<PAGE>   1
================================================================================

                                  UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION

                             Washington, D.C. 20549
                          -----------------------------

                                    FORM 10-Q
(Mark one)

[X]     Quarterly report pursuant to Section 13 or 15(d) of the Securities
        Exchange Act of 1934. For the quarterly period ended March 31, 2001.

        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           (I.R.S. Employer
     incorporation or organization)           Identification No.)


                3832 BAY CENTER PLACE, HAYWARD, CALIFORNIA 94545
                    (address of principal executive offices)

                                 (510) 732-8400
              (Registrant's telephone number, including area code)

                          -----------------------------




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 FILING REQUIREMENTS
FOR THE PAST 90 DAYS.

YES [X]  NO [ ]

INDICATE THE NUMBER OF SHARES OUTSTANDING OF EACH OF THE ISSUER'S CLASSES OF
COMMON STOCK, AS OF THE LATEST PRACTICABLE DATE. COMMON STOCK $.001 PAR VALUE;
25,202,556 SHARES OUTSTANDING AT APRIL 30, 2001.

================================================================================


<PAGE>   2
                         KOSAN BIOSCIENCES INCORPORATED

                                    Form 10-Q

                          Quarter Ended March 31, 2001

INDEX


<TABLE>
<CAPTION>
PART I     FINANCIAL INFORMATION                                                   PAGE
<S>        <C>                                                                     <C>
Item 1:    Condensed Financial Statements and Notes:

           Condensed Balance Sheets as of March 31, 2001
           and December 31, 2000.............................................         3

           Condensed Statements of Operations for the three
           months ended March 31, 2001 and 2000..............................         4

           Condensed Statements of Cash Flows for the three
           months ended March 31, 2001 and 2000..............................         5

           Notes to Condensed Financial Statements...........................         6

Item 2:    Management's Discussion and Analysis of Financial
           Condition and Results of Operations...............................        11

Item 3:    Quantitative and Qualitative Disclosures About Market Risk........        21


PART II    OTHER INFORMATION

Item 1:    Legal Proceedings.................................................        22

Item 2:    Changes in Securities and Use of Proceeds.........................        22

Item 3:    Defaults Upon Senior Securities...................................        22

Item 4:    Submission of Matters to a Vote of Security Holders...............        22

Item 5:    Other Information.................................................        22

Item 6:    Exhibits and Reports on Form 8-K..................................        22

SIGNATURES ..................................................................        23
</TABLE>


                                       2


<PAGE>   3
PART I.    FINANCIAL INFORMATION

ITEM 1: CONDENSED FINANCIAL STATEMENTS AND NOTES

                         KOSAN BIOSCIENCES INCORPORATED

                            CONDENSED BALANCE SHEETS
                                 (IN THOUSANDS)


<TABLE>
<CAPTION>
                                                                       MARCH 31,      DECEMBER 31,
                                                                          2001           2000
                                                                       ---------      ------------
                                                                      (unaudited)         (1)
<S>                                                                   <C>             <C>
                                     ASSETS
Current assets:
    Cash and cash equivalents ...................................      $  28,539       $  36,425
    Short-term investments ......................................         57,966          49,313
    Other receivables ...........................................             48              21
    Prepaid expenses and other current assets ...................            479             515
                                                                       ---------       ---------
         Total current assets ...................................         87,032          86,274
Property and equipment, net .....................................          3,274           3,133
Long-term investments ...........................................         13,598          17,003
Notes receivable from related parties ...........................            990             917
Other assets ....................................................            244             244
                                                                       ---------       ---------
         Total assets ...........................................      $ 105,138       $ 107,571
                                                                       =========       =========

                      LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
    Accounts payable ............................................      $   1,091       $     980
    Accrued liabilities .........................................          1,680           1,597
    Deferred revenue ............................................              -             619
    Current portion of capital lease obligation .................             62             124
    Current portion of equipment loans ..........................            939             911
                                                                       ---------       ---------
         Total current liabilities ..............................          3,772           4,231
    Capital lease obligation, less current portion ..............              -               8
    Equipment loans, less current portion .......................          1,721           1,967

Stockholders' equity:
    Common stock ................................................             25              25
    Additional paid-in capital ..................................        141,896         141,590
    Notes receivable from stockholders ..........................         (2,043)         (2,079)
    Deferred stock-based compensation ...........................         (9,558)        (11,122)
    Accumulated other comprehensive loss ........................            (83)           (380)
    Accumulated deficit .........................................        (30,592)        (26,669)
                                                                       ---------       ---------
         Total stockholders' equity .............................         99,645         101,365
                                                                       ---------       ---------
         Total liabilities and stockholders' equity .............      $ 105,138       $ 107,571
                                                                       =========       =========
</TABLE>


                             See accompanying notes.

(1)     The balance sheet at December 31, 2000 has been derived from the audited
        financial statements at that date.


                                       3


<PAGE>   4
                         KOSAN BIOSCIENCES INCORPORATED

                       CONDENSED STATEMENTS OF OPERATIONS
                                   (UNAUDITED)
                      (IN THOUSANDS, EXCEPT PER SHARE DATA)


<TABLE>
<CAPTION>
                                                                         THREE MONTHS ENDED
                                                                              MARCH 31,
                                                                       -----------------------
                                                                         2001           2000
                                                                       --------       --------
<S>                                                                    <C>            <C>
Revenues:
  Contract revenue ..............................................      $  1,009       $  1,042
  Grant revenue .................................................           220             37
                                                                       --------       --------
         Total revenues .........................................         1,229          1,079

Operating expenses:
  Research and development (including charges for stock-
    based compensation of $1,512 and $922, respectively) ........         5,564          3,263
  General and administrative (including charges for stock-
    based compensation of $244 and $339, respectively) ..........         1,093            760
                                                                       --------       --------
         Total operating expenses ...............................         6,657          4,023
                                                                       --------       --------
Loss from operations ............................................        (5,428)        (2,944)
Interest income, net ............................................         1,505             79
                                                                       --------       --------
Net loss ........................................................        (3,923)        (2,865)

Deemed dividend upon issuance of Series C
  convertible preferred stock ...................................             -        (11,267)
                                                                       --------       --------

Net loss attributable to common stockholders ....................      $ (3,923)      $(14,132)
                                                                       ========       ========

Basic and diluted net loss per common share .....................      $  (0.16)      $  (2.92)
                                                                       ========       ========

Shares used in computing basic and diluted net loss per
  common share ..................................................        23,845          4,833
</TABLE>


                             See accompanying notes.


                                       4


<PAGE>   5
                         KOSAN BIOSCIENCES INCORPORATED

                       CONDENSED STATEMENTS OF CASH FLOWS
                                   (UNAUDITED)
                                 (IN THOUSANDS)


<TABLE>
<CAPTION>
                                                                           THREE MONTHS ENDED
                                                                                MARCH 31,
                                                                         -----------------------
                                                                           2001          2000
                                                                         --------       --------
<S>                                                                      <C>            <C>
OPERATING ACTIVITIES
  Net loss ........................................................      $ (3,923)      $ (2,865)
    Adjustment to reconcile net loss to net cash used in
      operating activities:
      Depreciation and amortization ...............................           (94)           195
      Amortization of stock-based compensation ....................         1,603            883
      Other stock-based compensation ..............................           153            378
      Issuance of convertible preferred stock for license fees ....             -             30
      Changes in assets and liabilities:
        Other receivables .........................................           (28)           156
        Prepaid expenses and other current assets .................            36              -
        Other assets and notes receivable from related parties ....           (71)             3
        Accounts payable ..........................................           111            (27)
        Accrued liabilities .......................................            83            474
        Deferred revenue ..........................................          (619)          (142)
                                                                         --------       --------
         Net cash used in operating activities ....................        (2,749)          (915)
                                                                         --------       --------

INVESTING ACTIVITIES
  Acquisition of property and equipment, net ......................          (419)          (257)
  Purchase of investments .........................................       (39,941)             -
  Proceeds from maturity of investments ...........................        35,364            320
                                                                         --------       --------
         Net cash (used in) provided by investing activities ......        (4,996)            63
                                                                         --------       --------

FINANCING ACTIVITIES
  Proceeds from issuance of common stock, net of issuance
    costs .........................................................           148             42
  Proceeds from issuance of convertible preferred stock, net of
    issuance costs ................................................             -         24,600
  Proceeds from equipment loans ...................................             -            794
  Principal payments under capital lease obligation ...............           (71)           (33)
  Principal payments under equipment loans ........................          (218)          (151)
                                                                         --------       --------
         Net cash (used in) provided by financing activities ......          (141)        25,252
                                                                         --------       --------
Net (decrease) increase in cash and cash equivalents ..............        (7,886)        24,400
Cash and cash equivalents at beginning of period ..................        36,425          1,032
                                                                         --------       --------

Cash and cash equivalents at end of period ........................      $ 28,539       $ 25,432
                                                                         ========       ========
</TABLE>


                             See accompanying notes.


                                       5


<PAGE>   6
                         KOSAN BIOSCIENCES INCORPORATED

                     NOTES TO CONDENSED FINANCIAL STATEMENTS
                                   (UNAUDITED)


1.  ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

    Overview

    Kosan Biosciences Incorporated ("Kosan" or the "Company") 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. The Company was considered to be in the development
stage through December 31, 1998. Kosan has proprietary gene-engineering
technologies for the manipulation and production of polyketides, a rich source
of pharmaceutical products. The Company's product development opportunities
currently target the areas of cancer, infectious disease, gastrointestinal
motility disorders, mucus hypersecretion, nerve regeneration and
immunosuppression.

    The Company has funded its operations primarily through sales of common
stock, convertible preferred stock, contract payments under its collaboration
agreement, equipment financing arrangements and government grants. Prior to
achieving profitable operations, the Company intends to fund operations through
the additional sale of equity securities, strategic collaborations and debt
financing.

    Basis of Presentation

    The accompanying unaudited condensed financial statements have been prepared
in accordance with accounting principles generally accepted in the United States
for interim financial information. The information as of March 31, 2001, and for
the three months ended March 31, 2001 and 2000, reflects all adjustments
(including normal recurring adjustments) that the management of the Company
believes are necessary for a fair presentation of the results for the periods
presented. Results for any interim period are not necessarily indicative of
results for any future interim period or for the entire year. The accompanying
condensed financial statements should be read in conjunction with the financial
statements and notes thereto included in the Company's Annual Report on Form
10-K for the year ended December 31, 2000.

    Use of Estimates

    The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the amounts reported in the financial
statements and the accompanying notes. 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. The Company
limits its concentration of risk by diversifying its investments among a variety
of issuers. The Company classifies all investment securities as
available-for-sale in accordance with Statement of Financial Accounting
Standards No. 115, "Accounting for Certain Investments in Debt and Equity
Securities". Available-for-sale investments are recorded at fair value based on
quoted market prices, with unrealized gains and losses excluded from earnings
and reported in other comprehensive income (loss). Purchase premiums and
discounts are recognized in interest income using the interest method over the
terms of the securities. Declines in the fair value of available-for-sale
securities below their cost that are deemed to be other than temporary are
reflected in earnings as realized losses. Gains and losses on the sale of
securities are recorded on the trade date and are determined using the specific
identification method.


                                       6


<PAGE>   7
                         KOSAN BIOSCIENCES INCORPORATED

                     NOTES TO CONDENSED FINANCIAL STATEMENTS
                                   (UNAUDITED)


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

    Revenue Recognition

    The Company recognizes license and other up-front fees on a ratable basis
over the term of the respective agreement. Milestone payments are recognized
upon successful completion of a performance milestone event. Contract revenues
related to collaborative research and development agreements and government
grants are recognized on a ratable basis as services are performed. Any amounts
received in advance of performance are recorded as deferred revenue until
earned.

    Research and Development

    Research and development expenses consist of costs incurred for
Company-sponsored and collaborative research and development activities. These
costs consist of direct and indirect internal costs related to specific projects
as well as fees paid to other entities that conduct certain research activities
on behalf of the Company. Research and development expenses under the government
grants and collaborative agreements approximated the revenue recognized, less
milestone payments received under such arrangements.

    Net Loss per Share

    Basic and diluted net loss per common share is presented in conformity with
the Statement of Financial Accounting Standards No. 128, "Earnings per Share"
("SFAS 128"), for all periods presented. Following the guidance given by the
Securities and Exchange Commission ("SEC") Staff Accounting Bulletin No. 98,
common stock and convertible preferred stock that has been issued or granted for
nominal consideration prior to the anticipated effective date of the initial
public offering must be included in the calculation of the basic and diluted net
loss per common share as if these shares had been outstanding for all periods
presented. To date, the Company has not issued or granted shares for nominal
consideration.

    In accordance with SFAS 128, basic and diluted net loss per common share has
been computed using the weighted-average number of shares of common stock
outstanding during the period, less shares subject to repurchase. Diluted net
loss is not presented separately as the Company is in a net loss position and
including common stock equivalents in the loss per share computation would be
antidilutive. Pro forma net loss per common share has been computed to give
effect to the automatic conversion of preferred stock into common stock
immediately prior to the completion of the Company's initial public offering
(using the if-converted method) from the original date of issuance.


                                       7


<PAGE>   8
                         KOSAN BIOSCIENCES INCORPORATED

               NOTES TO CONDENSED FINANCIAL STATEMENTS (CONTINUED)
                                   (UNAUDITED)

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

    The following table presents the calculation of basic, diluted and pro forma
basic and diluted net loss per share (in thousands, except per share data):


<TABLE>
<CAPTION>
                                                                         Three Months Ended
                                                                              March 31,
                                                                       -----------------------
                                                                         2001           2000
                                                                       --------       --------
<S>                                                                    <C>            <C>
Net loss attributable to common stockholders ....................      $ (3,923)      $(14,132)
                                                                       ========       ========
Weighted-average shares of common
   stock outstanding ............................................        25,152          5,888
Less: weighted-average shares subject
   to repurchase ................................................        (1,307)        (1,055)
                                                                       --------       --------
Weighted-average shares used in computing
   basic and diluted net loss per common share ..................        23,845          4,833
                                                                       ========       ========
Basic and diluted net loss per common share .....................      $  (0.16)      $  (2.92)
                                                                       ========       ========

Pro forma:
Shares used above ...............................................        23,845          4,833
Pro forma adjustment to reflect weighted effect
   of conversion of convertible preferred stock .................             -          9,835
                                                                       --------       --------
Shares used in computing pro forma basic and
   diluted net loss per common share ............................        23,845         14,668
                                                                       ========       ========
Pro forma basic and diluted net loss per share ..................      $  (0.16)      $  (0.96)
                                                                       ========       ========
</TABLE>


    Stock-Based Compensation

    The Company accounts for common stock options granted to employees using the
intrinsic value method and, thus recognizes no compensation expense for options
granted with exercise prices equal to or greater than the deemed fair value of
the Company's common stock on the date of the grant.

    Stock-based compensation expense for options granted to non-employees has
been determined in accordance with Statement of Financial Accounting Standards
No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123") and Emerging
Issues Task Force ("EITF") Consensus No. 96-18 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.


                                        8


<PAGE>   9
                         KOSAN BIOSCIENCES INCORPORATED

               NOTES TO CONDENSED FINANCIAL STATEMENTS (CONTINUED)
                                   (UNAUDITED)

2.  COLLABORATIVE RESEARCH AND DEVELOPMENT AND LICENSE AGREEMENTS

    The R.W. Johnson Pharmaceutical Research Institute

    In September 1998, the Company signed a collaborative agreement with The
R.W. Johnson Pharmaceutical Research Institute and Ortho-McNeil Pharmaceutical,
Inc., both Johnson & Johnson companies. In August 2000, the Company amended its
collaborative research and development agreement. Under the terms of the amended
agreement, subject to termination provisions, the research program and funding
have been extended until at least December 28, 2001. In February 2001, the
Company received and recognized in full, a $250,000 milestone in connection with
this agreement.

    License Agreements

    The Company has collaborative and license agreements with several academic
and medical institutions. For the three months ended March 31, 2001 and 2000,
the Company did not make any payments under these agreements. At March 31, 2001,
the Company estimated its non-cancelable commitments under these agreements to
be approximately $384,000.

3.  COMPREHENSIVE GAIN/(LOSS)

    For the three months ended March 31, 2001 and 2000, comprehensive loss is as
follows (in thousands):


<TABLE>
<CAPTION>
                                                                         Three Months Ended
                                                                             March 31,
                                                                       ---------------------
                                                                        2001          2000
                                                                       -------       -------
<S>                                                                    <C>           <C>
Net loss ........................................................      $(3,923)      $(2,865)
Unrealized gain/(loss) on
    available-for-sale securities ...............................          297            (8)
                                                                       -------       -------
Comprehensive loss ..............................................      $(3,626)      $(2,873)
                                                                       =======       =======
</TABLE>


4.  CAPITAL LEASES AND EQUIPMENT FINANCING

    The Company leases certain equipment and facility improvements under
non-cancelable capital leases and debt obligations. The equipment loans have a
balloon payment at the end of the term. The interest rates of each of the leases
and loans are fixed at the time of the draw down, with the interest rates
ranging from 10.6% to 17.7%. In January 2000, the Company secured a $2.0 million
line of credit of which $1.7 million had been utilized and approximately
$300,000 was allowed to expire at December 31, 2000.


                                       9


<PAGE>   10
                         KOSAN BIOSCIENCES INCORPORATED

               NOTES TO CONDENSED FINANCIAL STATEMENTS (CONTINUED)
                                   (UNAUDITED)

5.  ACCRUED LIABILITIES

    Accrued liabilities consisted of the following (in thousands):


<TABLE>
<CAPTION>
                                                   March 31,    December 31,
                                                     2001          2000
                                                   --------     ------------
<S>                                                <C>          <C>
Facilities related ..........................      $    443      $    415
Compensation related ........................           503           451
Professional fees ...........................           256           250
Other .......................................           478           481
                                                   --------      --------
                                                   $  1,680      $  1,597
                                                   ========      ========
</TABLE>


6.  SUBSEQUENT EVENT

    At March 31, 2001, the Company had approximately $3.0 million invested in
short-term commercial paper of Southern California Edison, a utility company. At
the time of purchase, the security was a high investment-grade security, but was
subsequently downgraded due to the financial problems caused by the California
energy crisis. At March 31, 2001, the security was valued at approximately 83%
of cost, resulting in an unrealized loss of approximately $501,000.

    The security matured on April 18, 2001, and Southern California Edison
defaulted on payment. The Company has determined that there has been
an-other-than temporary decline in the fair value of the security and will
record a write-down in the second quarter of 2001. As of April 30, 2001, the
defaulted security was valued at approximately 80% of cost. On May 1, 2001, the
Company received payment for the April 2001 stated annual interest rate of 6.6%.
Southern California Edison has stated default interest payments are expected to
be made on a monthly basis.


                                       10


<PAGE>   11
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
        OF OPERATIONS

FORWARD-LOOKING STATEMENTS

    The following discussion of our financial condition and results of
operations contains forward-looking statements within the meaning of Section 27A
of the Securities Act of 1993 and Section 21E of the Securities Exchange Act of
1934. These statements relate to future events or our future financial
performance. In some cases, you can identify forward-looking statements by
terminology such as may, will, should, expect, plan, anticipate, believe,
estimate, predict, potential or continue, the negative of terms like these or
other comparable terminology. These statements are only predictions. Actual
events or results may differ materially. All forward-looking statements included
in this document are based on information available to us on the date hereof,
and we assume no obligation to update any such forward-looking statements. In
evaluating these statements, you should specifically consider various factors,
including the risks outlined under the caption "Risk Factors that May Affect
Results of Operations and Financial Condition" set forth at the end of this Item
2, the Risk Factors set forth in our Annual Report on Form 10-K filed with the
SEC and those contained from time to time in our other filings with the SEC. We
caution investors that our business and financial performance are subject to
substantial risks and uncertainties.

OVERVIEW

    We have proprietary gene-engineering technologies for the manipulation and
production of polyketides, a rich source of pharmaceutical products. Our product
development opportunities currently target the areas of cancer, infectious
disease, gastrointestinal motility disorders, mucus hypersecretion, nerve
regeneration and immunosuppression. In infectious disease, we have a
collaboration with The R.W. Johnson Pharmaceutical Research Institute, a Johnson
& Johnson company, focusing on the development of a next generation antibiotic.

    We have incurred significant losses since our inception. As of March 31,
2001, our accumulated deficit was $30.6 million. We expect to incur additional
operating losses over the next several years as we continue to develop our
technologies and fund internal product research and development.

STOCK-BASED COMPENSATION

    Stock-based compensation expense for the three months ended March 31, 2001
and 2000 represents the difference between the exercise price of an option and
the deemed fair value of our common stock on the date of the option grant
calculated in accordance with Accounting Principles Board Opinion No. 25 and its
related interpretations. Such amounts are included as a reduction of
stockholders' equity and are being amortized to expense using the graded vesting
method over the vesting periods of the underlying options, which are generally
four years. Stock-based compensation has been allocated to research and
development expense and general and administrative expense, as appropriate. We
recognized stock-based compensation expense of $1.6 million and $883,000 for the
three months ended March 31, 2001 and 2000, respectively. Based on deferred
stock-based compensation recorded as of March 31, 2001, we expect to record
amortization for deferred stock-based compensation approximately as follows:
$4.6 million for the nine months remaining in 2001, $3.3 million in 2002, $1.5
million in 2003 and $158,000 in 2004.

    In connection with the grants of stock options and restricted stock to
non-employees, we recognize compensation on a ratable basis over the related
service period. We recognized other stock-based compensation for non-employees
of $153,000 and $378,000 in the three months ended March 31, 2001 and 2000,
respectively. In addition, we expect to recognize other stock-based compensation
in connection with stock options and restricted stock granted to non-employees
of $426,000 in the nine months remaining in 2001, $459,000 in 2002, $139,000 in
2003 and $33,000 in 2004. The measurement of stock-based compensation to our
non-employees is subject to periodic adjustment as our stock price


                                       11


<PAGE>   12
changes and as the underlying securities vest. As such, changes to these
measurements could be substantial should we experience significant changes in
our stock price.

RESULTS OF OPERATIONS

    Revenue. Our revenues were $1.2 million for the three months ended March 31,
2001 compared to $1.1 million for the same period in 2000. During the quarter
ended March 31, 2001, we recognized a non-recurring $250,000 milestone received
in connection with the anti-infective collaboration with The R.W. Johnson
Pharmaceutical Research Institute. Included in 2000 revenues was $125,000 in
amortization of the up-front fee received in connection with this collaboration
that was amortized through September 2000, the initial term of the contract. The
initial term of the collaboration with The R.W. Johnson Pharmaceutical Research
Institute has been extended to December 28, 2001. If we do not maintain or
further extend this agreement, or if it is terminated early, our revenues will
significantly decrease thereafter, unless we enter into additional
collaborations.

    Research and Development Expenses. Our research and development expenses
consist primarily of stock-based compensation, salaries and other
personnel-related expenses, facility-related expenses, lab consumables and
depreciation of facilities and equipment. Research and development expenses
increased to $5.6 million for the three months ended March 31, 2001 from $3.3
million for the same period in 2000. This increase was primarily due to
increased payroll and personnel-related expenses, along with higher pre-clinical
development expenses reflecting the cost of advancing the epothilone-D program
towards clinical trials. Stock-based compensation also increased in the three
months ended March 31, 2001 to $1.5 million from $922,000 for the same period in
2000. We expect our research and development expenses will increase
substantially to fund the expansion of our technology platform, support our
collaborative research programs and advance our epothilone and other in-house
research programs into later stages of development.

    General and Administrative Expenses. General and administrative expenses
increased to $1.1 million for the three months ended March 31, 2001 from
$760,000 for the same period in 2000. This increase was primarily due to higher
employee-related costs to support our expanding research and development
activities and added public company-related expenses. We expect our general and
administrative expenses will increase in the future to support the continued
growth of our research and development efforts and to fulfill our obligations
associated with being a publicly held company.

    Interest Income. Interest income increased to $1.6 million for the three
months ended March 31, 2001 from $159,000 for the same period in 2000. This
increase was due to higher average investment balances due to aggregate net
proceeds of $98.0 million received in connection with our October 2000 initial
public offering of common stock and the issuance of Series C convertible
preferred stock in March 2000.

    Interest Expense. Interest expense increased to $94,000 for the three months
ended March 31, 2001 from $80,000 for the same period in 2000. This increase
resulted from additional debt financing associated with our capital purchases.

    Beneficial Conversion Feature. In March 2000, we sold 804,196 shares of
Series C convertible preferred stock (which converted into 2,412,588 shares of
common stock at the closing of our initial public offering) for net proceeds of
approximately $24.6 million. After evaluating the fair value of our common stock
in contemplation of our initial public offering, we determined that the issuance
of the Series C convertible preferred stock resulted in a beneficial conversion
feature calculated in accordance with EITF Consensus No. 98-5, "Accounting for
Convertible Securities with Beneficial Conversion Features." The beneficial
conversion feature was reflected as a deemed dividend of $11.3 million in our
financial statements for the three months ended March 31, 2000.


                                       12


<PAGE>   13
LIQUIDITY AND CAPITAL RESOURCES

    We have financed our operations from inception primarily through sales of
convertible preferred stock and common stock, totaling $119.2 million in net
proceeds, contract payments under our collaboration agreement, equipment
financing arrangements and government grants. As of March 31, 2001, we had
$100.1 million in cash, cash equivalents and investments compared to $102.7
million as of December 31, 2000. Our funds are currently invested in U.S.
Treasury and government agency obligations, investment-grade asset-backed
securities and corporate obligations.

    Our operating activities used cash of $2.8 million for the three months
ended March 31, 2001 compared to $915,000 for the same period in 2000. Our net
loss of $3.9 million for the three months ended March 31, 2001 was partially
offset by non-cash expenses of $1.8 million related to stock-based compensation.
Cash used for the same period in 2000 was used primarily to fund our net
operating losses of $2.9 million, partially offset by non-cash expenses of $1.5
million related to stock-based compensation and depreciation.

    Our investing activities, excluding changes in our investments, for the
three months ended March 31, 2001 used cash of $419,000 compared to $257,000 for
the same period in 2000, reflecting capital expenditures and facility
improvements as we continue to enhance our laboratory capabilities.

    Cash used in financing activities was $141,000 for the three months ended
March 31, 2001 compared to cash provided by financing activities of $25.3
million for the same period in 2000. Financing activities included $24.6 million
in net proceeds from the issuance of our Series C convertible preferred stock in
March 2000.

    For periods subsequent to March 31, 2001, we have estimated our
non-cancelable commitments under our collaborative and license agreements to be
approximately $384,000.

    We believe our existing cash and investments will be sufficient to meet our
anticipated cash requirements for at least 24 months. Our future capital uses
and requirements depend on numerous forward-looking factors. These factors
include, but are not limited to the following:

    -   our ability to establish and the amount of revenues received under any
        new collaborations;

    -   the progress and number of research programs carried out by us;

    -   the progress and success of pre-clinical and clinical trials of our drug
        candidates;

    -   our ability to maintain our existing collaboration with The R.W. Johnson
        Pharmaceutical Research Institute;

    -   the costs and timing of obtaining, enforcing and defending our patent
        and intellectual rights;

    -   the costs and timing of regulatory approvals; and

    -   expenses associated with unforeseen litigation.

    For the next several years, we do not expect our operations to generate the
amounts of cash required for our future cash needs. In order to fulfill our cash
requirements, we expect to finance future cash needs through the sale of equity
securities, strategic collaborations and debt financing. We cannot assure you
that additional financing or collaboration and licensing arrangements will be
available when needed or that, if available, will be on terms favorable to us or
our stockholders. Insufficient funds may require us to delay, scale back or
eliminate some or all of our research or development programs, to lose rights
under existing licenses or to relinquish greater or all rights to product
candidates at an earlier stage of development or on less favorable terms than we
would otherwise choose or may adversely affect our ability to operate as a going
concern. If additional funds are obtained by issuing equity securities,
substantial dilution to existing stockholders may result.


                                       13


<PAGE>   14
FACTORS THAT MAY AFFECT RESULTS OF OPERATIONS AND FINANCIAL CONDITION.

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

WE HAVE A HISTORY OF NET LOSSES AND MAY NEVER BECOME PROFITABLE.

    We commenced operations in 1996 and are still in an early stage of
development. We have not commercialized any products and we have incurred
significant losses to date. As of March 31, 2001, we had an accumulated deficit
of approximately $30.6 million. To date, our revenues have been solely from
collaborations and government grants. Our expenses have consisted principally of
costs incurred in research and development and from general and administrative
costs associated with our operations. We have incurred net losses since our
inception, including a net loss of approximately $3.9 million for the three
months ended March 31, 2001. We expect our expenses to increase and to continue
to incur operating losses for at least the next several years as we continue our
research and development efforts for our drug candidates. The amount of time
necessary to commercialize any of our drug candidates successfully is long and
uncertain and successful commercialization may not occur at all. As a result, we
may never become profitable.

IF WE DO NOT ESTABLISH AND MAINTAIN COLLABORATIONS WITH OTHER PARTIES, THE
DEVELOPMENT OF OUR PRODUCTS MAY BE DELAYED OR STOPPED.

    Because we do not currently possess the financial and other resources
necessary to develop potential products that may result from our technologies,
or the financial and other resources to complete any approval processes which
may be required for these products, we must enter into collaborative
arrangements to develop many of our drug candidates. If we do not maintain or
further extend our current collaboration with The R.W. Johnson Pharmaceutical
Research Institute and Ortho-McNeil Pharmaceutical, Inc., both Johnson & Johnson
companies, which expires on December 28, 2001, subject to termination
provisions, or if we do not enter into new collaborative agreements, then our
revenues will be significantly reduced, and our drug candidates may not be
developed, manufactured or marketed.

OUR POTENTIAL PRODUCTS ARE IN AN EARLY STAGE OF DEVELOPMENT AND SUBSTANTIAL
ADDITIONAL EFFORT WILL BE NECESSARY FOR DEVELOPMENT.

    Our technologies are new and our drug candidates are in early stages of
research and development. We may not develop products that prove to be safe and
effective, meet applicable regulatory standards, are capable of being
manufactured at reasonable costs, or can be marketed successfully. All of the
potential proprietary products that we are currently developing will require
significant development and investment, including extensive pre-clinical and
clinical testing before we can submit any application for regulatory approval.
Before obtaining regulatory approvals for the commercial sale of any of our
products, we must demonstrate through pre-clinical testing and clinical trials
that our drug candidates are safe and effective in humans. We have not commenced
clinical testing of any of our potential products, nor have we submitted any
application to test any potential products in humans. Conducting clinical trials
is a lengthy, expensive and uncertain process. Completion of clinical trials may
take several years or more. The length of time generally varies substantially
according to the type, complexity, novelty and intended use of the drug
candidate. Our clinical trials, if commenced, may be suspended at any time if we
or the U.S. Food and Drug Administration, or the FDA, believe the patients
participating in our studies are exposed to unacceptable health risks. We may
encounter problems in our studies that will cause us or the FDA to delay or
suspend the studies.


                                       14


<PAGE>   15
Our commencement and rate of completion of clinical trials may be delayed 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;

    -   failure of the FDA to approve our clinical trial protocols;

    -   slower than expected rate of patient recruitment;

    -   unforeseen safety issues; or

    -   government or regulatory delays.

    If any future clinical trials are not successful, our business, financial
condition and results of operations will be harmed.

ANY INABILITY TO PROTECT OUR PROPRIETARY TECHNOLOGIES ADEQUATELY COULD HARM OUR
COMPETITIVE POSITION.

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

    The patent positions of biotechnology companies, including our patent
position, involve complex legal and factual questions and, therefore, validity
and enforceability cannot be predicted with certainty. Patents may be
challenged, deemed unenforceable, invalidated or circumvented. We will be able
to protect our proprietary rights from unauthorized use by third parties only to
the extent that our proprietary technologies are covered by valid and
enforceable patents or are effectively maintained as trade secrets. We will
apply for patents covering both our technologies and drug candidates as we deem
appropriate. However, we may fail to apply for patents on important technologies
or products in a timely fashion or at all, and in any event, the applications we
do file may not result in issued patents or, if issued, may be challenged. 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. Furthermore, others may independently develop similar or alternative
technologies or design around our patented technologies. In addition, others may
challenge or invalidate our patents, or our patents may fail to provide us with
any competitive advantages. If the use or validity of any of our patents is ever
challenged, resulting in litigation or administrative proceedings, we would
incur substantial costs and the diversion of management in defending the patent.
In addition, we generally do not control the patent prosecution of technology
that we license from others. Accordingly, we are unable to exercise the same
degree of control over this intellectual property as we would over technology we
own.

    We rely upon trade secret protection for our confidential and proprietary
information. We have taken measures to protect our proprietary information.
These measures may not provide adequate protection for our trade secrets or
other proprietary information. We seek to protect our proprietary information by
entering into confidentiality agreements with employees, collaborators, and
consultants. Nevertheless, employees, collaborators or consultants may still
disclose our proprietary information, and we may not be able to protect our
trade secrets meaningfully. In addition, others may independently develop
substantially equivalent proprietary information or techniques or otherwise gain
access to our trade secrets.


                                       15


<PAGE>   16
LITIGATION OR OTHER PROCEEDINGS OR THIRD-PARTY CLAIMS OF INTELLECTUAL PROPERTY
INFRINGEMENT WOULD REQUIRE US TO SPEND TIME AND MONEY AND COULD PREVENT US FROM
DEVELOPING OR COMMERCIALIZING PRODUCTS.

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

    The biotechnology industry is characterized by extensive litigation
regarding patents and other intellectual property rights. We are aware of
patents and published patent applications that, if valid, and if we are
unsuccessful in circumventing or acquiring the rights to these patents, may
block our ability to commercialize products. We cannot be sure that other
parties have not been issued relevant patents that could affect our ability to
obtain patents or to operate as we would like to. Others may sue us in the
future to challenge our patent rights or claim infringement of their patents. An
adverse determination in litigation to which we may become a party could subject
us to significant liabilities to others, require us to license disputed rights
from others or require us to cease using the disputed technology.

    We are aware of a significant number of patents and patent applications
relating to aspects of our technologies and families of compounds filed by, and
issued to, other parties. Others have filed patent applications or have been
granted patents claiming inventions also claimed by us, and we may have to
participate in an interference proceeding declared by the relevant patent
regulatory agency to determine priority of invention and, thus, the right to a
patent for these inventions in the United States. For example, we believe one or
more interferences may be declared between patent applications we own or have
exclusively licensed and patents owned by Novartis relating to epothilone
biosynthetic genes and epothilone D and related compounds and patents owned by
Abbott Laboratories relating to erythromycin polyketide synthase genes and
methods for altering polyketide synthase genes. Such a proceeding or a lawsuit
in which we are alleged to have infringed an issued patent could result in
substantial cost to us even if the outcome is favorable, and if the outcome is
unfavorable, we could be required to license the other party's rights, at terms
that may be unfavorable to us, or cease using the technology. Even if successful
on priority grounds, an interference may result in loss of claims based on
patentability grounds raised in the interference. Although patent and
intellectual property disputes in the biotechnology area are often settled
through licensing or similar arrangements, costs associated with these
arrangements may be substantial and could include ongoing royalties.
Furthermore, we cannot be certain that the necessary license would be available
to us on satisfactory terms, if at all.

    Other parties may obtain future patents and claim that the use of our
technologies infringes these patents or that we are employing their proprietary
technology without authorization. We could incur substantial costs and diversion
of management and technical personnel in defending ourselves against any of
these claims or enforcing our patents against others. Furthermore, parties
making claims against us may be able to obtain injunctive or other equitable
relief which could effectively block our ability to further 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 damages;

    -   stop using our products or methods;

    -   develop non-infringing products or methods; and

    -   obtain one or more licenses from other parties.


                                       16


<PAGE>   17
    We may not be able to obtain these licenses at a reasonable cost, if at all.
In that event, we could encounter substantial delays in product introductions
while we attempt to develop alternative methods or products, which we may not be
able to accomplish.

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

IF WE ARE UNABLE TO MANAGE OUR GROWTH EFFECTIVELY THROUGH RECRUITING AND
RETAINING SKILLED EMPLOYEES AND EXPAND OUR MANAGEMENT AND IMPROVE OUR CONTROLS
AND SYSTEMS, WE MAY NOT BE ABLE TO MANAGE OUR DAY-TO-DAY OPERATIONS.

    We have experienced a period of rapid and substantial growth that has
placed, and if this growth continues will further place, a strain on our human
and capital resources. If we are unable to manage this growth effectively, then
our losses could increase. The number of our employees increased from 57 on
March 31, 2000 to 79 on March 31, 2001. Retaining our current employees and
recruiting qualified scientific personnel to perform future research and
development work will be critical to our success. Competition is intense for
experienced scientists, and we may not be able to retain or recruit sufficient
skilled personnel to allow us to pursue collaborations and develop our products
and core technologies to the extent otherwise possible. Additionally, we are
highly dependent on the principal members of our management and scientific
staff, such as our two co-founders, the loss of whose services would adversely
impact the achievement of our objectives. Although we maintain and are the
beneficiary of $1.0 million key-man life insurance policies for the lives of
each of our two co-founders, Dr. Daniel Santi, our chief executive officer, and
Dr. Chaitan Khosla, a director and consultant, we do not believe the proceeds
would be adequate to compensate us for their loss.

    Our ability to manage our operations and growth effectively requires us to
continue to expend funds to expand our management and improve our controls and
systems. If we are unable to implement successfully these expansions and
improvements, then we may not be able to effectively manage our day-to-day
operations.

WE FACE INTENSE COMPETITION FROM LARGE PHARMACEUTICAL COMPANIES, BIOTECHNOLOGY
COMPANIES AND ACADEMIC GROUPS.

    We face, and will continue to face, intense competition from organizations
such as large biotechnology and pharmaceutical companies, as well as academic
and research institutions and government agencies, that are pursuing competing
technologies and products. These organizations may develop technologies or
products that are superior alternatives to ours. Further, our competitors in the
polyketide gene engineering field may be more effective at implementing their
technologies to develop commercial products. Some of these competitors have
entered into collaborations with leading companies within our target markets to
produce polyketides for commercial purposes.

    Any products that we develop through our technologies will compete in
multiple, highly competitive markets. Development of pharmaceutical products
requires significant investment and resources. 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 modifying DNA, obtaining regulatory
approvals and product manufacturing and marketing. Accordingly, our competitors
may be able to develop technologies and products more easily, which would render
our technologies and products and those of our collaborators obsolete and
noncompetitive.

IF WE FACE CLAIMS IN CLINICAL TRIALS OF A DRUG CANDIDATE, THESE CLAIMS WILL
DIVERT OUR MANAGEMENT'S TIME AND WE WILL INCUR LITIGATION COSTS.

    We face an inherent business risk of clinical trial liability claims in the
event that the use or misuse of our potential products results in personal
injury or death. We may experience clinical trial liability claims if our drug
candidates are misused or cause harm before regulatory authorities approve them
for


                                       17


<PAGE>   18
marketing. Even though we have obtained clinical trial liability insurance, it
may not be sufficient to cover claims that may be made against us. Clinical
trial liability insurance is expensive, difficult to obtain and may not be
available in the future on acceptable terms, if at all. Any claims against us,
regardless of their merit, could materially and adversely affect our financial
condition, because litigation related to these claims would strain our financial
resources in addition to consuming the time and attention of our management. If
we are sued for any injuries caused by our products, our liability could exceed
our total assets.

WE USE HAZARDOUS CHEMICALS AND RADIOACTIVE AND BIOLOGICAL MATERIALS IN OUR
BUSINESS. ANY CLAIMS RELATING TO IMPROPER HANDLING, STORAGE OR DISPOSAL OF THESE
MATERIALS COULD BE TIME CONSUMING AND COSTLY.

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

WE RELY ON A CONTINUOUS POWER SUPPLY TO CONDUCT OUR OPERATIONS, AND CALIFORNIA'S
CURRENT ENERGY CRISIS COULD DISRUPT OUR OPERATIONS AND INCREASE OUR EXPENSES.

    California is in the midst of an energy crisis that could disrupt our
operations and increase our expenses. In the event of an acute power shortage,
that is, when power reserves for the State of California fall below 1.5%,
California has on some occasions implemented, and may in the future continue to
implement, rolling blackouts throughout California. We currently do not have
adequate backup generators or alternate sources of power in the event of a
blackout, and our current insurance does not provide coverage for any damages we
may suffer as a result of any interruption in our power supply. If blackouts
interrupt our power supply, we would be temporarily unable to continue
operations at our facilities, including but not limited to the disruption of
laboratory experiments and product manufacturing cycles. Any such interruption
in our ability to continue operations at our facilities could damage our
reputation, lead to our failure to meet certain time-based milestones and could
result in lost contract revenue, any of which could substantially harm our
business and results of operations.

    Furthermore, the deregulation of the energy industry instituted in 1996 by
the California government has caused power prices to increase. Under
deregulation, utilities were encouraged to sell their plants, which
traditionally had produced most of California's power, to independent energy
companies that were expected to compete aggressively on price. Instead, due in
part to a shortage of supply, wholesale prices have significantly increased over
the past year. If wholesale prices continue to increase, our operating expenses
will likely increase, as all of our facilities are located in California.

WE HAVE 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
undesignated 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


                                       18


<PAGE>   19
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.

SOME OF OUR EXISTING STOCKHOLDERS CAN EXERT CONTROL OVER US AND MAY NOT MAKE
DECISIONS THAT ARE IN THE BEST INTEREST OF ALL STOCKHOLDERS.

    Our officers, directors and affiliates together control approximately 46% of
our outstanding common stock. As a result, these stockholders, if they act
together, are able to exert a significant degree of influence over our
management and affairs and over matters requiring stockholder approval,
including the election of directors and approval of significant corporate
transactions. This concentration of ownership may delay or prevent a change in
control of us and might affect the market price of our common stock, even when a
change may be in the best interests of all stockholders. In addition, the
interests of this concentration of ownership may not always coincide with our
interests or the interests of other stockholders and accordingly, they could
cause us to enter into transactions or agreements that we would not otherwise
consider.

OUR STOCK PRICE HAS BEEN, AND MAY CONTINUE TO BE, EXTREMELY VOLATILE.

    The trading price of our common stock has been and is likely to continue to
be highly volatile and could be subject to wide fluctuations in price in
response to various factors, many of which are beyond our control, including:

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

    -   delay or failure in initiating, conducting, completing or analyzing
        clinical trials or unsatisfactory design or results of these trials;

    -   achievement of regulatory approvals;

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

    -   changes in financial estimates by securities analysts;

    -   announcements of departures or departures of key personnel;

    -   announcements of litigation or an unfavorable outcome in litigation; and

    -   sales of our common stock.

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


                                       19


<PAGE>   20
WE EXPECT THAT OUR QUARTERLY RESULTS OF OPERATIONS WILL FLUCTUATE, AND THIS
FLUCTUATION COULD CAUSE OUR STOCK PRICE TO DECLINE, CREATING INVESTOR LOSSES.

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

    -   expiration of research contracts with collaborators or government
        research grants, which may not be renewed or replaced;

    -   the success rate of our discovery efforts leading to milestones and
        royalties;

    -   the timing and willingness of collaborators to commercialize our
        products; and

    -   general and industry specific economic conditions, which may affect our
        collaborators' research and development expenditures.

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

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


                                       20


<PAGE>   21
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest Rate Risk

    The primary objective of our investment activities is to preserve principal
while at the same time maximizing yields without significantly increasing risk.
To achieve this objective, we maintain our portfolio of cash equivalents,
short-term and long-term investments in a variety of securities, including
corporate obligations and money market funds. As of March 31, 2001,
approximately 86% of our total portfolio will mature in one year or less, with
the remainder maturing in less than two years.

    At March 31, 2001, we had approximately $3.0 million invested in short-term
commercial paper of Southern California Edison, a utility company. At the time
of purchase, the security was a high investment-grade security, but was
subsequently downgraded due to the financial problems caused by the California
energy crisis. At March 31, 2001, the security was valued at approximately 83%
of cost, resulting in an unrealized loss of approximately $501,000. The security
matured on April 18, 2001, and Southern California Edison defaulted on payment.
We have determined that there has been an-other-than temporary decline in fair
value of the security and will record a write-down in the second quarter of
2001.

    The following table represents the fair value balance of our cash, cash
equivalents and short-term and long-term investments that are subject to
interest rate risk by year of expected maturity and average interest rates as of
March 31, 2001 (dollars in thousands):


<TABLE>
<CAPTION>
                                                  2001             2002
                                              ----------       ----------
<S>                                           <C>              <C>
Cash & equivalents .....................      $   28,539               --
Average interest rates .................            5.33%

Short-term investments .................          38,134       $   19,832
Average interest rates .................            6.33%            5.68%

Long-term investments ..................              --           13,598
Average interest rates .................                             6.14%
</TABLE>


    We did not hold derivative instruments as of March 31, 2001, and we have
never held such instruments in the past. In addition, we had outstanding debt,
consisting of borrowings under an equipment financing line of credit, of $2.7
million as of March 31, 2001, with a range of interest rates of between 10.6%
and 17.7%.


                                       21


<PAGE>   22
PART II.       OTHER INFORMATION

ITEM 1:  LEGAL PROCEEDINGS

         Not applicable.

ITEM 2:  CHANGES IN SECURITIES AND USE OF PROCEEDS

          d) USE OF PROCEEDS

             Our initial public offering of common stock was effected in October
          2000, in which we sold 5,750,000 shares of our common stock.

             The net proceeds of the 5,750,000 shares registered and sold were
          approximately $73.4 million. We paid a total of approximately $5.6
          million in underwriting discounts and commissions and approximately
          $1.5 million in other costs and expenses in connection with the
          offering through March 2001. None of the expenses were paid, directly
          or indirectly, to directors, officers or persons owning 10 percent or
          more of our common stock.

             We intend to use the net proceeds for advancing our drug candidates
          through pre-clinical and later stage development, discovering or
          acquiring new drug candidates, expanding our technology platform,
          capital expenditures, working capital, general corporate purposes and
          possible future acquisitions. To date, we have not used any of the net
          proceeds from the offering and, pending such use, our funds have been
          invested in U.S. Treasury and government agency obligations,
          investment-grade asset-backed securities and corporate obligations.

ITEM 3:  DEFAULTS UPON SENIOR SECURITIES

         Not applicable.

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

         None.

ITEM 5:  OTHER INFORMATION

         None.

ITEM 6:  EXHIBITS AND REPORTS ON FORM 8-K

         a)  EXHIBITS

                THE EXHIBITS LISTED ON THE ACCOMPANYING INDEX TO EXHIBITS ARE
                FILED OR INCORPORATED BY REFERENCE (AS STATED THEREIN) AS PART
                OF THIS QUARTERLY REPORT ON FORM 10-Q.

         b)  REPORTS ON FORM 8-K

                NO CURRENT REPORTS ON FORM 8-K WERE FILED DURING THE QUARTER
                ENDED MARCH 31, 2001.


                                       22


<PAGE>   23
                                   SIGNATURES

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


                             Kosan Biosciences Incorporated



May 11, 2001                 By: /s/ Daniel V. Santi
                                 --------------------------------
                                 Daniel V. Santi, M.D., Ph.D.
                                 Chairman and Chief Executive Officer



May 11, 2001                 By: /s/ Susan M. Kanaya
                                 --------------------------------
                                 Susan M. Kanaya
                                 Vice President, Finance and
                                 Chief Financial Officer
                                 (PRINCIPAL FINANCIAL AND ACCOUNTING OFFICER)


                                       23


<PAGE>   24
                                  EXHIBIT INDEX


<TABLE>
<CAPTION>
EXHIBIT
NUMBER         DESCRIPTION OF DOCUMENT
<S>            <C>
3.1            AMENDED AND RESTATED CERTIFICATE OF INCORPORATION (1)

3.2            BYLAWS (1)

4.1            FORM OF SPECIMEN COMMON STOCK CERTIFICATE (1)
</TABLE>


--------------
(1) FILED WITH KOSAN'S REGISTRATION STATEMENT ON FORM S-1, AS AMENDED (NO.
    333-33732), AND INCORPORATED HEREIN BY REFERENCE.


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