##### Table of Contents

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



FORM
10-K

(MARK ONE)

[ x ] Annual Report
Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the Fiscal Year Ended December 31, 2007.

or

[  ] Transition Report Pursuant to Section 13 or
15(d) of the Securities Exchange Act of 1934

For the Transition Period from
 to .



Commission File Number: 000-31633



KOSAN BIOSCIENCES INCORPORATED

(Exact name of registrant as
specified in its charter)



|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|DELAWARE                                                       |  | 94-3217016                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification
No.)



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:



|                                        |  |                                           
|--------------------------------------- |  | ------------------------------------------
|Title of each class:                    |  | Name of each exchange on which registered:
|Common Stock, $.001 par value per share |  | The NASDAQ Stock Market LLC               



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

---



Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes [  ]    No [ x ]



Indicate by check mark if the registrant is not required to file reports pursuant to Section 13
or Section 15(d) of the Act.    Yes [  ]    No [ x ]



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 (§229.405 of this Chapter) 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. [ x ].



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



|                                                                         |  |                               
|------------------------------------------------------------------------ |  | ------------------------------
|Large accelerated filer [  ]                                             |  | Accelerated filer [ x ]       
|Non-accelerated filer [  ] (Do not check if a smaller reporting company) |  | Smaller reporting company [  ]



Indicate by check mark whether the registrant
is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes [  ]    No [ x ]



The aggregate market value of the voting stock held by non-affiliates of the registrant was
approximately $204,935,000 as of June 29, 2007, based upon the closing sale price on the NASDAQ Global Market reported for such date. The determination of affiliate status for the purposes of this calculation is not necessarily a conclusive
determination for other purposes. The calculation excludes approximately 3,267,000 shares held by directors, officers and stockholders whose ownership exceeded ten percent of the registrants outstanding Common Stock as of June 29, 2007.
Exclusion of these shares should not be construed to indicate that such person controls, is controlled by or is under common control with the registrant.



The number of shares of common stock of the registrant outstanding at February 29, 2008 was 42,592,302 shares.



DOCUMENTS INCORPORATED BY REFERENCE

Certain
portions of the registrants Proxy Statement in connection with the registrants 2008 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 III of this report.



---

##### Table of Contents

Kosan Biosciences Incorporated

Form 10-K

For the Fiscal Year Ended December 31, 2007



TABLE OF
CONTENTS



|                     |  |                                                                                                              |  |     
|-------------------- |  | ------------------------------------------------------------------------------------------------------------ |  | ----
|                     |  |                                                                                                              |  | Page
|                     |  | PART I                                                                                                       |  |     
|Item 1.              |  | Business                                                                                                     |  | 3   
|Item 1A.             |  | Risk Factors                                                                                                 |  | 13  
|Item 1B.             |  | Unresolved Staff Comments                                                                                    |  | 30  
|Item 2.              |  | Properties                                                                                                   |  | 30  
|Item 3.              |  | Legal Proceedings                                                                                            |  | 30  
|Item 4.              |  | Submission of Matters to a Vote of Security Holders                                                          |  | 30  
|                     |  |                                                                                                             
|                     |  | PART II                                                                                                      |  |     
|Item 5.              |  | Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |  | 31  
|Item 6.              |  | Selected Financial Data                                                                                      |  | 33  
|Item 7.              |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                        |  | 35  
|Item 7A.             |  | Quantitative and Qualitative Disclosures about Market Risk                                                   |  | 45  
|Item 8.              |  | Financial Statements and Supplementary Data                                                                  |  | 45  
|Item 9.              |  | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure                         |  | 45  
|Item 9A.             |  | Controls and Procedures                                                                                      |  | 45  
|Item 9B.             |  | Other Information                                                                                            |  | 48  
|                     |  |                                                                                                             
|                     |  | PART III                                                                                                     |  |     
|Item 10.             |  | Directors, Executive Officers and Corporate Governance                                                       |  | 49  
|Item 11.             |  | Executive Compensation                                                                                       |  | 49  
|Item 12.             |  | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters               |  | 50  
|Item 13.             |  | Certain Relationships and Related Transactions, and Director Independence                                    |  | 50  
|Item 14.             |  | Principal Accountant Fees and Services                                                                       |  | 50  
|                     |  |                                                                                                             
|                     |  | PART IV                                                                                                      |  |     
|Item 15.             |  | Exhibits and Financial Statement Schedules                                                                   |  | 51  
|Signatures           |  | 56                                                                                                          
|Financial Statements |  | F-1                                                                                                         



2



---

##### Table of Contents

PART I

KOSAN BIOSCIENCES



ITEM 1. BUSINESS

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, the statements about:



| |  |  | our strategy, including our plans with respect to presenting clinical data and initiating clinical trials;
| | - |  | ----------------------------------------------------------------------------------------------------------



| |  |  | our research and development programs, including clinical testing;
| | - |  | ------------------------------------------------------------------



| |  |  | sufficiency of our cash resources;
| | - |  | ----------------------------------



| |  |  | revenues from our current licensing arrangement with Pfizer;
| | - |  | ------------------------------------------------------------



| |  |  | our research and development and other expenses; and
| | - |  | ----------------------------------------------------



| |  |  | our operations and legal risks.
| | - |  | -------------------------------



In some cases, forward-looking statements can be 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 throughout this Annual Report on Form 10-K, including the sections entitled 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 1A. Risk Factors, 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 1A.
Risk Factors and elsewhere in this report should be considered in evaluating our prospects and future performance.



The name Kosan Biosciences Incorporated, our logo and all other Kosan names are our trademarks. All other trademarks or brand names appearing in this Annual Report are the property
of their respective holders.



Overview

We are a cancer therapeutics company focused on advancing two new classes of anticancer agents through clinical development: heat shock protein 90, or Hsp90, inhibitors and
epothilones.



Hsp90 inhibitors
have a novel mechanism of action targeting multiple pathways involved in cancer cell growth and survival. Our Hsp90 inhibitor product candidates may have the potential to overcome resistance after relapse and to synergize the initial activity of
existing cancer therapies. Our first and second generation Hsp90 inhibitor product candidates have demonstrated antitumor activity in multiple indications in early clinical trials. Our proprietary injectable suspension formulation of tanespimycin,
or KOS-953, our first-generation Hsp90 inhibitor and most advanced product candidate, is in a Phase 3 clinical trial in combination with Velcade® (bortezomib) for multiple myeloma, as well as in a
Phase 2 clinical trial in combination with Herceptin® (trastuzumab) for HER2-positive metastatic breast cancer.



Epothilones inhibit cell division with a mechanism of action similar to taxanes, one of the most successful classes of anti-tumor agents. KOS-1584 is
our epothilone anticancer product candidate that is being evaluated in dose-escalating Phase 1 clinical trials in patients with solid tumors. We expect to initiate our Phase 2 clinical program with KOS-1584 in the first quarter 2008.



3



---

##### Table of Contents

KOSAN BIOSCIENCES



Our epothilone program was partnered with Hoffmann-La Roche, Inc. and F. Hoffmann-La Roche Ltd. (collectively Roche) through a global development and commercialization
agreement. Our agreement with Roche was terminated in its entirety effective in late February 2008. Following the termination of the agreement, the rights licensed to Roche reverted to us, and in connection with the termination, Roche provided us
with certain license rights, data and other assistance related to the product candidates licensed to Roche under the agreement. Roches development funding commitments under the agreement continued until the termination date in late February
2008, after which Roche is obligated to reimburse us for certain costs of completing the KOS-1584 Phase 1 clinical trials.



We also have a motilin receptor agonist program for the stimulation of gastrointestinal movement, or GI motility. In December 2006, we established a worldwide exclusive license
agreement with Pfizer Inc. for our motilin agonist program, including KOS-2187 and related compounds. Pfizer is responsible for all development, regulatory and commercial activities related to the motilin agonist program. Pfizer is conducting Phase
1 clinical testing of KOS-2187 as a potential treatment for gastroesophageal reflux disease (GERD).



We also have next-generation Hsp90 inhibitor, next-generation epothilone and nuclear export inhibitor programs for cancer that are undergoing preclinical evaluation. These programs
are also based on the use of our technology to improve the structure of known polyketides and the efficiency of large-scale production.



Our Strategy

Our goal is to develop and commercialize
innovative cancer therapeutics. Our strategy includes the following components:



Focus
on Advancing Later Stage Product Candidates. We are focused on advancing our lead product candidate, Hsp90 inhibitor tanespimycin, in multiple myeloma and in metastatic breast cancer, and our lead epothilone candidate, KOS-1584, in non-small
cell lung cancer and potentially other indications. We have prioritized our development portfolio to focus resources on product candidates that we believe represent the highest therapeutic potential and commercial value for the company in the
near-term.



Disciplined Management of Our Financial Resources. We intend to focus
our financial resources on advancing our clinical product candidates towards regulatory approval and commercialization.



Establish and Leverage Existing Partnering Arrangements. We have a license agreement with Pfizer for the development and commercialization of our motilin agonist program. We
plan to establish additional partnering arrangements with pharmaceutical companies and other research and development organizations to help us advance product candidates into or through clinical trials and to the market.



Develop Cancer Therapeutic Products with First-In-Class or Best-In-Class Potential. We have
developed a core expertise in the discovery and development of potential cancer therapeutics. We plan to continue to focus on cancer indications to best utilize our expertise and develop potential first-in-class or best-in-class therapies.



Strategically Invest in Our Drug Discovery Efforts and Polyketide Technology
Platform. We intend to continue internal research activities on polyketide biosynthesis and chemical synthesis with the goal of advancing high-quality product candidates into preclinical and clinical development. All of our programs are based on
the development of polyketides. Polyketides are complex natural products produced by certain microorganisms. Numerous pharmaceutical products in many therapeutic areas have been derived from polyketides. We focus on polyketides because of our
expertise in genetic manipulation, chemistry and production of polyketides. We use our technology to improve the structure of known polyketides with validated targets to make potential product candidates. We also improve the efficiency of
large-scale production in order to more cost-effectively access promising compounds that cannot be obtained from nature in sufficient quantities to permit development and potential commercialization.



4



---

##### Table of Contents

Product Pipeline

The following chart
indicates the most advanced stage of development for each of our product candidates.



LOGO



Oncology

Hsp90 Inhibitors

We are developing compounds 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. Hsp90 is a molecular chaperone in cells that maintains the stability and function of
client proteins that are important for cell proliferation, angiogenesis and metastasis of tumors. By preventing Hsp90 from protecting its client proteins, Hsp90 inhibitors cause the client proteins to degrade. By simultaneously depleting
multiple proteins involved in the genesis and maintenance of cancer cells, Hsp90 inhibitors may serve as chemotherapeutic agents in a number of cancers. Moreover, studies suggest that Hsp90 inhibitors re-sensitize cancer cells to drugs to which they
have become resistant. Hsp90 inhibitors may also enhance the initial activity of existing cancer therapies when used in combination. Hsp90 inhibitors, such as tanespimycin, can simultaneously target several of the key attributes of cancers and may
have broad therapeutic activity against multiple types of cancers.



Tanespimycin. Our proprietary injectable suspension formulation of tanespimycin, or KOS-953 (also known as 17-AAG), is
in a Phase 3 clinical trial in combination with Velcade® (bortezomib) for multiple myeloma, as well as a Phase 2 clinical trial in combination with Herceptin® (trastuzumab) in HER2-positive metastatic breast cancer. Our Tanespimycin in Myeloma Evaluation, or TIME, clinical program includes TIME-1, a Phase 3 pivotal study of tanespimycin in combination with Velcade in
first-relapse patients with multiple myeloma, which has been initiated. We also plan to conduct a second trial in multiple myeloma to support the pivotal TIME-1 trial with additional safety



5



---

##### Table of Contents

KOSAN BIOSCIENCES



and efficacy data. We plan to initiate the supporting trial in early 2009 and anticipate that the trial can be completed within the timeframe of TIME-1. The TIME
program is utilizing our tanespimycin injectable suspension formulation that replaced the prior Cremophor-based formulation. In addition to multiple myeloma, we intend to advance tanespimycin in metastatic breast cancer. We anticipate presenting
updated data with the injectable suspension formulation from our Phase 2 clinical trial of tanespimycin in combination with Herceptin in patients with HER2-positive metastatic breast cancer in the first half of 2008. We expect to conduct enabling
studies evaluating tanespimycin as monotherapy and in combination with other agents such as Taxol® (paclitaxel), Xeloda® (capecitabine®) and/or Herceptin® beginning in late 2008 or early 2009. Finally, our Phase 2 clinical trial of tanespimycin in metastatic melanoma was recently
completed. As we did not observe sufficient clinical activity to warrant continued pursuit of this indication, we do not plan to develop tanespimycin in this indication.



In 2004, tanespimycin received orphan drug designations from both the European Medicines Agency, or EMEA, and the U.S. Food and Drug Administration, or FDA, for the
treatment of two hematologic cancers, multiple myeloma and chronic myelogenous leukemia. Orphan drug designation makes a compound eligible for orphan drug exclusivity and, in the United States, specific tax credits. Generally, if a company receives
the first marketing approval for a compound with an orphan drug designation in the clinical indication for which it has such designation, the compound is entitled to orphan drug exclusivity. Orphan drug exclusivity means that another application to
market the same compound for the same indication may not be approved, except in limited circumstances, for a period of up to 10 years in Europe (reviewable after six years), and for a period of seven years in the United States.



Alvespimycin. Alvespimycin, or KOS-1022 (also known as 17-DMAG), is a highly-potent,
water-soluble and orally-active Hsp90 inhibitor. We have evaluated both intravenous and oral formulations of alvespimycin in clinical trials. In February 2008, we terminated development of alvespimycin in order to focus our resources on the
development of tanespimycin.



Epothilones

Epothilones are polyketides that inhibit cancer cells by a mechanism of action similar to a class of cytotoxic drugs known as
taxanes, including paclitaxel, marketed as Taxol® by Bristol-Myers Squibb Company, and docetaxel, marketed as Taxotere® by Sanofi-Aventis.
Epothilones may address a key limitation of the taxane class because they have shown activity against taxane-resistant human tumor cell lines in vitro and in animal models, as well as activity against taxane-sensitive human tumors cells in
these models. Through late February 2008, our epothilone program was partnered with Roche through a September 2002 global development and commercialization agreement.



KOS-1584. KOS-1584 is our lead epothilone product candidate being evaluated in dose-escalating Phase 1 clinical trials in patients with solid
tumors. KOS-1584 has demonstrated antitumor activity and favorable tolerability in Phase 1 clinical trials in patients with solid tumors, including non-small cell lung, ovarian and pancreatic cancers. We intend to initiate a Phase 2 clinical trial
of KOS-1584 in non-small cell lung cancer patients who have received one prior chemotherapy regimen in early 2008. We may conduct additional Phase 2 trials of KOS-1584. Kosan believes that KOS-1584 has best-in-class potential based on the
compounds activity and tolerability profile, which may contrast with currently marketed and other development-stage compounds in this class.



Gastrointestinal Motility

Motilin receptor agonists, called motilides, may be useful to
treat diseases such as gastroparesis and other conditions in which GI motility is impaired. Preclinical data indicate that our compound, KOS-2187, is a potent motilin receptor agonist that has high oral bioavailability, is rapidly absorbed and
significantly accelerates gastric emptying. In December 2006, we established a worldwide exclusive license agreement with Pfizer for our motilin agonist program, including KOS-2187 and related compounds. Pfizer is responsible for all development,
regulatory and commercial activities



6



---

##### Table of Contents

related to the motilin agonist program. Pfizer is conducting Phase 1 clinical testing of KOS-2187 as a potential treatment for GERD.



Early-Stage Programs

We also have next-generation Hsp90 inhibitor, next-generation epothilone and nuclear export inhibitor programs for cancer that are undergoing preclinical evaluation. These programs are also based on the use of our technology to improve the
structure of known polyketides and the efficiency of large-scale production.



Research and Development Expenses

Our research and development expenses consist 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. Our research and development
expenses were approximately $47.3 million in 2007, $37.2 million in 2006 and $38.4 million in 2005.



Intellectual Property

Our intellectual property consists of
patents, copyrights, trademarks, trade secrets and know-how. Our ability to compete effectively depends in large part on our ability to obtain patents and trademarks for our technologies and products, maintain trade secrets, 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, 2007, we owned or exclusively licensed approximately 143 patents and 79 patent
applications in the U.S. and approximately 80 foreign patents and 265 foreign patent applications. We pursue patent protection in countries where we believe it is commercially reasonable and advantageous to do so. Generally, U.S. and foreign patents
are granted for a term of 20 years counting from the date of filing or the earliest claimed priority date, whichever is earlier. The aforementioned patents licensed or owned by Kosan have filing or earliest priority dates ranging from 1993 to the
present.



Our practice 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.



Collaborative Research, Development and License Agreements

Roche

In September 2002, we entered into a research and collaboration agreement with Roche. Our agreement with Roche was terminated in its entirety
effective in late February 2008. Following the termination of the agreement, the rights licensed to Roche reverted to us, and in connection with the termination, Roche provided us with certain license rights, data and other assistance related to the
product candidates licensed to Roche under the agreement. Roches development funding commitments under the agreement continued until the termination date in February 2008, after which Roche is obligated to reimburse us for certain costs of
completing the KOS-1584 Phase 1 clinical trials.



We recognized under this agreement
approximately $12.0 million and $11.3 million of contract revenue in 2007 and 2006, respectively, of which $2.0 million was related to a non-recurring milestone earned in 2006. Included in 2007 and 2006 revenue was the ratable portion of the $25.0
million up-front fee that was recognized through the estimated clinical development period. As of December 31, 2007, we had received approximately $88.0 million from our collaboration with Roche.



7



---

##### Table of Contents

KOSAN BIOSCIENCES



Pfizer

In December 2006, we entered into an exclusive license agreement with Pfizer under
which we granted to Pfizer a worldwide exclusive license to our motilin agonist program. Under the terms of the agreement, Pfizer and we agreed to collaborate on filing of regulatory documents for the initiation of a Phase 1 clinical trial of our
clinical candidate, KOS-2187. Pfizer will be responsible for all development, regulatory and commercial activities related to the motilin agonist program.



We received an up-front fee of $12.5 million in December 2006 and are eligible to receive milestone payments for the successful development and commercialization of licensed
compounds, including milestone payments for achieving certain sales amounts, as well as royalties on worldwide sales. We recognized revenue of approximately $10.7 million and $1.8 million in contract revenue in 2007 and 2006, respectively, which
represents the ratable portion of the $12.5 million up-front fee that was recognized over the estimated period of the Companys participation in the development of KOS-2187.



Under the agreement, we agreed to assign to Pfizer all of our non-United States patent rights related to the technology licensed under the agreement,
and Pfizer is primarily responsible for the prosecution and maintenance of these patent rights. We also agreed to assign to Pfizer all of our United States patent rights related to the technology licensed to Pfizer at a later stage of clinical
development.



Either party may terminate the agreement at any time for the other
partys uncured material breach of the agreement. Pfizer may terminate the agreement for convenience. Upon a termination by Pfizer for uncured material breach by us, the license rights shall become perpetual and irrevocable. In the event of a
termination by Pfizer for convenience or by us for uncured material breach by Pfizer, the licensed rights would revert to us, Pfizer may be required to provide us with certain license rights, regulatory filings, data and technical transfer
assistance. Unless earlier terminated, the agreement will remain in effect for the life of the relevant patents or a specified number of years from the first commercial sale on a country-by-country basis.



Sloan-Kettering Institute for Cancer Research

Effective August 2000, we entered into a research and license agreement with the Sloan-Kettering Institute for Cancer Research, or Sloan-Kettering, relating to epothilones. Under
the agreement, we worked collaboratively with Sloan-Kettering to develop epothilone compounds and production methods. In addition, Sloan-Kettering granted us an exclusive license 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 funding for the collaborative research program and we are required to pay annual maintenance fees and patent fees during the term of the agreement. 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.



We may terminate the agreement in whole or on a product-by-product basis at any time. Either party may terminate the agreement upon the material
breach of the agreement by the other party. Upon termination, all licenses granted by one party to the other revert to the granting party, and we are required to transfer to Sloan-Kettering any marketing authorizations, data and regulatory filings
with respect to any compounds covered by the agreement. 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. 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.



8



---

##### Table of Contents

In 2003, we and Sloan-Kettering agreed that rights to certain epothilone analogs, including KOS-1584, are included in the exclusive
license to us under the August 2000 research and license agreement. The agreement provided for an up-front payment to Sloan-Kettering and provides for additional payments to Sloan-Kettering upon the achievement of certain development milestones.



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 and patent 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 and directors, Chaitan S. Khosla, Ph.D., related to polyketides or their production, and
chosen by Stanford University in its discretion. Under the March 2000 amendment, we paid an issue fee in preferred stock that was subsequently converted to common stock in our initial public offering, and we are obligated to pay an option fee and
patent expenses for each patent or patent application included in our option rights. We are also obligated to pay Stanford University a license fee and an annual fee, as well as royalties on net sales and a share of some sublicensing fees under the
original agreement, with respect to each patent or patent application for which we exercise our option. 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 harmonize it with the collaboration agreement with Roche and effect certain other changes.



NIH/NCI

Under a November 2002 license agreement with the NIH, we obtained exclusive
commercial rights under patent rights relating to the formulation of tanespimycin being studied by the NCI, alvespimycin and other geldanamycin analogs. Initially, our license was limited to specified medical fields of use, including the treatment
of cancer, and the prevention of undesired cell growth or its deleterious effects, such as the prevention of restenosis and neurodegenerative diseases. In May 2005, we amended the license to include several additional fields of use. We 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 any sublicensing revenues. Our license could
terminate if we are not diligent in developing licensed products or otherwise default in performing our material obligations under the agreement and fail to cure the deficiency. We may terminate the agreement on a country-by-country basis. The
agreement contains standard NIH licensing terms. Unless the agreement is earlier terminated, our license will remain in effect for the life of the licensed patents. We developed our proprietary formulations of tanespimycin independently from the
NIH.



Oregon State University

Under an April 2005 license agreement with Oregon State University, or OSU, we obtained an exclusive right to a patent and related intellectual property for synthesizing
epothilones and epothilone analogs. Under the terms of the agreement, we paid a license issue fee to OSU, and we pay annual maintenance fees and patent 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. Our license could terminate if we are not diligent in developing licensed products or otherwise default in
performing our material obligations under the agreement and fail to cure the deficiency. Unless the agreement is earlier terminated, our license will remain in effect for the life of the licensed patents. In October 2007, we amended the license
agreement



9



---

##### Table of Contents

KOSAN BIOSCIENCES



because we entered into a settlement agreement with OSU and Sloan-Kettering setting forth the agreed upon procedure to conduct an interference hearing. This amendment
confirms, as well as makes certain adjustments to, our financial obligations to OSU under our license agreement regardless of which party ultimately prevails in the interference.



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 current and potential future 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 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 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. Companies with competing Hsp90 inhibitors include Biogen Idec Inc., which has initiated Phase 1 and 2 clinical trials in solid tumors with its oral synthetic Hsp90 inhibitor; Infinity
Pharmaceuticals, which has initiated a Phase 1/2 clinical trials of its intravenous Hsp90 inhibitor in gastrointestinal stromal tumors, and has an oral formulation in preclinical development in collaboration with MedImmune, Inc. (now a part of the
AstraZeneca group of companies); Abraxis BioScience, Inc., which has an albumin-bound particle suspension formulation of 17-AAG in preclinical development; Vernalis plc, which has announced that it has selected an intravenous and an oral Hsp90
inhibitor preclinical development candidate in collaboration with Novartis AG and initiated a Phase 1 clinical trial in late 2007; Serenex, Inc., which has initiated Phase 1 clinical trials for its oral Hsp90 inhibitor in solid and hematological
tumors and has agreed to be acquired by Pfizer; and Synta Pharmaceuticals Corp., which initiated Phase 1 clinical trials for its Hsp90 inhibitor in melanoma, as well as other companies reported to be pursuing Hsp90 inhibitors. Competing epothilones
in clinical development include those being developed by Novartis AG, which is reported to be in Phase 3 clinical trials; and Schering AG, which is reported to be in Phase 2 clinical trials. In addition, IXEMPRA(TM) (ixabepilone), an epothilone
developed by Bristol-Myers Squibb Company, was approved by the FDA in October 2007 for use in breast cancer and Bristol-Myers Squibb Company is reported to be in numerous post-marketing clinical trials of ixabepilone. Gastrointestinal motility
competitors include Chugai Pharmaceuticals, whose motilide agonist is reported to be in Phase 2 clinical trials.



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 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, distribution, post-marketing surveillance, 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:



| |  |  | preclinical laboratory and animal tests;
| | - |  | ----------------------------------------



10



---

##### Table of Contents

| |  |  | submission of an IND, which must become effective before clinical trials may begin;
| | - |  | -----------------------------------------------------------------------------------



| |  |  | adequate and well-controlled human clinical trials to establish the safety and efficacy of the proposed drug for its intended use; and
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------



| |  |  | FDA approval of a New Drug Application, or NDA, or Biologics License Application, or BLA.
| | - |  | -----------------------------------------------------------------------------------------



Satisfaction of FDA requirements or similar requirements of state, local and foreign regulatory agencies typically takes multiple years, and the
actual time required may vary substantially based upon the type, complexity and novelty of the product or indication.



In the United States, 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 and places the trial on clinical hold. 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. Outside of the United States, mechanisms to commence clinical trials vary,
but often require submission of supporting information and prior health authority approval. Further, an independent institutional review board or ethics committee must review and approve the plan for the clinical trial before it commences.



The FDA (or foreign equivalent), an institutional review board, data safety monitoring
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.



In an effort to obtain marketing authorization in the United States, 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, require additional clinical data or ultimately determine that the NDA or BLA does not satisfy the criteria for
approval. After review of an NDA or BLA, the FDA can grant a normal marketing authorization, or full approval, or a marketing authorization under accelerated approval conditions. Under accelerated approval conditions, FDA may grant a marketing
authorization for a new drug on the basis of adequate and well-controlled clinical trials establishing that the drug product has an effect on a surrogate endpoint that is reasonably likely to predict clinical benefit. Accelerated approval under this
condition will require the applicant to study the drug further to verify and describe its clinical benefit.



Even 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. 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.



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.



11



---

##### Table of Contents

KOSAN BIOSCIENCES



New federal legislation known as the FDA Amendments Act of 2007 was recently enacted. This legislation grants the FDA extensive new authority to impose post-approval clinical study
and clinical trial requirements, require safety-related changes to product labeling, review advertising aimed at consumers, and require the adoption of risk management plans. Other proposals have been made to impose additional requirements on drug
approvals, further expand post-approval requirements and restrict sales and promotional activities. The new legislation, and the additional proposals if enacted, may make it more difficult or burdensome for us to obtain approval of our product
candidates, any approvals we receive may be more restrictive or be subject to onerous post-approval 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 from country to country. At present, foreign marketing authorizations are applied for at a national level, although within the European Union, or EU,
centralized registration procedures are available to companies seeking to market a product throughout the EU community. If the regulatory authority is satisfied that adequate evidence of safety, quality and efficacy has been presented, a marketing
authorization will be granted. These foreign regulatory approval processes involve all of the risks associated with FDA clearance and may be influenced by FDA actions with respect to a product candidate.



We are also subject to various federal, state and local laws and regulations relating to such matters
as the use, handling and disposal of hazardous or potentially hazardous substances used in connection with our research, development and manufacturing operations. We believe that we are in compliance with these laws and regulations in all material
respects.



Employees

As of February 29, 2008, we had 91 full-time employees, 34 of whom held Ph.D. degrees and 73 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.



Corporate Information

Kosan was 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. We maintain a website at www.kosan.com; however, information found on, or that can be
accessed through, our website is not incorporated by reference into this report.



Available Information

We file electronically with the U.S.
Securities and Exchange Commission our annual reports 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 Securities Exchange Act
of 1934. We make available on our website at www.kosan.com, free of charge, copies of these reports as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. Further, copies of these reports
are located at the SECs Public Reference Room at 100 F Street, NE, Washington, D.C. 20549. Information on the operation of the Public Reference Room can be obtained by calling the SEC at 1-800-SEC-0330. The SEC maintains a website that
contains reports, proxy and information statements, and other information regarding our filings, at www.sec.gov.



12



---

##### Table of Contents

ITEM 1A. RISK FACTORS

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 developing our product candidates. We have not commercialized any products, and we have incurred net losses since our inception, including a net loss of approximately $28.7 million for the year ended December 31, 2007. As of
December 31, 2007, we had an accumulated deficit of approximately $189.0 million. To date, our revenues have been primarily from partnering arrangements 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 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 product candidates and research programs. The amount of time necessary to successfully commercialize any of our product candidates is long and uncertain, and successful commercialization may not occur at all. As a result,
we may never become profitable.



We expect that additional financing will be required,
and an inability to obtain the capital necessary to fund our operations on acceptable terms or at all would threaten the continued operation of our business.

We
expect that additional financing will be required to fund operations. We do not know whether additional financing will be available when needed, or that, if available, we will obtain financing on favorable terms. We have consumed substantial amounts
of cash to date and expect to incur significant operating expenditures over the next several years as we continue to advance our product candidates into and through clinical trials. We currently have no commitments from third parties for external
funding of our product development efforts (other than limited clinical trial cost reimbursements from Roche) and absent any new partnering arrangements with third parties, we will be required to independently to fund any development and clinical
trial activities that we may undertake.



If we are unable to raise sufficient funds when
needed, we may be required to delay, scale back or eliminate some or all of our research or development programs; lose rights under existing licenses; or relinquish greater or all rights to product candidates at an earlier stage of development or on
less favorable terms than we would otherwise choose. Insufficient funds may adversely affect our ability to operate as a going concern, and an inability to obtain the capital necessary to fund our operations on acceptable terms or at all would
threaten the continued operation of our business. See Part II, Item 7. Managements Discussion and Analysis of Financial Condition and Result of Operations.



We believe that our existing cash and investments will be sufficient to support our current operating plan into the first half of 2009. We have based
this estimate on assumptions that may prove to be wrong. Our future capital uses and requirements depend on numerous forward-looking factors, including the following:



| |  |  | our ability to establish new partnering arrangements, our rights and obligations under any new partnering arrangements and our ability to generate revenues under any new
partnering arrangements;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the extent to which clinical and other development activities are funded or conducted by potential future partners, if any;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------



| |  |  | the progress, success and costs of preclinical testing and clinical trials of our product candidates;
| | - |  | -----------------------------------------------------------------------------------------------------



| |  |  | the costs of any drugs used in combination with our product candidates in our clinical trials;
| | - |  | ----------------------------------------------------------------------------------------------



13



---

##### Table of Contents

KOSAN BIOSCIENCES



| |  |  | any acceleration or expansion of our clinical development plans;
| | - |  | ----------------------------------------------------------------



| |  |  | our ability to maintain or extend our existing licensing arrangement with Pfizer;
| | - |  | ---------------------------------------------------------------------------------



| |  |  | the progress, number and costs of our research programs;
| | - |  | --------------------------------------------------------



| |  |  | the costs and timing of obtaining, enforcing and defending patent and other intellectual property rights;
| | - |  | ---------------------------------------------------------------------------------------------------------



| |  |  | any need to obtain licenses to additional patents or other intellectual property in order to use, import, manufacture, market or sell our product candidates;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | any need to expand our manufacturing capabilities; and
| | - |  | ------------------------------------------------------



| |  |  | expenses associated with any possible future litigation.
| | - |  | --------------------------------------------------------



We may raise additional financing through public or private equity offerings, debt financings, partnering or licensing arrangements, government grant awards or any combination of
the foregoing or other arrangements. To the extent that we raise additional capital by issuing equity securities, our stockholders may experience dilution. Debt financing, if available, may subject us to restrictive covenants and significant
interest costs. To the extent that we raise additional funds through collaboration and licensing arrangements, we would be required to relinquish some rights to our technologies, product candidates or marketing territories.



If we fail to enter into new partnering or licensing arrangements in the future, our business and
operations would be negatively impacted.

Our strategy depends upon the formation and sustainability of multiple partnering arrangements and license agreements with
third parties, particularly with respect to our Hsp90 inhibitor and epothilone programs. 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 in the past established partnering arrangements and various license agreements, we do not know if we will be able to establish additional
arrangements on favorable terms, or whether any such partnering arrangements will ultimately be successful. For example, our collaboration arrangement with Roche for our epothilone program was terminated by Roche, effective in late February 2008,
and our cooperative research and development agreements with the NCI with respect to the clinical development of tanespimycin and alvespimycin have also expired. There have been, and may continue to be, a significant number of business combinations
among pharmaceutical companies that have resulted, and may continue to result, in a reduced number of potential future partners, which may limit our ability to find partners who will work with us in developing and commercializing our product
candidates. If we do not enter into new partnering arrangements, in particular, partnering arrangements for the further development of our Hsp90 inhibitor and epothilone programs, we will be required to undertake Hsp90 inhibitor and epothilone
development and commercialization at our own expense, which would likely limit the number of product candidates that we will be able to develop and commercialize and significantly increase our capital requirements and may reduce the likelihood of
successful product introduction. We may also be required to further curtail, suspend, delay or terminate research and development programs, including planned clinical trials for our product candidates, and therefore our ability to generate revenues
from our epothilone, Hsp90 inhibitor or other programs will be adversely affected. Our ability to partner our Hsp90 inhibitor program may be difficult because the composition of matter of patent for 17-AAG is in the public domain. Our novel
formulation patent applications combined with method of treatment patent applications may not be sufficient to attract partners. In addition, there may be new information that may weaken the strength of the issued patent for 17-DMAG or alvespimycin.
Our ability to start new research and development programs may also be materially harmed if we are unable to establish new partnering arrangements with third parties.



14



---

##### Table of Contents

If our current licensing arrangements or potential future partnering or licensing arrangements are unsuccessful or are terminated,
or if conflicts develop with our current licensees or licensors, or our potential future partners, licensees or licensors, 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 obtained licenses to technology and compounds from several research groups, including Sloan-Kettering and the
Oregon State University in the field of epothilones, the NCI in the field of geldanamycin analogs and Stanford University in the field of polyketide technology. These agreements permit our licensors to terminate the agreements under certain
circumstances. We also have a license agreement with Pfizer pursuant to which Pfizer is responsible for development, regulatory and commercial activities related to our motilin agonist program, which may be terminated by Pfizer at any time for its
convenience. If we do not maintain, extend or replace our license agreement with Pfizer, we may be required to seek new third parties to undertake motilin agonist development and commercialization or to undertake such efforts at our own expense, the
research and development efforts for our motilin agonist program could be delayed, our revenues could significantly decrease and our operations would be adversely affected. Furthermore, if our in-license agreements are terminated, or disputes arise
that we are not able to resolve in our favor concerning our rights to particular compounds or technologies, our research and development efforts could be delayed, curtailed or terminated, or we could lose our rights to use the licensed compounds or
technologies.



We control neither the amount nor timing of resources that Pfizer devotes
to our motilin agonist program, nor the scope, content and timing of the preclinical studies, clinical trials and other development efforts that Pfizer conducts or permits, including for KOS-2187. Even if we are successful in establishing new
partnering arrangements with respect to our epothilone program, our Hsp90 inhibitor program or our other programs, we may not be able to control the amount nor timing of resources that potential future partners devote to our programs. As a result,
we do not know if Pfizer or any potential future partners will dedicate sufficient resources, or if the development or commercialization efforts by Pfizer or any potential future partners will be successful. We also do not know if the development or
commercialization efforts by Pfizer or any potential future partners will be the same as those we would choose to devote if we solely controlled the development and commercialization of our programs and product candidates. In addition, we do not
know whether Pfizer or potential future 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 the partnering or licensing arrangements with us. In addition, business combinations or significant changes in a partners business strategy may adversely affect its willingness or ability to continue the partnering or
licensing arrangement with us. If Pfizer or any potential future partners fail to conduct research, development or commercialization activities with respect to compounds or products for which they have rights from us successfully and in a timely
manner, or if they or our licensors 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. For example, if Pfizer does not
successfully develop and commercialize a product from our motilin agonist program, we may not receive any future milestone payments and will not receive any royalties under our license agreement with Pfizer.



Our committed equity financing facility with Kingsbridge may not be available to us if we elect to make
a draw down, may require us to make additional blackout or other payments to Kingsbridge and may result in dilution to our stockholders.

In July 2006, we
entered into a CEFF with Kingsbridge. The CEFF entitles us to sell and obligates Kingsbridge to purchase, from time to time through September 25, 2009, shares of our common stock for cash consideration up to an aggregate of $47.0 million as of
December 31, 2007, subject to certain conditions and restrictions. Kingsbridge will



15



---

##### Table of Contents

KOSAN BIOSCIENCES



not be obligated to purchase shares under the CEFF unless certain conditions are met, which include a minimum price for our common stock (which condition, for example,
would not have been met as of March 5, 2008 and will not be met unless the volume weighted average market price of our common stock is at least $2.00), the accuracy of representations and warranties made to Kingsbridge; compliance with laws;
and the effectiveness of a registration statement registering for resale the shares of common stock to be issued in connection with the CEFF. In addition, among other termination rights, Kingsbridge is permitted to terminate the CEFF by providing
written notice to us within 10 trading days after it obtains actual knowledge that an event has occurred resulting in a material and adverse effect on our business, operations, properties or financial condition. If we are unable to access funds
through the CEFF, or if Kingsbridge terminates the CEFF, we may be unable to access capital on favorable terms, or at all.



We are entitled, in certain circumstances, to deliver a blackout notice to Kingsbridge to suspend the use of the resale registration statement and prohibit Kingsbridge from selling
shares under the resale registration statement for a certain period of time. If we deliver a blackout notice in certain circumstances, or if the resale registration statement is not effective in circumstances not permitted by the agreement, then we
must make a payment to Kingsbridge, or issue Kingsbridge additional shares in lieu of this payment, calculated on the basis of the number of shares purchased by Kingsbridge in the most recent draw down and held by Kingsbridge immediately prior to
the blackout period and the change in the market price of our common stock during the period in which the use of the registration statement is suspended. If the trading price of our common stock declines during a suspension of the resale
registration statement, the blackout or other payment could be significant.



Should we
sell shares to Kingsbridge under the CEFF, or issue shares in lieu of a blackout payment, it will have a dilutive effect on the holdings of our current stockholders and may result in downward pressure on the price of our common stock. If we draw
down under the CEFF, we will issue shares to Kingsbridge at a discount of up to 10% from the volume weighted average price of our common stock. If we draw down amounts under the CEFF when our share price is decreasing, we will need to issue more
shares to raise the same amount than if our stock price was higher. Issuances in the face of a declining share price will have an even greater dilutive effect than if our share price were stable or increasing and may further decrease our share
price.



If we are unable to recruit and retain skilled employees and consultants, we may
not be able to successfully operate our business.

Retaining our current management and other employees and recruiting qualified personnel to perform future research,
manufacturing, development and other work will be critical to our success. None of our employees has employment commitments for any fixed period of time and could leave our employment at will. In the past, we have experienced turnover among our
management, including the resignations in 2007 of our former General Counsel and former Chief Medical Officer, and the recently-announced resignation of our former Chief Executive Officer. We may have difficulty attracting and retaining required
personnel as a result of our management turnover, our need for additional financing and the associated perceived risk of expense reductions, or for other reasons. Competition is intense among biotechnology, pharmaceutical and healthcare companies,
universities and non-profit research institutions for experienced scientists and other personnel, and we may not be able to retain or recruit sufficient skilled personnel on acceptable terms to allow us to pursue potential partnering arrangements
and develop our product candidates and research programs, which would likely have an adverse effect on our business.



16



---

##### Table of Contents

Our only product candidates currently in clinical development are tanespimycin, our first-generation Hsp90 inhibitor product
candidate, and KOS-1584, our epothilone anticancer product candidate. Substantial additional effort and expense will be necessary for further clinical development of tanespimycin and KOS-1584 and there can be assurance that our clinical trials will
show that tanespimycin, KOS-1584 or our potential future product candidates are safe and effective treatments.

Our only product candidates currently in clinical
development are tanespimycin and KOS-1584. Our motilin agonist program has been exclusively licensed to Pfizer, and our remaining potential product candidates are in preclinical development. We may not be able to develop product candidates,
including tanespimycin and KOS-1584, that prove to be safe and effective, meet applicable regulatory standards, are capable of being manufactured at reasonable costs or can be marketed successfully. Tanespimycin, KOS-1584 and our potential future
product candidates will require significant development and investment, including extensive clinical testing, before we can submit any application for regulatory approval. For example, we expect to incur significant expenses in connection with our
TIME registration program for tanespimycin in combination with Velcade for multiple myeloma. These expenses will be even higher to the extent we are required to pay for patients medical or other expenses, including, for example, the cost of
Velcade or any other drugs used in combination with our product candidates for these studies.



Our product candidates must satisfy rigorous standards of safety and efficacy before they can be approved by the FDA and international regulatory authorities for commercial use. We will need to conduct significant additional research and
clinical trials before we can determine if our product candidates are sufficiently safe and effective to file with the FDA and other regulatory agencies for product approval. Clinical trials are expensive and time-consuming, and therefore,
significant amounts of money will need to be spent testing our product candidates. Further, we may incur significant development costs for one or more of our product candidates and subsequently discontinue the development of any of these product
candidates as a result of clinical trial failures or other factors. For example, we recently ceased the development of alvespimycin, our former second-generation Hsp90 inhibitor product candidate, as a result of a reprioritization of our development
portfolio and we do not expect to receive any return on our investment in that product candidate.



In addition, significant time and investment will be required to try to develop manufacturing processes for our products so that they are economical to manufacture on a commercial scale and satisfactory to the FDA and other governmental
authorities.



The progress and results of our preclinical and clinical testing are highly
uncertain.

We must provide the FDA and foreign regulatory authorities with clinical data that demonstrate the safety and efficacy of our product candidates before
they can be approved for commercial sale. As a result, commercialization of our product candidates depends upon successful completion of preclinical and clinical trials. Preclinical testing and clinical development are long, expensive and uncertain
processes. It may take us a number of years to complete our testing, and failure can occur at any stage of testing. We could experience failures in current or future clinical testing of our product candidates or determine to discontinue the
development of any of our product candidates as a result of clinical trial failures or other factors.



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 and biotechnology industry, including Kosan, have suffered significant setbacks in advanced clinical trials, even after reporting promising results in earlier trials. Also, preclinical and clinical data can be interpreted in different
ways, which could delay, limit or prevent further testing or regulatory approval.



17



---

##### Table of Contents

KOSAN BIOSCIENCES



We do not know whether clinical trials of our product candidates will begin on time or whether any of our clinical trials will be completed on schedule, or at all. We may plan and
initiate clinical trials before final data from earlier studies have been collected and analyzed because it takes a significant amount of time and effort to plan and initiate clinical trials and because of the length of time it takes to successfully
develop a product candidate. Consequently, we may need to modify, suspend, cancel or terminate clinical trials based on results from earlier studies. We also do not know whether clinical trials will indicate that an earlier-stage compound or
formulation will be more appropriate for clinical and commercial development than a compound or formulation that is at a later stage of clinical development, and therefore result in extended timelines as well as increased development costs. For
example, Roche and we decided in February 2007 to cease development of KOS-862 in favor of further development of our second- generation epothilone product candidate, KOS-1584, and in May 2007, we decided to change the formulation for tanespimycin
to our injectable suspension formulation, which delayed the commencement of clinical trials. Negative or inconclusive results or adverse medical events during a clinical trial could cause a clinical trial to be suspended, terminated or repeated.
Certain of the clinical trials of our product candidates are or may in the future be designed to include two stages, with the decision whether to proceed to the second stage dependent on results obtained in the first stage. Failure to achieve
predetermined response rates as defined in the protocol may result in the decision not to proceed into the second stage of the clinical trial.



Tanespimycin and KOS-1584 are in human clinical trials for the treatment of cancer. Anticancer drugs frequently have a narrow therapeutic window between efficacy and toxicity. If
unacceptable toxicity is observed in a clinical trial, the trial may be terminated at an early stage. We cannot predict whether any clinical trials of our product candidates will demonstrate toxicity issues or adverse events resulting in significant
patient withdrawals.



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 product candidate. Our clinical trials may be suspended at any time if we, the FDA, or other regulatory authorities believe the patients
participating in our studies are exposed to unacceptable health risks or that study protocols or patient informed consents should be amended to reflect additional health risks, additional testing procedures or other changes.



Our ability to commence or timely complete clinical trials may be adversely affected by many factors,
including:



| |  |  | ineffectiveness of the study compound, or perceptions by physicians that the compound is not effective for a particular indication;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------



| |  |  | inability to manufacture sufficient quantities of compound for use in clinical trials;
| | - |  | --------------------------------------------------------------------------------------



| |  |  | a failure to obtain approval from the FDA, other regulatory authorities or an investigational sites institutional review board to conduct a clinical trial;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | inability to reach agreement with a sufficient number of investigational sites to conduct a study;
| | - |  | --------------------------------------------------------------------------------------------------



| |  |  | inability to obtain product liability insurance, including clinical trial insurance, that meets the requirements of a location outside the U.S.;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the number of patients required, slower than expected rate of patient recruitment or inability to recruit a sufficient number of patients;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the occurrence of adverse medical events, including death, during a clinical trial, even if caused by the advanced status of patients disease or medical problems that
are not related to our product candidates;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | inconclusive or negative results from a clinical trial;
| | - |  | -------------------------------------------------------



| |  |  | competing clinical trials in the same or similar indication;
| | - |  | ------------------------------------------------------------



18



---

##### Table of Contents

| |  |  | third-party clinical investigators failing to perform our clinical trials on our anticipated schedule or consistent with a clinical trial protocol, and other third-party
organizations not performing data collection and analysis in a timely or accurate manner; and
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | a decision by the FDA or other governmental authorities to require suspension or modification of a clinical trial.
| | - |  | ------------------------------------------------------------------------------------------------------------------



Our product development costs will increase if we have delays in testing or approvals, if we need to
perform more or larger clinical trials than planned or if our clinical trials include more expensive testing or other procedures than planned. If the delays are significant, our financial results and the commercial prospects for our products will be
harmed, and our ability to become profitable will be adversely affected. If any clinical trials of our 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,
manufacture 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. Our products may not be commercialized unless and until we or
our partners, if any, obtain regulatory approval from the FDA or foreign governmental authorities to do so. 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, novelty, safety and efficacy of the product candidates involved. We have not received regulatory approval to market any of our product candidates in any jurisdiction and, although our personnel have
experience from working at other companies, we as a company have no experience in preparing and filing the applications necessary to gain regulatory approvals to commercialize our products. This lack of experience may impede our ability to obtain
FDA or other foreign regulatory approvals to commercialize our products in a timely manner, if at all.



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 for regulatory approval. For example, new federal legislation known as the FDA Amendments Act of 2007 was recently enacted. This legislation grants the FDA extensive new authority to impose
post-approval clinical study and clinical trial requirements, require safety-related changes to product labeling, review advertising aimed at consumers, and require the adoption of risk management plans. Other proposals have been made to impose
additional requirements on drug approvals, further expand post-approval requirements and restrict sales and promotional activities. The new legislation, and the additional proposals if enacted, may make it more difficult or burdensome for us to
obtain approval of our product candidates, any approvals we receive may be more restrictive or be subject to onerous post-approval requirements, Pfizers or our potential future partners ability to commercialize approved products
successfully may be hindered and our business may be harmed as a result. 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 and other regulatory authorities have 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 or modifications to the manufacturing processes or facilities or quality control procedures for our product candidates. For example, we commenced a Phase 3 clinical trial of tanespimycin in combination with Velcade



19



---

##### Table of Contents

KOSAN BIOSCIENCES



in first-relapse patients with multiple myeloma and we plan to commence an additional supportive clinical trial in multiple myeloma in 2009, and, if the results are
favorable, we believe that these clinical trials will support the filing of an NDA with the FDA for the treatment of multiple myeloma. However, the FDA or other regulatory authorities may require additional data prior to accepting or approving
an application for marketing approval for tanespimycin or other product candidates, which would result in delays in potential FDA or other regulatory authority approval and additional costs, either of which may be too significant to continue
development of tanespimycin or other product candidates. This risk is further compounded by any changes during development of a product candidate, such as changes in manufacturing processes, formulations or dosing regimens.



Any clinical trial may fail to produce results satisfactory to the FDA or other regulatory authorities.
For example, we currently conduct, and expect to conduct in the future, clinical trials for our product candidates in countries outside of the United States. The FDA or other regulatory authorities may reject data from clinical trials conducted in
other countries if they are not conducted in accordance with applicable regulatory standards and procedures.



We do not know whether clinical trials for our product candidates will demonstrate safety and efficacy sufficient to obtain the requisite regulatory approvals or will result in marketable products. The 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.

We do not have the ability to independently conduct all clinical trials for our product candidates, and we rely on third parties such as Pfizer with respect to KOS-2187, contract
research organizations, laboratory testing companies, medical institutions and clinical investigators to conduct, supervise or monitor our clinical trials. We have less control over the timing and other aspects of these clinical trials than if we
conducted them entirely on our own.



We are supervising our Phase 3 clinical trial for
tanespimycin but rely on contract research organizations and testing laboratories to assist in the conduct of the trial. In 2007, we initiated a broad, multinational registration program for the treatment of multiple myeloma. The tanespimycin in
myeloma evaluation, or TIME program, includes a Phase 3 clinical trial that we initiated in the first quarter of 2008 and an additional supportive clinical trial that we plan to commence in 2009. To date, we have not successfully conducted a
clinical trial intended to form the basis of an NDA (or foreign equivalent thereto) filing. Additionally, the TIME program includes a multinational clinical trial. We have not conducted large clinical trials outside of North America. Consequently,
we may not have the necessary capabilities to successfully execute and complete these planned clinical trials in a manner that supports approval of our product candidates for their target indications in a timely manner, or at all. Failure to
commence or complete, or delays in our planned or current clinical trials, would prevent us from commercializing products, and thus seriously harm our business.



We also rely on Pfizer to conduct all clinical trials for our motilin agonist program, including KOS-2187. We may rely on potential future partners, if any, to conduct clinical
trials for our product candidates. If any of these third parties do not successfully carry out their obligations or meet expected deadlines, clinical trials may be extended, delayed, suspended or terminated, data generated from clinical trials may
not be acceptable to the FDA or other regulatory authorities and our product candidates may not receive regulatory approval or be successfully commercialized.



We may not be able to obtain or maintain orphan drug exclusivity for our product candidates.

Some jurisdictions, including Europe and the United States, may designate drugs for relatively small patient populations as orphan drugs. The FDA and the European Medicines Agency have granted orphan drug status to tanespimycin for



20



---

##### Table of Contents

the treatment of multiple myeloma and chronic myelogenous leukemia. Orphan drug designation does not convey any advantage in, or shorten the duration of, the
regulatory review and approval process, but does make the product eligible for orphan drug exclusivity and, in the United States, specific tax credits. Generally, if a company receives the first marketing approval for a product with an orphan drug
designation in the clinical indication for which it has such designation, the product is entitled to orphan drug exclusivity. Orphan drug exclusivity means that another application to market the same drug for the same indication may not be approved,
except in limited circumstances, for a period of up to ten years in Europe (reviewable after six years), and for a period of seven years in the United States. This exclusivity, however, could block the approval of tanespimycin for the treatment of
multiple myeloma or chronic myelogenous leukemia in the United States or Europe if a competitor obtains approval before us of a product containing tanespimycin for these specific indications. Even if we obtain orphan drug exclusivity for any of our
product candidates, we may not be able to maintain it. For example, if a competitive product is shown to be clinically superior to our product, any orphan drug exclusivity we have obtained will not block the approval of such competitive product.



Even if any of our product candidates receives regulatory approval, we may still face
significant development and regulatory difficulties.

Even if the FDA or other regulatory authorities 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. In addition, regulatory agencies subject a product, its manufacturer and the manufacturers facilities to continual review and periodic inspections. If a regulatory agency discovers previously unknown problems
with a product, including adverse events of unanticipated severity or frequency, or problems with the facility where the product is manufactured, a regulatory agency may impose restrictions on that product, our partners, if any, or us, including
requiring withdrawal of the product from the market.



If we, Pfizer, potential future
partners or any of our product candidates that become approved for marketing by a regulatory authority fail to comply with applicable regulatory requirements, a regulatory authority may take various actions, including:



| |  |  | issuing warning letters;
| | - |  | ------------------------



| |  |  | imposing civil or criminal penalties;
| | - |  | -------------------------------------



| |  |  | suspending regulatory approval;
| | - |  | -------------------------------



| |  |  | refusing to approve pending applications or supplements to approved applications filed by us or our partners, if any;
| | - |  | ---------------------------------------------------------------------------------------------------------------------



| |  |  | imposing restrictions on operations, including costly new manufacturing requirements; or
| | - |  | ----------------------------------------------------------------------------------------



| |  |  | seizing or detaining products or requiring a product recall.
| | - |  | ------------------------------------------------------------



Any inability to protect our proprietary technologies could significantly harm our business and 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 product
candidates in the United States and other countries and prevent others from infringing our proprietary rights. If we are unable to adequately protect our intellectual property, competitors may be able to use our technologies and erode or negate any
competitive advantage we may have. Intellectual property laws vary from country to country, and the laws of a particular country may afford less intellectual property protection than another country.



21



---

##### Table of Contents

KOSAN BIOSCIENCES



Any patents that we or our potential future partners own or license from third parties may not provide protection against competitors. 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. However, our patent positions, as well as
the patent positions of biotechnology companies and other third parties, involve complex legal and factual questions, and, therefore, we cannot predict with certainty whether our patent applications will be allowed or any resulting patents will be
valid and enforceable. Further, our patents or patent applications or those of our licensors could be placed into interference, and we may lose our rights in such patents or applications. Patents may be challenged, held unenforceable, invalidated or
circumvented. Certain of our current exclusive license agreements restrict, and any future exclusive license agreements may restrict, our rights under patents and patent applications to certain fields of use, and therefore, we may not have the
ability to prevent competitors from developing and commercializing our product candidates or technologies in fields of use not covered by our exclusive license agreements.



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



| |  |  | we or our licensors were the first to make the inventions covered by each of our patents or pending patent applications;
| | - |  | ------------------------------------------------------------------------------------------------------------------------



| |  |  | we or our licensors were the first to file patent applications for these inventions;
| | - |  | ------------------------------------------------------------------------------------



| |  |  | others will not independently develop similar or alternative technologies or duplicate any of our technologies;
| | - |  | ---------------------------------------------------------------------------------------------------------------



| |  |  | any of our or our licensors pending patent applications will result in issued patents;
| | - |  | ---------------------------------------------------------------------------------------



| |  |  | any of our or our licensors patents will be valid or enforceable;
| | - |  | ------------------------------------------------------------------



| |  |  | any patents issued to us or our licensors or collaborators will provide a basis for commercially viable products, will provide us with any competitive advantages or will not
be challenged by third parties;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | we will develop additional proprietary technologies that are patentable; or
| | - |  | ---------------------------------------------------------------------------



| |  |  | the patents of others will not have an adverse effect on our business.
| | - |  | ----------------------------------------------------------------------



We apply for patents covering our technologies, product candidates, formulations and uses thereof, 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, tanespimycin was originally disclosed in a now-expired third party patent. Consequently, others can develop products containing tanespimycin. We are aware of at least three other companies that have
been developing product candidates containing or based on tanespimycin, and these companies have filed patent applications relating to their products in development. Other competitors may currently be developing, or may in the future develop,
products containing or based on tanespimycin. In addition, we generally are unable to control the patent prosecution of technology that we license from others to the same degree as we would for our own technology. Further, some of our patents and
patent applications for our motilide program have been assigned to Pfizer, and additional patents and patent applications may in the future be assigned to Pfizer or potential future partners. We generally are unable to control the filing,
prosecution and maintenance of patent rights that we assign to partners to the same degree as we would if we maintained ownership of them.



In addition to patents, we rely on trade secrets and proprietary know-how. We have taken measures to protect our confidential information and trade secrets. However, these measures
may not provide adequate protection. We seek to protect our confidential information and trade secrets by entering into confidentiality agreements with employees,



22



---

##### Table of Contents

collaborators, consultants and others. Nevertheless, parties may breach these agreements or competitors may otherwise obtain or independently develop our trade
secrets.



Interference, opposition or similar proceedings relating to our patents and
patent applications are costly, and an unfavorable outcome could prevent us from commercializing our product candidates.

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 or licensed 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, has the right to a patent for these inventions.



We are the exclusive licensee to two patent rights claiming our epothilone product candidate KOS-1584.
One is a granted patent and one is a patent application, owned by the Oregon State University and Sloan-Kettering, respectively. In June 2007, the US Patent and Trademark Office declared an interference between the patent and patent application. In
October 2007, we entered into a settlement agreement with the Oregon State University and Sloan-Kettering setting forth the agreed upon procedure to conduct the interference. In addition, we entered into amendments to our agreements with the Oregon
State University and Sloan-Kettering in connection with the settlement agreement. These amendments confirm, as well as make certain adjustments to, our financial obligations to each of the Oregon State University and Sloan-Kettering under our
agreements with them, regardless of which party ultimately prevails in the interference.



A proceeding or a lawsuit involving an interference or opposition could result in substantial cost to us even if the outcome is favorable, and if the outcome is unfavorable, we could be required to license the other partys rights, on
terms that may be unfavorable to us, or cease using the technology. We could incur additional cost because we are licensed under both partys patent rights. An interference or opposition may also result in loss of claims based on patentability
grounds raised in the interference or opposition. 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
Novartis AG in the area of potential epothilone products, may be particularly unwilling to grant us a license at any price. If we are not able to obtain necessary licenses, we may not be able to manufacture or commercialize our product candidates,
which would materially harm our business, financial condition and results of operations.



Claims by third parties of intellectual property infringement would require us to spend time and money and could deprive us of valuable rights needed to develop or commercialize our products.

Our commercial success depends significantly 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. Other parties may currently or in the future possess intellectual property rights covering product candidates that we, Pfizer or potential future partners are developing or desire to develop; methods of
treatment or administration involving our product candidates; formulations of our product candidates; and genes, gene fragments, cell lines, compounds and other technologies we use or may wish to use. Any infringement of patent rights or violation
of other proprietary rights may require us to obtain a license from another party, forego product development or commercialization or face lawsuits or other claims.



23



---

##### Table of Contents

KOSAN BIOSCIENCES



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 product 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 obtained relevant patents that could affect our ability to obtain patents or operate our business. Others, including Pfizer or potential future
partners, may challenge our patent or other intellectual property rights or sue us for patent infringement, misappropriation of their intellectual property rights or breach of license agreements. We may be required to commence legal proceedings to
resolve our patent or other intellectual property rights. An adverse determination in any litigation or administrative proceeding to which we may become a party could subject us to significant liabilities, result in our patents being deemed invalid,
unenforceable or revoked, require us to license disputed rights from others or 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.



Other parties may obtain patents in the future and
claim that our products or 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:



| |  |  | pay substantial damages;
| | - |  | ------------------------



| |  |  | stop producing certain products and using certain methods;
| | - |  | ----------------------------------------------------------



| |  |  | develop non-infringing products and methods; and
| | - |  | ------------------------------------------------



| |  |  | obtain one or more licenses from other parties.
| | - |  | -----------------------------------------------



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 manufacturing or
commercializing products and could materially harm our business, financial condition and results of operation.



Manufacturing and supply difficulties could delay or preclude commercialization of our products and substantially increase our expenses.

We
currently use contract manufacturers to make and supply us with the tanespimycin active pharmaceutical ingredient. We currently formulate the final drug product for tanespimycin injectable suspension formulation at our facilities and use a contract
manufacturer to fill the final drug product vials. In the future, we expect to use a contract manufacturer to conduct the entire tanespimycin injectable suspension formulation and filling process. We maintain a limited inventory of tanespimycin drug
product at our facilities in Hayward, California, and we also maintain a limited inventory at the facilities of an outside contractor. In our epothilone program, we rely on contract manufacturers for the active pharmaceutical ingredient for
KOS-1584. Drug product for KOS-1584 is formulated by an outside contractor. We maintain limited inventories of formulated drug product for KOS-1584 at our facilities in Hayward,



24



---

##### Table of Contents

California and at the facilities of outside contractors. For all of our projects, drug product is distributed to clinical sites primarily through outside contractors.



If any of our or our contract manufacturers manufacturing or inventory facilities
encounter delays, are destroyed or otherwise become unavailable to us, then the clinical development of our product candidates or submissions for their regulatory approval, and therefore commercialization, could be delayed or precluded. In addition,
in our clinical trials for tanespimycin, tanespimycin is being evaluated in combination with another pharmaceutical compound. If any of the manufacturers of the drug compounds used in these combination therapy clinical trials are unable to continue
to manufacture these drug compounds, or those manufacturers manufacturing or inventory facilities encounter delays, are destroyed or otherwise become unavailable, then the clinical development of tanespimycin, or submissions for its regulatory
approval, and therefore commercialization, could be delayed or precluded. Adverse effects would be particularly acute if problems arise with our sole sourcing or inventory relationships. Alternative qualified production capacity may not be available
on a timely basis or at all because manufacturing processes for our product candidates are complex and may be subject to a lengthy regulatory approval process.



A number of factors could cause prolonged interruptions in the manufacturing and supply of our product candidates, including:



| |  |  | the failure of a supplier to provide raw materials or intermediates used for manufacture of our product candidates;
| | - |  | -------------------------------------------------------------------------------------------------------------------



| |  |  | equipment malfunctions or failures;
| | - |  | -----------------------------------



| |  |  | the failure to manufacture in accordance with current good manufacturing practices, FDA or other regulatory requirements;
| | - |  | -------------------------------------------------------------------------------------------------------------------------



| |  |  | the delay of product shipments due to U.S. custom regulations or third-party carriers used to transport our product candidates, and damage to our product candidates while
they are in transit;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | changes in FDA or other regulatory authority requirements or standards that require modifications to the manufacturing processes or facilities used in the production of our
product candidates;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | action by the FDA or other regulatory authorities to suspend production of one or more of our product candidates; or
| | - |  | --------------------------------------------------------------------------------------------------------------------



| |  |  | difficulties in scaling-up production of our product candidates for large clinical trials or commercial supply.
| | - |  | ---------------------------------------------------------------------------------------------------------------



While our manufacturing personnel have extensive experience from working at other companies, we as a
company have no experience manufacturing products for commercial sale. We may encounter difficulties in scaling-up our manufacturing processes and equipment. We may not be able to achieve such scale-up in a timely manner or at a commercially
reasonable cost, if at all. In addition, our facilities in Hayward, California are located within the San Francisco Bay Area, an area where earthquakes periodically occur. They are also located in a designated flood zone. Our access to any raw
materials, intermediates, active pharmaceutical ingredients or formulated drug product for our product candidates sourced or inventoried through our facilities in Hayward, California may be subject to interruption, damage or loss in the event of an
earthquake or flood.



As discussed above, we rely upon outside contractors to manufacture
and supply to us raw materials, intermediates, active pharmaceutical ingredients and formulated drug product for our product candidates. Our dependence upon others for the manufacture of our product candidates and their components may adversely
affect our ability to continue clinical development of our product candidates in a timely manner 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.



25



---

##### Table of Contents

KOSAN BIOSCIENCES



Dependence on contract manufacturers involves a number of additional risks, many of which are outside of our control, including:



| |  |  | failure of a contract manufacturer to manufacture products to our specifications or to deliver products in the quantities, timeframe or manner that we require;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | a decision by the FDA or other regulatory authorities not to approve our use of a particular contract manufacturer to supply our products;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | intellectual property rights to any improvements in a manufacturing process or new manufacturing processes being owned by or shared with a contract manufacturer;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | termination of an agreement with a contract manufacturer or increased prices charged by a contract manufacturer; or
| | - |  | -------------------------------------------------------------------------------------------------------------------



| |  |  | a contract manufacturer declaring bankruptcy or otherwise going out of business.
| | - |  | --------------------------------------------------------------------------------



Any of these factors could cause us to delay or suspend clinical trials, regulatory submissions or commercialization of our products and could result
in significantly increased costs.



In addition, our future contract manufacturers may not
be in the United States, and we currently utilize contract manufacturers located outside the United States. Consequently, we may face additional manufacturing difficulties due to a number of potential factors, including importation and customs
issues, political uncertainties and a potentially limited ability to enforce our contractual rights against parties not located within the United States.



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

We face, and will continue to face, intense competition from organizations such as 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 or currently possess technologies or products that are superior alternatives to ours. For example, companies with competing Hsp90 inhibitors include Biogen Idec Inc., which has initiated Phase 1 and 2
clinical trials in solid tumors with its oral synthetic Hsp90 inhibitor; Infinity Pharmaceuticals, which has initiated a Phase 1/2 clinical trials of its intravenous Hsp90 inhibitor in gastrointestinal stromal tumors, and has an oral formulation in
preclinical development in collaboration with MedImmune, Inc. (now a part of the AstraZeneca group of companies); Abraxis BioScience, Inc., which has an albumin-bound particle suspension formulation of 17-AAG in preclinical development; Vernalis
plc, which has announced that it has selected an intravenous and an oral Hsp90 inhibitor preclinical development candidate in collaboration with Novartis AG and initiated a Phase 1 clinical trial in late 2007; Serenex, Inc., which has initiated
Phase 1 clinical trials for its oral Hsp90 inhibitor in solid and hematological tumors and has agreed to be acquired by Pfizer; and Synta Pharmaceuticals Corp., which initiated Phase 1 clinical trials for its Hsp90 inhibitor in melanoma, as well as
other companies reported to be pursuing Hsp90 inhibitors. Competing epothilones in clinical development include those being developed by Novartis AG, which is reported to be in Phase 3 clinical trials; and Schering AG, which is reported to be in
Phase 2 clinical trials. In addition, IXEMPRA(TM) (ixabepilone), an epothilone developed by Bristol-Myers Squibb Company, was approved by the FDA in October 2007 for use in breast cancer and Bristol-Myers Squibb Company is reported to be in numerous
post-marketing clinical trials of ixabepilone. Gastrointestinal motility competitors include Chugai Pharmaceuticals, whose motilide agonist is reported to be in Phase 2 clinical trials. Thus, it is possible that, even if we are successful in
developing any of our product candidates, one or more compounds of our competitors will be approved and marketed before our own. This could place us and our current or potential future partners at a significant disadvantage and could prevent us from
realizing significant commercial benefit from such compounds.



26



---

##### Table of Contents

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.



We also face and will continue to face intense competition from other companies for partnering 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 superior to ours.



Any products that we develop through our technologies will compete in multiple, highly
competitive markets. Development of pharmaceutical products requires significant investment and resources. 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 succeed in more rapidly developing and
marketing technologies and products that are more effective than our technologies and products or that would render our products or technologies obsolete or noncompetitive.



We believe that our ability to successfully compete will depend on, among other things:



| |  |  | our ability to develop novel product candidates with attractive pharmaceutical properties and to secure and protect intellectual property rights based on our innovations;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the efficacy and safety of our product candidates;
| | - |  | --------------------------------------------------



| |  |  | the speed at which we, Pfizer and potential future partners develop our product candidates;
| | - |  | -------------------------------------------------------------------------------------------



| |  |  | our, Pfizers and potential future partners ability to design and successfully execute appropriate clinical trials;
| | - |  | --------------------------------------------------------------------------------------------------------------------



| |  |  | our, Pfizers and potential future partners ability to obtain regulatory approvals to market our product candidates and the timing and scope of any regulatory
approvals;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | our, Pfizers and potential future partners ability to manufacture commercial quantities and sell any product candidates that are approved for marketing;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | acceptance of future products by physicians and other healthcare providers; and
| | - |  | -------------------------------------------------------------------------------



| |  |  | the development of effective pricing and reimbursement strategies.
| | - |  | ------------------------------------------------------------------



If we face product liability claims, these claims will divert our managements time and we will incur litigation costs, and if we are held liable, our business, financial
condition and results of operation may be materially harmed.

We face an inherent business risk of liability claims in the event that the use of our potential
products in clinical trials or otherwise, or any other products manufactured in our facility, results in personal injury or death. Even though we have obtained product liability insurance, it may not be sufficient to cover claims that may be made
against us. Product liability insurance is expensive, difficult to obtain and may not be available on acceptable terms, if at all. Any claims against us, regardless of their merit, could materially and adversely affect our business, financial
condition and results of operation, 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 or products
manufactured at our facility, our liability could exceed our total assets.



27



---

##### Table of Contents

KOSAN BIOSCIENCES



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, shipment and disposal of these materials. 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 current or
potential future partners of these materials, and our liability may exceed our insurance coverage and 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. In the event we do not comply with any of these laws or regulations, we may incur significant fines, our governmental licenses or permits may be revoked or we may face additional penalties, any of
which could harm our business.



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 (subject to adjustment), 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 acquirer 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.



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
the period from January 1, 2007 through December 31, 2007, our common stock traded between $3.20 and $7.35 on the



28



---

##### Table of Contents

NASDAQ Global 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:



| |  |  | delay or failure in initiating, conducting, completing or analyzing clinical trials or unsatisfactory design of or data from these trials;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | our ability to enter into new partnering arrangements on favorable terms, or at all;
| | - |  | ------------------------------------------------------------------------------------



| |  |  | announcements of data from clinical trials or other developments that do not meet the expectations of analysts, investors or other third parties;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | developments in clinical trials for potentially competitive product candidates;
| | - |  | -------------------------------------------------------------------------------



| |  |  | changes in the United States or foreign health care systems or regulations;
| | - |  | ---------------------------------------------------------------------------



| |  |  | regulatory approvals for competitive product candidates or delays or failures in obtaining regulatory approvals for our product candidates;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | new products or services introduced or announced by us or our competitors;
| | - |  | --------------------------------------------------------------------------



| |  |  | announcements of technological developments in research by us or our competitors;
| | - |  | ---------------------------------------------------------------------------------



| |  |  | published reports by securities analysts;
| | - |  | -----------------------------------------



| |  |  | announcements of expirations, terminations or amendments of our current license agreements, or announcements that we have entered into new partnering, licensing or similar
arrangements;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | departures of key personnel;
| | - |  | ----------------------------



| |  |  | developments or disputes as to patent or other proprietary rights;
| | - |  | ------------------------------------------------------------------



| |  |  | litigation or an unfavorable outcome in litigation;
| | - |  | ---------------------------------------------------



| |  |  | sales of our common stock;
| | - |  | --------------------------



| |  |  | announcements of, and actual or anticipated fluctuations in, our financial results; and
| | - |  | ---------------------------------------------------------------------------------------



| |  |  | economic and other external factors, disasters or crises.
| | - |  | ---------------------------------------------------------



In addition, the stock market in general, and the NASDAQ Global Market and the market for biotechnology companies in particular, have 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 and annual results of operations will fluctuate, and this fluctuation
could cause our stock price to decline, creating investor losses.

Our quarterly and annual 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:



| |  |  | expiration or termination of licensing arrangements, which may not be renewed or replaced;
| | - |  | ------------------------------------------------------------------------------------------



| |  |  | the success rate of our, Pfizers or potential future partners efforts leading to milestone payments and royalties under our licensing arrangements with Pfizer, or
any future partnering arrangements that we may establish;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the progress of our product candidates in clinical trials, and therefore, the timing of expenses for those clinical trials;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------



29



---

##### Table of Contents

KOSAN BIOSCIENCES



| |  |  | the timing and willingness of Pfizer and potential future partners to develop and commercialize our products;
| | - |  | -------------------------------------------------------------------------------------------------------------



| |  |  | general and industry specific economic conditions, which may affect Pfizers and potential future partners research and development expenditures; and
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | costs and expenses related to any litigation or administrative proceedings in which we may be involved.
| | - |  | -------------------------------------------------------------------------------------------------------



If our revenues decline or do not grow due to the failure to enter into new partnering arrangements or
as a result of the expiration, termination or amendment of our current licensing agreements or other factors, we may not be able to reduce our operating expenses correspondingly. In addition, we expect operating expenses to continue to increase
since, absent any new partnering arrangements with third parties, we will be required to independently to fund any development and clinical trial activities that we may undertake. 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 or year-to-year comparisons of our operating results are not a good indication of our future performance. Our operating results in some quarters or years
may not meet the expectations of stock market analysts and investors. In that case, our stock price may decline.



If we are unable to favorably assess the effectiveness of our internal control over financial reporting, or if our independent auditors are unable to provide an unqualified
attestation report on our internal control over financial reporting, our stock price could be adversely affected.

Pursuant to Section 404 of the Sarbanes-Oxley
Act of 2002 and the rules and regulations of the SEC, on an annual basis, our management is required to report on, and our independent auditors to attest to, the effectiveness of our internal control over financial reporting. The rules governing the
standards that must be met for management to make its annual assessment are complex and require significant documentation and testing. While our internal controls over financial reporting were deemed effective by both our management and our
independent auditors as of December 31, 2007, there may be changes in our systems, processes or operations that will affect the effectiveness of internal controls in the future. Because of its inherent limitations, internal control over
financial reporting may not prevent or detect misstatements. Our future assessments of internal control over financial reporting may continue to result in increased expenses and the devotion of significant management resources. If we cannot
favorably assess the effectiveness of our internal controls over financial reporting in the future, or if our independent auditors are unable to provide an unqualified attestation report on our internal control over financial reporting, investor
confidence and our stock price could be adversely affected.



ITEM 1B. UNRESOLVED STAFF COMMENTS

None.



ITEM 2. PROPERTIES

Our facilities consist of research and office space located in Hayward, California. Our lease commitments expire in
February 2013, although we have options to renew for an additional period of five years. We believe that our current facilities are adequate for our needs for the foreseeable future.



ITEM 3. LEGAL PROCEEDINGS

None.



ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.



30



---

##### Table of Contents

PART II

KOSAN BIOSCIENCES



ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES



Market for Registrants Common Equity

Our common stock
trades on the NASDAQ Global Market under the symbol KOSN. The following table shows the high and low sales prices per share of our common stock as reported on the NASDAQ Global Market for the periods indicated:



|               |  |      |      |     |   |      |  |      |  |                |  |     |      |  |   |     
|-------------- |  | ---- | ---- | --- | - | ---- |  | ---- |  | -------------- |  | --- | ---- |  | - | ----
|2007           |  | High |      | Low |   |      |  | 2006 |  | High           |  | Low
|Fourth Quarter |  | $    | 6.29 |     | $ | 3.20 |  |      |  | Fourth Quarter |  | $   | 5.68 |  | $ | 3.70
|Third Quarter  |  | $    | 6.40 |     | $ | 4.00 |  |      |  | Third Quarter  |  | $   | 5.00 |  | $ | 2.88
|Second Quarter |  | $    | 6.58 |     | $ | 4.83 |  |      |  | Second Quarter |  | $   | 5.93 |  | $ | 3.65
|First Quarter  |  | $    | 7.35 |     | $ | 4.90 |  |      |  | First Quarter  |  | $   | 6.19 |  | $ | 4.43



As of February 29, 2008, there were
approximately 90 record holders of our common stock.



Dividend Policy

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.



31



---

##### Table of Contents

KOSAN BIOSCIENCES



Performance Graph(1)

The following graph shows the total stockholder return of an investment
of $100 in cash on December 31, 2002 through December 29, 2007, the last date of trading of the 2007 fiscal year, for (i) our common stock, (ii) the NASDAQ Stock Market (U.S.) Index and (iii) the NASDAQ Pharmaceutical Index.
All values assume reinvestment of the full amount of all dividends.



COMPARISON OF FIVE-YEAR CUMULATIVE TOTAL RETURNS

PERFORMANCE GRAPH FOR

KOSAN BIOSCIENCES INCORPORATED



LOGO



---

|(1) | This section is not soliciting material, is not deemed filed with the SEC and is not to be incorporated by reference into any filing of Kosan Biosciences Incorporated
under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date hereof and irrespective of any general incorporation language in any such filing.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



32



---

##### Table of Contents

ITEM 6. SELECTED FINANCIAL DATA

The statement of operations data for each of the years ended December 31, 2007, 2006 and 2005, and
the balance sheet data as of December 31, 2007 and 2006, have been derived from our audited financial statements included elsewhere in this Annual Report on Form 10-K. We have derived the statement of operations data for the years ended
December 31, 2004 and 2003, and the balance sheet data as of December 31, 2005, 2004 and 2003 from our audited financial statements that are not included 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.



|                                                                       |  |                         |         |   |          |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|---------------------------------------------------------------------- |  | ----------------------- | ------- | - | -------- | - | ------- | ---- |  | - | ------- | - |  | ---- | ------- | - |  | - | ------- | -
|                                                                       |  |                         |         |   |          |   |         |      |  |   |         |   |  |      |        
|(in thousands, except per share data)                                  |  |                         |         |   |          |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|                                                                       |  | Year Ended December 31, |        
|                                                                       |  | 2007                    |         |   | 2006 (2) |   |         | 2005 |  |   | 2004    |   |  | 2003 |        
|STATEMENT OF OPERATIONS DATA:                                          |  |                         |         |   |          |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Contract revenue                                                       |  | $                       | 22,707  |   |          | $ | 13,105  |      |  | $ | 11,916  |   |  | $    | 20,493  |   |  | $ | 28,482  |  
|Grant revenue                                                          |  |                         |        |   |          |   | 401     |      |  |   | 1,494   |   |  |      | 2,399   |   |  |   | 2,907   |  
|                                                                       |  |                         |         |   |          |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Total revenues                                                         |  |                         | 22,707  |   |          |   | 13,506  |      |  |   | 13,410  |   |  |      | 22,892  |   |  |   | 31,389  |  
|Operating expenses (1):                                                |  |                         |         |   |          |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Research and development                                               |  |                         | 47,283  |   |          |   | 37,179  |      |  |   | 38,400  |   |  |      | 40,175  |   |  |   | 36,789  |  
|General and administrative                                             |  |                         | 8,162   |   |          |   | 7,823   |      |  |   | 6,038   |   |  |      | 5,934   |   |  |   | 5,137   |  
|                                                                       |  |                         |         |   |          |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Total operating expenses                                               |  |                         | 55,445  |   |          |   | 45,002  |      |  |   | 44,438  |   |  |      | 46,109  |   |  |   | 41,926  |  
|                                                                       |  |                         |         |   |          |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Loss from operations                                                   |  |                         | (32,738 | ) |          |   | (31,496 | )    |  |   | (31,028 | ) |  |      | (23,217 | ) |  |   | (10,537 | )
|Interest and other income, net                                         |  |                         | 4,080   |   |          |   | 2,027   |      |  |   | 1,391   |   |  |      | 1,091   |   |  |   | 869     |  
|                                                                       |  |                         |         |   |          |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Net loss                                                               |  | $                       | (28,658 | ) |          | $ | (29,469 | )    |  | $ | (29,637 | ) |  | $    | (22,126 | ) |  | $ | (9,668  | )
|                                                                       |  |                         |         |   |          |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Basic and diluted net loss per common share                            |  | $                       | (0.69   | ) |          | $ | (0.88   | )    |  | $ | (1.01   | ) |  | $    | (0.77   | ) |  | $ | (0.38   | )
|                                                                       |  |                         |         |   |          |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Shares used in computing basic and diluted net loss per common share   |  |                         | 41,685  |   |          |   | 33,394  |      |  |   | 29,227  |   |  |      | 28,913  |   |  |   | 25,567  |  
|(1) Includes non-cash charges for stock-based compensation as
follows: | 
|Research and development                                               |  | $                       | 1,698   |   |          | $ | 1,419   |      |  | $ | 224     |   |  | $    | 594     |   |  | $ | 695     |  
|General and administrative                                             |  |                         | 1,493   |   |          |   | 1,046   |      |  |   | 131     |   |  |      | 163     |   |  |   | 232     |  
|                                                                       |  |                         |         |   |          |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|                                                                       |  | $                       | 3,191   |   |          | $ | 2,465   |      |  | $ | 355     |   |  | $    | 757     |   |  | $ | 927     |  
|                                                                       |  |                         |         |   |          |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  

|(2) | Effective January 1, 2006, we adopted the fair value recognition provisions of Statement of Financial Accounting Standards No. 123 (revised 2004) or SFAS 123R, Share-Based
Payment, using the modified prospective transition method and therefore have not restated prior periods results. See Note 3 to the financial statements.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



33



---

##### Table of Contents

KOSAN BIOSCIENCES



|                                                  |  |                         |          |   |      |   |          |      |  |   |          |   |  |      |          |   |  |   |         |  
|------------------------------------------------- |  | ----------------------- | -------- | - | ---- | - | -------- | ---- |  | - | -------- | - |  | ---- | -------- | - |  | - | ------- | -
|(in thousands, except per share data)             |  |                         |          |  
|                                                  |  | Year Ended December 31, |         
|                                                  |  | 2007                    |          |   | 2006 |   |          | 2005 |  |   | 2004     |   |  | 2003 |         
|BALANCE SHEET DATA:                               |  |                         |          |   |      |   |          |      |  |   |          |   |  |      |          |   |  |   |         |  
|Cash, cash equivalents and short-term investments |  | $                       | 70,008   |   |      | $ | 63,138   |      |  | $ | 54,177   |   |  | $    | 67,560   |   |  | $ | 81,459  |  
|Working capital                                   |  |                         | 54,222   |   |      |   | 42,262   |      |  |   | 44,458   |   |  |      | 60,276   |   |  |   | 75,773  |  
|Restricted cash                                   |  |                         | 949      |   |      |   | 949      |      |  |   | 949      |   |  |      | 949      |   |  |   | 904     |  
|Long-term investments                             |  |                         |         |   |      |   |         |      |  |   |         |   |  |      | 14,884   |   |  |   | 22,936  |  
|Total assets                                      |  |                         | 77,867   |   |      |   | 71,187   |      |  |   | 65,997   |   |  |      | 96,613   |   |  |   | 123,189 |  
|Deferred revenue, current portion                 |  |                         | 3,268    |   |      |   | 13,992   |      |  |   | 3,277    |   |  |      | 3,277    |   |  |   | 5,625   |  
|Deferred revenue, less current portion            |  |                         |         |   |      |   | 5,599    |      |  |   | 8,876    |   |  |      | 12,153   |   |  |   | 15,234  |  
|Equipment loans, less current portion             |  |                         | 699      |   |      |   | 899      |      |  |   | 1,785    |   |  |      | 2,283    |   |  |   | 2,701   |  
|Accumulated deficit                               |  |                         | (188,964 | ) |      |   | (160,306 | )    |  |   | (130,837 | ) |  |      | (101,200 | ) |  |   | (79,074 | )
|Stockholders equity                              |  |                         | 59,560   |   |      |   | 41,754   |      |  |   | 41,106   |   |  |      | 69,186   |   |  |   | 89,452  |  



34



---

##### Table of Contents

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 1A. Risk
Factors and elsewhere in this Annual Report on Form 10-K.



Overview

We are a cancer therapeutics company focused on advancing two new classes of anticancer agents through clinical development: Hsp90
inhibitors and epothilones. The following is the status of our product candidates.



Hsp90 Inhibitors



Tanespimycin

Our proprietary injectable suspension formulation of tanespimycin, or KOS-953 (also known as 17-AAG), is in a Phase 3
clinical trial in combination with Velcade® (bortezomib) for multiple myeloma, as well as a Phase 2 clinical trial in combination with Herceptin®
(trastuzumab) for HER2-positive metastatic breast cancer. Our Tanespimycin in Myeloma Evaluation, or TIME, clinical program includes TIME-1, a Phase 3 pivotal clinical trial of tanespimycin in combination with Velcade in first-relapse patients with
multiple myeloma, which has been initiated. We also plan to conduct a second clinical trial in multiple myeloma to support the pivotal TIME-1 clinical trial with additional safety and efficacy data. We plan to initiate the supporting clinical trial
in early 2009 and anticipate that the clinical trial can be completed within the timeframe of TIME-1. The TIME program is utilizing our tanespimycin injectable suspension formulation that replaced the prior Cremophor-based formulation. In addition
to multiple myeloma, we intend to advance tanespimycin in metastatic breast cancer. We anticipate presenting updated data with the injectable suspension formulation of tanespimycin from our Phase 2 clinical trial of tanespimycin in combination with
Herceptin in patients with HER2-positive metastatic breast cancer in the first half of 2008. We expect to conduct enabling studies evaluating tanespimycin as monotherapy and in combination with other agents such as Taxol® (paclitaxel), Xeloda® (capecitabine®) and/or Herceptin® beginning
in late 2008 or early 2009.



Alvespimycin

Alvespimycin, or KOS-1022 (also known as 17-DMAG), is a highly-potent, water-soluble and orally-active Hsp90 inhibitor. We have evaluated both intravenous and oral formulations of
alvespimycin in clinical trials. In February 2008, we terminated development of alvespimycin in order to focus our resources on the development of tanespimycin.



Epothilones

KOS-1584. KOS-1584 is our lead epothilone anticancer product
candidate being evaluated in dose-escalating Phase 1 clinical trials in patients with solid tumors. KOS-1584 has demonstrated antitumor activity and favorable tolerability in Phase 1 clinical trials in patients with solid tumors, including non-small
cell lung, ovarian and pancreatic cancers. We intend to initiate in the first quarter of 2008 a Phase 2 clinical trial of KOS-1584 in non-small cell lung cancer patients who have received one prior chemotherapy regimen. Kosan may conduct additional
Phase 2 trials of KOS-1584.



Our epothilone program was partnered with Hoffmann-La Roche,
Inc. and F. Hoffmann-La Roche Ltd., or collectively Roche, through a global development and commercialization agreement. Our agreement with Roche was terminated in its entirety effective late in February 2008. Following the termination of the
agreement, the rights licensed to Roche



35



---

##### Table of Contents

KOSAN BIOSCIENCES



reverted to us, and in connection with the termination, Roche provided us with certain license rights, data and other assistance related to the product candidates
licensed to Roche under the agreement. Roches development funding commitments under the agreement continued until the termination date in late February 2008, after which Roche is obligated to reimburse us for certain costs of completing the
KOS-1584 Phase 1 clinical trials.



Other Programs

We also have a motilin receptor agonist program for the stimulation of gastrointestinal movement, or GI motility. In December 2006, we established a worldwide exclusive license
agreement with Pfizer for our motilin agonist program, including KOS-2187 and related compounds. Pfizer is responsible for all development, regulatory and commercial activities related to the motilin agonist program. Pfizer is conducting Phase 1
testing of KOS-2187 as a potential treatment for gastroesophageal reflux disease (GERD).



We also have next-generation Hsp90 inhibitor, next-generation epothilone and nuclear export inhibitor programs for cancer that are undergoing preclinical evaluation. These programs are also based on the use of our technology to
improve the structure of known polyketides and the efficiency of large-scale production.



We have incurred significant losses since our inception.



As of
December 31, 2007, our accumulated deficit was approximately $189.0 million. We expect to incur additional operating losses over the next several years as we continue to advance our product candidates into and through clinical trials.



We believe that our existing cash and investment securities will be sufficient to
support our current operating plan into the first half of 2009. We have based this estimate on assumptions that may prove to be wrong, and we expect that additional financing will be required in order to fund our operations.



Critical Accounting Policies and 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 U.S. generally
accepted accounting principles. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and the disclosure of contingent assets and
liabilities as of the date of the financial statements. Estimates and assumptions are reviewed periodically and the effects of revisions are reflected in the financial statements in the period they are determined. 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 could differ from these estimates.



We believe the
following critical accounting policies and estimates, 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 revenue when (i) persuasive evidence of an arrangement exists; (ii) delivery of the services, supplies or technology license has occurred; (iii) the price is fixed and determinable; and (iv) collectibility
is reasonably assured. We recognize license and other up-front fees pursuant to research and development collaboration agreements over our estimated period of continuing involvement with the research and development of the respective agreement.
These estimates are reviewed on a periodic basis and updated if the underlying assumptions are modified. Any changes in these estimates will result in either an acceleration or further deferral of the related revenue recognition. Payments related to
substantive performance milestones that are at risk at the initiation of an agreement are recognized upon successful completion of a performance milestone event.



36



---

##### Table of Contents

Contract revenues related to collaborative research and development efforts are recognized as revenue as the related services are
performed or delivered in accordance with contract terms. Such payments generally are made based on the number of full-time equivalent researchers assigned to the collaboration project and the related research and development expenses incurred or as
other deliverables under the contracts are fulfilled.



In the first quarter of 2007, upon
the decision to advance KOS-1584 into Phase 2 clinical trials, we determined that the estimated clinical development period of our agreement with Roche extended from 2009 to 2012. The change in this estimate as of March 1, 2007, resulted in a
further deferral of the unrecognized portion of the Roche up-front fee. On October 25, 2007, we received notice from Roche that it is terminating our agreement in its entirety, which termination was effective in late February 2008. The
termination of our agreement resulted in an acceleration of the unrecognized portion of the Roche up-front fee to 2008. The net effect of these changes resulted in increased revenue of approximately $2.3 million in 2007. We expect that we will
recognize the remaining portion of the Roche up-front fee of approximately $3.3 million in the first quarter of 2008.



Clinical Trial and Drug Manufacturing Accruals

Research and development expenditures are
expensed as incurred. Our expenses related to clinical trials and drug manufacturing are based on estimates of the services received or efforts expended pursuant to contracts with multiple institutions, clinical research organizations, contract
manufacturers and other service providers that conduct and manage clinical trial activities or drug manufacturing on our behalf. The financial terms of these agreements are established prior to the initiation of the related services, 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 or work performed. Expenses related to clinical trials and drug manufacturing generally
are accrued based on estimates of work performed or the level of patient enrollment and activities according to the planned protocols or agreements. We monitor planned protocols, work performed, patient enrollment levels and related activities to
the extent possible and adjust our estimates accordingly. All estimates may differ significantly from the actual amounts subsequently invoiced. No adjustments for material changes in estimates have been recognized in any period presented.



Stock-Based Compensation

Effective January 1, 2006, we adopted the fair value expense recognition provisions of Statement of Financial Accounting Standards No. 123 (revised 2004) or SFAS
123R, Share-Based Payment, using the modified prospective transition method and therefore we did not restate prior periods results. Under this transition method, stock-based compensation expense beginning January 1, 2006
included compensation expense for all stock-based compensation awards granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS 123. Stock-based
compensation expense for all stock-based payment awards granted after December 31, 2005 is based on the grant-date fair value estimated in accordance with the provisions of SFAS 123R. We recognize these compensation costs, net of an expected
forfeiture rate, on a graded-vesting basis over the requisite service period of the award, which is generally the option vesting term of one or four years.



We use the Black-Scholes model to value stock-based compensation expense. Separate groups of employees that have similar historical exercise behavior are considered separately for
valuation purposes. Expected term is based on the simplified method allowed under the provisions of Staff Accounting Bulletin No. 107. The risk-free interest rate is based on the U.S. Treasury zero coupon issues with an equivalent remaining
term at the time of the option grant. Expected volatility is based on the historical volatility of our stock price and other factors. The assumptions used to value stock-based compensation to employees are subject to periodic adjustment. As such,
changes to these assumptions in the future could be substantial.



37



---

##### Table of Contents

KOSAN BIOSCIENCES



Stock-based compensation expense for options granted to non-employees has been determined in accordance with SFAS 123 and Emerging Issues Task Force 96-18 Accounting for
Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services as the fair value of the consideration received or the fair value of the equity instruments issued, whichever is more
reliably measured. The measurement of stock-based compensation to non-employees 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.



Impairment of Investments

We carry our investments of debt securities at fair value, estimated as the amount at which an asset or liability could be bought or sold in a current transaction between willing
parties. In 2007, the credit markets began reacting to these changing factors and the prices of many securities backed by subprime mortgages began to decline. Lower volumes of transactions in certain types of collateralized securities might make it
more difficult to obtain relevant market information to estimate the fair value of these financial instruments. However, we do not hold any mortgage-backed securities, auction rate securities or other securities where credit risk have increased
significantly in the current markets. In accordance with our investment policy, we diversify our credit risk and invest in debt securities with high credit quality. Substantially all of our investments held as of December 31, 2007 are actively
traded and our estimate of fair value is based upon quoted market prices. We will continue to monitor our credit risks and evaluate the potential need for impairment charges related to credit risks in future periods. We recognize an impairment
charge when the decline in the estimated fair value of a marketable security below the amortized cost is determined to be other-than-temporary. We consider various factors in determining whether to recognize an impairment charge, including the
duration of time and the severity to which the fair value has been less than its amortized cost, any adverse changes in the investees financial condition and associated downgrades to credit ratings and our intent and ability to hold the
marketable security for a period of time sufficient to allow for any anticipated recovery in market value. We do not believe any unrealized losses represent other-than-temporary impairments based on our evaluation of available evidence as of these
dates. We have the intention and ability to hold such securities until the maturity dates, which are all currently within one year. For the years ended December 31, 2007, 2006 and 2005, we did not recognize an impairment charge related to our
investment securities.



Concentration of Risk

Financial instruments that potentially subject us to a concentration of credit risk consist of cash, cash equivalents, investments and restricted cash. Substantially all of our
cash, cash equivalents and restricted cash are held by two financial institutions that we believe are of high credit quality. Such deposits may, at times, exceed federally insured limits. We have not experienced any losses on our deposits of cash,
cash equivalents and restricted cash. Our investments are held in high-credit quality government sponsored enterprise and corporate obligations. We believe that our guidelines for investment of our excess cash maintain safety and liquidity through
diversification and investment maturity. We are exposed to credit risk in the event of default by the institutions holding our cash, cash equivalents, investments and restricted cash to the extent of the amounts recorded on our balance sheets.



38



---

##### Table of Contents

Results of Operations

Revenues



|                                  |  |                         |        |                       |   |        |  |           |        |  |           |    |  |     |   
|--------------------------------- |  | ----------------------- | ------ | --------------------- | - | ------ |  | --------- | ------ |  | --------- | -- |  | --- | --
|(in thousands except percentages) |  |                         |        |                       |   |        |  |           |        |  |           |    |  |     |   
|                                  |  | Year Ended December 31, |        | Annual Percent Change |  
|                                  |  | 2007                    |        | 2006                  |   | 2005   |  | 2007/2006 |        |  | 2006/2005 |   
|                                  |  |                         |        |                       |   |        |  |           |        |  |           |    |  |     |   
|Contract revenue                  |  | $                       | 22,707 |                       | $ | 13,105 |  | $         | 11,916 |  | 73        | %  |  | 10  | % 
|Grant revenue                     |  |                         |       |                       |   | 401    |  |           | 1,494  |  | (100      | )% |  | (73 | )%
|                                  |  |                         |        |                       |   |        |  |           |        |  |           |    |  |     |   
|Total revenues                    |  | $                       | 22,707 |                       | $ | 13,506 |  | $         | 13,410 |  | 68        | %  |  | 1   | % 



Revenues for the years ended December 31,
2007, 2006 and 2005 were approximately $22.7 million, $13.5 million and $13.4 million, respectively, of which $2.0 million was related to a non-recurring milestone earned in 2006. Revenues in 2007 and 2006 consisted primarily of contract revenue
recognized under our agreements with Roche and Pfizer. Revenues in 2005 consisted primarily of contract revenue recognized under our agreement with Roche and funded research related to government grant awards.



The increase in revenues of approximately 68%, or $9.2 million, in 2007 compared to 2006 was the result
of the following:



| |  |  | approximately $8.9 million in increased contract revenue from Pfizer, reflecting the amortization of the $12.5 million up-front payment received in December 2006;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | approximately $0.7 million in increased contract revenue from Roche, reflecting an acceleration of the unrecognized portion of our up-front fee and higher funding for our
KOS-1584 program, partially offset by the $2.0 million non-recurring milestone and a decrease in KOS-862 development activities due to the conclusion of certain clinical trials; offset by
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | approximately $0.4 million in decreased grant revenue.
| | - |  | ------------------------------------------------------



The increase in revenues of approximately 1%, or $0.1 million, in 2006 compared to 2005 was the result of the following:



| |  |  | approximately $1.8 million in contract revenue from Pfizer, reflecting the amortization of the $12.5 million up-front payment received in December 2006; and
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | approximately $0.6 million in lower contract revenue from Roche, reflecting a decrease in KOS-862 development activities due to the conclusion of certain clinical trials,
partially offset by the $2.0 million non-recurring milestone; offset by
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | approximately $1.1 million in decreased grant revenue due to fewer grant awards in 2006.
| | - |  | ----------------------------------------------------------------------------------------



On October 25, 2007, we received notice from Roche that it was terminating our agreement in its entirety, which termination was effective in late
February 2008. The termination of our agreement resulted in an acceleration of the unrecognized portion of the up-front fee. Roches development funding commitments under the agreement continued until the termination date, after which Roche is
obligated to reimburse us for certain costs of completing the KOS-1584 Phase 1 clinical trials. Accordingly, we expect that we will recognize the remaining portion of the Roche up-front fee of approximately $3.3 million in the first quarter of 2008
and that our contract revenues from Roche will significantly decrease in 2008 compared to 2007 as a result of the termination of our agreement. As of March 31, 2007, we had fully amortized the Pfizer up-front fee and, as a result, we do not
expect to recognize any further contract revenue related to the amortization of this fee.



39



---

##### Table of Contents

KOSAN BIOSCIENCES



Research and Development Expenses

For the years ended December 31, 2007, 2006 and
2005, our research and development expenses were approximately $47.3 million, $37.2 million, and $38.4 million, respectively. Our research and development activities consist primarily of salaries and other personnel-related expenses, including
associated stock-based compensation, facility-related expenses, licensing-related expenses, depreciation of facilities and equipment, lab consumables and services performed by clinical research organizations and research institutions, contract
manufacturers and other outside service providers. We group these activities into two major categories: clinical development and research and preclinical. We are unable to estimate the nature, timing or costs to complete our
major research and development projects, or when material net cash inflows to us could be expected to commence, if ever, due to the numerous risks and uncertainties associated with developing pharmaceutical products. These risks and uncertainties
are fully discussed in this Annual Report under Part I, Item 1A. Risk Factors.



The costs associated with clinical development and research and preclinical activities approximated the following:



|                                       |  |                         |        |                       |   |        |                             |           |        |  |           |    |  |     |    |  |   |        
|-------------------------------------- |  | ----------------------- | ------ | --------------------- | - | ------ | --------------------------- | --------- | ------ |  | --------- | -- |  | --- | -- |  | - | -------
|(In thousands, except for percentages) |  |                         |        |                       |   |        |                             |           |        |  |           |    |  |     |   
|                                       |  | Year Ended December 31, |        | Annual Percent Change |   |        | Inception December 31,2007
|                                       |  | 2007                    |        | 2006                  |   | 2005   |                             | 2007/2006 |        |  | 2006/2005 |    | 
|Clinical development                   |  |                         |        |                       |   |        |                             |           |        |  |           |    |  |     |    |  |   |        
|Epothilones                            |  | $                       | 8,303  |                       | $ | 7,627  |                             | $         | 11,170 |  | 9         | %  |  | (32 | )% |  | $ | 65,471 
|Hsp90 inhibitors                       |  |                         | 26,694 |                       |   | 16,680 |                             |           | 9,616  |  | 60        | %  |  | 73  | %  |  |   | 58,448 
|                                       |  |                         |        |                       |   |        |                             |           |        |  |           |    |  |     |    |  |   |        
|Total clinical development             |  |                         | 34,997 |                       |   | 24,307 |                             |           | 20,786 |  | 44        | %  |  | 17  | %  |  |   | 123,919
|Research and preclinical (1)           |  |                         | 12,286 |                       |   | 12,872 |                             |           | 17,614 |  | (5        | )% |  | (27 | )% |  |   | 163,418
|                                       |  |                         |        |                       |   |        |                             |           |        |  |           |    |  |     |    |  |   |        
|Total research and development         |  | $                       | 47,283 |                       | $ | 37,179 |                             | $         | 38,400 |  | 27        | %  |  | (3  | )% |  | $ | 287,337
|                                       |  |                         |        |                       |   |        |                             |           |        |  |           |    |  |     |    |  |   |        

---

|(1) | Research and preclinical constitutes research and development costs for our early stage programs in the areas of cancer, gastrointestinal motility and technology development in
2007, 2006 and 2005 and infectious disease in 2005. Expenses for the years ended December 31, 2007, 2006, and 2005 include allocated personnel-related expenses of approximately $4.8 million, $6.1 million and $8.2 million, allocated
facility-related expenses of approximately $3.3 million, $3.9 million and $5.5 million and allocated lab consumables of approximately $0.5 million, $0.5 million and $1.2 million, respectively. Expenses for the period from inception through
December 31, 2007 include allocated personnel-related expenses of approximately $79.4 million, allocated facility-related expense of approximately $40.6 million and allocated lab consumables of approximately $10.8
million.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



The increase of 27%, or approximately $10.1 million, in research
and development expenses for the year ended December 31, 2007 compared to 2006 was primarily due to the following:



| |  |  | an increase of approximately $10.7 million in clinical development, primarily due to the increased clinical costs in the Hsp90 inhibitor and epothilone programs, including
costs associated with the initiation of the clinical trials in our TIME registration program in multiple myeloma and preparation for the KOS-1584 phase 2 clinical program, which preparation was funded by Roche; offset by
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | a decrease of approximately $0.6 million in preclinical and research costs primarily related to reorganization related expenses and a reduction in investment in certain
early-stage research programs in 2006, partially offset by costs associated with the development our next generation epothilone, KOS-1803.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



40



---

##### Table of Contents

The decrease of 3%, or approximately $1.2 million, in research and development expenses for the year ended December 31, 2006
compared to 2005 was primarily due to the following, including the recognition of stock-based compensation expense due to the implementation of SFAS 123R:



| |  |  | approximately $4.7 million decrease in preclinical and research costs primarily related to reduced investment in certain non-oncology, early-stage research programs; offset
by
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | an increase of approximately $3.5 million in clinical development primarily due to the advancement of our clinical product candidates in the Hsp90 inhibitor
program.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------



We allocate salary-driven and space-use-driven overhead
expenses to research and development and to general and administrative expenses based on salaries and utilization by each respective area. Our research and development employees increased to 76 employees in 2007 from 62 in 2006, primarily in support
of our clinical development programs. We initiated TIME-1, a Phase 3 pivotal clinical trial of tanespimycin in combination with Velcade in first-relapse patients with multiple myeloma, and plan to initiate a supporting clinical trial in multiple
myeloma in early 2009. We also expect to initiate our Phase 2 clinical program with KOS-1584 in non-small cell lung cancer in the first quarter of 2008. These clinical trials will result in an increase in our research and development expenses over
the next several quarters.



Phase 1 clinical trials generally are expected to last
between 12 and 18 months, Phase 2 clinical trials are expected to last between 18 and 24 months and Phase 3 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 product candidates that are in preclinical development, the timing of an IND filing varies significantly and is difficult to predict and therefore not reflected in the table above.



General and Administrative Expenses

For the years ended December 31, 2007, 2006 and 2005, general and administrative expenses were approximately $8.2 million, $7.8 million and $6.0 million, respectively.



|                                   |  |                         |       |                       |   |       |  |           |       |  |           |   |  |    |  
|---------------------------------- |  | ----------------------- | ----- | --------------------- | - | ----- |  | --------- | ----- |  | --------- | - |  | -- | -
|(in thousands, except percentages) |  |                         |       |                       |   |       |  |           |       |  |           |   |  |    |  
|                                   |  | Year Ended December 31, |       | Annual Percent Change |  
|                                   |  | 2007                    |       | 2006                  |   | 2005  |  | 2007/2006 |       |  | 2006/2005 |  
|General and administrative         |  | $                       | 8,162 |                       | $ | 7,823 |  | $         | 6,038 |  | 4         | % |  | 30 | %



The increase of 4%, or approximately $0.3
million, in general and administrative expenses in 2007 compared to 2006 was primarily due to increased personnel costs to support our increasing development activities. The increase of 30%, or approximately $1.8 million, in general and
administrative expenses in 2006 compared to 2005 was primarily due to severance related payments in 2006 to a former officer and the recognition of stock-based compensation expense due to the implementation of SFAS 123R. Our general and
administrative employees increased to 18 in 2007 from 17 in 2006, primarily to support our increasing development activities. We expect our general and administrative expenses to increase in the first quarter of 2008 due to payments associated with
the resignation of our former Chief Executive Officer in February 2008.



41



---

##### Table of Contents

KOSAN BIOSCIENCES



Interest Income and Interest Expense



|                                       |  |                         |       |   |                       |   |       |      |  |   |           |   |  |           |    |  |    |  
|-------------------------------------- |  | ----------------------- | ----- | - | --------------------- | - | ----- | ---- |  | - | --------- | - |  | --------- | -- |  | -- | -
|(in thousands except percentages)      |  |                         |       |   |                       |   |       |      |  |   |           |   |  |           |    |  |    |  
|                                       |  | Year Ended December 31, |       |   | Annual Percent Change |  
|                                       |  | 2007                    |       |   | 2006                  |   |       | 2005 |  |   | 2007/2006 |   |  | 2006/2005 |   
|Interest income                        |  | $                       | 4,283 |   |                       | $ | 2,549 |      |  | $ | 1,711     |   |  | 68        | %  |  | 49 | %
|Interest expense                       |  |                         | (230  | ) |                       |   | (522  | )    |  |   | (320      | ) |  | (56       | )% |  | 63 | %
|Gain on sale of property and equipment |  |                         | 27    |   |                       |   |      |      |  |   |          |   |  | 100       | %  |  |   |  
|                                       |  |                         |       |   |                       |   |       |      |  |   |           |   |  |           |    |  |    |  
|Other income, net                      |  | $                       | 4,080 |   |                       | $ | 2,027 |      |  | $ | 1,391     |   |  | 101       | %  |  | 46 | %



Interest Income.Interest income
increased to approximately $4.3 million in 2007 from approximately $2.5 million in 2006. We received approximately $42.3 million in net proceeds from the sale of our common stock in February 2007. The increase in interest income in 2007
compared to 2006 primarily resulted from higher average investment balances in 2007 compared to 2006. Interest income increased to approximately $2.5 million in 2006 from approximately $1.7 million in 2005. We received approximately $24.0
million in net proceeds from the sale of our common stock in April 2006. The increase in interest income in 2006 compared to 2005 primarily resulted from higher returns in a rising interest rate environment, partially offset by lower average
investment balances in 2006 compared to 2005.



Interest Expense. Interest expense
decreased to approximately $0.2 million in 2007 from approximately $0.5 million in 2006. Interest expense increased to $0.5 million in 2006 from approximately $0.3 million in 2005. The changes from year-to-year primarily resulted from fees
associated with our Silicon Valley Bank line of credit facility, which expired in May 2006.



Provision for Income Taxes

We incurred net operating losses in
the years ended December 31, 2007, 2006 and 2005 and consequently did not pay federal or state income taxes. As of December 31, 2007, we had approximately $148.2 million of federal and $138.0 million of state net operating loss
carryforwards available to offset future taxable income. The federal net operating loss carryforwards will expire at various dates beginning in the year 2010 through 2027, if not utilized. The state net operating loss carryforwards will expire at
various dates from 2012 through 2017, if not utilized. At December 31, 2007, we also had federal and state research and development tax credit carryforwards of approximately $5.4 million and $4.9 million, respectively, and federal orphan drug
credit carryforwards of approximately $6.2 million. The federal tax credit carryforwards will begin to expire in 2011, if not utilized. The state tax credit carryforwards do not expire. 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 10 of our financial statements.



Liquidity and Capital Resources

Since inception we have financed our operations primarily through sales of our equity securities, contract payments received
under our collaboration and license agreements and government grant awards, interest income and equipment financing arrangements. As of December 31, 2007, we had received approximately $221.5 million from the sales of equity securities,
approximately $131.9 million from contract payments received under our corporate collaboration and license agreements and government grant awards, approximately $22.7 million from interest income and approximately $14.9 million from equipment
financing arrangements. As of December 31, 2007, we had approximately $71.0 million in cash, cash equivalents, restricted cash and investments, compared to approximately $64.1 million as of December 31, 2006. Our funds are currently
invested in government sponsored enterprise and corporate obligations.



42



---

##### Table of Contents

Cash used in operating activities was approximately $34.7 million in 2007, compared to approximately $16.4 million in 2006. Our net
loss of approximately $28.7 million in 2007 was partially offset by non-cash expenses of approximately $4.7 million related to stock-based compensation, depreciation and amortization of property and equipment and investment premiums and discounts,
and an approximately $10.8 million decrease in assets and liabilities primarily due to the net effect of deferred revenue from the up-front fees from Pfizer and Roche. Our net loss of approximately $29.5 million in 2006 was partially offset by
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, and an approximately $8.5 million increase in assets and liabilities
primarily due to the net effect of deferred revenue from the up-front fees from Pfizer and Roche. We do not anticipate generating cash from operating activities at least for the next several years.



Cash used in investing activities, excluding changes in our restricted cash and investments, for the
year ended December 31, 2007 was approximately $1.7 million, compared to approximately $1.1 million in 2006. Investing activities in 2007 and 2006 primarily reflected the purchase of additional laboratory and office equipment.



Cash provided by financing activities was approximately $42.6 million for the year ended
December 31, 2007, compared to approximately $26.0 million in 2006. Financing activities in 2007 included approximately $43.3 million in net proceeds from the sale of our common stock, stock option exercises and stock purchases made under our
2000 Employee Stock Purchase Plan and approximately $0.7 million of equipment debt financing, offset by approximately $1.3 million of scheduled payments on equipment loans. Financing activities in 2006 included approximately $27.5 million in net
proceeds from the sale of our common stock, stock option exercises and stock purchases made under our 2000 Employee Stock Purchase Plan and approximately $0.5 million of equipment debt financing, offset by approximately $1.9 million of scheduled
payments on equipment loans.



On July 19, 2006, we entered into a Committed Equity
Financing Facility, or CEFF, with Kingsbridge, pursuant to which Kingsbridge committed to purchase up to $50.0 million of our common stock, subject to certain conditions including a minimum price for our common stock (which condition will not be met
unless the volume weighted average market price of our common stock is at least $2.00). The CEFF allows us to raise capital as required, at the time and in the amounts deemed suitable to us, through September 25, 2009. We are not obligated to
sell any of the $50.0 million of common stock available under the CEFF, and there are no minimum commitments or minimum use penalties. Under the terms of the CEFF, the maximum number of shares that we may sell to Kingsbridge is 6,879,868 shares
(exclusive of the shares underlying a warrant), which may limit the amount of proceeds that we are able to obtain from the CEFF. In connection with the CEFF, we issued a warrant to Kingsbridge to purchase 285,000 shares of our common stock at an
exercise price of $4.94 per share. The warrant is currently exercisable and expires in 2011. In October 2006, we received $3.0 million in gross proceeds for the sale of 770,351 shares of our common stock to Kingsbridge.



We believe that our existing cash and investment securities will be sufficient to support our current
operating plan into the first half of 2009. We have based this estimate on assumptions that may prove to be wrong, and we expect that additional financing will be required in order to fund our operations. Our future capital uses and requirements
depend on numerous forward-looking factors, including those set forth in Part I, Item 1A. Risk Factors.



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



43



---

##### Table of Contents

KOSAN BIOSCIENCES



We expect that additional financing will be required in order to fund our operations. We expect to finance future cash needs through public or private equity offerings, debt
financings, additional partnering or licensing arrangements or any combination of the foregoing or other arrangements. In August 2007, we filed a shelf registration statement on Form S-3 with the SEC pursuant to which we may offer and sell up to
$75.0 million of our common stock and/or warrants to purchase our common stock, either individually or in units. Pursuant to two prior shelf registration statements we filed on Form S-3, we may offer and sell approximately $26.0 million of our
common stock (including $24.5 million of warrants to purchase our common stock and/or units consisting of common stock and warrants to purchase common stock). In total, we may offer and sell up to $101.0 million of our equity securities under our
three shelf registration statements, plus an additional approximately $20.2 million that we could sell under immediately effective related registration statements, assuming we continue to meet the SECs eligibility requirements for primary
offerings on Form S-3. We filed a resale registration statement covering the resale of 6,879,868 shares issuable pursuant to the CEFF with Kingsbridge and 285,000 shares underlying the warrant at an exercise price of $4.94 issued to Kingsbridge in
connection with our CEFF. We have the availability to sell under the CEFF up to $47.0 million of common stock in the future, subject to certain conditions, including a minimum price for our common stock (which condition will not be met unless the
volume weighted average market price of our common stock is at least $2.00).



We have no
current commitments to offer and sell any securities that may be offered or sold pursuant to the registration statements described above. To the extent that we raise additional capital by issuing equity securities, our stockholders may experience
dilution. Debt financing, if available, may subject us to restrictive covenants and significant interest costs. To the extent that we raise additional funds through collaboration and licensing arrangements, we would be required to relinquish some
rights to our technologies, product candidates or marketing territories. 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. Insufficient funds may preclude us from meeting the conditions required for the extension of credit and may adversely affect our ability to operate as a going concern. In
addition, see Part I, Item 1A. Risk Factors.



As of December 31,
2007, our obligations and commitments to make future payments under contracts, such as debt and lease agreements, were as follows:



|                                |  |                        |        |                 |   |           |  |           |       |              |   |       |  |   |    
|------------------------------- |  | ---------------------- | ------ | --------------- | - | --------- |  | --------- | ----- | ------------ | - | ----- |  | - | ---
|(in thousands)                  |  |                        |        |                 |   |           |  |           |       |              |   |       |  |   |    
|                                |  | Payments Due by Period
|                                |  | Total                  |        | Less than1 Year |   | 1-3 Years |  | 4-5 Years |       | After5 Years
|Equipment financing obligations |  | $                      | 1,695  |                 | $ | 941       |  | $         | 715   |              | $ | 39    |  | $ |   
|Operating leases                |  |                        | 11,319 |                 |   | 1,988     |  |           | 4,303 |              |   | 4,630 |  |   | 398
|                                |  |                        |        |                 |   |           |  |           |       |              |   |       |  |   |    
|Total contractual obligations   |  | $                      | 13,014 |                 | $ | 2,929     |  | $         | 5,018 |              | $ | 4,669 |  | $ | 398
|                                |  |                        |        |                 |   |           |  |           |       |              |   |       |  |   |    



Off-Balance
Sheet Arrangements

As of December 31, 2007, we did not have any off-balance sheet arrangements as defined in Item 303(a)(4)(ii) of SEC Regulation S-K.



44



---

##### Table of Contents

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The primary objective of our investment activities is to preserve
our capital for the purpose of funding our operations while at the same time maximizing 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 value of 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, which may include 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, 2007 and 2006 rates, the fair value of our portfolio on those dates would decline
by approximately $20,000 and $0.1 million, respectively.



ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The reports of our Independent Registered Public Accounting Firm, Financial
Statements and Notes to Financial Statements begin on page F-1 of this Annual Report on Form 10-K.



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 as of
December 31, 2007, our principal executive officer and chief financial officer have concluded that our 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 effective.



Managements Annual Report on
Internal Control over Financial Reporting. Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) or 15d-15(f) under the Exchange Act). Under the
supervision and with the participation of our management, including our principal executive officer and chief financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework
in Internal Control  Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.



Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the preparation and fair presentation of financial statements for
external purposes in accordance with generally accepted accounting principles. Internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that in reasonable detail accurately
and fairly reflect the transactions and dispositions of the assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use or disposition of the Companys assets that could have a material effect on the financial statements.



Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to
future periods are subject to the risk that controls may become



45



---

##### Table of Contents

KOSAN BIOSCIENCES



inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.



Based on our evaluation under the framework in Internal Controls  Integrated Framework, our
management concluded that our internal control over financial reporting was effective as of December 31, 2007.



Ernst & Young LLP, an independent registered public accounting firm, has issued an unqualified opinion on the effectiveness of our internal control over financial
reporting, as stated in their report included below.



46



---

##### Table of Contents

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM



The Board of Directors and Stockholders of

Kosan Biosciences Incorporated



We have audited Kosan Biosciences Incorporateds internal control over financial reporting as of December 31, 2007, based on criteria established in Internal ControlIntegrated Framework issued by the Committee
of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Kosan Biosciences Incorporateds management is responsible for maintaining effective internal control over financial reporting and for its assessment of the
effectiveness of internal control over financial reporting included in the accompanying Managements Annual Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the companys internal control
over financial reporting based on our audit.



We conducted our audit in accordance with
the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was
maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of
internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.



A companys internal control over financial reporting is a process designed to provide reasonable
assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting
includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable
assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with
authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material
effect on the financial statements.



Because of its inherent limitations, internal
control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that
the degree of compliance with the policies or procedures may deteriorate.



In our
opinion, Kosan Biosciences Incorporated maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007 based on the COSO criteria.



We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the accompanying balance
sheets of Kosan Biosciences Incorporated as of December 31, 2007 and 2006, and the related statements of operations, stockholders equity and cash flows for each of the three years in the period ended December 31, 2007 and our report
dated March 13, 2008 expressed an unqualified opinion thereon.



/s/ ERNST & YOUNG LLP



San
Francisco, California

March 13, 2008



47



---

##### Table of Contents

KOSAN BIOSCIENCES



Changes in Internal Controls over Financial Reporting. There were no changes in our internal controls over financial reporting during the quarter ended December 31,
2007 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.



Limitations on the Effectiveness of Controls. Our management, including our principal 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. 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 our company have been 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 principal executive officer and chief financial officer have concluded,
based on their evaluation as of the end of the period covered by this report, that our disclosure controls and procedures were sufficiently effective to provide reasonable assurance that the objectives of our disclosure control system were met.



ITEM 9B. OTHER
 INFORMATION

None.



48



---

##### Table of Contents

PART III

KOSAN BIOSCIENCES



Certain information required by Part III is omitted from this Annual Report on Form 10-K since we intend to file our definitive
Proxy Statement for our 2008 Annual Meeting of Stockholders, pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended (the 2008 Proxy Statement), not later than 120 days after the end of the fiscal year covered by
this Annual Report on Form 10-K, and certain information to be included in the Proxy Statement is incorporated herein by reference.



ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

(1) The information required by this Item concerning our directors and
nominees for director, including information with respect to our audit committee and audit committee financial experts, may be found under the section entitled Proposal 1  Election of Directors appearing in the 2008 Proxy
Statement. Such information is incorporated herein by reference.



(2) The information
required by this Item concerning our executive officers may be found under the section entitled Executive Officers appearing in the 2008 Proxy Statement. Such information is incorporated herein by reference.



(3) The information required by this Item concerning compliance with Section 16(a) of the
Securities Exchange Act of 1934 may be found in the section entitled Section 16(a) Beneficial Ownership Reporting Compliance appearing in the 2008 Proxy Statement. Such information is incorporated herein by reference.



(4) We have adopted a Code of Business Conduct and Ethics that applies to our employees, officers and
directors. We have posted the text of our Code of Business Conduct and Ethics on our website at www.kosan.com on the Corporate Governance page under the Investors/Press tab. In addition, we intend to promptly disclose
(1) the nature of any amendment to our Code of Business Conduct and 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 Business Conduct and 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 11. EXECUTIVE COMPENSATION

(1) The information required by this Item concerning director and executive compensation is
incorporated herein by reference to the information from the 2008 Proxy Statement under the sections entitled Executive Compensation and Director Compensation.



(2) The information required by this Item concerning Compensation Committee interlocks and insider participation is incorporated herein by reference
to the information from the 2008 Proxy Statement under the section entitled Compensation Committee Interlocks and Insider Participation.



49



---

##### Table of Contents

KOSAN BIOSCIENCES



(3) The information required by this Item concerning our Compensation Committees review and discussion of the Compensation Discussion and Analysis section of the 2008 Proxy
Statement is incorporated herein by reference to the information from the 2008 Proxy Statement under the section entitled Compensation Committee Report.



ITEM 12. SECURITY
 OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

(1) The information required by this Item with
respect to security ownership of certain beneficial owners and management is incorporated herein by reference to the information from the 2008 Proxy Statement under the section entitled Security Ownership of Certain Beneficial Owners and
Management.



(2) The following table summarizes the securities for issuance under
our equity compensation plans as of December 31, 2007, including our 1996 Stock Option Plan, 2000 Non-Employee Director Stock Option Plan, 2000 Employee Stock Purchase Plan and 2006 Equity Incentive Plan:



|                                                           |  |                                                                                            |  |                                                                            |      |                                                                                                                                             |          
|---------------------------------------------------------- |  | ------------------------------------------------------------------------------------------ |  | -------------------------------------------------------------------------- | ---- | ------------------------------------------------------------------------------------------------------------------------------------------- | ---------
|Plan Category                                              |  | Number of Securitiesto be Issued UponExercise ofOutstanding Options,Warrants and Rights(a) |  | Weighted AverageExercise Price ofOutstandingOptions, Warrantsand Rights(b) |      | Number of SecuritiesRemaining Availablefor Future IssuanceUnder EquityCompensation Plans(1)(excluding securitiesreflected in column (a))(c)
|Equity compensation plans approved by security holders     |  | 5,049,480                                                                                  |  | $                                                                          | 6.83 |                                                                                                                                             | 3,496,299
|Equity compensation plans not approved by security holders |  |                                                                                           |  |                                                                            |     |                                                                                                                                             |         
|                                                           |  |                                                                                            |  |                                                                            |      |                                                                                                                                             |          
|Total                                                      |  | 5,049,480                                                                                  |  | $                                                                          | 6.83 |                                                                                                                                             | 3,496,299
|                                                           |  |                                                                                            |  |                                                                            |      |                                                                                                                                             |          

---

|(1) | As of December 31, 2007, 159,500 shares of common stock remained available for future issuance under our 2000 Non-Employee Director Stock Option Plan and 3,244,173 shares of common stock
remained available for future issuance under our 2006 Equity Incentive Plan. In addition, as of December 31, 2007, 92,626 shares of common stock remained available for future issuance under our 2000 Employee Stock Purchase Plan and 30,716
shares were subject to outstanding purchase rights under our 2000 Employee Stock Purchase Plan. The number of shares reserved for issuance under our 2000 Employee Stock Purchase Plan automatically increases on January 1 of each year equal to
the lesser of (i) 150,000 shares, (ii) 0.75% of the outstanding shares on such date, or (iii) a lesser amount determined by our board of directors.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

(1) The information required by this Item concerning
related party transactions is incorporated herein by reference to the information from the 2008 Proxy Statement under the section entitled Certain Relationships and Related Party Transactions.



(2) The information required by this Item concerning director independence is incorporated herein by
reference to the information from the 2008 Proxy Statement under the section entitled Proposal 1  Election of Directors  Independence of the Board of Directors.



ITEM 14. PRINCIPAL
 ACCOUNTANT FEES AND SERVICES

The information required by this Item is incorporated herein by reference to the information from the 2008
Proxy Statement under the section entitled Proposal 2  Ratification of Selection of Independent Registered Public Accounting Firm.



50



---

##### Table of Contents

PART
IV

KOSAN BIOSCIENCES



ITEM 15. EXHIBITS
 AND FINANCIAL STATEMENT SCHEDULES



(a) The following documents
are filed or incorporated by reference as part of this Annual Report on Form 10-K:



| | (1) | Financial Statements:
| | --- | ---------------------

Report of Independent Registered Public Accounting Firm

Balance SheetsDecember 31, 2007 and 2006

Statements of OperationsYears Ended December 31, 2007, 2006, and 2005

Statement of Changes in Stockholders
EquityYears Ended December 31, 2007, 2006 and 2005

Statements of Cash FlowsYears Ended December 31, 2007, 2006 and 2005

Notes to Financial Statements



| | (2) | Financial Statement Schedules:
| | --- | ------------------------------

All financial statement schedules are omitted
because they are not applicable or not required or because the required information is included in the financial statements or notes thereto.



| | (3) | Exhibits:
| | --- | ---------



|            |  |                                                                                                                                      
|----------- |  | -------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Description                                                                                                                          
|            | 
|3.1         |  | Amended and Restated Certificate of Incorporation of Registrant. (1)                                                                 
|            | 
|3.2         |  | Amended and Restated Bylaws of Registrant. (2)                                                                                       
|            | 
|4.1         |  | Specimen Registrants Common Stock Certificate. (3)                                                                                  
|            | 
|4.2         |  | Third Amended and Restated Registration Rights Agreement, dated March 30, 2000, between Registrant and certain stockholders. (3)     
|            | 
|4.3         |  | Registrants Certificate of Designation of Series A Junior Preferred Stock. (4)                                                      
|            | 
|4.4         |  | Warrant for the purchase of shares of common stock, dated July 19, 2006, issued by the Registrant to Kingsbridge Capital Limited. (5)
|            | 
|4.5         |  | Registration Rights Agreement, dated July 19, 2006, by and between the Registrant and Kingsbridge Capital Limited. (5)               
|            | 
|10.1        |  | Form of Indemnification Agreement entered into by Registrant with each of its directors and executive officers.                      
|            | 
|10.2        |  | Form of Level I Change of Control and Severance Benefit Agreement. (6)*                                                              
|            | 
|10.3        |  | Form of Level II Change of Control and Severance Benefit Agreement. (6)*                                                             
|            | 
|10.4        |  | 1996 Stock Option Plan, as amended. (3)*                                                                                             
|            | 
|10.5        |  | 2000 Employee Stock Purchase Plan and related agreements. (3)*                                                                       
|            | 
|10.6        |  | 2000 Non-Employee Director Stock Option Plan and related agreements, as amended. (7)*                                                
|            | 
|10.7        |  | 2006 Equity Incentive Plan. (8)*                                                                                                     
|            | 
|10.8        |  | Form of Stock Option Grant Notice and Stock Option Agreement under the 2006 Equity Incentive Plan. (8)*                              



51



---

##### Table of Contents

KOSAN BIOSCIENCES



|            |  |                                                                                                                                                                                                                                                                                                                                                             
|----------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Description                                                                                                                                                                                                                                                                                                                                                 
|            | 
|10.9        |  | Non-Employee Director Compensation Arrangements, effective as of July 2006. (9)*                                                                                                                                                                                                                                                                            
|            | 
|10.10       |  | 2007 Compensation Information for Executive Officers.*                                                                                                                                                                                                                                                                                                      
|            | 
|10.11       |  | Summary of 2007 Executive Officer Cash Bonus Plan. (10)*                                                                                                                                                                                                                                                                                                    
|            | 
|10.12      |  | Research and License Agreement between Registrant and The Sloan-Kettering Institute for Cancer Research, dated August 25, 2000. (3)                                                                                                                                                                                                                         
|            | 
|10.13      |  | Consent and Amendment to the License Agreement, effective as of September 16, 2002, by and between Registrant and The Sloan-Kettering Institute for Cancer Research. (11)                                                                                                                                                                                   
|            | 
|10.14      |  | Settlement Agreement, entered into September 19, 2003, by and between Registrant and The Sloan-Kettering Institute for Cancer Research. (12)                                                                                                                                                                                                                
|            | 
|10.15      |  | Letter Agreement between Registrant and The Sloan-Kettering Institute for Cancer Research, dated May 4, 2006. (7)                                                                                                                                                                                                                                           
|            | 
|10.16      |  | License Agreement between Registrant and The Board of Trustees of The Leland Stanford Junior University, dated March 11, 1996. (3)                                                                                                                                                                                                                          
|            | 
|10.17      |  | Amendment No. 1 to License Agreement with the Board of Trustees of The Leland Stanford Junior University, dated March 1996; Letter to Mona Wan to confirm the agreement between Registrant and the Board
of Trustees of The Leland Stanford Junior University, dated September 21, 1998; and Amendment No. 3 to License Agreement, dated March 10, 2000. (3)
|            | 
|10.18      |  | Consent and Amendment to the License Agreement, effective as of September 16, 2002, by and between Registrant and Stanford University. (11)                                                                                                                                                                                                                 
|            | 
|10.19      |  | License Agreement between Registrant and President and Fellows of Harvard College, dated December 2, 1998. (3)                                                                                                                                                                                                                                              
|            | 
|10.20       |  | Employment Agreement between Registrant and Robert G. Johnson, Jr., dated September 5, 2000. (3)*                                                                                                                                                                                                                                                           
|            | 
|10.21       |  | Rights Agreement, dated as of October 5, 2001, between Registrant and Mellon Investor Services, LLC. (4)                                                                                                                                                                                                                                                    
|            | 
|10.22       |  | Lease Agreement, dated as of June 7, 2002, by and between EOP-Industrial Portfolio, L.L.C. and Registrant. (13)                                                                                                                                                                                                                                             
|            | 
|10.23       |  | Landlord Consent to Assignment and Assumption of Lease, dated as of June 20, 2002, by and among EOP-Industrial Portfolio, L.L.C., Aventis Pharmaceuticals, Inc. and Registrant. (13)                                                                                                                                                                        
|            | 
|10.24      |  | Collaborative Research, Development and Commercialization Agreement, dated as of September 19, 2002, by and among Registrant, Hoffmann-La Roche, Inc. and F. Hoffmann-La Roche Ltd. (11)                                                                                                                                                                    
|            | 
|10.25       |  | Amendment to Collaborative Research, Development and Commercialization Agreement, effective July 1, 2004, by and among Registrant, Hoffmann-La Roche Inc. and F. Hoffmann-La Roche Ltd.
(14)                                                                                                                                                                
|            | 
|10.26      |  | Letter agreement among Registrant, Hoffmann-La Roche Inc. and F. Hoffmann-La Roche Ltd. dated March 27, 2006. (15)                                                                                                                                                                                                                                          



52



---

##### Table of Contents

|            |  |                                                                                                                                                                                                                                         
|----------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Description                                                                                                                                                                                                                             
|            | 
|10.27       |  | Loan and Security Agreement between the Registrant and Silicon Valley Bank dated July 15, 2005. (16)                                                                                                                                    
|            | 
|10.28       |  | First Amendment to Loan and Security Agreement between Registrant and Silicon Valley Bank dated as of February 21, 2006. (6)                                                                                                            
|            | 
|10.29       |  | Employment Agreement between Registrant and Peiter Timmermans, Ph.D. dated December 6, 2004. (6)*                                                                                                                                       
|            | 
|10.30       |  | Employment Agreement between Registrant and Margaret A. Horn dated December 1, 2005. (17)*                                                                                                                                              
|            | 
|10.31       |  | Consulting Agreement between Registrant and Susan M. Kanaya dated January 1, 2006. (6)*                                                                                                                                                 
|            | 
|10.32       |  | Separation and Consulting Agreement between Registrant and Daniel V. Santi, M.D., Ph.D. dated March 20, 2006. (15)*                                                                                                                     
|            | 
|10.33       |  | Common Stock Purchase Agreement between Registrant and Kingsbridge Capital Limited, dated July 19, 2006. (5)                                                                                                                            
|            | 
|10.34       |  | Amendment No. 1 to Common Stock Purchase Agreement between Registrant and Kingsbridge Capital Limited, dated January 24, 2007. (21)                                                                                                     
|            | 
|10.35       |  | Scientific Advisory Board Agreement between Registrant and Chaitan S. Khosla, Ph.D., dated July 19, 2006. (18)*                                                                                                                         
|            | 
|10.36       |  | Employment Agreement between Registrant and Gary S. Titus dated August 7, 2006. (19)*                                                                                                                                                   
|            | 
|10.37       |  | Employment Agreement between Registrant and Robert L. De Jager, M.D., F.A.C.P. dated October 24, 2006. (20)*                                                                                                                            
|            | 
|10.38      |  | Exclusive License Agreement between Registrant and Pfizer Inc. dated December 19, 2006. (21)                                                                                                                                            
|            | 
|10.39      |  | Consulting Agreement, dated August 24, 2007, by and between the Registrant and Margaret A. Horn. (22)                                                                                                                                   
|            | 
|10.40      |  | Amendment to the Research and License Agreement, dated October 2, 2007, by and between the Registrant and the Sloan-Kettering Institute for Cancer Research. (22)                                                                       
|            | 
|10.41      |  | Exclusive License Agreement, dated April 4, 2005, by and between the Registrant and the State of Oregon, acting by and through the State Board of Higher Education on Behalf of Oregon State University.
(22)                           
|            | 
|10.42      |  | Amendment No. One to the Exclusive License Agreement, dated October 2, 2007, by and between the Registrant and the State of Oregon, acting by and through the State Board of Higher Education on behalf
of Oregon State University. (22)
|            | 
|10.43       |  | 2008 Compensation Information for Executive Officers.*                                                                                                                                                                                  
|            | 
|10.44       |  | Summary of 2008 Executive Officer Cash Bonus Plan. (23)*                                                                                                                                                                                
|            | 
|10.45       |  | Employment Agreement between Registrant and Helen S. Kim dated December 5, 2007.*                                                                                                                                                       
|            | 
|10.46       |  | Employment Agreement between Registrant and Jonathan Wright dated October 29, 2007.*                                                                                                                                                    



53



---

##### Table of Contents

KOSAN BIOSCIENCES



|            |  |                                                                                                                                                                                                                                                   
|----------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  | Description                                                                                                                                                                                                                                       
|            | 
|10.47      |  | Form of Executive Employee Restricted Stock Unit Grant Notice and Restricted Stock Unit Award Agreement under the 2006 Equity Incentive Plan.*                                                                                                    
|            | 
|10.48       |  | Form of Non-Executive Employee Restricted Stock Unit Grant Notice and Restricted Stock Unit Award Agreement under the 2006 Equity Incentive Plan.*                                                                                                
|            | 
|10.49       |  | Severance Benefits and Consulting Agreement, effective as of August 8, 2007, by and between the Registrant and Robert L. De Jager, M.D., F.A.C.P.*                                                                                                
|            | 
|10.50       |  | Non-Employee Director Compensation Arrangements, effective as of January 1, 2008.*                                                                                                                                                                
|            | 
|10.51       |  | Employment Agreement between Registrant and Peter J. Licari, Ph.D., dated July 10, 1998.*                                                                                                                                                         
|            | 
|23.1        |  | Consent of Independent Registered Public Accounting Firm.                                                                                                                                                                                         
|            | 
|24.1        |  | Power of Attorney (included in signature page hereto).                                                                                                                                                                                            
|            | 
|31.1        |  | Certification required by Rule 13a-14(a) or Rule 15d-14(a).                                                                                                                                                                                       
|            | 
|31.2        |  | Certification required by Rule 13a-14(a) or Rule 15d-14(a).                                                                                                                                                                                       
|            | 
|32.1        |  | Certification by the Chief Executive Officer and Chief Financial Officer of Kosan Biosciences Incorporated, as required by Rule 13a-14(b) or 15d-14(b) and Section 1350 of Chapter 63 of Title 18 of the
United States Code (18 U.S.C. 1350). (24)

---

|(1) | Incorporated herein by reference to an exhibit of our quarterly report on Form 10-Q for the period ended June 30, 2001.
|--- | -----------------------------------------------------------------------------------------------------------------------

|(2) | Incorporated herein by reference to an exhibit of our quarterly report on Form 10-Q for the period ended June 30, 2003.
|--- | -----------------------------------------------------------------------------------------------------------------------

|(3) | Incorporated herein by reference to an exhibit of our Registration Statement on Form S-1, Registration No. 333-33732.
|--- | ---------------------------------------------------------------------------------------------------------------------

|(4) | Incorporated herein by reference to an exhibit of our current report on Form 8-K filed on October 15, 2001.
|--- | -----------------------------------------------------------------------------------------------------------

|(5) | Incorporated herein by reference to an exhibit of our current report on Form 8-K filed on July 25, 2006.
|--- | --------------------------------------------------------------------------------------------------------

|(6) | Incorporated herein by reference to an exhibit of our Annual Report on Form 10-K for the period ended December 31, 2005.
|--- | ------------------------------------------------------------------------------------------------------------------------

|(7) | Incorporated herein by reference to an exhibit of our quarterly report on Form 10-Q for the period ended June 30, 2006.
|--- | -----------------------------------------------------------------------------------------------------------------------

|(8) | Incorporated herein by reference to an exhibit of our current report on Form 8-K filed on June 1, 2006.
|--- | -------------------------------------------------------------------------------------------------------

|(9) | Incorporated herein by reference to an exhibit of our quarterly report on Form 10-Q for the period ended September 30, 2006.
|--- | ----------------------------------------------------------------------------------------------------------------------------

|(10) | Incorporated herein by reference to an exhibit of our current report on Form 8-K filed on December 22, 2006.
|---- | ------------------------------------------------------------------------------------------------------------

|(11) | Incorporated herein by reference to an exhibit of our quarterly report on Form 10-Q for the period ended September 30, 2002.
|---- | ----------------------------------------------------------------------------------------------------------------------------

|(12) | Incorporated herein by reference to an exhibit of our quarterly report on Form 10-Q for the period ended September 30, 2003.
|---- | ----------------------------------------------------------------------------------------------------------------------------

|(13) | Incorporated herein by reference to an exhibit of our quarterly report on Form 10-Q for the period ended June 30, 2002.
|---- | -----------------------------------------------------------------------------------------------------------------------



54



---

##### Table of Contents

|(14) | Incorporated herein by reference to an exhibit of our quarterly report on Form 10-Q for the period ended September 30, 2004.
|---- | ----------------------------------------------------------------------------------------------------------------------------

|(15) | Incorporated herein by reference to an exhibit of our quarterly report on Form 10-Q for the period ended March 31, 2006.
|---- | ------------------------------------------------------------------------------------------------------------------------

|(16) | Incorporated by reference to an exhibit of our quarterly report on Form 10-Q for the period ended June 30, 2005.
|---- | ----------------------------------------------------------------------------------------------------------------

|(17) | Incorporated by reference to an exhibit of our current report on Form 8-K filed on December 7, 2005.
|---- | ----------------------------------------------------------------------------------------------------

|(18) | Incorporated by reference to an exhibit of our current report on Form 8-K filed on July 25, 2006.
|---- | -------------------------------------------------------------------------------------------------

|(19) | Incorporated by reference to an exhibit of our current report on Form 8-K filed on August 15, 2006.
|---- | ---------------------------------------------------------------------------------------------------

|(20) | Incorporated by reference to an exhibit of our current report on Form 8-K filed on October 26, 2006.
|---- | ----------------------------------------------------------------------------------------------------

|(21) | Incorporated herein by reference to an exhibit of our Annual Report on Form 10-K for the period ended December 31, 2007.
|---- | ------------------------------------------------------------------------------------------------------------------------

|(22) | Incorporated by reference to an exhibit of our quarterly report on Form 10-Q for the period ended September 30, 2007.
|---- | ---------------------------------------------------------------------------------------------------------------------

|(23) | Incorporated by reference to an exhibit of our current report on Form 8-K filed on January 29, 2008.
|---- | ----------------------------------------------------------------------------------------------------

|(24) | This certification accompanies this Annual Report on Form 10-K and shall not be deemed filed by Registrant for purposes of Section 18 of the Exchange Act.
|---- | ------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Confidential treatment has been granted with respect to certain portions of this exhibit. Omitted portions have been filed separately with the Securities and Exchange Commission.
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Confidential treatment has been requested with respect to certain portions of this exhibit. Omitted portions have been filed separately with the Securities and Exchange Commission.
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|* | Represents a management or director compensation plan.
|- | ------------------------------------------------------



55



---

##### Table of Contents

KOSAN BIOSCIENCES



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.



|               |  |                                |  |                                     
|-------------- |  | ------------------------------ |  | ------------------------------------
|               |  | Kosan Biosciences Incorporated
|               |  |                               
|March 14, 2008 |  | By:                            |  | /s/ Helen Kim                       
|               |  |                                |  | Helen S. Kim                        
|               |  |                                |  | President and Chief Business Officer



POWER OF ATTORNEY



KNOW TO ALL PERSONS BY THESE PRESENTS, that the persons whose signatures appear below each severally
constitutes and appoints Helen S. Kim and Gary S. Titus 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 Securities and Exchange Act of 1934, this Report has been signed
below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.



|                                                           |  |                                                                                                |  |               
|---------------------------------------------------------- |  | ---------------------------------------------------------------------------------------------- |  | --------------
|Signature                                                  |  | Title                                                                                          |  | Date          
|                                                           |  |                                                                                               
|/s/ Helen KimHelen S. Kim                                  |  | President and Chief Business Officer (Principal Executive Officer)                             |  | March 14, 2008
|                                                           |  |                                                                                               
|/s/ Gary S. TitusGary S. Titus                             |  | Senior Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) |  | March 14, 2008
|                                                           |  |                                                                                               
|/s/ Peter Davis, Ph.D.Peter Davis, Ph.D.                   |  | Chairman                                                                                       |  | March 14, 2008
|                                                           |  |                                                                                               
|/s/ Bruce A. Chabner, M.D.Bruce A. Chabner, M.D.           |  | Director                                                                                       |  | March 14, 2008
|                                                           |  |                                                                                               
|/s/ Kevan E. Clemens, Ph. D.Kevan E. Clemens, Ph. D.       |  | Director                                                                                       |  | March 14, 2008
|                                                           |  |                                                                                               
|/s/ Jean Deleage, Ph.D.Jean Deleage, Ph.D.                 |  | Director                                                                                       |  | March 14, 2008
|                                                           |  |                                                                                               
|/s/ Charles J. Homcy, M.D.Charles J. Homcy, M.D.           |  | Director                                                                                       |  | March 14, 2008
|                                                           |  |                                                                                               
|/s/ Chaitan S. Khosla, Ph.D.Chaitan S. Khosla, Ph.D.       |  | Director                                                                                       |  | March 14, 2008
|                                                           |  |                                                                                               
|/s/ Christopher T. Walsh, Ph.D.Christopher T. Walsh, Ph.D. |  | Director                                                                                       |  | March 14, 2008



56



---

##### Table of Contents

Kosan Biosciences Incorporated



INDEX TO FINANCIAL STATEMENTS



|                                                                                |  |    
|------------------------------------------------------------------------------- |  | ---
|Report of Independent Registered Public Accounting Firm                         |  | F-2
|Balance SheetsDecember 31, 2007 and 2006                                       |  | F-3
|Statements of OperationsYears ended December 31, 2007, 2006 and 2005           |  | F-4
|Statements of Stockholders EquityYears ended December 31, 2007, 2006 and 2005 |  | F-5
|Statements of Cash FlowsYears ended December 31, 2007, 2006 and 2005           |  | F-6
|Notes to Financial Statements                                                   |  | F-7



F-1



---

##### Table of Contents

REPORT OF INDEPENDENT

REGISTERED PUBLIC ACCOUNTING FIRM



The Board of Directors and Stockholders of

Kosan Biosciences
Incorporated



We have audited the accompanying balance sheets of Kosan Biosciences
Incorporated as of December 31, 2007 and 2006, and the related statements of operations, stockholders equity and cash flows for each of the three years in the period ended December 31, 2007. These financial statements are the
responsibility of Kosan Biosciences Incorporateds management. Our responsibility is to express an opinion on these financial statements based on our audits.



We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (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, 2007 and 2006, and the results of its operations and its cash flows for each of the three years in the period ended
December 31, 2007, in conformity with U.S. generally accepted accounting principles.



As discussed in Note 1 to the Notes to Financial Statements, under the heading Organization and Summary of Significant Accounting Policies  Stock-Based Compensation, in 2006 Kosan Biosciences Incorporated changed its method of
accounting for employee stock-based compensation.



We also have audited, in accordance
with the standards of the Public Company Accounting Oversight Board (United States), Kosan Biosciences Incorporateds internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control
 Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 13, 2008 expressed an unqualified opinion thereon.



/S/ ERNST &
YOUNG LLP



San Francisco, California

March 13, 2008



F-2



---

##### Table of Contents

Kosan Biosciences Incorporated



BALANCE SHEETS

(in thousands, except share and per share data)



|                                                                                                                                                                                                            |  |              |          |   |      |   |          |  
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------ | -------- | - | ---- | - | -------- | -
|                                                                                                                                                                                                            |  | December 31, |         
|                                                                                                                                                                                                            |  | 2007         |          |   | 2006 |  
|ASSETS                                                                                                                                                                                                      |  |              |          |   |      |   |          |  
|Current assets:                                                                                                                                                                                             |  |              |          |   |      |   |          |  
|Cash and cash equivalents                                                                                                                                                                                   |  | $            | 46,950   |   |      | $ | 35,655   |  
|Short-term investments                                                                                                                                                                                      |  |              | 23,058   |   |      |   | 27,483   |  
|Accounts receivable                                                                                                                                                                                         |  |              | 1,301    |   |      |   | 1,152    |  
|Prepaid and other current assets                                                                                                                                                                            |  |              | 521      |   |      |   | 907      |  
|                                                                                                                                                                                                            |  |              |          |   |      |   |          |  
|Total current assets                                                                                                                                                                                        |  |              | 71,830   |   |      |   | 65,197   |  
|Restricted cash                                                                                                                                                                                             |  |              | 949      |   |      |   | 949      |  
|Property and equipment, net                                                                                                                                                                                 |  |              | 4,848    |   |      |   | 4,801    |  
|Other assets                                                                                                                                                                                                |  |              | 240      |   |      |   | 240      |  
|                                                                                                                                                                                                            |  |              |          |   |      |   |          |  
|Total assets                                                                                                                                                                                                |  | $            | 77,867   |   |      | $ | 71,187   |  
|                                                                                                                                                                                                            |  |              |          |   |      |   |          |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                                                                        |  |              |          |   |      |   |          |  
|Current liabilities:                                                                                                                                                                                        |  |              |          |   |      |   |          |  
|Accounts payable                                                                                                                                                                                            |  | $            | 2,840    |   |      | $ | 1,323    |  
|Accrued liabilities                                                                                                                                                                                         |  |              | 10,656   |   |      |   | 6,331    |  
|Current portion of deferred revenue                                                                                                                                                                         |  |              | 3,268    |   |      |   | 13,992   |  
|Current portion of equipment loans                                                                                                                                                                          |  |              | 844      |   |      |   | 1,289    |  
|                                                                                                                                                                                                            |  |              |          |   |      |   |          |  
|Total current liabilities                                                                                                                                                                                   |  |              | 17,608   |   |      |   | 22,935   |  
|Deferred revenue, less current portion                                                                                                                                                                      |  |              |         |   |      |   | 5,599    |  
|Equipment loans, less current portion                                                                                                                                                                       |  |              | 699      |   |      |   | 899      |  
|Commitments                                                                                                                                                                                                 |  |              |          |   |      |   |          |  
|Stockholders equity:                                                                                                                                                                                       |  |              |          |   |      |   |          |  
|Convertible preferred stock, $0.001 par value, 10,000,000 shares authorized, 1,000,000 shares designated as Series A junior preferred stock, no shares
issued and outstanding at December 31, 2007 and 2006 |  |              |         |   |      |   |         |  
|Common stock, $0.001 par value, 100,000,000 shares authorized 42,592,302 and 35,389,717 shares issued and outstanding at December 31, 2007 and
2006, respectively                                           |  |              | 43       |   |      |   | 35       |  
|Additional paid-in capital                                                                                                                                                                                  |  |              | 248,452  |   |      |   | 202,016  |  
|Accumulated other comprehensive income                                                                                                                                                                      |  |              | 29       |   |      |   | 9        |  
|Accumulated deficit                                                                                                                                                                                         |  |              | (188,964 | ) |      |   | (160,306 | )
|                                                                                                                                                                                                            |  |              |          |   |      |   |          |  
|Total stockholders equity                                                                                                                                                                                  |  |              | 59,560   |   |      |   | 41,754   |  
|                                                                                                                                                                                                            |  |              |          |   |      |   |          |  
|Total liabilities and stockholders equity                                                                                                                                                                  |  | $            | 77,867   |   |      | $ | 71,187   |  
|                                                                                                                                                                                                            |  |              |          |   |      |   |          |  



See accompanying notes.



F-3



---

##### Table of Contents

Kosan Biosciences Incorporated



STATEMENTS OF
OPERATIONS

(in thousands, except per share data)



|                                                                                                                                                                          |  |                         |         |   |      |   |         |      |  |   |         |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                                                                                                                                          |  | Year Ended December 31, |        
|                                                                                                                                                                          |  | 2007                    |         |   | 2006 |   |         | 2005 | 
|Revenues:                                                                                                                                                                 |  |                         |         |   |      |   |         |      |  |   |         |  
|Contract revenue                                                                                                                                                          |  | $                       | 22,707  |   |      | $ | 13,105  |      |  | $ | 11,916  |  
|Grant revenue                                                                                                                                                             |  |                         |        |   |      |   | 401     |      |  |   | 1,494   |  
|                                                                                                                                                                          |  |                         |         |   |      |   |         |      |  |   |         |  
|Total revenues                                                                                                                                                            |  |                         | 22,707  |   |      |   | 13,506  |      |  |   | 13,410  |  
|Operating expenses:                                                                                                                                                       |  |                         |         |   |      |   |         |      |  |   |         |  
|Research and development (including charges for stock-based compensation of $1,698, $1,419 and $224 for the years ended December 31, 2007, 2006 and
2005, respectively)   |  |                         | 47,283  |   |      |   | 37,179  |      |  |   | 38,400  |  
|General and administrative (including charges for stock-based compensation of $1,493, $1,046 and $131 for the years ended December 31, 2007, 2006
and 2005, respectively) |  |                         | 8,162   |   |      |   | 7,823   |      |  |   | 6,038   |  
|                                                                                                                                                                          |  |                         |         |   |      |   |         |      |  |   |         |  
|Total operating expenses                                                                                                                                                  |  |                         | 55,445  |   |      |   | 45,002  |      |  |   | 44,438  |  
|                                                                                                                                                                          |  |                         |         |   |      |   |         |      |  |   |         |  
|Loss from operations                                                                                                                                                      |  |                         | (32,738 | ) |      |   | (31,496 | )    |  |   | (31,028 | )
|Interest income                                                                                                                                                           |  |                         | 4,283   |   |      |   | 2,549   |      |  |   | 1,711   |  
|Interest expense                                                                                                                                                          |  |                         | (230    | ) |      |   | (522    | )    |  |   | (320    | )
|Gain from sale of property and equipment                                                                                                                                  |  |                         | 27      |   |      |   |        |      |  |   |        |  
|                                                                                                                                                                          |  |                         |         |   |      |   |         |      |  |   |         |  
|Net loss                                                                                                                                                                  |  | $                       | (28,658 | ) |      | $ | (29,469 | )    |  | $ | (29,637 | )
|                                                                                                                                                                          |  |                         |         |   |      |   |         |      |  |   |         |  
|Basic and diluted net loss per common share                                                                                                                               |  | $                       | (0.69   | ) |      | $ | (0.88   | )    |  | $ | (1.01   | )
|                                                                                                                                                                          |  |                         |         |   |      |   |         |      |  |   |         |  
|Shares used in computing basic and diluted net loss per common share                                                                                                      |  |                         | 41,685  |   |      |   | 33,394  |      |  |   | 29,227  |  
|                                                                                                                                                                          |  |                         |         |   |      |   |         |      |  |   |         |  



See accompanying notes.



F-4



---

##### Table of Contents

Kosan Biosciences Incorporated



STATEMENTS OF
STOCKHOLDERS EQUITY

(in thousands, except shares)



|                                                                                                               |  |                            |  |              |   |                          |            |        |                                            |    |  |                         |         |   |                     |   |      |   |  |   |          |   |  |   |         |  
|-------------------------------------------------------------------------------------------------------------- |  | -------------------------- |  | ------------ | - | ------------------------ | ---------- | ------ | ------------------------------------------ | -- |  | ----------------------- | ------- | - | ------------------- | - | ---- | - |  | - | -------- | - |  | - | ------- | -
|                                                                                                               |  | ConvertiblePreferred Stock |  | Common Stock |   | AdditionalPaid-InCapital |            |        | AccumulatedOtherComprehensiveLoss/(Income) |    |  | TotalAccumulatedDeficit |         |   | StockholdersEquity |  
|                                                                                                               |  | Shares                     |  | Amount       |   | Shares                   |            | Amount |                                            |    |  |                        
|BALANCES AT DECEMBER 31, 2004                                                                                  |  |                           |  | $            |  |                          | 29,096,333 |        | $                                          | 29 |  | $                       | 170,735 |   |                     | $ | (378 | ) |  | $ | (101,200 | ) |  | $ | 69,186  |  
|Issuance of common stock upon exercise of options for cash                                                     |  |                           |  |              |  |                          | 80,400     |        |                                            |   |  |                         | 320     |   |                     |   |     |   |  |   |         |   |  |   | 320     |  
|Issuance of common stock under employee stock purchase plan                                                    |  |                           |  |              |  |                          | 194,869    |        |                                            |   |  |                         | 673     |   |                     |   |     |   |  |   |         |   |  |   | 673     |  
|Stock-based compensation                                                                                       |  |                           |  |              |  |                          |           |        |                                            |   |  |                         | 355     |   |                     |   |     |   |  |   |         |   |  |   | 355     |  
|Comprehensive income (loss):                                                                                   |  |                            |  |              |   |                          |            |        |                                            |    |  |                         |         |   |                     |   |      |   |  |   |          |   |  |   |         |  
|Net loss                                                                                                       |  |                           |  |              |  |                          |           |        |                                            |   |  |                         |        |   |                     |   |     |   |  |   | (29,637  | ) |  |   | (29,637 | )
|Change in unrealized gain on available-for-sale securities, net                                                |  |                           |  |              |  |                          |           |        |                                            |   |  |                         |        |   |                     |   | 209  |   |  |   |         |   |  |   | 209     |  
|                                                                                                               |  |                            |  |              |   |                          |            |        |                                            |    |  |                         |         |   |                     |   |      |   |  |   |          |   |  |   |         |  
|Comprehensive loss                                                                                             |  |                            |  |              |   |                          |            |        |                                            |    |  |                         |         |   |                     |   |      |   |  |   |          |   |  |   | (29,428 | )
|                                                                                                               |  |                            |  |              |   |                          |            |        |                                            |    |  |                         |         |   |                     |   |      |   |  |   |          |   |  |   |         |  
|BALANCES AT DECEMBER 31, 2005                                                                                  |  |                           |  | $            |  |                          | 29,371,602 |        | $                                          | 29 |  | $                       | 172,083 |   |                     | $ | (169 | ) |  | $ | (130,837 | ) |  | $ | 41,106  |  
|Issuance of common stock in a direct offering, net of offering costs of $1,520                                 |  |                           |  |              |  |                          | 5,100,000  |        |                                            | 5  |  |                         | 23,975  |   |                     |   |     |   |  |   |         |   |  |   | 23,980  |  
|Issuance of common stock upon exercise of options for cash                                                     |  |                           |  |              |  |                          | 59,994     |        |                                            |   |  |                         | 222     |   |                     |   |     |   |  |   |         |   |  |   | 222     |  
|Issuance of common stock under employee stock purchase plan                                                    |  |                           |  |              |  |                          | 87,770     |        |                                            |   |  |                         | 379     |   |                     |   |     |   |  |   |         |   |  |   | 379     |  
|Issuance of common stock in connection with committed equity financing facility, net of issuance costs of $107 |  |                           |  |              |  |                          | 770,351    |        |                                            | 1  |  |                         | 2,892   |   |                     |   |     |   |  |   |         |   |  |   | 2,893   |  
|Financing cost of warrant issued in connection with committed equity financing facility                        |  |                           |  |              |  |                          |           |        |                                            |   |  |                         | (629    | ) |                     |   |     |   |  |   |         |   |  |   | (629    | )
|Issuance of warrant in connection with committed equity financing facility                                     |  |                           |  |              |  |                          |           |        |                                            |   |  |                         | 629     |   |                     |   |     |   |  |   |         |   |  |   | 629     |  
|Stock-based compensation                                                                                       |  |                           |  |              |  |                          |           |        |                                            |   |  |                         | 2,465   |   |                     |   |     |   |  |   |         |   |  |   | 2,465   |  
|Comprehensive income (loss):                                                                                   |  |                            |  |              |   |                          |            |        |                                            |    |  |                         |         |   |                     |   |      |   |  |   |          |   |  |   |         |  
|Net loss                                                                                                       |  |                           |  |              |  |                          |           |        |                                            |   |  |                         |        |   |                     |   |     |   |  |   | (29,469  | ) |  |   | (29,469 | )
|Change in unrealized gain on available-for-sale securities, net                                                |  |                           |  |              |  |                          |           |        |                                            |   |  |                         |        |   |                     |   | 178  |   |  |   |         |   |  |   | 178     |  
|                                                                                                               |  |                            |  |              |   |                          |            |        |                                            |    |  |                         |         |   |                     |   |      |   |  |   |          |   |  |   |         |  
|Comprehensive loss                                                                                             |  |                            |  |              |   |                          |            |        |                                            |    |  |                         |         |   |                     |   |      |   |  |   |          |   |  |   | (29,291 | )
|                                                                                                               |  |                            |  |              |   |                          |            |        |                                            |    |  |                         |         |   |                     |   |      |   |  |   |          |   |  |   |         |  
|BALANCES AT DECEMBER 31, 2006                                                                                  |  |                           |  | $            |  |                          | 35,389,717 |        | $                                          | 35 |  | $                       | 202,016 |   |                     | $ | 9    |   |  | $ | (160,306 | ) |  | $ | 41,754  |  
|Issuance of common stock in a direct offering, net of offering and shelf registration costs of $3,240          |  |                           |  |              |  |                          | 7,000,000  |        |                                            | 7  |  |                         | 42,253  |   |                     |   |     |   |  |   |         |   |  |   | 42,260  |  
|Issuance of common stock upon exercise of options for cash                                                     |  |                           |  |              |  |                          | 81,308     |        |                                            |   |  |                         | 487     |   |                     |   |     |   |  |   |         |   |  |   | 487     |  
|Issuance of common stock under employee stock purchase plan                                                    |  |                           |  |              |  |                          | 121,277    |        |                                            | 1  |  |                         | 505     |   |                     |   |     |   |  |   |         |   |  |   | 506     |  
|Stock-based compensation                                                                                       |  |                           |  |              |  |                          |           |        |                                            |   |  |                         | 3,191   |   |                     |   |     |   |  |   |         |   |  |   | 3,191   |  
|Comprehensive income (loss):                                                                                   |  |                            |  |              |   |                          |            |        |                                            |    |  |                         |         |   |                     |   |      |   |  |   |          |   |  |   |         |  
|Net loss                                                                                                       |  |                           |  |              |  |                          |           |        |                                            |   |  |                         |        |   |                     |   |     |   |  |   | (28,658  | ) |  |   | (28,658 | )
|Change in unrealized gain on available-for-sale securities, net                                                |  |                           |  |              |  |                          |           |        |                                            |   |  |                         |        |   |                     |   | 20   |   |  |   |         |   |  |   | 20      |  
|                                                                                                               |  |                            |  |              |   |                          |            |        |                                            |    |  |                         |         |   |                     |   |      |   |  |   |          |   |  |   |         |  
|Comprehensive loss                                                                                             |  |                            |  |              |   |                          |            |        |                                            |    |  |                         |         |   |                     |   |      |   |  |   |          |   |  |   | (28,638 | )
|                                                                                                               |  |                            |  |              |   |                          |            |        |                                            |    |  |                         |         |   |                     |   |      |   |  |   |          |   |  |   |         |  
|BALANCES AT DECEMBER 31, 2007                                                                                  |  |                           |  | $            |  |                          | 42,592,302 |        | $                                          | 43 |  | $                       | 248,452 |   |                     | $ | 29   |   |  | $ | (188,964 | ) |  | $ | 59,560  |  
|                                                                                                               |  |                            |  |              |   |                          |            |        |                                            |    |  |                         |         |   |                     |   |      |   |  |   |          |   |  |   |         |  



See accompanying notes.



F-5



---

##### Table of Contents

Kosan Biosciences Incorporated



STATEMENTS OF
CASH FLOWS

(in thousands)



|                                                                            |  |                         |         |   |      |   |         |      |  |   |         |  
|--------------------------------------------------------------------------- |  | ----------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                                            |  | Year Ended December 31, |        
|                                                                            |  | 2007                    |         |   | 2006 |   |         | 2005 | 
|OPERATING ACTIVITIES                                                        |  |                         |         |   |      |   |         |      |  |   |         |  
|Net loss                                                                    |  | $                       | (28,658 | ) |      | $ | (29,469 | )    |  | $ | (29,637 | )
|Adjustments to reconcile net loss to net cash used in operating activities: |  |                         |         |   |      |   |         |      |  |   |         |  
|Depreciation and amortization                                               |  |                         | 2,246   |   |      |   | 2,326   |      |  |   | 2,532   |  
|Amortization of investment premiums and discounts                           |  |                         | (688    | ) |      |   | (224    | )    |  |   | 610     |  
|Stock-based compensation expense                                            |  |                         | 3,191   |   |      |   | 2,465   |      |  |   | 355     |  
|Gain on sale of property and equipment                                      |  |                         | (27     | ) |      |   |        |      |  |   |        |  
|Changes in assets and liabilities:                                          |  |                         |         |   |      |   |         |      |  |   |         |  
|Accounts and other receivables                                              |  |                         | (149    | ) |      |   | 2,167   |      |  |   | 711     |  
|Prepaid and other current assets                                            |  |                         | 386     |   |      |   | 285     |      |  |   | 68      |  
|Other assets and notes receivable from related parties                      |  |                         |        |   |      |   | 59      |      |  |   | 55      |  
|Accounts payable and accrued liabilities                                    |  |                         | 5,305   |   |      |   | (1,445  | )    |  |   | 1,301   |  
|Deferred revenue                                                            |  |                         | (16,323 | ) |      |   | 7,438   |      |  |   | (3,277  | )
|                                                                            |  |                         |         |   |      |   |         |      |  |   |         |  
|Net cash used in operating activities                                       |  |                         | (34,717 | ) |      |   | (16,398 | )    |  |   | (27,282 | )
|                                                                            |  |                         |         |   |      |   |         |      |  |   |         |  
|INVESTING ACTIVITIES                                                        |  |                         |         |   |      |   |         |      |  |   |         |  
|Acquisition of property and equipment                                       |  |                         | (1,839  | ) |      |   | (1,066  | )    |  |   | (1,434  | )
|Proceeds from sale of property and equipment                                |  |                         | 110     |   |      |   |        |      |  |   |        |  
|Purchase of investments and restricted cash                                 |  |                         | (64,103 | ) |      |   | (39,004 | )    |  |   | (28,287 | )
|Proceeds from maturity of investments and restricted cash                   |  |                         | 69,236  |   |      |   | 47,350  |      |  |   | 61,126  |  
|                                                                            |  |                         |         |   |      |   |         |      |  |   |         |  
|Net cash provided by investing activities                                   |  |                         | 3,404   |   |      |   | 7,280   |      |  |   | 31,405  |  
|                                                                            |  |                         |         |   |      |   |         |      |  |   |         |  
|FINANCING ACTIVITIES                                                        |  |                         |         |   |      |   |         |      |  |   |         |  
|Proceeds from issuance of common stock, net of issuance costs               |  |                         | 43,253  |   |      |   | 27,474  |      |  |   | 993     |  
|Proceeds from equipment loans                                               |  |                         | 678     |   |      |   | 458     |      |  |   | 2,005   |  
|Principal payments under equipment loans                                    |  |                         | (1,323  | ) |      |   | (1,909  | )    |  |   | (2,148  | )
|                                                                            |  |                         |         |   |      |   |         |      |  |   |         |  
|Net cash provided by financing activities                                   |  |                         | 42,608  |   |      |   | 26,023  |      |  |   | 850     |  
|                                                                            |  |                         |         |   |      |   |         |      |  |   |         |  
|Net increase in cash and cash equivalents                                   |  |                         | 11,295  |   |      |   | 16,905  |      |  |   | 4,973   |  
|Cash and cash equivalents at beginning of period                            |  |                         | 35,655  |   |      |   | 18,750  |      |  |   | 13,777  |  
|                                                                            |  |                         |         |   |      |   |         |      |  |   |         |  
|Cash and cash equivalents at end of period                                  |  | $                       | 46,950  |   |      | $ | 35,655  |      |  | $ | 18,750  |  
|                                                                            |  |                         |         |   |      |   |         |      |  |   |         |  
|SUPPLEMENTAL DISCLOSURE                                                     |  |                         |         |   |      |   |         |      |  |   |         |  
|Interest paid                                                               |  | $                       | 230     |   |      | $ | 522     |      |  | $ | 320     |  
|                                                                            |  |                         |         |   |      |   |         |      |  |   |         |  
|NON-CASH FINANCING ACTIVITIES                                               |  |                         |         |   |      |   |         |      |  |   |         |  
|Issuance of warrant in connection with committed equity financing facility  |  | $                       |        |   |      | $ | 629     |      |  | $ |        |  
|                                                                            |  |                         |         |   |      |   |         |      |  |   |         |  



See accompanying notes.



F-6



---

##### Table of Contents

Kosan Biosciences Incorporated



NOTES TO
FINANCIAL STATEMENTS



1. ORGANIZATION AND SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES



Overview

Kosan Biosciences Incorporated (the Company or Kosan) was incorporated under the laws of the State of California on January 6, 1995 and commenced
operations in 1996. In July 2000, the Company was reincorporated under the laws of the State of Delaware.



Kosan is a cancer therapeutics company focused on advancing two new classes of anticancer agents through clinical
development: heat shock protein 90, or Hsp90, inhibitors and epothilones. Hsp90 inhibitors have a novel mechanism of action targeting multiple pathways involved in cancer cell growth and survival. Kosans Hsp90 inhibitor product candidates may
have the potential to overcome resistance after relapse and to synergize the initial activity of existing cancer therapies. Kosans Hsp90 inhibitor product candidates have demonstrated antitumor activity in multiple indications in early
clinical trials. Kosans proprietary injectable suspension formulation of tanespimycin (KOS-953), its first-generation Hsp90 inhibitor and most advanced product candidate, is in a Phase 3 clinical trial in combination with Velcade® (bortezomib) for multiple myeloma, as well as a Phase 2 clinical trial in combination with Herceptin® (trastuzumab) for HER-2 positive metastatic breast
cancer. In February 2008, the Kosan terminated the development of alvespimycin, which it had evaluated in clinical trials, in order to focus the Kosans resources on the development of tanespimycin.



Kosan is also developing KOS-1584 in Phase 1 dose-escalating clinical trials in patients with solid
tumors. Epothilones inhibit cell division with a mechanism of action similar to taxanes, one of the most successful classes of anti-tumor agents. The epothilone program was partnered with Hoffmann-La Roche, Inc. and F. Hoffmann-La Roche Ltd.
(collectively, Roche) through a global development and commercialization agreement. The agreement with Roche was terminated in its entirety effective in late February 2008.



Kosan also has a motilin receptor agonist program for the stimulation of gastrointestinal movement, or GI motility. In December 2006, the Company
established a worldwide exclusive license agreement with Pfizer Inc. for its motilin agonist program, including KOS-2187 and related compounds. Pfizer is responsible for all development, regulatory and commercial activities related to the motilin
agonist program. Pfizer is conducting a Phase 1 clinical trial of KOS-2187 as a potential treatment for gastroesophageal reflux disease.



Kosan also has next-generation Hsp90 inhibitor, next-generation epothilone and nuclear export inhibitor programs for cancer that are undergoing preclinical evaluation. These
programs are also based on the use of the Companys technology to improve the structure of known polyketides and the efficiency of large-scale production.



Kosan has funded its operations primarily through equity financing, contract payments under its collaboration agreements, equipment financing arrangements and government grants.



Use of Estimates

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as of the date of the financial statements and the accompanying notes. Estimates and assumptions are reviewed periodically, and the effects of
revisions are reflected in the financial statements in the period they are determined. Actual results could differ from those estimates.



Cash Equivalents and Investments

The Company considers all
highly liquid investments with a maturity from date of purchase of three months or less to be cash equivalents. All investment securities are classified as available-for-sale and are recorded at fair value based on



F-7



---

##### Table of Contents

Kosan Biosciences Incorporated



NOTES TO FINANCIAL STATEMENTS (Continued)



1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)



quoted market prices, with unrealized gains and losses excluded from earnings and reported in other comprehensive loss. Purchase premiums and discounts are recognized
in interest income using the interest method over the terms of the securities. Realized gains and losses and declines in fair value that are deemed to be other-than-temporary are reflected in earnings. The cost of securities sold is based on the
specific identification method.



The Company recognizes an impairment charge when the
decline in the estimated fair value of a marketable security below the amortized cost is determined to be other-than-temporary. The Company considers various factors in determining whether to recognize an impairment charge, including the duration of
time and the severity to which the fair value has been less than its amortized cost, any adverse changes in the investees financial condition and associated downgrades to credit ratings and the Companys intent and ability to hold the
marketable security for a period of time sufficient to allow for any anticipated recovery in market value. For each of the three years ended December 31, 2007, the Company did not recognize an impairment charge related to its investment
securities.



Restricted Cash

The Company held a restricted investment consisting of a certificate of deposit of approximately $949,000 at December 31, 2007 and 2006. This investment is carried at fair
value and is restricted as to withdrawal under a letter of credit agreement related to a facility lease.



Concentration of Risk

Financial instruments that potentially
subject the Company to a concentration of credit risk consist of cash, cash equivalents, investments and restricted cash. Substantially all the Companys cash, cash equivalents and restricted cash are held by two financial institutions that the
Company believes are of high credit quality. Such deposits may, at times, exceed federally insured limits. The Company has not experienced any losses on its deposits of cash, cash equivalents and restricted cash. The Companys investments are
held in high-credit quality government sponsored enterprise and corporate obligations. The Company believes that its guidelines for investment of its excess cash maintain safety and liquidity through diversification and investment maturity. The
Company is exposed to credit risk in the event of default by the institutions holding the cash, cash equivalents, investments and restricted cash to the extent of the amounts recorded on the balance sheets.



Property and Equipment

Property and equipment are stated at cost, net of accumulated depreciation and amortization. Property and equipment are depreciated on a straight-line basis over the estimated
useful lives of three to five years. Leasehold improvements are amortized over the shorter of their estimated useful lives or the lease term.



Revenue Recognition

The Company generates revenue under license
agreements with pharmaceutical companies and, in prior years, under research grants from the National Institutes of Health. The arrangements may include up-front non-refundable fees, reimbursement for personnel and supply costs, milestone payments
for the achievement of defined collaboration objectives and royalties on potential sales of commercialized products. The Company recognizes revenue under these arrangements when (i) persuasive evidence of an arrangement exists;
(ii) delivery of the services, supplies or technology license has occurred; (iii) the price is fixed and determinable; and (iv) collectibility is reasonably assured.



The Company recognizes license and other up-front fees pursuant to research and development collaboration agreements over the Companys estimated
period of continuing involvement with research and development of the respective agreement. These estimates are reviewed on a periodic basis and updated if the underlying assumptions are modified. Any changes in these estimates will result in either
an acceleration or further deferral of the related revenue



F-8



---

##### Table of Contents

Kosan Biosciences Incorporated



NOTES TO FINANCIAL STATEMENTS (Continued)



1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)



recognition. Payments related to substantive performance milestones that are at risk at the initiation of an agreement are recognized upon successful completion of a
performance milestone event.



Contract revenues related to research and development
efforts are recognized as revenue as the related services are performed or delivered in accordance with contract terms. Such payments generally are made based on the number of full-time equivalent researchers assigned to the project and the related
research and development expenses incurred or as other deliverables under the contracts are fulfilled. Revenues related to government grants are recognized at the time a grant is awarded and as related research expenses are incurred. Any amounts
received in advance of performance are recorded as deferred revenue until earned.



Research and Development

Research and development consists of
costs incurred for Company-sponsored and collaborative research and development activities. These costs consist primarily of salaries and other personnel-related expenses, including associated stock-based compensation, facility-related expenses,
licensing-related expenses, depreciation of facilities and equipment, lab consumables, services performed by clinical research organizations and research institutions and other outside service providers. Expenses related to clinical trials and drug
manufacturing generally are accrued based on estimates of work performed or the level of patient enrollment and activities according to the protocols and agreements. The Company monitors planned protocols, work performed, patient enrollment levels
and related activities to the extent possible and adjusts estimates accordingly. Research and development expenses under government grant awards and collaborative agreements approximated the revenue recognized, excluding milestone, up-front fees
received under such arrangements.



The Companys research and development expenses
do not reflect the costs incurred by the Companys partners, Roche, the National Cancer Institute (NCI) or Pfizer, associated with the clinical trials they are conducting in connection with the Companys epothilone, Hsp90
inhibitor and motilin agonist receptor programs, respectively.



Net Loss Per Share

Basic and diluted net loss per common share have been computed using the weighted-average number of shares of common stock outstanding
during the period. Diluted net loss is not presented separately as the Company is in a net loss position and including potentially dilutive securities in the loss per share computation would be antidilutive.



The Company has excluded all convertible preferred stock and outstanding stock options and warrants
from the calculation of diluted net loss per common share because all such securities are antidilutive for all applicable periods presented. The total number of outstanding stock options and warrants excluded from the calculations of diluted net
loss per share, prior to application of the treasury stock method for options, was 5,334,480, 4,652,852, and 4,902,597 for the years ended December 31, 2007, 2006 and 2005, respectively. Such securities, had they been dilutive, would have been
included in the computations of diluted net loss per share. See Notes 3 and 9 for further information on these securities.



Stock-Based Compensation

Effective January 1, 2006, the
Company adopted the fair value recognition provisions of Statement of Financial Accounting Standards (SFAS) No. 123 (revised 2004) or SFAS 123R, Share-Based Payment, using the modified prospective transition
method. SFAS 123R requires that the compensation cost relating to share-based payment transactions, including stock options and employee stock purchase plans, be recognized in the financial statements. Under this transition method, stock-based
compensation expense is recognized for all stock-based compensation awards granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in



F-9



---

##### Table of Contents

Kosan Biosciences Incorporated



NOTES TO FINANCIAL STATEMENTS (Continued)



1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)



accordance with the original provision of SFAS No. 123, Accounting for Stock-Based Compensation. Stock-based compensation expense for all stock-based
compensation awards granted after December 31, 2005 is based on the grant-date fair value estimated in accordance with the provisions of SFAS 123R. The Company recognizes these compensation costs net of an expected forfeiture rate on a
graded-vesting basis over the requisite service period of the award, which is generally the option vesting term of one or four years. Prior to the adoption of SFAS 123R, the Company accounted for common stock options granted to employees using the
intrinsic value method as prescribed by Accounting Principles Board (APB) No. 25 Accounting for Stock Issued to Employees and related interpretations, and thus, recognized compensation expense for options granted with
exercise prices less than the fair value of the Companys common stock on the date of the grant. Other stock compensation expense for options granted to non-employees has been determined in accordance with SFAS 123 and Emerging Issues Task
Force (EITF) 96-18 Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services as the fair value of the consideration received or the fair value
of the equity instruments issued, whichever is more reliably measured. The measurement of stock-based compensation to non-employees is subject to periodic adjustment as the underlying securities vest. As such, changes to these measurements could be
substantial should the Company experience significant changes in its stock price.



Comprehensive Loss

Comprehensive loss is comprised of net
income and other comprehensive loss, which includes certain changes in equity that are excluded from net income. The Company includes unrealized gains and losses on available-for-sale securities in other comprehensive loss.



Income Taxes

Since inception, the Company has recognized income taxes under the liability method. Deferred income taxes are recognized for differences between the financial statement and tax
basis of assets and liabilities at enacted statutory rates in effect for years in which the differences are expected to reverse. The effect on deferred taxes of a change in tax rates is recognized in income in the period that includes the enactment
date. In addition, valuation allowances are established when necessary to reduce deferred tax assets to the amounts expected to be realized.



Effective January 1, 2007, the Company adopted FASB Interpretation No. (FIN) 48 Accounting for Uncertainty in Income Taxes. FIN 48 prescribes the
minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. The Company did not recognize any material adjustment in its liability for unrecognized income tax benefits upon the adoption of
FIN 48, including any amounts for interest and penalties. The Company recognizes interest and penalties related to income taxes in income tax expense. See Note 10 for further information.



Segment Reporting

The Company has
determined that it operates in only one segment. Accordingly, no segment disclosures have been included in the accompanying notes to the financial statements.



Recent Accounting Pronouncements

In September 2006, the
Financial Accounting Standards Board (FASB) issued SFAS No. 157, Fair Value Measurements (SFAS 157). SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted
accounting principles, and expands disclosures about fair value measurements. SFAS 157 applies under other accounting pronouncements that require or permit fair value measurements. Accordingly, SFAS 157 does not require any new fair value
measurements. SFAS 157 is effective beginning January 1, 2008, except that, with



F-10



---

##### Table of Contents

Kosan Biosciences Incorporated



NOTES TO FINANCIAL STATEMENTS (Continued)



1. ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)



respect to the nonfinancial assets and nonfinancial liabilities, the effective date is January 1, 2009. The Company is currently evaluating the impact of SFAS 157
on its financial statements.



In June 2007, the Emerging Issues Task Force
(EITF) of the FASB reached a consensus on EITF No. 07-3, Accounting for Nonrefundable Advance Payments for Goods or Services to Be Used in Future Research and Development Activities. Under EITF 07-3, nonrefundable
advance payments for goods or services to be received in the future for use in research and development activities should be deferred and capitalized. Such amounts should be expensed as the related goods are delivered or services are performed. If
the Companys expectations change such that it does not expect the goods to be delivered or services to be rendered, the capitalized advance payment should be charged to expense. EITF 07-3 is effective for new contracts entered into beginning
January 1, 2008. The Company is currently evaluating the impact of EITF 07-3 on its financial statements.



In December 2007, the FASB ratified EITF No. 07-1, Accounting for Collaborative Arrangements. EITF 07-1 defines collaborative arrangements and establishes reporting requirements for transactions between
participants in a collaborative arrangement and between participants in the arrangement and third parties. EITF 07-1 also establishes the appropriate income statement presentation and classification guidance for joint operating activities and
payments between participants, as well as the sufficiency of the disclosures related to these arrangements. EITF 07-1 is effective for fiscal years beginning after December 15, 2008. The Company is currently evaluating the impact of EITF 07-1
on its financial statements.



In December 2007, the Securities and Exchange Commission
issued Staff Accounting Bulletin (SAB) No. 110, which permits entities, under certain circumstances, to continue to use the simplified method as the basis for estimating the expected term of plain vanilla share options as allowed
under the provisions of SAB 107. Expected term is a valuation assumption used to determine stock-based compensation expense. The use of the simplified method was scheduled to expire on December 31, 2007. SAB 110 is effective beginning
January 1, 2008. The Company currently uses the simplified method as prescribed by SAB 107 and the extension of this method under SAB 110 will have no impact on the Companys financial statements.



2. RESEARCH AND DEVELOPMENT AGREEMENTS



Roche

In September 2002, the Company entered into a research and development collaboration agreement (the Roche Agreement) with Roche. Under the terms of the Roche Agreement, Roche was granted worldwide exclusive rights
to market and sell KOS-1584 and any other epothilones developed under the collaboration in the field of oncology, and the Company was granted the right to co-promote in the United States any epothilone products developed under the collaboration. The
Roche Agreement provided, among other things, for the Company to receive payments for the reimbursement of agreed upon research and development expenditures. The Roche Agreement was terminated in its entirety effective in late February 2008.
Following the termination of the agreement, the rights licensed to Roche reverted to the Company, and in connection with the termination, Roche provided the Company with certain license rights, data and other assistance related to the product
candidates licensed to Roche under the agreement. Roches development funding commitments under the agreement continued until the termination date in late February 2008, after which Roche will be obligated to reimburse the Company for certain
costs of completing the KOS-1584 Phase 1 clinical trials.



For the years ended
December 31, 2007, 2006 and 2005, the Company recognized revenue related to the Roche Agreement of approximately $12.0 million, $11.3 million, and $11.9 million, respectively, representing approximately



F-11



---

##### Table of Contents

Kosan Biosciences Incorporated



NOTES TO FINANCIAL STATEMENTS (Continued)



2. RESEARCH AND DEVELOPMENT AGREEMENTS (Continued)



53%, 84%, and 89%, respectively, of total revenues, of which $2.0 million was related to a non-recurring milestone earned in 2006. Such amounts, excluding the ratable
portion of up-front fees and milestone payments, approximated research and development expenses incurred under the Roche Agreement. Included in total Roche-related revenue for 2007, 2006 and 2005 was approximately $5.6 million, $3.3 million, and
$3.3 million, respectively, related to the ratable portion of the $25.0 million up-front fee that is being recognized through the current estimated clinical development period for product candidates in clinical trials. In the first quarter of 2007,
upon the decision to advance KOS-1584 into Phase 2 clinical trials, the Company determined that the estimated clinical development period of its agreement with Roche extended from 2009 to 2012. The change in this estimate as of March 1, 2007,
resulted in a further deferral of the unrecognized portion of the Roche up-front fee. On October 25, 2007, as a result of the termination of the Companys agreement with Roche, the amortization of the unrecognized portion of the Roche
up-front fee was accelerated to 2008. The net effect of these changes resulted in increased revenue of approximately $2.3 million in 2007. The Company expects that it will recognize the remaining portion of the Roche up-front fee of approximately
$3.3 million in the first quarter of 2008. The Companys research and development expenses do not reflect the costs incurred by Roche associated with the clinical trials it is conducting in connection with the Companys epothilone program.
At December 31, 2007 and 2006, approximately $1.3 million and $1.1 million, or 100% and 95%, respectively, of accounts receivable were due from Roche.



Pfizer

In December 2006, the Company entered into an exclusive
license agreement (the Pfizer Agreement) with Pfizer Inc. under which the Company granted to Pfizer a worldwide exclusive license to its motilin agonist program. Under the terms of the Pfizer Agreement, Pfizer and the Company agreed to
collaborate on filing of regulatory documents for the initiation of a Phase 1 clinical trial of the Companys product candidate, KOS-2187. Pfizer is responsible for all development, regulatory and commercial activities related to the motilin
agonist program. The Company received an up-front fee of $12.5 million in December 2006 and is eligible to receive milestone payments for the successful development and commercialization of licensed compounds, including milestone payments for
achieving certain sales amounts, as well as royalties on worldwide sales. For the years ended December 31, 2007 and 2006, the Company recognized revenue of approximately $10.7 million and $1.8 million of contract revenue from Pfizer,
representing approximately 47% and 13% of total revenues for fiscal year 2007 and 2006, respectively. Such amounts represent the ratable portion of the $12.5 million up-front fee that was recognized through the current estimated period of the
Companys participation in the development of KOS-2187.



License Agreements

The Company has license agreements with several academic, government and medical institutions. Included in research and development
expenses were fees incurred in connection with these agreements of approximately $227,000, $578,000, and $428,000 for the years ended December 31, 2007, 2006 and 2005, respectively.



3. STOCK-BASED COMPENSATION



At December 31, 2007, the Company had the following stock-based compensation plans:



2006 Equity Incentive Plan

The Companys 2006 Equity
Incentive Plan (the 2006 Plan) provides for the granting of incentive stock options, nonstatutory stock options, restricted stock awards, restricted stock unit awards, stock appreciation rights and other forms of equity compensation. The
2006 Plan also provides for the granting of performance stock awards and performance cash awards so that the Compensation Committee of the Companys board of directors may use



F-12



---

##### Table of Contents

Kosan Biosciences Incorporated



NOTES TO FINANCIAL STATEMENTS (Continued)



3. STOCK-BASED COMPENSATION (Continued)



performance criteria in establishing specific targets to be attained as a condition to the grant or vesting of one or more awards under the 2006 Plan. Incentive and
nonstatutory stock options may be granted with exercise prices not less than fair value on the date of determination. The fair value of grants is determined by the closing sales price of the Companys common stock as listed on an established
stock exchange on the last market trading date preceding the date of grant. Stock options granted to a stockholder owning more than 10% of voting stock of the Company may be granted with an exercise price of not less than 110% of the fair value on
the date of grant. Options expire no later than ten years from the date of the grant. The number of shares, terms and exercise periods are determined by the Companys board of directors or its delegates. Options generally vest at 25% per
year over a four-year period. Certain option awards are subject to accelerated vesting if there is a change in control.



1996 Stock Option Plan

The Companys 1996 Stock Option
Plan (the 1996 Plan) provided for the granting of incentive stock options and nonstatutory stock options to employees, officers, directors and consultants of the Company. Incentive stock options were granted with exercise prices not less
than fair value, and nonstatutory stock options were granted with exercise prices not less than 85% of the fair value on the date of grant. The fair value of grants was determined by the closing sales price of the Companys common stock as
listed on any established stock exchange for the last market trading day prior to the time of determination. Stock options granted to a stockholder owning more than 10% of voting stock of the Company were granted with an exercise price of not less
than 110% of the fair value on the date of grant. Options expire no later than ten years from the date of the grant. The number of shares, terms and exercise period were determined by the Companys board of directors or its delegates. Options
generally vest at 25% per year over a four-year period. Certain option awards are subject to accelerated vesting if there is a change in control. The 1996 Plan expired in June 2006.



Shares subject to outstanding options under the 1996 Plan as of May 25, 2006 that expire or otherwise terminate without being exercised in full
will be added to the share reserve under the 2006 Plan. The maximum number of shares of common stock authorized for issuance under the 1996 Plan and the 2006 Plan was 11,475,000 as of December 31, 2007.



2000 Employee Stock Purchase Plan

The Companys 2000 Employee Stock Purchase Plan (the Purchase Plan) permits eligible employees to purchase common stock at a discount through payroll deductions
during defined offering periods. The maximum number of shares authorized for issuance pursuant to the Purchase Plan was 900,000 as of December 31, 2007. The Purchase Plan provides for an annual increase of shares on January 1 of each year
equal to the lesser of 150,000 shares, 0.75% of the outstanding shares on such date or such amount as determined by the Companys board. The price at which the stock is purchased is equal to the lower of 85% of the fair market value of the
common stock on the first day of the offering or 85% of the fair market value of the Companys common stock on the purchase date. Each offering is for a six-month period. As of December 31, 2007, 807,374 shares were issued under the
Purchase Plan.



2000 Non-Employee Director Stock Option
Plan

The Companys 2000 Non-Employee Director Stock Option Plan (the Directors Plan) provides for the granting of nonstatutory stock options
to non-employee directors of the Company. The maximum number of shares of common stock authorized for issuance pursuant to the Directors Plan was 500,000 as of December 31, 2007. Under the Directors Plan, as amended, each
non-employee director who becomes a director of the Company will be automatically granted a non-statutory stock option to purchase 20,000 shares of common stock on the date on which such person first becomes a director, and such option will vest
over four years. Beginning with the 2002 Annual



F-13



---

##### Table of Contents

Kosan Biosciences Incorporated



NOTES TO FINANCIAL STATEMENTS (Continued)



3. STOCK-BASED COMPENSATION (Continued)



Stockholders Meeting and each year thereafter, each non-employee director will automatically be granted, one day following each years annual meeting of
stockholders, a non-statutory option to purchase 5,000 shares of common stock, which will vest one day before the annual meeting of stockholders subsequent to the date of grant. The exercise price of options under the Directors Plan will be
equal to the fair market value of the common stock on the date of grant. The maximum term of the options granted under the Directors Plan is ten years. As of December 31, 2007, options to purchase 340,500 shares were granted under the
Directors Plan.



Prior to January 1, 2006, the Company provided pro forma
disclosure amounts in accordance with SFAS 123, as amended by SFAS No. 148, Accounting for Stock-Based CompensationTransition and Disclosure, as if the fair value method defined by SFAS 123 had been applied to its stock-based
compensation. Effective January 1, 2006, the Company adopted the fair value recognition provisions of SFAS 123R, using the modified prospective transition method and therefore has not restated prior periods results. Under this transition
method, stock-based compensation expense beginning January 1, 2006 included compensation expense for all stock-based compensation awards granted prior to, but not yet vested as of, January 1, 2006, based on the grant date fair value
estimated in accordance with the original provisions of SFAS 123. Stock-based compensation expense for all share-based payment awards granted after December 31, 2005 is based on the grant-date fair value estimated in accordance with the
provisions of SFAS 123R. The Company recognizes these compensation costs, net of an expected forfeiture rate, on a graded-vesting basis over the requisite service period of the award, which is generally the option vesting term of one or four years.



As a result of adopting SFAS 123R on January 1, 2006, the Companys net loss
for the year ended December 31, 2006 was approximately $2.1 million greater than if the Company had continued to account for stock-based compensation under APB 25. The impact on both basic and diluted earnings per share for the year ended
December 31, 2006 was $0.06 per share. Due to the Companys lack of earnings history, no income tax benefit or cash flow effect is recognized as any resulting deferred tax asset is fully offset by a valuation allowance.



The following table presents the calculation of basic and diluted net loss per share (in thousands,
except per share data) had the Company applied the fair value recognition provisions under SFAS 123 for the year ended December 31, 2005:



|                                                                                                        |  |   |         |  
|------------------------------------------------------------------------------------------------------- |  | - | ------- | -
|Net loss as reported                                                                                    |  | $ | (29,637 | )
|Plus: Stock-based employee compensation expense included in reported net loss                           |  |   |        |  
|Less: Stock-based employee compensation expense determined under fair value based method for all awards |  |   | (2,312  | )
|                                                                                                        |  |   |         |  
|Pro forma net loss                                                                                      |  | $ | (31,949 | )
|                                                                                                        |  |   |         |  
|Basic and diluted net loss per common share:                                                            |  |   |         |  
|As reported                                                                                             |  | $ | (1.01   | )
|Pro forma                                                                                               |  | $ | (1.09   | )



F-14



---

##### Table of Contents

Kosan Biosciences Incorporated



NOTES TO FINANCIAL STATEMENTS (Continued)



3. STOCK-BASED COMPENSATION (Continued)



The Company uses the Black-Scholes model to value stock-based compensation expense. Separate groups of
employees that have similar historical exercise behavior are considered separately for valuation purposes. The table below presents the valuation assumptions used to determine stock-based compensation expense under the provisions of SFAS 123R and
SFAS 123 for each of the three years ended December 31, 2007. Expected term under SFAS 123R is based on the simplified method allowed under the provisions of SAB No. 107. The risk-free interest rate is based on the U.S. Treasury zero
coupon issues with an equivalent remaining term at the time of the option grant. Expected volatility is based on the historical volatility of the Companys stock price and other factors.



|                         |  |                         |   |  |          |   |  |      |  
|------------------------ |  | ----------------------- | - |  | -------- | - |  | ---- | -
|                         |  | Year Ended December 31, |  
|                         |  | 2007                    |   |  | 2006     |   |  | 2005 |  
|Risk-free interest rate  |  | 3.9%-4.8                | % |  | 4.6%-5.0 | % |  | 4.0  | %
|Expected dividends       |  |                        |   |  |         |   |  |     |  
|Expected term (in years) |  | 6.25                    |   |  | 6.25     |   |  | 4.0  |  
|Expected volatility      |  | 61%-66                  | % |  | 65%-67   | % |  | 64   | %



A summary of stock option activity as of
December 31, 2007, and changes during the year then ended is presented below:



|                                                 |  |                 |   |  |                               |      |                                          |      |                          |   |    
|------------------------------------------------ |  | --------------- | - |  | ----------------------------- | ---- | ---------------------------------------- | ---- | ------------------------ | - | ---
|                                                 |  | Number ofShares |   |  | Weighted-AverageExercisePrice |      | Weighted-AverageRemainingContractualTerm |      | AggregateInstrinsicValue
|                                                 |  | (in thousands)  |   |  |                               |      | (in years)                               |      | (in thousands)          
|Outstanding at January 1, 2007                   |  | 4,368           |   |  | $                             | 7.16 |                                          |      |                          |   |    
|Granted                                          |  | 1,167           |   |  | $                             | 5.42 |                                          |      |                          |   |    
|Forfeited or expired                             |  | (405            | ) |  | $                             | 6.53 |                                          |      |                          |   |    
|Exercised                                        |  | (81             | ) |  | $                             | 5.99 |                                          |      |                          |   |    
|                                                 |  |                 |   |  |                               |      |                                          |      |                          |   |    
|Outstanding at December 31, 2007                 |  | 5,049           |   |  | $                             | 6.83 |                                          | 5.57 |                          | $ | 300
|                                                 |  |                 |   |  |                               |      |                                          |      |                          |   |    
|Vested and expected to vest at December 31, 2007 |  | 4,504           |   |  | $                             | 6.97 |                                          | 5.53 |                          | $ | 285
|Exercisable at December 31, 2007                 |  | 3,351           |   |  | $                             | 7.53 |                                          | 4.49 |                          | $ | 247



The weighted-average grant-date fair value of
options granted for the years ended December 31, 2007, 2006 and 2005 was $5.42, $2.73 and $2.41 per share, respectively. The total intrinsic value of options exercised for the years ended December 31, 2007, 2006 and 2005 was approximately
$16,000, $107,000 and $295,000, respectively. The unamortized compensation expense related to unvested options as of December 31, 2007, excluding estimated forfeitures, was $2.9 million. The weighted-average period over which compensation
expense related to these options is expected to be recognized is 1.5 years.



The Company
recognized stock-based compensation of approximately $2.8 million, $2.1 million and $0 for the years ended December 31, 2007, 2006 and 2005, respectively.



F-15



---

##### Table of Contents

Kosan Biosciences Incorporated



NOTES TO FINANCIAL STATEMENTS (Continued)



3. STOCK-BASED COMPENSATION (Continued)



Non-Employee Stock-Based Compensation

As of December 31, 2007, the Company had issued consultant stock options totaling approximately 1.4 million shares with exercise prices ranging from $0.15 to $14.40 and
terms up to ten years. Compensation related to the grants of stock options is recorded in accordance with SFAS 123 and EITF 96-18 using the Black-Scholes Model. The measurement of stock-based compensation to non-employees is subject to periodic
adjustment as the underlying awards vest. The Company recognized non-employee stock-based compensation of approximately $0.4 million for each of the three years ended December 31, 2007, 2006 and 2005.



4. INVESTMENTS



The amortized cost and fair value of securities, with gross unrealized gains and losses, at
December 31, were as follows (in thousands):



|                                      |  |               |        |                 |        |    |           |   |               |       |                 |        |        |           |   |        |  |   |    |  |   |    |   |  |   |       
|------------------------------------- |  | ------------- | ------ | --------------- | ------ | -- | --------- | - | ------------- | ----- | --------------- | ------ | ------ | --------- | - | ------ |  | - | -- |  | - | -- | - |  | - | ------
|                                      |  | 2007          |        | 2006           
|                                      |  | AmortizedCost |        | GrossUnrealized |        |    | FairValue |   | AmortizedCost |       | GrossUnrealized |        |        | FairValue
|                                      |  |               | Gains  |                 | Losses |    |           |   |               | Gains |                 | Losses |        |          
|Debt Securities:                      |  |               |       
|Government Sponsored Enterprise notes |  | $             | 10,458 |                 | $      | 19 |           |   |              |       |                 | $      | 10,477 |           | $ | 23,637 |  | $ | 12 |  | $ | (3 | ) |  | $ | 23,646
|Corporate bonds                       |  |               | 12,574 |                 |        | 8  |           |   | (1            | )     |                 |        | 12,581 |           |   | 3,837  |  |   |   |  |   |   |   |  |   | 3,837 
|                                      |  |               |        |                 |        |    |           |   |               |       |                 |        |        |           |   |        |  |   |    |  |   |    |   |  |   |       
|                                      |  | $             | 23,032 |                 | $      | 27 |           | $ | (1            | )     |                 | $      | 23,058 |           | $ | 27,474 |  | $ | 12 |  | $ | (3 | ) |  | $ | 27,483
|                                      |  |               |        |                 |        |    |           |   |               |       |                 |        |        |           |   |        |  |   |    |  |   |    |   |  |   |       



At December 31, 2007, all
available-for-sale securities had remaining contractual maturities of less than one year.



5. PROPERTY AND EQUIPMENT



Property and equipment at December 31, consisted of the following (in thousands):



|                                               |  |      |         |   |      |   |         |  
|---------------------------------------------- |  | ---- | ------- | - | ---- | - | ------- | -
|                                               |  | 2007 |         |   | 2006 |  
|Lab equipment                                  |  | $    | 12,959  |   |      | $ | 11,499  |  
|Leasehold improvements                         |  |      | 5,211   |   |      |   | 5,128   |  
|Computer equipment and software                |  |      | 2,268   |   |      |   | 2,211   |  
|Office furniture                               |  |      | 537     |   |      |   | 517     |  
|                                               |  |      |         |   |      |   |         |  
|                                               |  |      | 20,975  |   |      |   | 19,355  |  
|Less accumulated depreciation and amortization |  |      | (16,127 | ) |      |   | (14,554 | )
|                                               |  |      |         |   |      |   |         |  
|                                               |  | $    | 4,848   |   |      | $ | 4,801   |  
|                                               |  |      |         |   |      |   |         |  



Depreciation and amortization expense was
approximately $2.2 million, $2.3 million, and $2.5 million for the years ended December 31, 2007, 2006 and 2005, respectively.



F-16



---

##### Table of Contents

Kosan Biosciences Incorporated



NOTES TO FINANCIAL STATEMENTS (Continued)



6. EQUIPMENT FINANCING



The Company financed certain equipment and facility improvements under debt obligations. The term of the debt obligations is 48 months. Interest rates
are fixed at the time of the draw down, with rates ranging from 6.86% to 9.09%. Obligations under the loans are secured by the underlying assets financed. As of December 31, 2007, future minimum loan payments under these obligations were as
follows (in thousands):



|                                      |  |   |       |  
|------------------------------------- |  | - | ----- | -
|Year Ended December 31,               |  |   |      
|2008                                  |  | $ | 941   |  
|2009                                  |  |   | 488   |  
|2010                                  |  |   | 227   |  
|2011                                  |  |   | 39    |  
|                                      |  |   |       |  
|Total minimum debt payments           |  |   | 1,695 |  
|Less amount representing interest     |  |   | (152  | )
|                                      |  |   |       |  
|Present value of net minimum payments |  |   | 1,543 |  
|Less current portion                  |  |   | (844  | )
|                                      |  |   |       |  
|Long-term portion                     |  | $ | 699   |  
|                                      |  |   |       |  



7. FACILITY
LEASES



The Company holds two non-cancelable operating leases, both of which expire in
February 2013, with options to renew for an additional five years. Minimum annual rental commitments at December 31, 2007 were as follows (in thousands):



|                        |  |   |       
|----------------------- |  | - | ------
|Year Ended December 31, |  |  
|2008                    |  |   | 1,988 
|2009                    |  |   | 2,112 
|2010                    |  |   | 2,191 
|2011                    |  |   | 2,272 
|2012                    |  |   | 2,358 
|Thereafter              |  |   | 398   
|                        |  |   |       
|Total minimum payments  |  | $ | 11,319
|                        |  |   |       



Rent expense for operating leases was
approximately $1.7 million for each of the three years ended December 31, 2007.



The
Company holds a stand-by letter of credit for approximately $903,000 from a commercial bank as security for the Companys obligation under one of its facility leases. The letter of credit is secured by a certificate of deposit in the amount of
$949,000 held in an investment account that the Company must maintain for the term of the letter of credit. The investment account is classified as restricted cash on the balance sheet.



F-17



---

##### Table of Contents

Kosan Biosciences Incorporated



NOTES TO FINANCIAL STATEMENTS (Continued)



8. ACCRUED LIABILITIES



Accrued liabilities at December 31, consisted of the following (in thousands):



|                                 |  |      |        |      |   |      
|-------------------------------- |  | ---- | ------ | ---- | - | -----
|                                 |  | 2007 |        | 2006
|Research and development-related |  | $    | 7,775  |      | $ | 3,538
|Compensation-related             |  |      | 1,639  |      |   | 1,564
|Professional services            |  |      | 632    |      |   | 486  
|Facilities-related               |  |      | 514    |      |   | 508  
|Other                            |  |      | 96     |      |   | 235  
|                                 |  |      |        |      |   |      
|                                 |  | $    | 10,656 |      | $ | 6,331
|                                 |  |      |        |      |   |      



9.
STOCKHOLDERS EQUITY



Common Stock Offering

In February 2007, the Company completed a registered direct public offering of 7,000,000 shares of common stock at a public offering price of $6.50 per share. The
Company received approximately $42.3 million in net proceeds after placement agent fees and other offering costs.



Committed Equity Financing Facility

In July 2006, the Company
entered into a Committed Equity Financing Facility (CEFF) with Kingsbridge Capital Limited (Kingsbridge) which entitles the Company to sell and obligates Kingsbridge to purchase, subject to certain conditions, up to $50.0
million of the Companys common stock. The CEFF allows the Company to raise capital as required, at the time and in the amounts deemed suitable to the Company, during the three-year period following September 25, 2006, the date of
effectiveness of the registration statement filed by the Company with the Securities and Exchange Commission covering the resale of the shares of the Companys common stock issuable in connection with the CEFF and the shares of common stock
underlying the warrant discussed below. The Company can draw down on the CEFF in tranches of up to a maximum of 2.0% of the Companys market capitalization at the time of draw down, or $10.0 million, whichever is less, subject to certain
conditions. The purchase price of these shares will be between 90% and 94% of the volume weighted average price of the Companys common stock for each of the eight trading days following the election to sell shares. Kingsbridge is not obligated
to purchase shares at prices below $2.00 per share or at a price below 85% of the closing share price of the Companys stock on the trading day immediately preceding the commencement of the draw down. The Company is entitled, in certain
circumstances, to deliver a blackout notice to Kingsbridge to suspend the use of the resale registration statement and prohibit Kingsbridge from selling shares under the resale registration statement for a certain period of time. If the Company
delivers a blackout notice in certain circumstances, or if the resale registration statement is not effective in circumstances not permitted by the agreement, then the Company must make a payment to Kingsbridge, or issue Kingsbridge additional
shares in lieu of this payment, calculated on the basis of the number of shares purchased by Kingsbridge in the most recent draw down and held by Kingsbridge immediately prior to the blackout period and the change in the market price of our common
stock during the period in which the use of the registration statement is suspended.



In
connection with the CEFF, the Company issued a warrant to Kingsbridge to purchase 285,000 shares of the Companys common stock at an exercise price of $4.94 per share. The warrant is exercisable beginning six months after the date of grant and
for a period of five years thereafter. The fair value of the warrant was valued on the date of issuance under the Black-Scholes method using the following assumptions: contractual life of 5.5 years, risk free



F-18



---

##### Table of Contents

Kosan Biosciences Incorporated



NOTES TO FINANCIAL STATEMENTS (Continued)



9. STOCKHOLDERS EQUITY (Continued)



interest rate of 4.84%, volatility of 66% and no dividends. The fair value of the warrant was $629,000 and was recorded as a contra-equity amount in additional
paid-in-capital. As of December 31, 2007, a warrant to purchase 285,000 shares was outstanding.



The Company is not obligated to sell any of the $50.0 million of common stock available under the CEFF, and there are no minimum commitments or minimum use penalties. Under the terms of the CEFF, the maximum number of shares
the Company may sell to Kingsbridge is 6,879,868 shares (exclusive of the shares underlying the warrant), which may limit the amount of proceeds the Company is able to obtain from the CEFF. The CEFF does not contain any restrictions on the
Companys operating activities, automatic pricing resets or minimum market volume restrictions.



In October 2006, the Company received proceeds of $3.0 million, before expenses of approximately $0.1 million relating to the execution of the CEFF in July 2006 and the sale of 770,351 shares of common stock to Kingsbridge in
October 2006.



Stockholder Rights Plan

In October 2001, the board of directors of the Company adopted a Stockholder Rights Plan (the Rights Plan) under which all stockholders received rights (the
Rights) to purchase shares of a new series of Preferred Stock. 1,000,000 shares of Junior A Preferred Stock were authorized in conjunction with the Series A Junior Participating Preferred Stock under certain circumstances at an exercise
price of $70.00 per adoption of the Rights Plan. Each Right entitles the holder to purchase one one-hundredth of a share of a Series A Junior Participating Preferred Stock under certain circumstances at an exercise price of $70.00 per one-one
hundredth of a share. The Rights were distributed as a non-taxable dividend and expire on October 29, 2011. At the time of the adoption, the Rights were neither exercisable nor traded separately from the common stock. However, subject to
certain exceptions, the Rights will become exercisable at such time that a person (or group of affiliated persons) acquires beneficial ownership of 20% or more of the outstanding Company common stock (an Acquiring Person) or on the tenth
business day after a person or entity commences, or expresses an intention to commence, a tender or exchange offer that would result in such person acquiring 20% or more of the outstanding Company common stock.



In the event a person becomes an Acquiring Person, each Right held by all persons other than the
Acquiring Person will become the right to acquire one share of Company common stock at a price equal to 50% of the then-current market value of the Company common stock. Furthermore, in the event an Acquiring Person effects a merger of the Company,
each Right will entitle the holder thereof to purchase one share of common stock of the Acquiring Person or the Acquiring Persons ultimate parent at a price equal to 50% of the then-current market value of the Acquiring Persons or the
Acquiring Persons ultimate parents common stock.



The board of directors can
redeem the Rights at any time prior to a person becoming an Acquiring Person at a redemption price of $0.001 per Right. In addition, the board of directors may, after any time a person becomes an Acquiring Person, exchange each Right for one share
of common stock of the Company. As of December 31, 2007, no shares had been issued under the Rights Plan.



10. INCOME TAXES



As of December 31, 2007, the Company had approximately $148.2 million of federal and $138.0 million of state net operating loss carryforwards available to offset future
taxable income. The federal net operating loss carryforwards will expire at various dates beginning in the year 2010 through 2027, if not utilized. The state net operating loss



F-19



---

##### Table of Contents

Kosan Biosciences Incorporated



NOTES TO FINANCIAL STATEMENTS (Continued)



10. INCOME TAXES (Continued)



carryforwards will expire at various dates from 2012 through 2017, if not utilized. At December 31, 2007, the Company also had federal and state research and
development tax credit carryforwards of approximately $5.4 million and $4.9 million, respectively, and federal orphan drug credit carryforwards of approximately $6.2 million. The federal tax credit carryforwards will begin to expire in 2011, if not
utilized. The state tax credit carryforwards do not expire.



Utilization of the federal
net operating loss and credit carryforwards may be subject to a substantial annual limitation due to the change in ownership provisions of the Internal Revenue Code of 1986. The annual limitation may result in the expiration of net
operating losses and credits before utilization.



Deferred income taxes reflect the net
tax effects of temporary differences between the carrying amounts of assets for financial reporting and the amount used for income tax purposes. Significant components of the Companys deferred tax assets for federal income taxes as of
December 31 were as follows (in thousands):



|                                                 |  |      |         |   |      |   |         |  
|------------------------------------------------ |  | ---- | ------- | - | ---- | - | ------- | -
|                                                 |  | 2007 |         |   | 2006 |  
|Deferred tax assets:                             |  |      |         |   |      |   |         |  
|Net operating loss carryforwards                 |  | $    | 58,670  |   |      | $ | 43,700  |  
|Deferred revenue                                 |  |      | 1,310   |   |      |   | 7,830   |  
|Depreciable assets                               |  |      | 1,550   |   |      |   | 1,210   |  
|Research and development and orphan drug credits |  |      | 7,420   |   |      |   | 5,330   |  
|Capitalized research and development expenses    |  |      | 760     |   |      |   | 1,050   |  
|Other                                            |  |      | 3,260   |   |      |   | 1,370   |  
|                                                 |  |      |         |   |      |   |         |  
|Total deferred tax assets                        |  |      | 72,970  |   |      |   | 60,490  |  
|                                                 |  |      |         |   |      |   |         |  
|Valuation allowance                              |  |      | (72,970 | ) |      |   | (60,490 | )
|                                                 |  |      |         |   |      |   |         |  
|Net deferred taxes                               |  | $    |        |   |      | $ |        |  
|                                                 |  |      |         |   |      |   |         |  



Based on the available evidence, management of
the Company believes it is more likely than not that the net deferred tax assets will not be realized. Accordingly, the Company has provided a full valuation allowance against its deferred tax assets for all periods presented. The valuation
allowance increased by $12.5 million and $13.6 million during the years ended December 31, 2007 and 2006, respectively.



Effective January 1, 2007, the Company adopted FASB Interpretation No. (FIN) 48 Accounting for Uncertainty in Income Taxes. FIN 48 prescribes the
minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. The Company did not recognize any material adjustment in its liability for unrecognized income tax benefits upon the adoption of
FIN 48, including any amounts for interest and penalties.



A reconciliation of the
beginning and ending amount of unrecognized tax benefits is as follows (in thousands):



|                                                             |  |   |      
|------------------------------------------------------------ |  | - | -----
|                                                             |  |  
|Balance at January 1, 2007                                   |  | $ | 5,460
|Additions based on tax positions related to the current year |  |   | 2,790
|Additions for tax positions related to prior years           |  |   |     
|Reductions for tax positions related to prior years          |  |   |     
|                                                             |  |   |      
|Balance at December 31, 2007                                 |  | $ | 8,250
|                                                             |  |   |      



F-20



---

##### Table of Contents

Kosan Biosciences Incorporated



NOTES TO FINANCIAL STATEMENTS (Continued)



10. INCOME TAXES (Continued)



In the event that any unrecognized tax benefits are recognized, the effective tax rate will be affected. Approximately $7.4 million of unrecognized
tax benefit would impact the effective tax rate if recognized. The Companys policy is to classify interest accrued or penalties related to unrecognized tax benefits as a component of income tax expense. No such interest or penalties have been
recorded to date.



All tax years remain open to examination by the major taxing
jurisdictions to which the Company is subject. The Company does not anticipate significant changes to its uncertain tax positions through the next twelve months.



11. RESTRUCTURING CHARGE



In March 2006, the Company implemented and completed a corporate restructuring, reflecting a realignment of research priorities and corporate operations to support its clinical
product candidates and pipeline opportunities. As a result, the Company reduced its workforce by 39 positions, from 119 to 80 full-time employees, primarily in research and general and administrative. The reduction in workforce resulted in a
one-time severance-related charge of approximately $0.6 million, all of which was recognized and paid in 2006.



12. QUARTERLY INFORMATION (Unaudited)



The Companys quarterly results were as follows (in thousands, except per share amounts):



|                                            |  |               |         |   |          |   |         |               |  |   |              |   |  |   |         |   |  |   |         |  
|------------------------------------------- |  | ------------- | ------- | - | -------- | - | ------- | ------------- |  | - | ------------ | - |  | - | ------- | - |  | - | ------- | -
|                                            |  | Quarter Ended |         |   | Total    |  
|                                            |  | March 31,     |         |   | June 30, |   |         | September 30, |  |   | December 31, |   | 
|2007                                        |  |               |         |   |          |   |         |               |  |   |              |   |  |   |         |   |  |   |         |  
|Revenue                                     |  | $             | 12,918  |   |          | $ | 2,206   |               |  | $ | 1,947        |   |  | $ | 5,636   |   |  | $ | 22,707  |  
|Income/(Loss) from operations               |  |               | 1,777   |   |          |   | (11,938 | )             |  |   | (12,203      | ) |  |   | (10,374 | ) |  |   | (32,738 | )
|Net Income/(Loss)                           |  |               | 2,744   |   |          |   | (10,788 | )             |  |   | (11,133      | ) |  |   | (9,481  | ) |  |   | (28,658 | )
|Basic and diluted earnings per common share |  | $             | 0.07    |   |          | $ | (0.25   | )             |  | $ | (0.26        | ) |  | $ | (0.22   | ) |  | $ | (0.69   | )
|2006                                        |  |               |         |   |          |   |         |               |  |   |              |   |  |   |         |   |  |   |         |  
|Revenue                                     |  | $             | 2,961   |   |          | $ | 2,666   |               |  | $ | 2,169        |   |  | $ | 5,710   |   |  | $ | 13,506  |  
|Loss from operations                        |  |               | (10,948 | ) |          |   | (7,176  | )             |  |   | (8,175       | ) |  |   | (5,197  | ) |  |   | (31,496 | )
|Net loss                                    |  |               | (10,581 | ) |          |   | (6,789  | )             |  |   | (7,540       | ) |  |   | (4,559  | ) |  |   | (29,469 | )
|Basic and diluted earnings per common share |  | $             | (0.36   | ) |          | $ | (0.20   | )             |  | $ | (0.22        | ) |  | $ | (0.13   | ) |  | $ | (0.88   | )



F-21