typically takes several years, and the actual time required may vary substantially, based upon the type, complexity and novelty of the product or indication. Government regulation may delay or prevent marketing of potential products or for new indications for a considerable period of time and impose costly procedures upon our activities. Success in early-stage clinical trials does not assure success in later-stage clinical trials. Data obtained from clinical activities are not always conclusive and may be susceptible to varying interpretations that could delay, limit or prevent regulatory approval. Even

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if a product receives regulatory approval, the approval may be significantly limited to specific indications and dosages. Further, even after regulatory approval is obtained, later discovery of previously unknown problems with a product may result in restrictions on the product or even complete withdrawal of the product from the market. Delays in obtaining, or failures to obtain, additional regulatory approvals for any of our products would have a material adverse effect on our business.

Any products manufactured or distributed by us pursuant to FDA approvals are subject to continuing regulation by the FDA, including record-keeping requirements and reporting of adverse experiences with the drug. Drug manufacturers and their subcontractors are required to register their establishments with the FDA and certain state agencies, and are subject to periodic unannounced inspections by the FDA and certain state agencies for compliance with good manufacturing practices, which impose certain procedural and documentation requirements upon us and our third-party manufacturers. We cannot be certain that we or our suppliers will be able to comply with the good manufacturing practices regulations and other FDA regulatory requirements.

Outside the United States, our ability to market a product is contingent upon receiving a marketing authorization from the appropriate regulatory authorities. The requirements governing the conduct of clinical trials, marketing authorization, pricing and reimbursement vary widely from country to country. At present, foreign marketing authorizations are applied for at a national level, although within the European Union, or EU, registration procedures are available to companies wishing to market a product in more than one EU member state. If the regulatory authority is satisfied that adequate evidence of safety, quality and efficacy has been presented, a marketing authorization will be granted. This foreign regulatory approval process involves all of the risks associated with FDA clearance and may be influenced by FDA actions with respect to the product.

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Risk Factors That May Affect Results of Operations and Financial Condition

You should carefully consider the risks described below, together with all of the other information included in this report, in considering our business and prospects. The risks and uncertainties described below are not the only ones facing us. Additional risks and uncertainties not presently known to us or that we currently deem immaterial also may impair our business operations. The occurrence of any of the following risks could harm our business, financial condition or results of operations.

We have a history of net losses and may never become profitable.

We commenced operations in 1996 and are still in an early stage of development. We have not commercialized any products, and we have incurred significant losses to date. As of December 31, 2003, we had an accumulated deficit of approximately $79.1 million. To date, our revenues have been solely from collaborations and government grant awards. Our expenses have consisted principally of costs incurred in research and development and from general and administrative costs associated with our operations. We have incurred net losses since our inception, including net losses of approximately $9.7 million in 2003, $20.9 million in 2002 and $21.9 million in 2001. We expect our expenses to increase and to continue to incur operating losses for at least the next several years as we continue our research and development efforts for our drug candidates and research programs. The amount of time necessary to commercialize any of our drug candidates successfully is long and uncertain, and successful commercialization may not occur at all. As a result, we may never become profitable.

If our current collaborations are unsuccessful or if conflicts develop with these relationships or under our license agreements, our research and development efforts could be delayed, curtailed or terminated, our revenues could significantly decrease and our operations may be adversely affected.

We have a corporate research and commercialization collaboration with Hoffmann-La Roche, Inc. and F. Hoffmann-La Roche Ltd. in the field of epothilones. We also have collaborations with, or have licenses to technology and compounds from, several research groups, including The Sloan-Kettering Institute for Cancer Research in the field of epothilones, the National Cancer Institute in the field of geldanamycin analogs and Stanford University in the field of polyketide technology. The agreements permit our collaborators or licensors to terminate the agreement under certain circumstances. We may not be able to maintain or extend these collaborations or license agreements on acceptable terms, if at all. If we do not maintain, extend or replace our corporate collaboration with Roche, our research and development efforts could be delayed, our revenues would significantly decrease and our operations could be adversely affected. If we are unable to maintain our research collaborations or if our license agreements are terminated, our research and development efforts could be delayed, curtailed or terminated or we could lose our rights to use the licensed technology and compounds. Loss of these rights could also result in termination of, curtailment of or a delay of research and development efforts under our corporate collaborations, under some circumstances.

We do not control the amount and timing of resources that our collaborators devote to our programs or potential products, nor the scope, content and timing of the efforts that they conduct or permit under the collaborations. As a result, we do not know if our collaborators will dedicate sufficient resources or if the development or commercialization efforts by our corporate partners will be successful, or if the development or commercialization efforts that our collaborators make or authorize will be the same as those we would choose to devote ourselves if we solely controlled the development and commercialization of our programs and product candidates. In particular, in our collaboration with Roche, we do not control the amount and timing of resources that Roche devotes to the epothilone program beyond limited funding for certain Kosan activities in the amount specified under the contract, and we do not control the scope, content and timing of the preclinical studies, clinical trials and other development efforts that Roche conducts or permits under the program. In our collaboration with the

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National Cancer Institute, we do not control the selection, conduct, timing and resources provided to clinical trials of geldanamycin analogs sponsored by the National Cancer Institute. We also do not know whether our current collaborative partners or future collaborative partners, if any, might pursue alternative technologies or develop alternative products either on their own or in collaboration with others, including our competitors, as a means for developing treatments for the diseases targeted by collaborative arrangements with us. In addition, if a business combination involving our existing collaboration with Roche were to occur, the effect could diminish, terminate or cause delays in the epothilone program corporate collaborations. Should our corporate partners fail to develop or commercialize a compound or product for which they have rights from us, we may not receive any future milestones and will not receive any royalties associated with such compound or product.

If our collaborators fail to conduct the collaborative activities successfully and in a timely manner or if they or our licensors were to breach or terminate their agreements with us, the development or commercialization of the affected product candidates, technology or research program could be delayed or terminated. Conflicts might also arise with collaborators or licensors concerning rights to particular compounds or technologies. If we are unable to resolve these conflicts in our favor, we could lose our rights to use those compounds or technologies.

If we fail to enter into new collaborative agreements in the future, our business and operations would be negatively impacted.

Our strategy depends upon the formation and sustainability of multiple collaborative arrangements and license agreements with third parties in the future. We expect to rely on these arrangements for not only financial resources, but also for expertise that we expect to need in the future relating to clinical trials, manufacturing, sales and marketing, and for license and technology rights. Although we have established collaborative arrangements and various license agreements, we do not know if we will be able to establish additional arrangements on favorable terms, or whether current or any future collaborative arrangements will ultimately be successful. There have been, and may continue to be, a significant number of business combinations among large pharmaceutical companies that have resulted, and may continue to result, in a reduced number of potential future corporate collaborators, which may limit our ability to find partners who will work with us in developing and commercializing our drug candidates. If we do not enter into new collaborative agreements, then our revenues will be reduced, and our drug candidates may not be developed, manufactured or marketed.

Our potential products are in an early stage of development, and substantial additional effort will be necessary for development.

Our technologies are new, and our drug candidates are in early stages of research and development. We may not develop products that prove to be safe and effective, meet applicable regulatory standards, are capable of being manufactured at reasonable costs or can be marketed successfully. All of the potential products that we are currently developing will require significant development and investment, including extensive preclinical and clinical testing, before we can submit any application for regulatory approval.

Our products must satisfy rigorous standards of safety and efficacy before they can be approved by the U.S. Food and Drug Administration, or FDA, and international regulatory authorities for commercial use. We will need to conduct significant additional research, preclinical testing and clinical trials, before we or our collaborators can file applications with the FDA for product approval. Clinical trials are expensive and have a high risk of failure. In addition, to compete effectively, our products must be easy to use, cost-effective and economical to manufacture on a commercial scale. We may not achieve any of these objectives. Any of our products may not attain market acceptance. Typically, there is a high rate of attrition for products in preclinical testing and clinical trials. Also, third parties may develop superior products or have proprietary rights that preclude us or our collaborators from marketing our products. If research and testing is not successful or we fail to obtain regulatory approval, we will be unable to market and sell our future product candidates.

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The progress and results of our animal and human testing are uncertain.

We must provide the FDA and foreign regulatory authorities with clinical data that demonstrates the safety and efficacy of our products before they can be approved for commercial sale. As a result, commercialization of our product candidates depends upon successful completion of clinical trials. Preclinical testing and clinical development are long, expensive and uncertain processes. It may take us several years to complete our testing, and failure can occur at any stage of testing. Success in preclinical testing and early clinical trials does not ensure that later clinical trials will be successful, and interim results of trials do not necessarily predict final results. A number of companies in the pharmaceutical industry, including biotechnology companies, have suffered significant setbacks in advanced clinical trials, even after promising results in earlier trials. Preclinical and clinical data can be interpreted in different ways, which could delay, limit or prevent further testing or regulatory approval.

We do not know whether planned clinical trials (including ongoing and anticipated clinical trials of KOS-862, 17-AAG, KOS-953, 17-DMAG and other product candidates) will begin on time or whether any of our clinical trials (including ongoing and anticipated clinical trials of KOS-862, 17-AAG, KOS-953, 17-DMAG and other product candidates) will be completed on schedule, or at all. Negative or inconclusive results or adverse medical events during a clinical trial could cause a clinical trial to be repeated or a program to be terminated. We have two product candidates in human clinical trials for the treatment of cancer. Anticancer drugs generally have a narrow therapeutic window between efficacy and toxicity. If unacceptable toxicity is observed in clinical trials, the trials may be terminated at an early stage. Drug-related deaths may occur in clinical trials with anticancer drugs, because drugs for the treatment of cancer are typically dangerous and cancer patients are critically ill.

Completion of clinical trials may take several years or more. The length of time generally varies substantially according to the type, complexity, novelty and intended use of the drug candidate. Our clinical trials (including ongoing and anticipated clinical trials of KOS-862, 17-AAG, KOS-953, 17-DMAG and other product candidates) may be suspended at any time, if we or the FDA believe the patients participating in our studies are exposed to unacceptable health risks. Our commencement and rate of completion of clinical trials may be delayed by many factors, including:

Our product development costs will increase if we have delays in testing or approvals or if we need to perform more or larger clinical trials than planned. If the delays are significant, our financial results and

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the commercial prospects for our products will be harmed, and our ability to become profitable will be delayed. If any current or future clinical trials (including ongoing and anticipated clinical trials of KOS-862, 17-AAG, KOS-953, 17-DMAG and other product candidates) are not successful, our business, financial condition and results of operations will be harmed.

If we are not able to obtain required regulatory approvals, we will not be able to commercialize our product candidates, and our ability to generate revenue will be materially impaired.

Our product candidates and the activities associated with their development and commercialization are subject to comprehensive regulation by the FDA, and other regulatory agencies in the United States and by comparable authorities in other countries. Failure to obtain regulatory approval for a product candidate will prevent us from commercializing the product candidate. We have not received regulatory approval to market any of our product candidates in any jurisdiction and have only limited experience in preparing and filing the applications necessary to gain regulatory approvals. The process of obtaining regulatory approvals is expensive, often takes many years, if approval is obtained at all, and can vary substantially based upon the type, complexity and novelty of the product candidates involved.

Changes in the regulatory approval policy during the development period, changes in or the enactment of additional regulations or statutes, or changes in regulatory review for each submitted product application, may cause delays in the approval or rejection of an application. Even if the FDA approves a product candidate, the approval may impose significant restrictions on the indicated uses, conditions for use, labeling, advertising, promotion, marketing and/or production of such product, and may impose ongoing requirements for post-approval studies, including additional research and development and clinical trials. The FDA also may impose various civil or criminal sanctions for failure to comply with regulatory requirements, including withdrawal of product approval.

Furthermore, the approval procedure and the time required to obtain approval varies among countries and can involve additional testing beyond that required by the FDA. Approval by one regulatory authority does not ensure approval by regulatory authorities in other jurisdictions.

The FDA has substantial discretion in the approval process and may refuse to accept any application or may decide that our data is insufficient for approval and require additional preclinical, clinical or other studies. Any clinical trial may fail to produce results satisfactory to the FDA. Preclinical and clinical data can be interpreted in different ways, which could delay, limit or prevent regulatory approval. Furthermore, even if we file an application with the FDA for marketing approval of a product candidate, it may not result in marketing approval from the FDA.

We do not know whether our existing or any future clinical trials (including ongoing and anticipated clinical trials of KOS-862, 17-AAG, KOS-953, 17-DMAG and other product candidates) will demonstrate safety and efficacy sufficient to obtain the requisite regulatory approvals or will result in marketable products. Our failure to adequately demonstrate the safety and efficacy of our products under development will prevent receipt of FDA and foreign approvals and, ultimately, commercialization of our products.

We rely on third parties to conduct our clinical trials, and those third parties may not perform satisfactorily.

If third parties do not successfully carry out their contractual duties or meet expected deadlines, we will not be able to obtain or may be delayed in obtaining regulatory approvals for our product candidates and will not be able to or may be delayed in our efforts to successfully commercialize our product candidates for targeted diseases. We do not have the ability to independently conduct clinical trials for our products, and we rely on third parties such as contract research organizations, medical institutions

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and clinical investigators to perform this function. If these third parties do not perform satisfactorily, our clinical trials may be extended or delayed. We may not be able to locate any necessary acceptable replacements or enter into favorable agreements with them, if at all.

If our manufacturing or formulation facilities encounter delays or disasters or become unavailable and our inventories are insufficient to meet our needs during the time required to overcome a problem or establish alternative arrangements, then clinical development of our product candidates may be delayed or suspended, submissions for their regulatory approval may be delayed and we may be unable to meet demand for any products that we may successfully develop and lose potential revenue.

We rely in some cases, and in the future may rely upon, single sources for key intermediates, active pharmaceutical ingredients and formulated drug product for our product candidates. Currently, we are the sole manufacturer of the active pharmaceutical ingredient for KOS-862, and we use a single outside contractor to formulate drug product for KOS-862. We (or, with respect to KOS-862, Roche) currently maintain limited inventories of the active pharmaceutical ingredient for KOS-862 at our facilities in Hayward, California and of formulated drug product for KOS-862 at a total of three locations (including our facility in Hayward). In our geldanamycin program, we currently use a single manufacturer to make the active pharmaceutical ingredient 17-AAG and formulate drug product for KOS-953 both at our own facility and through a contract manufacturer. We currently maintain a limited inventory of KOS-953 in two locations. The NCI is responsible for formulation of drug product for its clinical work with 17-AAG, and the NCI is not obligated to maintain an inventory of either the active pharmaceutical ingredient or formulated drug product for 17-AAG. If any of our manufacturing or inventory facilities or relationships encounter delays, are destroyed or otherwise become unavailable, then the clinical development of our product candidates (including KOS-862, 17-AAG, KOS-953 and 17-DMAG) or submissions for their regulatory approval could be delayed or precluded, and our ability to deliver on a timely basis any products that we may develop could be impaired or precluded. This potential delay would be particularly acute if problems arise with our sole sourcing and inventory relationships. Our facilities in Hayward, California are located within the San Francisco Bay area, an area that is subject periodically to earthquakes. Our access to any key intermediates, active pharmaceutical ingredient or formulated drug product for our product candidates sourced or inventoried solely through our facilities in Hayward may be subject to interruption in the event of an earthquake.

We currently rely upon in some cases, and in the future may rely upon, outside contractors to manufacture and supply to us key intermediates, active pharmaceutical ingredients and formulated drug product for our product candidates. Our future contract manufacturers may not be in the United States, and some of our current manufacturers are not in the United States. Our current dependence upon others for the manufacture of our product candidates and components thereof, and our anticipated dependence upon others for the manufacture of any products that we may develop, may adversely affect our ability to continue in a timely manner clinical development of our product candidates and may adversely affect any future profit margins and our ability to commercialize any products that we may develop on a timely and competitive basis. In addition, when we use contract manufacturers outside the United States, the certainty of our supply may be diminished due to importation and customs issues and a potentially limited ability to enforce our contractual rights against parties not located within the United States.

Any inability to protect our proprietary technologies adequately could harm our ability to successfully commercialize product candidates.

Our commercial success will depend in part on our ability to obtain patents and maintain adequate protection of other intellectual property for our technologies and products in the United States and other countries. If we do not adequately protect our intellectual property, competitors may be able to use our technologies and erode or negate any competitive advantage we may have. The laws of some foreign countries do not protect our proprietary rights to the same extent as the laws of the United States, and we may encounter significant problems in protecting our proprietary rights in these countries.

The patent positions of biotechnology companies, including our patent position, involve complex legal and factual questions, and, therefore, validity and enforceability cannot be predicted with certainty. Patents may be challenged, deemed unenforceable, invalidated or circumvented. We will be able to protect our proprietary rights from unauthorized use by third parties only to the extent that our proprietary technologies and products are covered by valid and enforceable patents or are effectively maintained as trade secrets.

The degree of future protection for our proprietary rights is uncertain, and we cannot ensure that:

We apply for patents covering both our technologies and drug candidates, as we deem appropriate. However, we may fail to apply for patents on important technologies or products in a timely fashion or at all. Our existing patents and any future patents we obtain may not be sufficiently broad to prevent others from practicing our technologies or from developing competing products and technologies. For example, our lead product in our geldanamycin analog program, 17-AAG, is not covered by a composition of matter patent, and thus others could develop 17-AAG based products. In addition, we generally do not control the patent prosecution of technology that we license from others. Accordingly, we are unable to exercise the same degree of control over this intellectual property as we would over our own.

We rely upon trade secret protection for our confidential information. We have taken measures to protect our confidential information. However, these measures may not provide adequate protection for our trade secrets. We seek to protect our confidential information by entering into confidentiality agreements with employees, collaborators and consultants. Nevertheless, we may not be able to protect adequately our trade secrets.

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Litigation or other proceedings or third-party claims of intellectual property infringement would require us to spend time and money and could prevent us from developing or commercializing products.

Our commercial success depends in part on not infringing the patents and proprietary rights of other parties and not breaching any licenses that we have entered into with regard to our technologies and products. Others have filed patent applications and issued patents, and in the future are likely to continue to file patent applications and cause to be issued patents, claiming drug candidates that we are developing and genes, gene fragments, compounds and technologies we use or may wish to use. If we wish to use the claimed technology in issued and unexpired patents owned by others, we may need to obtain a license from another party, enter into litigation or incur the risk of litigation.

The biotechnology industry is characterized by extensive litigation regarding patents and other intellectual property rights. We are aware of patents and published patent applications that, if valid, and if we are unsuccessful in circumventing or acquiring the rights to these patents, may block our ability to commercialize products based on the drug candidates that we are developing or pursue our PKS gene manipulation and production technologies. We cannot be sure that other parties have not filed for or been issued relevant patents that could affect our ability to obtain patents or to operate as we would like to. Others may sue us in the future to challenge our patent or other intellectual property rights or claim infringement or misappropriation of their patents or other intellectual property rights or a breach of license agreements, or we may be required to commence legal proceedings to resolve our patent or other intellectual property rights. In particular, we recently settled litigation between us and Sloan-Kettering regarding our August 2000 research and license agreement. Under the terms of the settlement, pending litigation has been dismissed, and we and Sloan-Kettering have agreed that rights to epothilone analogs that were in dispute are included in the exclusive license Sloan-Kettering granted to us in the research and license agreement, and that so long as we make the payments required under the settlement, Sloan-Kettering does not have the right to terminate that agreement (including our exclusive license from Sloan-Kettering for KOS-862) on the basis of any alleged breach prior to the settlement. An adverse determination in any other litigation or in administrative proceeding to which we may become a party could subject us to significant liabilities to others, result in our patents being deemed invalid, unenforceable or revoked, require us to license disputed rights from others or require us to cease using the disputed technology. In addition, our involvement in any of these proceedings may cause us to incur substantial costs and result in diversion of management and technical personnel.

We are aware of a significant number of patents and patent applications relating to aspects of our technologies and compounds filed by, and issued to, other parties. Others have filed patent applications or have been granted patents claiming inventions also claimed by us, and we may have to participate in an interference or other proceeding before a patent agency or court to determine priority of invention or which party was first to invent and, thus, the right to a patent for these inventions in the United States. For example, we believe one or more interferences may be declared between patents and applications we own or have exclusively licensed and patents and applications owned by Novartis relating to epothilone biosynthetic genes and Epothilone D; patent applications believed by us to be licensed to Bristol-Myers Squibb relating to epothilones; and patents and applications owned by Abbott Laboratories and Biotica relating to erythromycin polyketide synthase genes, methods for altering polyketide synthase genes and erythromycin analogs and derivatives. In addition, the European patent office has recently published a notice of its intent to grant a patent on an application that we believe to be licensed to Bristol-Myers Squibb and that if issued, valid and enforceable would cover Epothilone D. We intend to and are preparing to oppose the grant of this patent. A proceeding or a lawsuit in which we are alleged to have infringed an issued patent could result in substantial cost to us even if the outcome

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is favorable, and if the outcome is unfavorable, we could be required to license the other party’s rights, at terms that may be unfavorable to us, or cease using the technology. Even if successful on priority grounds, an interference may result in loss of claims based on patentability grounds raised in the interference. Although patent and intellectual property disputes in the biotechnology area are often settled through licensing or similar arrangements, costs associated with these arrangements may be substantial and could include ongoing royalties. Furthermore, we cannot be certain that a license would be available to us on satisfactory terms, if at all. Companies and others developing products that could compete with our product candidates, such as Bristol-Myers Squibb and Novartis in the area of potential epothilone products may be particularly unwilling to grant us a license at any price.

Other parties may obtain patents in the future and claim that the use of our technologies infringes these patents or that we are employing their proprietary technology without authorization. We could incur substantial costs and diversion of management and technical personnel in defending ourselves against any claims that the use of our technologies infringes any patents, defending ourselves against any claim that we are employing any proprietary technology without authorization or enforcing our patents against others. Furthermore, parties making claims against us may be able to obtain injunctive or other equitable relief that could effectively block our ability to develop, commercialize and sell products, and could result in the award of substantial damages against us. In the event of a successful claim of infringement against us, we may be required to:

We may not be able to obtain licenses from other parties at a reasonable cost, or at all. If we are not able to obtain necessary licenses at a reasonable cost or at all, we could encounter substantial delays in product introductions while we attempt to develop alternative methods and products, which we may not be able to accomplish.

Litigation or the failure to obtain licenses could prevent us from commercializing products.

If we are unable to recruit and retain skilled employees, we may not be able to achieve our objectives.

Retaining our current employees and recruiting qualified scientific personnel to perform future research and development work will be critical to our success. Competition is intense for experienced scientists, and we may not be able to retain or recruit sufficient skilled personnel to allow us to pursue collaborations and develop our products and core technologies to the extent otherwise possible. Additionally, we are highly dependent on the principal members of our management and scientific staff, such as our two co-founders, the loss of whose services would adversely impact the achievement of our objectives. Although we maintain and are the beneficiary of $1.0 million key-man life insurance policies for the lives of each of our two co-founders, Daniel V. Santi, M.D., Ph.D., our chairman and chief executive officer, and Chaitan S. Khosla, Ph.D., a director and consultant, we do not believe the proceeds would be adequate to compensate us for their loss.

We face intense competition from large pharmaceutical companies, biotechnology companies and academic groups.

We face, and will continue to face, intense competition from organizations such as large biotechnology and pharmaceutical companies, as well as academic and research institutions and government agencies, that are pursuing competing technologies and products. These organizations may develop technologies

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or products that are superior alternatives to ours. For example, competing epothilones in clinical development include those being developed by Bristol-Myers Squibb (reported to be in Phase III clinical trials) and Novartis AG (reported to be in Phase II clinical trials). Further, our competitors in the polyketide gene-engineering field may be more effective at implementing their technologies to develop commercial products or may hold or develop patents or other proprietary rights that may prevent us from practicing our technologies and pursuing our programs. Some of these competitors have entered into collaborations with leading companies within our target markets to produce polyketides for commercial purposes.

Any products that we develop through our technologies will compete in multiple, highly competitive markets. Development of pharmaceutical products requires significant investment and resources. In addition, to compete effectively, our products must be easy to use, cost-effective and economical to manufacture on a commercial scale. Many of the organizations competing with us in the markets for such products have greater capital resources, research and development and marketing staffs, facilities and capabilities, and greater experience in discovery and developing drugs, obtaining regulatory approvals and product manufacturing and marketing. Accordingly, our competitors may be able to develop technologies and products more easily, which would render our technologies and products and those of our collaborators obsolete and noncompetitive.

If we face liability claims in clinical trials of a drug candidate, these claims will divert our management’s time and we will incur litigation costs.

We face an inherent business risk of clinical trial liability claims in the event that the use or misuse of our potential products results in personal injury or death. We may experience clinical trial liability claims if our drug candidates are misused or cause harm before regulatory authorities approve them for marketing. Even though we have obtained clinical trial liability insurance, it may not be sufficient to cover claims that may be made against us. Clinical trial liability insurance is expensive, difficult to obtain and may not be available in the future on acceptable terms, if at all. Any claims against us, regardless of their merit, could materially and adversely affect our financial condition, because litigation related to these claims would strain our financial resources in addition to consuming the time and attention of our management. If we are sued for any injuries caused by our products, our liability could exceed our total assets.

We use hazardous chemicals and radioactive and biological materials in our business. Any claims relating to improper handling, storage or disposal of these materials could be time consuming and costly.

Our research and development processes involve the controlled use of hazardous materials, including hazardous chemicals and radioactive and biological materials. Some of these materials may be novel, including bacteria with novel properties and bacteria that produce biologically active compounds. Our operations also produce hazardous waste products. We cannot eliminate the risk of accidental contamination or discharge and any resultant injury from these materials. Federal, state and local laws and regulations govern the use, manufacture, storage, handling and disposal of these materials. We believe that our current operations comply in all material respects with these laws and regulations. We could be subject to civil damages in the event of an improper or unauthorized release of, or exposure of individuals to, hazardous materials. In addition, we could be sued for injury or contamination that results from our use or the use by third parties or our collaborators of these materials, and our liability may exceed our total assets. Compliance with environmental laws and regulations may be expensive, and current or future environmental regulations may impair our research, development or commercialization efforts.

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We have a stockholders rights plan and anti-takeover provisions in our corporate charter documents that may result in outcomes with which you do not agree.

Our board of directors has the authority to issue up to 10,000,000 shares of preferred stock and to determine the rights, preferences, privileges and restrictions of those shares without further vote or action by our stockholders. The rights of the holders of any preferred stock that may be issued in the future may adversely affect the rights of the holders of common stock. The issuance of preferred stock could make it more difficult for third parties to acquire a majority of our outstanding voting stock.

Our certificate of incorporation provides for staggered terms for the members of the board of directors and prevents our stockholders from acting by written consent. These provisions and other provisions of our bylaws and of Delaware law applicable to us could delay or make more difficult a merger, tender offer or proxy contest involving us. This could reduce the price that investors might be willing to pay for shares of our common stock and result in the market price being lower than it would be without these provisions. In addition, these provisions may frustrate or prevent any attempts by our stockholders to replace or remove our current management by making it more difficult for stockholders to replace members of our board of directors. This is because our board of directors is responsible for appointing the members of our management team.

We have adopted a rights agreement under which all stockholders have the right to purchase shares of a new series of preferred stock at an exercise price of $70.00 per one one-hundredth of a share, if a person acquires more than 20% of our common stock. The rights plan could make it more difficult for a person to acquire a majority of our outstanding voting stock. The rights plan could also reduce the price that investors might be willing to pay for shares of our common stock and result in the market price being lower than it would be without the rights plan. In addition, the existence of the rights plan itself may deter a potential acquiror from acquiring us. As a result, either by operation of the rights plan or by its potential deterrent effect, mergers and acquisitions of us that our stockholders may consider in their best interests may not occur.

Some of our existing stockholders can exert control over us, and may not make decisions that are in the best interest of all stockholders.

Our officers, directors and their affiliates together controlled approximately 27% of our outstanding common stock as of December 31, 2003. As a result, these stockholders, if they act together, are able to exert a significant degree of influence over our management and affairs and over matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions. This concentration of ownership may delay or prevent a change in control of us and might affect the market price of our common stock, even when a change may be in the best interests of all stockholders. In addition, the interests of this concentration of ownership may not always coincide with our interests or the interests of other stockholders, and accordingly, they could cause us to enter into transactions or agreements, which we would not otherwise consider.

Our stock price has been, and may continue to be, extremely volatile.

The trading price of our common stock has been, and is likely to continue to be, highly volatile. During 2003, our common stock traded between $4.42 and $10.30 on the Nasdaq National Market. The trading price of our common stock could be subject to wide fluctuations in price in response to various factors, many of which are beyond our control, including:

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In addition, the stock market in general, and the Nasdaq National Market and the market for biotechnology companies in particular, has experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of those companies. These broad market and industry factors may seriously harm the market price of our common stock, regardless of our operating performance. In the past, following periods of volatility in the market price of a company’s securities, securities class-action litigation has often been instituted against that company. If this type of litigation were instituted against us, we would be faced with substantial costs and management’s attention and resources would be diverted, which could in turn seriously harm our business, financial condition and results of operations.

We expect that our quarterly results of operations will fluctuate, and this fluctuation could cause our stock price to decline, creating investor losses.

Our quarterly operating results have fluctuated in the past and are likely to do so in the future. These fluctuations could cause our stock price to fluctuate significantly or decline. Some of the factors that could cause our operating results to fluctuate include:

A large portion of our expenses is relatively fixed, including expenses for facilities, equipment and personnel. Accordingly, if revenues decline or do not grow due to expiration or termination of research contracts or government research grants, failure to obtain new contracts or other factors, we may not be able to reduce our operating expenses correspondingly. In addition, we expect operating expenses to continue to increase. Failure to achieve anticipated levels of revenues could therefore significantly harm our operating results for a particular fiscal period.

Due to the possibility of fluctuations in our revenues and expenses, we believe that quarter-to-quarter comparisons of our operating results are not a good indication of our future performance. Our operating results in some quarters may not meet the expectations of stock market analysts and investors. In that case, our stock price would probably decline.

If we fail to obtain the capital necessary to fund our operations, we will be unable to successfully develop products.

Additional financing will be required in the future to fund operations. We do not know whether additional financing will be available when needed, or that, if available, we will obtain financing on terms favorable to our stockholders or us. We have consumed substantial amounts of cash to date and expect capital outlays and operating expenditures to increase over the next several years as we expand our infrastructure and research and development activities.

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We believe that our existing cash and investment securities and anticipated cash flow from our existing collaboration will be sufficient to support our current operating plan into 2006. We have based this estimate on assumptions that may prove to be wrong. Our future capital requirements depend on many factors that affect our research, development, collaboration and sales and marketing activities. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

We may raise additional financing through public or private equity offerings, debt financings or additional corporate collaboration or licensing arrangements or any combination of the foregoing. To the extent we raise additional capital by issuing equity securities, our stockholders may experience dilution. To the extent that we raise additional funds through collaboration and licensing arrangements, it may be necessary to relinquish some rights to our technologies or product candidates, or grant licenses on terms that are not favorable to us. If adequate funds are not available, we will not be able to continue developing our products or financing our operations.

Employees

As of February 29, 2004, we had 134 full-time employees, 52 of whom hold Ph.D. degrees and 108 of whom were engaged in research and development activities. None of our employees is represented by a collective bargaining agreement, nor have we experienced any work stoppage. We believe that our relations with our employees are good.

Directors and Executive and Other Officers of the Registrant

Our directors and executive and other officers, and their ages as of March 15, 2004, are as follows:

Daniel V. Santi, M.D., Ph.D., is one of our co-founders and has served as Chairman of the Board of Directors since our inception in January 1995 and as our Chief Executive Officer since November 1998. Until his retirement in January 2001, Dr. Santi was on leave of absence from his position as Professor of Biochemistry and Biophysics, and of Pharmaceutical Chemistry at University of California, San Francisco, a position that he held since 1974. Dr. Santi was one of the original members of the Scientific Advisory Boards of Chiron Corporation and Mitotix, Inc., and has served as a consultant to several large pharmaceutical companies. In 1988, Dr. Santi founded and served as Chairman of the Board of Directors of Protos, Inc., a biotechnology firm and a subsidiary of Chiron Corporation, which was merged with

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Chiron in 1992. Dr. Santi was also founder and Chairman of Parnassus Pharmaceuticals. Dr. Santi has published over 275 scientific papers and is inventor on many patents in combinatorial chemistry and other areas. Dr. Santi received a B.S. in pharmacy from the State University of New York, an M.D. from the University of California, San Francisco and a Ph.D. in medicinal chemistry from the State University of New York.

Michael S. Ostrach has served as our President and Chief Operating Officer since January 2002. From October 1998 to January 2002, Mr. Ostrach served as our Chief Operating Officer. Prior to joining Kosan in October 1997 as Vice President, Corporate Development, Mr. Ostrach worked as an independent consultant for biotechnology companies from October 1996 to October 1997. Mr. Ostrach was Executive Vice President and Chief Operating Officer of Neurobiological Technologies, Inc., a publicly held biotechnology company, from 1994 to 1996. From 1993 to 1994, Mr. Ostrach worked as a consultant to a number of biotechnology companies. From 1981 to 1991, he was a Senior Vice President at Cetus Corporation, a biotechnology company. In 1991, Cetus Corporation merged into Chiron Corporation, and during 1992, Mr. Ostrach was a Vice President of Chiron Corporation and a founder and the President of Chiron Technologies, a Chiron business unit. Mr. Ostrach received a B.A. from Brown University and a J.D. from Stanford Law School.

Robert G. Johnson, Jr., M.D., Ph.D., has served as our Senior Vice President, Medical Affairs and Corporate Development and Chief Medical Officer since January 2003 and as our Senior Vice President, Medical Affairs and Corporate Development since January 2002. From September 2000 to January 2002, Dr. Johnson served as our Vice President, Medical Affairs and Corporate Development. From 1998 to September 2000, Dr. Johnson was employed by Chiron Corporation, where he served as Vice President, Pharmacology and Preclinical Affairs through 1999 and most recently as Vice President, Corporate Development. From 1991 to 1998, Dr. Johnson was Director of Pharmacology at Merck & Co., Inc., a pharmaceutical company. In addition, Dr. Johnson was a member of the faculty at the University of Pennsylvania from 1987 to 1991 and at Harvard Medical School from 1985 to 1987. Dr. Johnson received a B.A., a Ph.D. in biophysics and an M.D. each from the University of Pennsylvania.

Susan M. Kanaya has served as our Senior Vice President, Finance and Chief Financial Officer since January 2002 and was appointed Secretary in June 2001. From November 1999 to January 2002, Ms. Kanaya served as our Vice President, Finance and Chief Financial Officer. From 1994 to November 1999, Ms. Kanaya was employed by SUGEN, Inc., a publicly held biotechnology company that was acquired by Pharmacia in 1999, most recently serving as Vice President, Finance and Treasurer. Before joining SUGEN, Ms. Kanaya was the Controller at 50/50 Micro Electronics, Inc., an electronics company, and at Power Up Software Corporation, a computer software company. Ms. Kanaya received a B.S. in business administration from the University of California, Berkeley.

Dorian L. Rinella has served as our Vice President, Human Resources and Facilities since February 2004. From 1991 to 2003, Ms. Rinella was employed by SUGEN, Inc., a Pharmacia Company that merged with Pfizer Inc, serving in several management positions, most recently as Senior Vice President of Operations. Before joining SUGEN, Ms. Rinella held positions at Doric Development, a real estate development firm, and Bio-Rad Laboratories, a manufacturer and distributor of life science research and clinical products.

Bruce A. Chabner, M.D., has served as a director since September 2001. Dr. Chabner has served as the Chief of Hematology/Oncology at the Massachusetts General Hospital and as Professor of Medicine at Harvard Medical School since 1995. Dr. Chabner has also served as the Associate Director for Clinical Science of the Dana-Farber/Harvard Cancer Center since 1999 and has held numerous academic appointments, including the position of Director of the Division of Cancer Treatment of the National Cancer Institute from 1982 to 1995. Dr. Chabner has received numerous awards, including Phi Beta

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Kappa, Alpha Omega Alpha, the Public Health Service’s Distinguished Service Medal, the Karnofsky Award of the American Society for Clinical Oncology and the Bruce F. Cain Award for Drug Development of the American Association for Cancer Research. Dr. Chabner received a B.A. from Yale College and an M.D. from Harvard Medical School.

Peter Davis, Ph.D., has served as a director since April 1998. Since 2002, Dr. Davis has worked as an independent consultant to a number of companies. Dr. Davis served as president of DNA Plant Technologies Corp., an agriculture biotechnology company, from 2001 to 2002. Dr. Davis was a member of the Executive Committee of Pulsar International, S.A., a management company and an affiliate of A.G. Biotech Capital, from 1993 to 2001. From 1975 to 1993, Dr. Davis was a faculty and staff member of the Wharton School of the University of Pennsylvania. His primary appointments included Director of the Applied Research Center and Director of Executive Education. He is a member of the board of directors of several private companies. Dr. Davis received a B.A. in physics from Cambridge University, a Masters Degree in operations research from the London School of Economics and a Ph.D. in operations research from the Wharton School.

Jean Deleage, Ph.D., has served as a director since April 1996. Dr. Deleage is a founder and managing director of Alta Partners, a venture capital firm investing in information technologies and life science companies. Alta Partners was formed in 1996. In 1979, Dr. Deleage founded, and is a managing partner of, Burr, Egan, Deleage & Co., a major venture capital firm in San Francisco and Boston. Dr. Deleage was a member of Sofinnova’s initial team, a venture capital organization in Paris, and in 1976 formed Sofinnova, Inc. (the U.S. subsidiary of Sofinnova). Dr. Deleage is presently a member of the board of directors of Crucell, N.V., Rigel Pharmaceuticals, Inc. and several private companies. In 1984, Dr. Deleage was awarded the Ordre National du Merite, and in 1993, he was awarded the Legion of Honor from the French government in recognition of his career accomplishments. Dr. Deleage received a Master’s Degree in electrical engineering from Ecole Superieurie d’Electricite and a Ph.D. in economics from the University of Paris, Sorbonne.

Charles J. Homcy, M.D., has served as a director since April 2003. Since November 2003, Dr. Homcy has served as Chief Executive Officer of Portola Pharmaceuticals, Inc., a biopharmaceutical company. From January 2003 to November 2003, Dr. Homcy served as Senior Research and Development Advisor of Millennium Pharmaceuticals. From February 2002 to December 2002, Dr. Homcy served as the President of Research and Development at Millennium Pharmaceuticals. From 1995 to February 2002, he served as Executive Vice President, Research and Development of COR Therapeutics, Inc., where he served as a member of the board of directors from 1998 to February 2002. From 1994 to March 1995, Dr. Homcy was President of the Medical Research Division of American Cyanamid Company-Lederle Laboratories (now a division of Wyeth-Ayerst Laboratories). From 1990 to 1994, Dr. Homcy was Executive Director of the Cardiovascular and Central Nervous System Research Section at Lederle Laboratories. Dr. Homcy currently serves on the boards of directors of Millennium Pharmaceuticals and Cytokinetics, a biopharmaceutical company. Dr. Homcy received an A.B. in Biology and a M.D. from Johns Hopkins University.

Chaitan S. Khosla, Ph.D., is one of our co-founders and has served as a director since our inception in January 1995. Dr. Khosla has been a Professor of Chemical Engineering, Chemistry and Biochemistry at Stanford University since 2001 and has been a faculty member since 1992. Dr. Khosla is co-chairman of our Scientific Advisory Board. Dr. Khosla is the inventor of the combinatorial biosynthesis technology that we licensed from Stanford University. He is the recipient of several awards, including the 1999 Alan T. Waterman award by the National Science Foundation, the 1999 Eli Lilly Award in biological chemistry and the 2000 ACS Award in pure chemistry. Dr. Khosla is the author of over 100 publications and is an inventor on numerous patents. Dr. Khosla received a B.S. Tech. from the Indian Institute of Technology, Bombay, India and a Ph.D. from the California Institute of Technology.

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Christopher T. Walsh, Ph.D., has served as a director since April 1996. Dr. Walsh has been the Hamilton Kuhn Professor of Biological Chemistry and Molecular Pharmacology at Harvard Medical School since 1991 and formerly was President of the Dana-Farber Cancer Institute and Chairman of the Department of Biological Chemistry and Molecular Pharmacology at Harvard Medical School. He has performed extensive research in enzyme stereochemistry, reaction mechanisms and the mechanisms of action of anti-infective and immunosuppressive agents. He is co-chairman of our Scientific Advisory Board. Dr. Walsh is also a member of the board of directors of Vicuron Inc. and several private companies. Dr. Walsh received an A.B. in biology from Harvard University and a Ph.D. in life sciences from The Rockefeller University, New York.

Scientific Advisory Board

The following individuals are members of our Scientific Advisory Board, or SAB:

Chaitan S. Khosla, Ph.D., is co-chairman of our SAB and a member of our board of directors.

Christopher T. Walsh, Ph.D., is co-chairman of our SAB and a member of our board of directors.

Paul S. Anderson, Ph.D., has extensive experience in the field of drug discovery and development. Dr. Andersen recently retired from Bristol-Myers Squibb, where he held the position of Vice President, Drug Discovery.

Homer A. Boushey, M.D., is a Professor of Medicine at the University of California, San Francisco. Dr. Boushey is an expert in clinical research on the causes and treatment of asthma and serves as Principal Investigator for University of California, San Francisco’s Asthma Clinical Research Center.

David E. Cane, Ph.D., is Professor of Chemistry and Biochemistry at Brown University. Dr. Cane is an expert in the biosynthesis of natural products, with particular emphasis on macrolide polyketides and terpenes.

Samuel J. Danishefsky, Ph.D., is Professor of Chemistry at Columbia University. Dr. Danishefsky is an expert in synthetic organic chemistry.

Sir David A. Hopwood, Ph.D., is Professor and Head of the Genetics Department at John Innes Institute, Norwich, U.K. Dr. Hopwood is an expert in streptomyces genetics, molecular biology and the genetic manipulation of polyketide genes.

Jack F. Kirsch, Ph.D., is a Professor of Chemistry, Biochemistry and Molecular Biology at the University of California, Berkeley. Dr. Kirsch is an expert in the physical organic chemistry of proteins and enzyme kinetics.

Ivan M. Kompis, Ph.D., has an extensive background in natural products chemistry, in particular antibacterial agents. Dr. Kompis recently retired from Hoffmann-La Roche, where he held the position of Deputy Director of the Department of Infectious Diseases since 1987.

Mohamed A. Marahiel, Ph.D., is Professor of Biochemistry at Philipps University, Marburg, Germany. Dr. Marahiel is an expert in the field of non-ribosomal peptide biosynthesis.

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Haruo Seto, Ph.D., is Professor Emeritus, University of Tokyo, Japan. Dr. Seto has an extensive background in the structure, biosynthesis and screening of antibiotics.

Amos B. Smith, III, Ph.D., is the Rhodes-Thompson Professor of Chemistry at the University of Pennsylvania. Dr. Smith is an expert in natural products synthesis, bioorganic chemistry and materials science.

Available Information

We maintain a website at www.kosan.com; however, information found on our website is not incorporated by reference into this report. We make available free of charge on or through our website our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC.

In 2002, we adopted a code of ethics that applies to our employees, officers and directors and in February 2004 we amended and restated the code. We have posted the text of our code of ethics on our website at www.kosan.com in connection with “Investor Relations” materials. In addition, we intend to promptly disclose (1) the nature of any amendment to our code of ethics that applies to our principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions and (2) the nature of any waiver, including an implicit waiver, from a provision of our code of ethics that is granted to one of these specified officers, the name of such person who is granted the waiver and the date of the waiver on our website in the future.

Item 2. Properties

Our facilities consist of approximately 118,000 square feet of research and office space located in Hayward, California, of which approximately 44,000, 69,000 and 5,000 square feet are leased to us until 2013, 2008 and 2005, respectively. We have an option to renew our lease on the 44,000 square foot facility for one additional period of five years and an option to renew our lease on the 69,000 square foot facility for two additional periods of five years.

Item 3. Legal Proceedings

None.

Item 4. Submission of Matters to a Vote of Security Holders

None.

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PART II

Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters

Market for Registrant’s Common Equity

Our common stock has traded on the Nasdaq National Market since our initial public offering on October 5, 2000 under the symbol “KOSN”. Prior to such time, there was no public market for our common stock. The following table shows the high and low sales prices per share of our common stock as reported on the Nasdaq National Market for the periods indicated:

As of February 29, 2004, there were approximately 146 record holders of our common stock. We have never declared or paid dividends on our capital stock. We currently expect to retain future earnings, if any, for use in the operation and expansion of our business and do not anticipate paying any cash dividends in the foreseeable future.

Information concerning securities authorized for issuance under equity compensation plans is contained in our definitive Proxy Statement with respect to our 2004 Annual Meeting of Stockholders, to be filed with the SEC before April 30, 2004, under the caption “Equity Compensation Plan Information,” and is incorporated herein by reference.

Use of Proceeds From Sales of Registered Securities

Our initial public offering of common stock was effected through a Registration Statement on Form S-1 (File No. 333-33372) that was declared effective by the SEC on October 4, 2000. All 5,750,000 shares of common stock offered, inclusive of 750,000 shares of common stock subject to the underwriters’ over-allotment option, were sold at a price per share of $14.00 for gross proceeds of approximately $80.5 million. The managing underwriters of our offering were Lehman Brothers, CIBC World Markets, SG Cowen and Fidelity Capital Markets.

We paid a total of approximately $5.6 million in underwriting discounts and commissions, and other costs and expenses, other than underwriting discounts and commissions, were approximately $1.5 million. After deducting the underwriting discounts and commissions and the offering costs and expenses, we received net proceeds from our initial public offering of common stock of approximately $73.4 million.

We intend to use the net proceeds from our initial public offering of common stock for advancing our drug candidates through preclinical and later stage development, discovering or acquiring new drug candidates, expanding our technology platform, capital expenditures, working capital, general corporate

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purposes and possible future acquisitions. Of the net proceeds, through December 31, 2003, approximately $45.3 million had been used for general corporate purposes and approximately $6.2 million had been used to purchase property and equipment, net of proceeds from equipment financing arrangements and principal payments under those arrangements. Pending such uses, the balance has been invested in U.S. Treasury and government agency obligations, investment-grade asset-backed securities and corporate obligations.

Item 6. Selected Financial Data

The statement of operations data for each of the years ended December 31, 2003, 2002 and 2001, and the balance sheet data as of December 31, 2003 and 2002, have been derived from our audited financial statements included elsewhere in this Annual Report on Form 10-K that have been audited by Ernst & Young LLP, independent auditors. We have derived the statement of operations data for the years ended December 31, 2000 and 1999, and the balance sheet data as of December 31, 2001, 2000 and 1999 from our audited financial statements that we do not include in this Annual Report on Form 10-K. Our historical results are not necessarily indicative of results to be expected for any future period. The data presented below have been derived from financial statements that have been prepared in accordance with accounting principles generally accepted in the United States and should be read with our financial statements, including the notes, and with “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this Annual Report on Form 10-K.

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New Accounting Standards

In November 2002, the FASB issued Emerging Issues Task Force Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables” (“EITF 00-21”). EITF 00-21 provides guidance on how to account for arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. The provisions of EITF 00-21 applied to revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The adoption of EITF 00-21 did not have an impact upon the Company’s financial statements.

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis should be read with “Selected Financial Data” and our financial statements and notes included elsewhere in this Annual Report on Form 10-K. The discussion in this Annual Report on Form 10-K contains forward-looking statements that involve risks and uncertainties, such as statements of our plans, objectives, expectations and intentions. The cautionary statements made in this Annual Report on Form 10-K should be read as applying to all related forward-looking statements wherever they appear in this Annual Report on Form 10-K. Our actual results could differ materially from those discussed here. Factors that could cause or contribute to these differences include those discussed in “Item 1. Business – Risk Factors That May Affect Results of Operations and Financial Condition” and elsewhere in this Annual Report on Form 10-K.

We have proprietary technologies for the manipulation and production of polyketides, a rich source of pharmaceutical products. We use our platform technologies to develop product candidates that target large pharmaceutical markets. In collaboration with Hoffmann-La Roche, Inc. and F. Hoffmann-La Roche Ltd., collectively Roche, we are testing KOS-862 (Epothilone D), a potential anticancer agent, in Phase II and Phase Ib clinical trials. We are developing geldanamycin derivatives as anticancer agents and are collaborating with the National Cancer Institute, or NCI, to test one of them, 17-AAG, which is in Phase I and Phase Ib clinical trials being conducted by us and the NCI. We also have additional product candidates in the areas of cancer, infectious diseases and gastrointestinal motility that are undergoing preclinical evaluation and several early stage product and research technology development programs.

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We have incurred significant losses since our inception. As of December 31, 2003, our accumulated deficit was $79.1 million. We expect to incur additional operating losses over the next several years as we continue to develop our technologies and fund internal product research and development.

Critical Accounting Policies and Management Estimates

Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to our research and development collaborations, investments, intangible assets, income taxes, financing operations and contingencies. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.

We believe the following critical accounting policies, which have been reviewed by our Audit Committee, affect our more significant judgments and estimates used in the preparation of our financial statements.

Revenue Recognition

We recognize license and other up-front fees over the estimated research and development term of the agreement. If the agreement does not have a specified research and development term, we must apply judgment in determining the appropriate level of recognition. As of December 31, 2003, we had $20.9 million in deferred revenue, representing the unamortized balance of the $25.0 million initial fee received in connection with our collaboration with Roche. This initial fee is being amortized through the second half of 2007, the estimated clinical development period, which remains unchanged from the time the original estimate was determined in the fourth quarter of 2002. Any changes in our estimate will result in either an acceleration or further deferral of the related revenue recognition.

Clinical Trial Accruals

Over the next year, the clinical trials of our epothilone and geldanamycin analog programs will significantly increase our research and development expenditures. Research and development expenditures are expensed as incurred. Our expenses related to clinical trials are based on estimates of the services received and efforts expended pursuant to contracts with multiple research institutions and clinical research organizations that conduct and manage clinical trials on our behalf. The financial terms of these agreements are established prior to the initiation of the related clinical trial, thus establishing the basis of our estimates. However, these terms may be subject to amendment due to changes in the scope and length of the related clinical trial. Expenses related to clinical trials generally are accrued based on the level of patient enrollment and activity according to the protocol. We monitor patient enrollment levels and related activity and adjust our estimates accordingly.

Stock-Based Compensation

Stock-based compensation expense for options granted to non-employees has been determined as the fair value of the consideration received or the fair value of the equity instruments issued, whichever is more reliably measured. We recognized other stock-based compensation for non-employees of approximately $619,000 in 2003, $1.4 million in 2002 and $681,000 in 2001. In addition, assuming no changes, we expect to recognize other stock-based compensation in connection with stock options granted to non-employees of approximately $834,000 in 2004, $362,000 in 2005, $240,000 in 2006, $116,000 in 2007 and $80,000 in 2008. The measurement of stock-based compensation to non-employees

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is subject to periodic adjustment as the underlying securities vest. As such, changes to these future period measurements could be substantial should we experience significant changes in our stock price. For example, a 50% increase in our stock price would translate into a 60% increase in the related estimated expenses above. See Notes 1 and 10 of our financial statements.

Results of Operations

Years Ended December 31, 2003 and 2002

Revenue. Our revenues increased to approximately $31.4 million in 2003 from approximately $9.6 million in 2002. This increase was primarily due to approximately $26.9 million in contract revenue recognized under our development and commercialization agreement with Roche, of which $3.4 million represented the ratable portion of a $25.0 million initial fee that is being recognized through the second half of 2007, the estimated clinical development period, and $6.0 million in non-recurring milestones. The remaining amount consisted of reimbursement of research and development expenses, including clinical trials conducted by us and clinical trial materials purchased by Roche from us. Total contract revenues under our collaboration agreement with Johnson & Johnson Pharmaceutical Research and Development, LLC, or J&JPRD, were approximately $1.2 million in 2003, compared to approximately $2.9 million in 2002. Included in 2003 revenues was approximately $250,000 related to a non-recurring milestone payment received in connection with this collaboration. This collaboration expired in December 2003 and no additional revenues will be generated under this agreement. Further, if we do not maintain or extend our agreement with Roche, our revenues will significantly decrease unless we enter into additional collaborations that provide substantial revenues.

In addition, we recognized approximately $2.9 million in grant revenue in 2003, compared to approximately $2.3 million in 2002. This increase was primarily due to additional government grants awarded during the year.

Research and Development Expenses. Our research and development expenses increased to approximately $36.8 million in 2003 from approximately $28.4 million in 2002. The approximately $8.4 million increase in 2003 as compared to 2002 was due in large part to an approximately $4.1 million increase in outside services related to the advancement of KOS-862 into Phase II clinical trials, the related production of clinical material, and preclinical development of our epothilone and geldanamycin analogs. Approximately $2.7 million of this increase was associated with higher licensing-related expenses and the settlement of the litigation with Sloan-Kettering representing the reimbursement of research expenses related to the epothilone analog program. Also contributing to the year-to-year increase was an approximately $2.2 million increase in research and development salaries and other personnel-related expenses due to internal growth, and an approximately $1.5 million increase in allocated facilities and expansion costs. These increases were partly offset by an approximately $2.1 million decrease in stock-based compensation.

Research and development expenses consisted primarily of salaries and other personnel-related expenses, clinical trial-related services performed by clinical research organizations and research institutions and other outside service providers, licensing-related expenses, lab consumables and facility-related expenses. We allocate salary-driven and space-use-driven overhead expenses to research and development and to general and administrative expenses based on salaries and space-use by each respective area. Our research and development employees increased to 110 in 2003 from 90 in 2002. We expect our research and development expenses will increase substantially as KOS-862 and 17-AAG advance further into the clinic, and as we advance our research programs into later stages of development.

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The table below summarizes the development status of our most advanced product candidates:

Phase I clinical trials generally are expected to last between 12 and 18 months, Phase II clinical trials are expected to last between 18 and 24 months and Phase III clinical trials are expected to last between 24 and 42 months. The length of clinical development depends on the specific disease and patient population. For drug candidates that are in preclinical development, the timing of an Investigational New Drug, or IND, filing varies significantly and is difficult to predict and therefore not reflected in the table above.

Roche is responsible for the costs of the epothilone clinical trails (currently, trials of KOS-862) conducted under our collaboration. We are responsible at our cost to supply 17-AAG for clinical trials sponsored by NCI under the CRADAs, and NCI is responsible for the remainder of the costs of these trials through Phase II. In addition, we may sponsor other clinical trials of geldanamycin analogs at our sole expense.

General and Administrative Expenses. General and administrative expenses increased to approximately $5.1 million in 2003 from approximately $4.9 million in 2002. The increase in 2003 compared to 2002 was due to an approximately $321,000 increase in employee-related expenses to support our expanding research and development activities, an approximately $169,000 increase in professional and outside services for corporate governance and Sarbanes-Oxley related expenses and an approximately $138,000 increase in facility-related allocations in connection with the expansion of our facilities. These increases were partially offset by approximately $424,000 in lower stock-based compensation that resulted from the reversal of deferred compensation expenses in connection with employee terminations. The number of our general and administrative employees remained unchanged at 22 at December 31, 2003 as compared to December 31, 2002. We expect our general and administrative expenses will increase in the future to support the continued growth of our research and development efforts.

Interest Income. Interest income decreased to approximately $1.2 million in 2003 from approximately $2.2 million in 2002. This decrease was attributable to lower investment yields associated with a continued depressed interest rate environment and lower average investment balances during the year.

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Interest Expense. Interest expense decreased to approximately $337,000 in 2003 from approximately $356,000 in 2002. This decrease resulted from the scheduled repayment of existing debt at higher average interest rates, partially offset by additional equipment debt financing at lower average interest rates in 2003. We expect our interest expense will increase in the future resulting from additional property and equipment-related debt financings.

Years Ended December 31, 2002 and 2001

Revenue. Our revenues increased to approximately $9.6 million in 2002 from approximately $5.2 million in 2001. This increase was primarily due to approximately $3.4 million in contract revenue recognized under our development and commercialization agreement with Roche, of which $730,000 represented the ratable portion of the first of two $12.5 million installments of an initial fee that is being recognized through the second half of 2007, the estimated clinical development period. In addition, we recognized approximately $2.3 million in grant revenue in 2002, compared to approximately $1.7 million in 2001. Total contract revenues under our collaboration agreement with J&JPRD were approximately $2.9 million in 2002, compared to approximately $3.2 million in 2001. Included in 2001 revenues was a non-recurring $250,000 milestone payment received in connection with this collaboration.

Research and Development Expenses. Research and development expenses increased to approximately $28.4 million in 2002 from approximately $25.5 million in 2001. This increase, partially offset by the decrease in stock-based compensation in 2002, was due in large part to our expanded research and development efforts, including three Phase I clinical trials of KOS-862, related licensing expenses and additional staffing in support of our continued investment in internally funded programs and technologies. Our research and development employees increased to 90 in 2002 from 76 in 2001.

General and Administrative Expenses. General and administrative expenses decreased to approximately $4.9 million in 2002 from approximately $5.2 million in 2001. The decrease was due to lower stock-based compensation expense in 2002, compared to 2001, partially offset by higher employee-related expenses to support our expanding research and development activities. Our general and administrative employees increased to 22 in 2002 from 20 in 2001.

Interest Income. Interest income decreased to approximately $2.2 million in 2002 from approximately $5.0 million in 2001. This decrease was attributable to lower average investment balances and lower investment yields associated with the declining interest rate environment.

Interest Expense. Interest expense increased to approximately $356,000 in 2002 from approximately $349,000 in 2001. This increase resulted from additional debt financing of property and equipment during 2002.

Gain/(Loss) on the Recovery or Write-Down of Investment. At June 30, 2001, we determined that an other-than-temporary decline in the fair value of our investment in short-term commercial paper of Southern California Edison, a utility company, had occurred. Accordingly, we recorded approximately $990,000 loss on the related write-down in the carrying value of the investment. In March 2002, the security was fully repaid. Thus, we recorded a realized gain on the investment of approximately $990,000 for the year ended December 31, 2002.

Provision for Income Taxes

We incurred net operating losses in the years ended December 31, 2003, 2002 and 2001 and consequently did not pay federal, state or foreign income taxes. As of December 31, 2003, we had federal net operating loss carryforwards of approximately $36.0 million. We also had federal research

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and development tax credit carryforwards of approximately $3.2 million. If not utilized, the net operating losses and credit carryforwards will expire at various dates beginning in 2010 through 2023. Use of the net operating losses and credits may be subject to a substantial annual limitation due to the change in ownership provisions of the Internal Revenue Code of 1986, as amended, and similar state provisions. The annual limitation may result in the expiration of net operating losses and credits before utilization. See Note 11 of our financial statements.

Liquidity and Capital Resources

Since inception we have financed our operations primarily through sales of our convertible preferred stock and common stock, contract payments received under our corporate collaboration agreements and government grant awards, interest income and equipment financing arrangements. As of December 31, 2003, we had received approximately $148.2 million from the sales of convertible preferred and common stock, approximately $69.3 million from contract payments received under our corporate collaboration agreements and government grant awards, approximately $12.7 million from interest income and approximately $10.4 million from equipment financing arrangements. As of December 31, 2003, we had approximately $105.3 million in cash and investments, compared to approximately $80.5 million as of December 31, 2002. Our funds are currently invested in U.S. Treasury and government agency obligations and corporate obligations.

Cash provided by operating activities was approximately $1.9 million in 2003, compared to cash used of approximately $6.9 million in 2002. Our net loss of approximately $9.3 million in 2003 was offset by the receipt of the second of two $12.5 million installments of an initial fee from Roche and non-cash expenses of approximately $4.6 million related to stock-based compensation, depreciation and amortization of property and equipment and investment premiums and discounts, partially offset by an approximately $5.1 million increase in accounts receivable primarily due to contract revenue and a milestone related to our Roche collaboration. We do not anticipate to generate cash from operating activities for the next several years. Our net loss of approximately $20.9 million in 2002 was partially offset by the receipt of the first of two $12.5 million installments of an initial fee from Roche and non-cash expenses of approximately $5.8 million related to stock-based compensation and depreciation and amortization of investment premiums and discounts.

Our investing activities, excluding changes in our investments, for the year ended December 31, 2003, used cash of approximately $4.3 million, compared to approximately $3.6 million in 2002, reflecting approximately $1.9 million related to the renovation of our facilities and approximately $2.4 million related to the purchase of additional laboratory and office equipment. Investing activities in 2002, excluding changes in our investments, reflected approximately $1.4 million related to the renovation and expansion of our facilities and approximately $2.2 million related to the purchase of additional laboratory and office equipment. We expect to continue our purchases of equipment and leasehold improvements in 2004 related to the enhancement and expansion of our leased facilities.

Cash provided by financing activities was approximately $28.7 million for the year ended December 31, 2003, compared to approximately $1.3 million in 2002. Financing activities in 2003 included approximately $26.0 million net proceeds from the sale of our common stock in a registered direct offering in December 2003, $3.1 million of equipment financing, net of scheduled payments on new and existing debt, and $776,000 related to proceeds from the repayment of notes receivable from stockholders. Financing activities in 2002 included approximately $2.2 million of equipment financing, which was offset by scheduled payments on new and existing debt. Financing activities in 2001 included approximately $1.1 million of equipment financing, which was offset by scheduled payments on new and existing debt.

In April 2003, we entered into a $3.5 million equipment line of credit agreement for facility improvements and capital purchases. As of December 31, 2003, we had utilized approximately $2.4 million of the line of credit leaving approximately $1.1 million available for future draws.

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We believe that our existing cash, investments, and anticipated cash flow from our existing collaboration will be sufficient to support our current operating plan into 2006. Our future capital uses and requirements depend on numerous forward-looking factors. These factors include, but are not limited to the following:

In addition, we review from time to time potential opportunities to expand our technologies or add to our portfolio of drug candidates. In the future, we may need further capital in order to acquire or invest in technologies, products or businesses.

We expect that additional financing will be required in the future to fund operations. We expect to finance future cash needs through the sale of equity securities, strategic collaborations, government grant awards and debt financing. In September 2003, we filed a registration statement on Form S-3 to offer to sell common stock in one or more offerings up to a dollar amount of $75.0 million. In December 2003, we completed a registered direct offering of 3,115,000 shares of common stock at a price of $9.00 per share. We received approximately $26.0 million in net proceeds after placement agent fees and other offering costs. As of December 31, 2003, approximately $47.0 million remained available on the Form S-3. We have no current commitments to offer and sell any securities that may be offered or sold pursuant to such registration statement. Additional financing or collaboration and licensing arrangements may not be available when needed or, if available, may not be on terms favorable to us or our stockholders. Insufficient funds may require us to delay, scale back or eliminate some or all of our research or development programs, to lose rights under existing licenses or to relinquish greater or all rights to product candidates at an earlier stage of development or on less favorable terms than we would otherwise choose or may adversely affect our ability to operate as a going concern. If additional funds are obtained by issuing equity securities, substantial dilution to existing stockholders may result. In addition, see “Item 1. Business – Risk Factors That May Affect Results of Operations and Financial Condition.”

Our obligations and commitments to make future payments under contracts, such as debt and lease agreements, and under contingent commitments are as follows:

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Item 7A. Quantitative and Qualitative Disclosures About Market Risk

The primary objective of our investment activities is to preserve principal while at the same time maximize the income we receive from our investments without significantly increasing risk. Some of the securities that we invest in may have market risk. This means that a change in prevailing interest rates may cause the principal amount of the investments to fluctuate. To minimize this risk in the future, we intend to maintain our portfolio of cash equivalents and investments in a variety of securities, including commercial paper, money market funds, government and non-government debt securities and investment-grade corporate obligations. Although changes in interest rates may affect the fair value of our portfolio and cause unrealized gains and losses, such gains and losses would not be realized unless the investments were sold prior to maturity. Through our money managers, we maintain risk management control systems to monitor interest rate risk. The risk management control systems use analytical techniques, including sensitivity analysis. If market interest rates were to increase by 100 basis points, or 1%, at December 31, 2003 rates, the fair value of our portfolio would decline by approximately $566,000 on that date.

At June 30, 2001, we determined that an other-than-temporary decline in fair value of our investment in short-term commercial paper of Southern California Edison, a utility company, had occurred. Accordingly, we recorded a $990,000 loss on the related write-down in the carrying value of the investment. In March 2002, the security was fully repaid. Thus, we recorded a realized gain of $990,000 for the year ended December 31, 2002.

The table below presents the principal amounts of our investments and equipment loans by expected maturity and related weighted average interest rates at December 31, 2003:

Item 8. Financial Statements and Supplementary Data

The report of Independent Auditors, Financial Statements and Notes to Financial Statements begin on page F-1 and are incorporated herein by reference.

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

None.

Item 9A. Controls and Procedures

Evaluation of Disclosure Controls and Procedures. Based on their evaluation, our chief executive officer and chief financial officer have concluded that the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) were sufficiently effective as of December 31, 2003 to ensure that information required to be disclosed by us in this Annual Report on Form 10-K was recorded, processed, summarized and reported within the time periods specified by the Securities and Exchange Commission’s rule and Form 10-K.

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Changes in Internal Controls over Financial Reporting. There were no changes in our internal controls over financial reporting during the twelve months ended December 31, 2003 that have materially affected, or are reasonably likely to affect, our internal control over financial reporting.

Limitations on the Effectiveness of Controls. The Company’s management, including our chief executive officer and chief financial officer, does not expect that our disclosure controls and procedures or our internal controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. Accordingly, our disclosure controls and procedures are designed to provide reasonable, not absolute, assurance that the objectives of our disclosure control system are met and, as set forth above, our chief executive officer and chief financial officer have concluded, based on their evaluation, that our disclosure controls and procedures were sufficiently effective as of December 31, 2003 to provide reasonable assurance that the objectives of our disclosure control system were met.

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Part III

Item 10. Directors and Executive Officers of the Registrant

Information concerning our directors will be contained in our definitive Proxy Statement with respect to our 2004 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission not later than April 30, 2004 (the “Proxy Statement”), under the caption “Proposal 1 - Election of Directors” and is incorporated herein by reference. See also “Item 1. Business – Directors and Executive and Other Officers of the Registrant.” Information concerning the composition of our audit committee, our audit committee financial experts and procedures for the nomination of directors are incorporated herein by reference to our Proxy Statement. Information concerning compliance with Section 16(a) of the Exchange Act will be contained in our Proxy Statement under the caption “Section 16(a) Beneficial Ownership Reporting Compliance” and is incorporated herein by reference. Information concerning our Code of Ethics is contained in this Annual Report on Form 10-K under “Item 1. Business – Available Information.”

Item 11. Executive Compensation

Information concerning executive compensation will be contained in our Proxy Statement under the caption “Executive Compensation” and is incorporated herein by reference.

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

Information concerning the security ownership of certain beneficial owners and management will be contained in our Proxy Statement under the caption “Security Ownership of Certain Beneficial Owners and Management” and is incorporated herein by reference. Information concerning securities authorized for issuance under equity compensation plans will be contained in our Proxy Statement under the caption “Equity Compensation Plan Information,” and is incorporated herein by reference.

Item 13. Certain Relationships and Related Transactions

Information concerning certain relationships will be contained in our Proxy Statement under the caption “Certain Relationships and Related Transactions” and will be incorporated herein by reference.

Item 14. Principal Accountant Fees and Services

Audit Fees. Information concerning audit fees will be contained in our Proxy Statement under the caption “Audit Fees” and is incorporated herein by reference.

Audit-Related Fees. Information concerning audit-related fees will be contained in our Proxy Statement under the caption “Audit-Related Fees” and is incorporated herein by reference.

Tax Fees. Information concerning tax fees will be contained in our Proxy Statement under the caption “Tax Fees” and is incorporated herein by reference.

All Other Fees. Information concerning other fees paid to our auditors will be contained in our Proxy Statement under the caption “All Other Fees” and is incorporated herein by reference.

Pre-Approval Policies and Procedures. Information concerning pre-approval policies and procedures will be contained in our Proxy Statement under the caption “Pre-Approval Policies and Procedures” and is incorporated herein by reference.

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PART IV

Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K

(a) The following documents are filed or incorporated by reference as part of this Annual Report:

Report of Ernst & Young LLP, Independent Auditors

Balance Sheets - December 31, 2003 and 2002

Statements of Operations - Years Ended December 31, 2003, 2002, and 2001

Statement of Changes in Stockholders’ Equity - Years Ended December 31, 2003, 2002 and 2001

Statements of Cash Flows - Years Ended December 31, 2003, 2002 and 2001

Notes to Financial Statements

None

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SIGNATURES

Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

POWER OF ATTORNEY

KNOW TO ALL PERSONS BY THESE PRESENTS, that the persons whose signatures appear below each severally constitutes and appoints Daniel V. Santi, M.D., Ph.D. and Susan M. Kanaya or either of them, his or her true and lawful attorneys-in-fact and agents, with full powers of substitution and re-substitution, for him or her and in his or her name, place and stead, in any and all capacities to sign any and all amendments to this Report on Form 10-K, and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto the attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith, as fully to all intents and purposes as he or she might or could do in person, hereby ratifying and confirming all that the attorneys-in-fact and agents, or either of them, or their, his or her substitutes or substitute, may lawfully do or cause to be done by virtue hereof.

Pursuant to the requirements of the Exchange Act, this Report on Form 10-K has been signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

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Kosan Biosciences Incorporated

INDEX TO FINANCIAL STATEMENTS

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REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

The Board of Directors and Stockholders

Kosan Biosciences Incorporated

We have audited the accompanying balance sheets of Kosan Biosciences Incorporated as of December 31, 2003 and 2002, and the related statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2003. 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 Kosan Biosciences Incorporated at December 31, 2003 and 2002, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States.

/s/ ERNST & YOUNG LLP

Palo Alto, California

February 10, 2004

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Kosan Biosciences Incorporated

BALANCE SHEETS

(in thousands, except share and per share data)