##### Table of Contents

---

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 September 30, 2005.



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)



---



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 by check
mark whether the registrant is an accelerated filer (as defined in Rules 12b-2 of the Exchange Act).    Yes  x    No ̈



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



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; 29,367,280 shares outstanding at October 31, 2005.



---



---

##### Table of Contents

KOSAN BIOSCIENCES INCORPORATED



Form 10-Q



Quarter Ended September 30, 2005



INDEX



|               |  |                                                                                                                |  |     
|-------------- |  | -------------------------------------------------------------------------------------------------------------- |  | ----
|               |  |                                                                                                                |  | Page
|PART I.        |  | FINANCIAL INFORMATION                                                                                          |  |     
|               |  |                                                                                                               
|Item 1:        |  | Condensed Financial Statements and Notes:                                                                      |  |     
|               |  |                                                                                                               
|               |  | Condensed Balance Sheets as of September 30, 2005 (unaudited) and December 31, 2004                            |  | 3   
|               |  |                                                                                                               
|               |  | Condensed Statements of Operations (unaudited) for the three and nine months ended September 30, 2005 and 2004 |  | 4   
|               |  |                                                                                                               
|               |  | Condensed Statements of Cash Flows (unaudited) for the nine months ended September 30, 2005 and 2004           |  | 5   
|               |  |                                                                                                               
|               |  | Notes to Condensed Financial Statements                                                                        |  | 6   
|               |  |                                                                                                               
|Item 2:        |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                          |  | 13  
|               |  |                                                                                                               
|Item 3:        |  | Quantitative and Qualitative Disclosures About Market Risk                                                     |  | 38  
|               |  |                                                                                                               
|Item 4:        |  | Controls and Procedures                                                                                        |  | 38  
|               |  |                                                                                                               
|PART II.       |  | OTHER INFORMATION                                                                                              |  |     
|               |  |                                                                                                               
|Item 5:        |  | Other Information                                                                                              |  | 40  
|               |  |                                                                                                               
|Item 6:        |  | Exhibits                                                                                                       |  | 40  
|               | 
|SIGNATURES     |  | 41                                                                                                            
|               | 
|CERTIFICATIONS |  |                                                                                                               



2



---

##### Table of Contents

PART I. FINANCIAL INFORMATION



Item 1:Condensed Financial Statements and Notes



KOSAN BIOSCIENCES INCORPORATED

CONDENSED BALANCE SHEETS

(in thousands)



|                                                       |  |                   |          |   |                      |   |          |  
|------------------------------------------------------ |  | ----------------- | -------- | - | -------------------- | - | -------- | -
|                                                       |  | September 30,2005 |          |   | December 31,2004 (1) |  
|                                                       |  | (unaudited)       |          |   |                      |  
|Assets                                                 |  |                   |          |   |                      |   |          |  
|                                                       |  |                  
|Current assets:                                        |  |                   |          |   |                      |   |          |  
|Cash and cash equivalents                              |  | $                 | 18,988   |   |                      | $ | 13,777   |  
|Short-term investments                                 |  |                   | 40,177   |   |                      |   | 53,783   |  
|Accounts and other receivables                         |  |                   | 2,946    |   |                      |   | 4,447    |  
|Prepaid and other current assets                       |  |                   | 1,071    |   |                      |   | 1,260    |  
|                                                       |  |                   |          |   |                      |   |          |  
|Total current assets                                   |  |                   | 63,182   |   |                      |   | 73,267   |  
|                                                       |  |                  
|Property and equipment, net                            |  |                   | 6,284    |   |                      |   | 7,159    |  
|Long-term investments                                  |  |                   | 2,922    |   |                      |   | 15,833   |  
|Other assets and notes receivable from related parties |  |                   | 307      |   |                      |   | 354      |  
|                                                       |  |                   |          |   |                      |   |          |  
|Total assets                                           |  | $                 | 72,695   |   |                      | $ | 96,613   |  
|                                                       |  |                   |          |   |                      |   |          |  
|Liabilities and Stockholders Equity                   |  |                   |          |   |                      |   |          |  
|                                                       |  |                  
|Current liabilities:                                   |  |                   |          |   |                      |   |          |  
|Accounts payable                                       |  | $                 | 896      |   |                      | $ | 1,343    |  
|Accrued liabilities                                    |  |                   | 7,118    |   |                      |   | 6,455    |  
|Current portion of deferred revenue                    |  |                   | 3,277    |   |                      |   | 3,277    |  
|Current portion of equipment loans                     |  |                   | 1,972    |   |                      |   | 1,916    |  
|                                                       |  |                   |          |   |                      |   |          |  
|Total current liabilities                              |  |                   | 13,263   |   |                      |   | 12,991   |  
|                                                       |  |                  
|Deferred revenue, less current portion                 |  |                   | 9,695    |   |                      |   | 12,153   |  
|Equipment loans, less current portion                  |  |                   | 2,011    |   |                      |   | 2,283    |  
|                                                       |  |                  
|Stockholders equity:                                  |  |                   |          |   |                      |   |          |  
|Common stock                                           |  |                   | 29       |   |                      |   | 29       |  
|Additional paid-in capital                             |  |                   | 172,014  |   |                      |   | 170,735  |  
|Accumulated other comprehensive income                 |  |                   | (255     | ) |                      |   | (378     | )
|Accumulated deficit                                    |  |                   | (124,062 | ) |                      |   | (101,200 | )
|                                                       |  |                   |          |   |                      |   |          |  
|Total stockholders equity                             |  |                   | 47,726   |   |                      |   | 69,186   |  
|                                                       |  |                   |          |   |                      |   |          |  
|Total liabilities and stockholders equity             |  | $                 | 72,695   |   |                      | $ | 96,613   |  
|                                                       |  |                   |          |   |                      |   |          |  

---

|(1) | The balance sheet data at December 31, 2004 has been derived from the audited financial statements at that date.
|--- | ----------------------------------------------------------------------------------------------------------------



See accompanying notes.



3



---

##### Table of Contents

KOSAN BIOSCIENCES INCORPORATED

CONDENSED STATEMENTS OF OPERATIONS

(unaudited)

(in thousands, except
per share data)



|                                                                     |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|-------------------------------------------------------------------- |  | ------------------------------- | ------ | - | ------------------------------ | - | ------ | ---- |  | - | ------- | - |  | - | ------- | -
|                                                                     |  | Three Months EndedSeptember 30, |        |   | Nine Months EndedSeptember 30, |  
|                                                                     |  | 2005                            |        |   | 2004                           |   |        | 2005 |  |   | 2004    |  
|Revenues:                                                            |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Contract revenue                                                     |  | $                               | 2,906  |   |                                | $ | 5,842  |      |  | $ | 8,419   |   |  | $ | 17,076  |  
|Grant revenue                                                        |  |                                 | 311    |   |                                |   | 915    |      |  |   | 1,011   |   |  |   | 1,982   |  
|                                                                     |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Total revenues                                                       |  |                                 | 3,217  |   |                                |   | 6,757  |      |  |   | 9,430   |   |  |   | 19,058  |  
|                                                                     |  |                                 |        |  
|Operating expenses:                                                  |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Research and development                                             |  |                                 | 9,335  |   |                                |   | 11,290 |      |  |   | 28,461  |   |  |   | 30,631  |  
|General and administrative                                           |  |                                 | 1,763  |   |                                |   | 1,617  |      |  |   | 4,827   |   |  |   | 4,408   |  
|                                                                     |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Total operating expenses                                             |  |                                 | 11,098 |   |                                |   | 12,907 |      |  |   | 33,288  |   |  |   | 35,039  |  
|                                                                     |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Loss from operations                                                 |  |                                 | (7,881 | ) |                                |   | (6,150 | )    |  |   | (23,858 | ) |  |   | (15,981 | )
|Other income, net                                                    |  |                                 | 350    |   |                                |   | 278    |      |  |   | 996     |   |  |   | 804     |  
|                                                                     |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Net loss                                                             |  | $                               | (7,531 | ) |                                | $ | (5,872 | )    |  | $ | (22,862 | ) |  | $ | (15,177 | )
|                                                                     |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Basic and diluted net loss per common share                          |  | $                               | (0.26  | ) |                                | $ | (0.20  | )    |  | $ | (0.78   | ) |  | $ | (0.53   | )
|                                                                     |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Shares used in computing basic and diluted net loss per common share |  |                                 | 29,247 |   |                                |   | 28,935 |      |  |   | 29,180  |   |  |   | 28,863  |  



See accompanying notes.



4



---

##### Table of Contents

KOSAN BIOSCIENCES INCORPORATED

CONDENSED STATEMENTS OF CASH FLOWS

(unaudited)

(in thousands)



|                                                                           |  |                                |         |   |      |   |         |  
|-------------------------------------------------------------------------- |  | ------------------------------ | ------- | - | ---- | - | ------- | -
|                                                                           |  | Nine Months EndedSeptember 30, |        
|                                                                           |  | 2005                           |         |   | 2004 |  
|Operating activities                                                       |  |                                |         |   |      |   |         |  
|Net loss                                                                   |  | $                              | (22,862 | ) |      | $ | (15,177 | )
|Adjustment to reconcile net loss to net cash used in operating activities: |  |                                |         |   |      |   |         |  
|Depreciation and amortization                                              |  |                                | 1,925   |   |      |   | 1,864   |  
|Amortization of investment premiums and discounts                          |  |                                | 522     |   |      |   | 1,430   |  
|Amortization of stock-based compensation                                   |  |                                |        |   |      |   | 152     |  
|Other stock-based compensation                                             |  |                                | 312     |   |      |   | 430     |  
|Changes in assets and liabilities:                                         |  |                                |         |   |      |   |         |  
|Accounts and other receivables                                             |  |                                | 1,084   |   |      |   | 6,051   |  
|Prepaid and other current assets                                           |  |                                | 189     |   |      |   | (22     | )
|Other assets and notes receivable from related parties                     |  |                                | 47      |   |      |   | 159     |  
|Accounts payable and accrued liabilities                                   |  |                                | 216     |   |      |   | (576    | )
|Deferred revenue                                                           |  |                                | (2,458  | ) |      |   | (4,218  | )
|                                                                           |  |                                |         |   |      |   |         |  
|Net cash used in operating activities                                      |  |                                | (21,025 | ) |      |   | (9,907  | )
|                                                                           |  |                                |         |   |      |   |         |  
|Investing activities                                                       |  |                                |         |   |      |   |         |  
|Acquisition of property and equipment                                      |  |                                | (1,050  | ) |      |   | (1,748  | )
|Purchase of investments                                                    |  |                                | (39,855 | ) |      |   | (70,904 | )
|Proceeds from maturity of investments                                      |  |                                | 65,973  |   |      |   | 56,181  |  
|                                                                           |  |                                |         |   |      |   |         |  
|Net cash provided by (used in) investing activities                        |  |                                | 25,068  |   |      |   | (16,471 | )
|                                                                           |  |                                |         |   |      |   |         |  
|Financing activities                                                       |  |                                |         |   |      |   |         |  
|Proceeds from issuance of common stock                                     |  |                                | 967     |   |      |   | 1,401   |  
|Proceeds from equipment loans                                              |  |                                | 1,804   |   |      |   | 1,290   |  
|Principal payments under equipment loans                                   |  |                                | (1,603  | ) |      |   | (1,517  | )
|                                                                           |  |                                |         |   |      |   |         |  
|Net cash provided by financing activities                                  |  |                                | 1,168   |   |      |   | 1,174   |  
|                                                                           |  |                                |         |   |      |   |         |  
|Net increase (decrease) in cash and cash equivalents                       |  |                                | 5,211   |   |      |   | (25,204 | )
|Cash and cash equivalents at beginning of period                           |  |                                | 13,777  |   |      |   | 31,491  |  
|                                                                           |  |                                |         |   |      |   |         |  
|Cash and cash equivalents at end of period                                 |  | $                              | 18,988  |   |      | $ | 6,287   |  
|                                                                           |  |                                |         |   |      |   |         |  



See accompanying notes.



5



---

##### Table of Contents

KOSAN BIOSCIENCES INCORPORATED

NOTES TO CONDENSED FINANCIAL STATEMENTS

(unaudited)



1. Organization and Summary of Significant Accounting Policies



Overview



Kosan Biosciences Incorporated (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. Kosan Biosciences is a biotechnology company that currently has two first-in-class anticancer agents in Phase II and Phase Ib clinical trials:
KOS-862 (Epothilone D) and 17-AAG, an Hsp90 (heat shock protein 90) inhibitor and geldanamycin analog. Its most advanced compound, KOS-862, which is in a Phase II clinical trial and multiple Phase Ib clinical trials, and its follow-on compound,
KOS-1584, which is in Phase I clinical trials, are partnered with Hoffmann-La Roche Inc. and F. Hoffmann-La Roche Ltd., collectively Roche, through a global development and commercialization agreement. Under a Cooperative Research and Development
Agreement between the Company and the National Cancer Institute (NCI) Cancer Therapy Evaluation Program, the NCI is sponsoring Phase II and Phase Ib combination clinical trials of 17-AAG. The Company intends to use the data from these
studies to support the clinical development of KOS-953, a proprietary formulation of 17-AAG, currently in Phase I and Phase Ib clinical trials. In addition, the Company is developing KOS-1022 (DMAG), a highly-potent, water-soluble and
orally-available analog of geldanamycin, in Phase I clinical trials in collaboration with the NCI. The Company has generated a pipeline of additional product candidates for gastrointestinal motility, infectious diseases and cancer based on its
proprietary technologies for discovering, developing and manufacturing polyketide analogs. All of the Companys product candidates, including those in clinical development, are polyketides. Polyketides are an important class of natural products
that have yielded numerous pharmaceuticals for the treatment of cancer, infectious diseases, high cholesterol, transplant rejection and other diseases.



The Company has funded its operations primarily through sales of common stock and convertible preferred stock, contract payments under its collaboration
agreements, equipment financing arrangements and government grant awards.



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 September 30, 2005, and for the three and nine
months ended September 30, 2005 and 2004, 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 unaudited 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, 2004 filed with the Securities and Exchange Commission on March 16, 2005.



6



---

##### Table of Contents

KOSAN BIOSCIENCES INCORPORATED

NOTES TO CONDENSED FINANCIAL STATEMENTS (continued)

(unaudited)



1. Organization and Summary of Significant Accounting Policies
(continued)



Use of Estimates



The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities 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. The Company limits its concentration of risk by diversifying its investments among a variety of issuers. All investment securities are classified as available-for-sale and 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. Realized gains and losses and declines in the 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 the three and nine months ended September 30, 2005 and 2004, the Company did not recognize an impairment charge related to its investment securities.



The Company held a restricted investment consisting of a
certificate of deposit of approximately $949,000 at September 30, 2005 and December 31, 2004. This investment is carried at fair value and is restricted as to withdrawal under a letter of credit agreement related to a facility lease. This investment
is held in the Companys name and is included in long-term investments on the Companys financial statements.



Revenue Recognition



The Company generates revenue under collaborative agreements with pharmaceutical companies and under research grants from the National Institutes of
Health and the National Institute of Standards and Technology. The arrangements may include upfront 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) collectability is reasonably assured.



7



---

##### Table of Contents

KOSAN BIOSCIENCES INCORPORATED

NOTES TO CONDENSED FINANCIAL STATEMENTS (continued)

(unaudited)



1. Organization and Summary of Significant Accounting Policies
(continued)



Revenue Recognition (Continued)



The Company recognizes license and other upfront and
initial fees pursuant to research and development collaboration agreements over the estimated research and development term of the respective agreement. These estimated terms are reviewed on a periodic basis and updated if the underlying assumptions
are modified. 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 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. 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.



As the Companys epothilone and Hsp90 programs
advance into and through Phase II clinical trials, the related costs will have a significant effect on the Companys research and development expenses. Expenses related to clinical trials generally are accrued based on the level of patient
enrollment and activity according to the protocol. The Company monitors patient enrollment levels and related activity and adjusts estimates accordingly.



Research and development expenses under government grant awards and collaborative agreements approximated the revenue recognized, excluding milestone
payments, upfront and initial fees received under such arrangements.



Net
Loss per Share



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
potentially dilutive securities in the loss per share computation would be antidilutive.



8



---

##### Table of Contents

KOSAN BIOSCIENCES INCORPORATED

NOTES TO CONDENSED FINANCIAL STATEMENTS (continued)

(unaudited)



1. Organization and Summary of Significant Accounting Policies
(continued)



Net Loss per Share (continued)



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



|                                                                                      |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|------------------------------------------------------------------------------------- |  | ------------------------------- | ------ | - | ------------------------------ | - | ------ | ---- |  | - | ------- | - |  | - | ------- | -
|                                                                                      |  | Three Months EndedSeptember 30, |        |   | Nine Months EndedSeptember 30, |  
|                                                                                      |  | 2005                            |        |   | 2004                           |   |        | 2005 |  |   | 2004    |  
|Net loss                                                                              |  | $                               | (7,531 | ) |                                | $ | (5,872 | )    |  | $ | (22,862 | ) |  | $ | (15,177 | )
|                                                                                      |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Weighted-average shares of common stock outstanding                                   |  |                                 | 29,247 |   |                                |   | 28,946 |      |  |   | 29,180  |   |  |   | 28,890  |  
|Less: weighted-average shares subject to repurchase                                   |  |                                 |       |   |                                |   | (11    | )    |  |   |        |   |  |   | (27     | )
|                                                                                      |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Weighted-average shares used in computing basic and diluted net loss per common share |  |                                 | 29,247 |   |                                |   | 28,935 |      |  |   | 29,180  |   |  |   | 28,863  |  
|                                                                                      |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Basic and diluted net loss per common share                                           |  | $                               | (0.26  | ) |                                | $ | (0.20  | )    |  | $ | (0.78   | ) |  | $ | (0.53   | )
|                                                                                      |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  



Stock-Based Compensation



The Company accounts for common stock options granted to
employees using the intrinsic value method and, thus, recognizes 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. Deferred stock compensation
calculated for options granted with exercise prices less than the deemed fair value of the common stock is amortized over the vesting period of the individual options, generally four years, using the graded vesting method.



Pro forma net loss and net loss per share information is required by
Statement of Financial Accounting Standard (SFAS) No. 123, Accounting for Stock-Based Compensation (SFAS 123) and has been determined as if the Company had accounted for its employee stock options under the fair
value method of that statement. The effects of applying the intrinsic value method for either recognizing compensation expense or providing pro forma disclosures are not likely to be representative of the effects on net income for future years.



9



---

##### Table of Contents

KOSAN BIOSCIENCES INCORPORATED

NOTES TO CONDENSED FINANCIAL STATEMENTS (continued)

(unaudited)



1. Organization and Summary of Significant Accounting Policies
(continued)



Stock-Based Compensation (continued)



The Companys pro forma information follows (in thousands, except per
share data):



|                                                                                                        |  |                                  |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|------------------------------------------------------------------------------------------------------- |  | -------------------------------- | ------ | - | ------------------------------ | - | ------ | ---- |  | - | ------- | - |  | - | ------- | -
|                                                                                                        |  | Three Months Ended September 30, |        |   | Nine Months EndedSeptember 30, |  
|                                                                                                        |  | 2005                             |        |   | 2004                           |   |        | 2005 |  |   | 2004    |  
|Net loss attributable to common stockholders, as reported                                               |  | $                                | (7,531 | ) |                                | $ | (5,872 | )    |  | $ | (22,862 | ) |  | $ | (15,177 | )
|Plus: Stock-based employee compensation expense included in reported net loss                           |  |                                  |       |   |                                |   | 33     |      |  |   |        |   |  |   | 152     |  
|Less: Stock-based employee compensation expense determined under fair value based method for all awards |  |                                  | (427   | ) |                                |   | (967   | )    |  |   | (1,805  | ) |  |   | (2,991  | )
|                                                                                                        |  |                                  |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Pro forma net loss                                                                                      |  | $                                | (7,958 | ) |                                | $ | (6,806 | )    |  | $ | (24,667 | ) |  | $ | (18,016 | )
|                                                                                                        |  |                                  |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Basic and diluted net loss per common share:                                                            |  |                                  |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|As reported                                                                                             |  | $                                | (0.26  | ) |                                | $ | (0.20  | )    |  | $ | (0.78   | ) |  | $ | (0.53   | )
|Pro forma                                                                                               |  | $                                | (0.27  | ) |                                | $ | (0.24  | )    |  | $ | (0.85   | ) |  | $ | (0.62   | )



New Accounting Pronouncements



In December 2004, the Financial Accounting Standards
Board (FASB) issued SFAS No. 123 (revised 2004), Share-Based Payment (SFAS 123R). 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 Companys financial statements. The cost will be measured based on the fair value of the instruments issued. SFAS 123R replaces SFAS 123 and supersedes APB Opinion No. 25 (APB 25). As
originally issued in 1995, SFAS 123 established as preferable the fair-value-based method of accounting for share-based payment transactions with employees. However, SFAS 123 permitted entities the option of continuing to apply the guidance in APB
25, as long as the footnotes to financial statements disclosed what net income would have been had the preferable fair-value-based method been used. The Company will be required to apply SFAS 123R effective January 1, 2006 and is currently
evaluating the impact SFAS 123R will have on its financial statements. The adoption of SFAS 123R will increase the Companys future operating expenses.



In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections (SFAS 154), a replacement of APB No. 20
Accounting Changes (APB 20) and FASB Statement No. 3, Reporting Accounting Changes in Interim Financial Statements. SFAS 154 requires retrospective application to prior periods financial statements for
reporting a voluntary change in accounting principle, unless it is impracticable. APB 20 previously required that most voluntary changes in accounting principle be recognized by including in net income of the period of the change the cumulative
effect of changing to the new accounting principle. SFAS 154 also applies to changes required by an accounting pronouncement that does not include specific transition provisions and redefines restatement as the revising of previously issued
financial statements to reflect the correction of an error. SFAS 154 is effective January 1, 2006. The Company does not believe that the adoption of SFAS 154 will have a material impact to its financial statements.



10



---

##### Table of Contents

KOSAN BIOSCIENCES INCORPORATED

NOTES TO CONDENSED FINANCIAL STATEMENTS (continued)

(unaudited)



2. Research and Development Agreements



Roche



Effective September 2002, the Company entered into a research and development collaboration agreement (the
Agreement) with Roche. Under the terms of the Agreement, Roche has worldwide exclusive rights to market and sell KOS-862 (Epothilone D) and other epothilones (including KOS-1584) in the field of oncology, and the Company will co-develop
and has the right to co-promote the product in the United States. The Agreement provides for the Company to receive payments for the reimbursement of research and development expenditures, funding of a back-up program, achievement of clinical,
regulatory and commercial milestones, development activities and royalties on sales of collaboration products. In addition, the Company has the opportunity to increase its royalties through a buy-in at a later stage of clinical development and by
co-promotion of products resulting from the collaboration. Effective July 1, 2004, the Company entered into an amendment to the Agreement that provided for the reimbursement by Roche of certain costs incurred that exceeded the previously stipulated
amounts set forth in the Agreement.



In December 2004, upon the
commencement of a Phase I clinical trial of KOS-1584, the Company determined that the estimated clinical development period extended from the second half of 2007, which was initially estimated when the Company entered into the collaboration with
Roche in 2002, to the second half of 2009. The Companys initial estimate of the clinical development period contemplated development of one product candidate, KOS-862. The change in the estimate has resulted in a further deferral of the
unrecognized portion of the initial fee received in connection with its research and development collaboration agreement with Roche. For the nine months ended September 30, 2005 and 2004, the Company recognized revenue related to this agreement of
approximately $8.4 million and $17.1 million, respectively.



License
Agreements



The Company has collaborative and license
agreements with several academic, government and medical institutions. Included in research and development expenses were total payments made under these agreements of approximately $323,000 and $769,000 for the nine months ended September 30, 2005
and 2004, respectively and $675,000 for the three months ended September 30, 2004. There were no payments made for the three months ended September 30, 2005.



3. Comprehensive Loss



For the three and nine months ended September 30, 2005 and 2004, comprehensive loss was as follows (in thousands):



|                                                        |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|------------------------------------------------------- |  | ------------------------------- | ------ | - | ------------------------------ | - | ------ | ---- |  | - | ------- | - |  | - | ------- | -
|                                                        |  | Three Months EndedSeptember 30, |        |   | Nine Months EndedSeptember 30, |  
|                                                        |  | 2005                            |        |   | 2004                           |   |        | 2005 |  |   | 2004    |  
|Net loss                                                |  | $                               | (7,531 | ) |                                | $ | (5,872 | )    |  | $ | (22,862 | ) |  | $ | (15,177 | )
|Unrealized gain (loss) on available-for-sale securities |  |                                 | 26     |   |                                |   | 162    |      |  |   | 123     |   |  |   | (331    | )
|                                                        |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Comprehensive loss                                      |  | $                               | (7,505 | ) |                                | $ | (5,710 | )    |  | $ | (22,739 | ) |  | $ | (15,508 | )
|                                                        |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  



11



---

##### Table of Contents

KOSAN BIOSCIENCES INCORPORATED

NOTES TO CONDENSED FINANCIAL STATEMENTS (continued)

(unaudited)



4. Equipment Financing



The Company finances certain equipment and facility improvements under debt
obligations with terms of 48 months.



In April 2004, the
Company entered into a $3.5 million equipment line of credit agreement, of which $2.2 million had been utilized as of September 30, 2005. The interest rates of each of the loans are fixed at the time of the draw down, with the interest rates ranging
from 6.31% to 8.90%. Obligations under the loans are secured by the assets financed under the loans.



5. Accrued Liabilities



Accrued liabilities consisted of the following (in thousands):



|                                 |  |                   |       |                  |   |      
|-------------------------------- |  | ----------------- | ----- | ---------------- | - | -----
|                                 |  | September 30,2005 |       | December 31,2004
|Research and development-related |  | $                 | 3,214 |                  | $ | 2,896
|Compensation-related             |  |                   | 1,314 |                  |   | 1,602
|Professional services            |  |                   | 1,507 |                  |   | 718  
|Facilities-related               |  |                   | 801   |                  |   | 948  
|Other                            |  |                   | 282   |                  |   | 291  
|                                 |  |                   |       |                  |   |      
|                                 |  | $                 | 7,118 |                  | $ | 6,455
|                                 |  |                   |       |                  |   |      



6. Line of Credit Facility



In July 2005, the Company entered into a $35.0 million
secured line of credit facility with Silicon Valley Bank (Bank), a subsidiary of SVB Financial Group. Under the terms of the agreement, the Company has the option of making up to two draws through May 31, 2006, with a minimum initial
draw of $15.0 million. The credit facility contains financial covenants, including covenants requiring the Company to maintain: a ratio of unrestricted cash and cash equivalents, investments and eligible accounts to the aggregate principal amount
outstanding under the line of credit of at least 1.3 to 1; at least six months remaining months liquidity, which is calculated by dividing (i) cash and cash equivalents, investments and eligible accounts by (ii) the Companys cash
utilization calculated on a rolling three-month basis; and aggregate balances in its investment and operating accounts with Bank or SVB Asset Management equal to the lesser of (a) the amount of the aggregate outstanding principal amount under the
line of credit plus $5 million; and (b) 85% of the Companys aggregate cash and investment account balances. As of September 30, 2005, the Company had not made any draws on the facility.



12



---

##### Table of Contents

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 1933, as amended, and within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, which are subject to the safe harbor created by those sections. These forward-looking statements include, but
are not limited to, statements about:



| |  |  | our plans with respect to the timing of announcements of clinical data and initiation of clinical trials;
| | - |  | ---------------------------------------------------------------------------------------------------------



| |  |  | our expectations that KOS-862, KOS-1584, KOS-953 and KOS-1022 will advance further into clinical trials and that our research programs, including our motilide program, will be
advanced into later stages of development;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | our beliefs that the accounting policies identified in this report are the critical accounting policies that affect our more significant judgments and estimates used in the
preparation of our financial statements;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | sufficiency of our cash resources, including our belief that our existing cash and investment securities and anticipated cash flow from our existing collaboration with Roche will be
sufficient to support our current operating plan into at least the fourth quarter of 2006; and
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | our expectations to finance future cash needs through the sale of equity securities, debt financings, additional collaboration or license agreements or government grant awards.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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
Form 10-Q, including the section entitled Item 2: Managements Discussion and Analysis of Financial Condition and Results of Operations. These forward-looking statements involve risks and uncertainties, including the risks discussed
below under the heading Risks Factors That May Affect Results of Operations and Financial Condition, that could cause our actual results to differ materially from those in the forward-looking statements. We undertake no obligation to
publicly release any revisions to the forward-looking statements or reflect events or circumstances after the date of this document. The risks discussed below under the heading Risks Factors That May Affect Results of Operations and Financial
Condition and elsewhere in this report should be considered in evaluating our prospects and future financial performance.



Overview



We are a biotechnology company developing drug candidates from an important class of natural compounds known as polyketides. We have proprietary
technologies for the manipulation of polyketides, a rich source of pharmaceutical products. We use our platform technologies to develop product candidates that target large pharmaceutical markets. We have two first-in-class anticancer agents in
Phase II and Phase Ib clinical trials, both of which have follow-on compounds in Phase I clinical trials. The following is the status of our product candidates.



| |  |  | KOS-862 (Epothilone D). In collaboration with Roche, we are testing KOS-862, a potential anticancer agent, in Phase II and Phase Ib clinical trials. The ongoing
Phase II clinical trial, a metastatic breast cancer trial being conducted by Roche, is a Simon two-stage design trial that has an interim review and decision point following the completion of stage one before advancing to stage two. In April 2005,
we announced that this Phase II clinical trial had achieved the primary
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



13



---

##### Table of Contents

| | objective of the first stage and would proceed into the second stage of the trial. At the time of the analysis of data for an abstract submitted to the 2005
American Society of Clinical Oncology Annual Meeting, preliminary Phase II data from the metastatic breast cancer trial demonstrated that two of the then ten evaluable patients had confirmed partial responses by RECIST criteria. Updated interim
results of this trial are expected to be presented in December 2005. In October 2005, we discontinued our Phase II clinical trial in hormone refractory prostate cancer as it did not meet the primary objective of tumor marker response in the first
stage of the Simon two-stage trial design. The three ongoing Phase Ib trials are traditional dose-escalating trials in combination with other chemotherapeutic agents. Preliminary data from the Phase Ib trials of KOS-862 administered in combination
with Gemzar® and Paraplatin® suggested anti-tumor activity. The Phase Ib portion of the KOS-862 plus Herceptin® trial has completed enrollment, with the Phase II component of the trial expected to initiate enrollment in the fourth
quarter of 2005.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | KOS-1584 (second generation Epothilone D). In December 2004, in collaboration with Roche, we initiated a Phase I clinical trial of KOS-1584 in solid tumors. In July 2005, we
initiated a second Phase I clinical trial of KOS-1584 in solid tumors that is investigating a different dosing regimen.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | 17-AAG (geldanamycin analog). 17-AAG, an Hsp90 inhibitor, is being evaluated in multiple Phase II and Phase Ib combination clinical trials sponsored by the NCIs Cancer Therapy
Evaluation Program under a Cooperative Research and Development Agreement, or CRADA, between us and the NCI. We intend to use the data from these clinical trials to support the clinical development of KOS-953.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | KOS-953 (proprietary formulation of 17-AAG). We are developing our proprietary formulation of 17-AAG, which we refer to as KOS-953. During the second quarter of 2005, we presented
preliminary data from our Phase I and Phase Ib clinical trials of KOS-953 as monotherapy and in combination with Velcade® in patients with multiple myeloma. The data demonstrated early signs of anticancer activity and tolerability in an advanced
and heavily pre-treated population. We expect to report additional data from these trials in December 2005. We are also conducting Phase Ib clinical trials of KOS-953 in combination with Herceptin®, primarily in patients with metastatic breast
cancer, and Gleevec®, in patients with chronic myelogenous leukemia, and expect to announce preliminary data from the Herceptin combination clinical trial in December 2005.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | KOS-1022 (second generation proprietary geldanamycin analog, DMAG). In collaboration with the NCI, we are developing our second generation Hsp90 inhibitor, KOS-1022. The NCI
initiated Phase I clinical trials of KOS-1022 in solid tumors in July 2004. Under a Kosan-sponsored Investigational New Drug Application, or IND, filed in December 2004, we initiated a Phase I clinical trial of intravenously-delivered KOS-1022 in
hematologic malignancies in June 2005. We filed an IND for our oral formulation of KOS-1022 in July 2005.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



As announced on August 15, 2005, protocols and patient informed consents for the NCIs clinical studies of 17-AAG and KOS-1022 and our clinical
studies of KOS-953 and KOS-1022 were amended in response to five patients who showed electrocardiogram, or ECG, changes without clinically significant consequences after infusion of 17-AAG. After an initial machine reading of the ECGs, two of the
five cases were believed to represent QTc prolongation, which could lead to an increased risk for potentially serious ventricular arrhythmias. Subsequent centralized analysis and cardiologist interpretation of the ECGs from these two cases favorably
indicated that there was no clear evidence of clinically significant QTc prolongation and that the initial machine readings were inaccurate. The other three cases of ECG changes represented atrioventricular arrhythmias. These events were not
initially considered to be reportable adverse events, but were subsequently reported in light of the two potential cases of QTc prolongation discussed above. Preliminary conclusions by our external cardiology reviewers indicated that while other
factors may be involved, causation of the arrhythmias by 17-AAG or the DMSO (an excipient in the formulation used in the NCIs studies of 17-AAG) could not be excluded.



14



---

##### Table of Contents

We also have additional product candidates in the areas of gastrointestinal motility and infectious
disease that are undergoing preclinical evaluation and several early stage product and research technology development programs largely based on polyketides.



We have incurred significant losses since our inception. As of September 30, 2005, our accumulated deficit was approximately $124.1 million. We expect to
incur additional operating losses over the next several years as we continue to fund our research and development.



Velcade is registered trademark of Millenium Pharmaceuticals, Inc., Herceptin is a registered trademark of Genentech, Inc. and Gleevec is a registered
trademark of Novartis AG.



Critical Accounting Policies



Critical accounting policies are those that require significant judgment
and/or estimates by management at the time that the financial statements are prepared such that materially different results might have been reported if other assumptions had been made. We consider certain accounting policies related to revenue
recognition, clinical trial accruals and stock-based compensation to be critical policies. 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 our making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. The basis of our current estimates or assumptions has not changed since we filed our Annual Report on Form
10-K for the year ended December 31, 2004 with the SEC on March 16, 2005. Since December 31, 2004, we have not made any significant changes to either our policies or any significant estimates or assumptions.



Results of Operations



Revenues



Revenues were approximately $3.2 million and $9.4 million for the three and nine months ended September 30, 2005, respectively, compared to approximately
$6.8 million and $19.1 million for the same periods in 2004. Revenues in both periods consisted primarily of contract revenues recognized under our development and commercialization agreement with Roche and funded research related to government
grant awards.



|                                       |  |                                 |       |      |   |          |                                |     |      |  |      |       |          |   |        |  |     |  
|-------------------------------------- |  | ------------------------------- | ----- | ---- | - | -------- | ------------------------------ | --- | ---- |  | ---- | ----- | -------- | - | ------ |  | --- | -
|                                       |  | Three Months EndedSeptember 30, |       |      |   |          | Nine Months EndedSeptember 30, |     |      | 
|                                       |  | 2005                            |       | 2004 |   | % Change |                                |     | 2005 |  | 2004 |       | % Change |  
|(In thousands, except for percentages) |  |                                 |       |      |   |          |                                |     |      |  |      |       |          |  
|Contract revenue                       |  | $                               | 2,906 |      | $ | 5,842    |                                | -50 | %    |  | $    | 8,419 |          | $ | 17,076 |  | -51 | %
|Grant revenue                          |  |                                 | 311   |      |   | 915      |                                | -66 | %    |  |      | 1,011 |          |   | 1,982  |  | -49 | %
|                                       |  |                                 |       |      |   |          |                                |     |      |  |      |       |          |   |        |  |     |  
|Total revenues                         |  | $                               | 3,217 |      | $ | 6,757    |                                | -52 | %    |  | $    | 9,430 |          | $ | 19,058 |  | -51 | %
|                                       |  |                                 |       |      |   |          |                                |     |      |  |      |       |          |   |        |  |     |  



The decrease in
revenues of approximately 52%, or $3.5 million, and 51%, or $9.6 million, for the three and nine months ended September 30, 2005 compared to the same periods last year was the result of the following:



| |  |  | approximately $3.4 million and $9.8 million, respectively, in lower research funding as a result of the selection of KOS-1584 as a second-generation epothilone
compound and its advancement into clinical trials in December 2004, lower reimbursement for KOS-862 production-related activities due to the previous manufacture of sufficient clinical supply and lower clinical trial
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



15



---

##### Table of Contents

| | reimbursement associated with the conclusion of certain KOS-862 Phase I and Phase II clinical trials and the conduct of the Phase II clinical trial of
KOS-862 in hormone refractory prostate cancer at our own expense;
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | approximately $0.6 million and $1.8 million, respectively, in lower amortization of the $25.0 million initial fee from Roche, which is now being amortized through the second half of
2009, the current estimated clinical development period; and
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | approximately $0.6 million and $1.0 million, respectively, in lower grant revenue due to the timing of effort spent on our grants and a lower number of grant awards in 2005;
partially offset by
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | approximately $1.1 million and $2.9 million, respectively, in increased KOS-1584 clinical and production-related reimbursement.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------



If we do not maintain our agreement with Roche, our revenues will
significantly decrease unless we enter into additional collaborations that provide substantial new revenues.



Research and Development Expenses



Our research and development expenses decreased to approximately $9.3 million and $28.5 million for the three and nine months ended September 30, 2005, respectively, from approximately $11.3 million and $30.6 million
for the same periods in 2004. Our research and development activities 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. We group these activities into two major categories: research and preclinical and clinical development. 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 include those discussed in this report under the heading Risk Factors That May Affect Results of Operations and Financial Condition.



16



---

##### Table of Contents

|                                       |  |                          |        |                                  |   |        |  |      |                                |      |   |          |  |                               |        |  |      |   |          |   |        |  |   |        |  |     |   |  |   |        
|-------------------------------------- |  | ------------------------ | ------ | -------------------------------- | - | ------ |  | ---- | ------------------------------ | ---- | - | -------- |  | ----------------------------- | ------ |  | ---- | - | -------- | - | ------ |  | - | ------ |  | --- | - |  | - | -------
|                                       |  | Years Ended December 31, |        | Three Months Ended September 30, |   |        |  |      | Nine Months EndedSeptember 30, |      |   |          |  | Inception - September 30,2005
|                                       |  | 2004                     |        | 2003                             |   | 2002   |  | 2005 |                                | 2004 |   | % Change |  |                               | 2005   |  | 2004 |   | % Change |   |       
|(In thousands, except for percentages) |  |                          |        |                                  |   |        |  |      |                                |      |   |          |  |                               |        |  |      |   |          |   |        | 
|Clinical development                   |  |                          |        |                                  |   |        |  |      |                                |      |   |          |  |                               |        |  |      |   |          |   |        |  |   |        |  |     |   |  |   |        
|Epothilones                            |  | $                        | 12,101 |                                  | $ | 14,038 |  | $    | 8,848                          |      | $ | 2,794    |  | $                             | 3,924  |  | -29  | % |          | $ | 7,840  |  | $ | 9,500  |  | -17 | % |  | $ | 46,212 
|Hsp90 inhibitors                       |  |                          | 5,432  |                                  |   |       |  |      |                               |      |   | 2,509    |  |                               | 1,489  |  | 69   | % |          |   | 7,054  |  |   | 3,269  |  | 116 | % |  |   | 12,486 
|                                       |  |                          |        |                                  |   |        |  |      |                                |      |   |          |  |                               |        |  |      |   |          |   |        |  |   |        |  |     |   |  |   |        
|Total clinical development             |  |                          | 17,533 |                                  |   | 14,038 |  |      | 8,848                          |      |   | 5,303    |  |                               | 5,413  |  | -2   | % |          |   | 14,894 |  |   | 12,769 |  | 17  | % |  |   | 58,698 
|                                       |  |                          |        |                                  |   |        |  |      |                                |     
|Research and preclinical               |  |                          |        |                                  |   |        |  |      |                                |      |   |          |  |                               |        |  |      |   |          |   |        |  |   |        |  |     |   |  |   |        
|Epothilones                            |  |                          | 4,655  |                                  |   | 5,032  |  |      | 2,112                          |      |   | 49       |  |                               | 956    |  | -95  | % |          |   | 310    |  |   | 4,520  |  | -93 | % |  |   | 24,770 
|Hsp90 inhibitors                       |  |                          |       |                                  |   | 3,828  |  |      | 3,183                          |      |   | 197      |  |                               |       |  | NA   |   |          |   | 366    |  |   |       |  | NA  |   |  |   | 7,940  
|Other (1)                              |  |                          | 17,987 |                                  |   | 13,891 |  |      | 14,235                         |      |   | 3,786    |  |                               | 4,921  |  | -23  | % |          |   | 12,891 |  |   | 13,342 |  | -3  | % |  |   | 101,529
|                                       |  |                          |        |                                  |   |        |  |      |                                |      |   |          |  |                               |        |  |      |   |          |   |        |  |   |        |  |     |   |  |   |        
|Total research and preclinical         |  |                          | 22,642 |                                  |   | 22,751 |  |      | 19,530                         |      |   | 4,032    |  |                               | 5,877  |  | -31  | % |          |   | 13,567 |  |   | 17,862 |  | -24 | % |  |   | 134,239
|                                       |  |                          |        |                                  |   |        |  |      |                                |      |   |          |  |                               |        |  |      |   |          |   |        |  |   |        |  |     |   |  |   |        
|Total research and development         |  | $                        | 40,175 |                                  | $ | 36,789 |  | $    | 28,378                         |      | $ | 9,335    |  | $                             | 11,290 |  | -17  | % |          | $ | 28,461 |  | $ | 30,631 |  | -7  | % |  | $ | 192,937
|                                       |  |                          |        |                                  |   |        |  |      |                                |      |   |          |  |                               |        |  |      |   |          |   |        |  |   |        |  |     |   |  |   |        

---

|(1) | Other constitutes internal research and development costs for our early stage product candidates in the areas of gastrointestinal motility, infectious disease, cancer
and technology development. For the years ended December 31, 2004, 2003 and 2002, Other expenses consisted primarily of allocated personnel-related expenses of approximately $8.1 million, $5.7 million and $6.8 million, allocated
facility-related expenses of approximately $5.4 million, $3.8 million and $3.5 million and allocated lab consumables of approximately $1.4 million, $1.0 million and $905,000, respectively. During the three months ended September 30, 2005 and
2004, Other expenses consisted primarily of allocated personnel-related expenses of approximately $1.8 million and $2.2 million, allocated facility-related expense of approximately $1.1 million and $1.6 million, and allocated lab
consumables of approximately $260,000 and $415,000, respectively. During the nine months ended September 30, 2005 and 2004, Other expenses consisted primarily of allocated personnel-related expenses of approximately $6.1 million and $5.9
million, allocated facility-related expenses of approximately $4.1 million and $4.0 million and allocated lab consumables of $865,000 and $1.1 million, respectively. During the period from inception through September 30, 2005, Other
expenses consisted primarily of allocated personnel-related expenses of approximately $51.5 million, allocated facility-related expense of approximately $25.1 million and allocated lab consumables of $7.5 million.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



The decrease of 17%, or approximately $2.0 million, and 7%, or approximately
$2.2 million, in research and development expenses for the three and nine months ended September 30, 2005, respectively, compared to the same periods in 2004 was the result of the following:



| |  |  | approximately $0.9 million and $4.2 million in lower preclinical costs, respectively, primarily due to advancing KOS-1584 through IND-enabling studies in the first half of 2004; and
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | approximately $1.1 million and $1.7 million, respectively, in lower clinical development costs in our epothilone program due to non-recurring milestone payments made to a licensor
in the third quarter of 2004; partially offset by
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | approximately $1.0 million and $3.8 million, respectively, in higher clinical development costs in our Hsp90 inhibitor program, including initiation of our KOS-1022 Phase I clinical
trial, filing an IND for our oral formulation of KOS-1022 and further advancement of KOS-953 through Phase I and Phase Ib clinical trials.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



We expect that our research and development expenses will increase substantially as KOS-862, KOS-1584, KOS-953 and KOS-1022 advance further into the
clinic and as we advance our research programs, including our motilide program, into later stages of development.



17



---

##### Table of Contents

General and Administrative Expenses



|                                       |  |                                 |       |      |   |          |                                |   |      |  |      |       |          |   |       |  |    |  
|-------------------------------------- |  | ------------------------------- | ----- | ---- | - | -------- | ------------------------------ | - | ---- |  | ---- | ----- | -------- | - | ----- |  | -- | -
|                                       |  | Three Months EndedSeptember 30, |       |      |   |          | Nine Months EndedSeptember 30, |   |      | 
|                                       |  | 2005                            |       | 2004 |   | % Change |                                |   | 2005 |  | 2004 |       | % Change |  
|(In thousands, except for percentages) |  |                                 |       |      |   |          |                                |   |      |  |      |       |          |  
|General and administrative             |  | $                               | 1,763 |      | $ | 1,617    |                                | 9 | %    |  | $    | 4,827 |          | $ | 4,408 |  | 10 | %
|                                       |  |                                 |       |      |   |          |                                |   |      |  |      |       |          |   |       |  |    |  



For the three and nine
months ended September 30, 2005, the increase of 9% and 10%, respectively, or approximately $146,000 and $419,000, respectively, in general and administrative expenses compared to the same periods in 2004 was the result of the following:



| |  |  | approximately $469,000 and $575,000, respectively, in higher professional services expenses primarily for legal and audit-related expenses associated with the August 2005 terminated
offering of our common stock and increased fees for our financial statement and federal grant audit services; partially offset by
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | approximately $314,000 and $148,000, respectively, in lower employee-related expenses primarily associated with certain management departures in the third quarter of 2004.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------



We expect that our general and administrative
expenses will increase in the future to support the continued growth of our research and development efforts.



Other income, net



|                                       |  |                                 |     |   |      |   |     |                                |  |    |      |  |   |       |   |  |          |       |   |  |    |  
|-------------------------------------- |  | ------------------------------- | --- | - | ---- | - | --- | ------------------------------ |  | -- | ---- |  | - | ----- | - |  | -------- | ----- | - |  | -- | -
|                                       |  | Three Months EndedSeptember 30, |     |   |      |   |     | Nine Months EndedSeptember 30, |  |    |      | 
|                                       |  | 2005                            |     |   | 2004 |   |     | % Change                       |  |    | 2005 |  |   | 2004  |   |  | % Change |      
|(In thousands, except for percentages) |  |                                 |     |   |      |   |     |                                |  |    |      |  |   |       |   |  |          |      
|Interest income                        |  | $                               | 438 |   |      | $ | 367 |                                |  | 19 | %    |  | $ | 1,244 |   |  | $        | 1,070 |   |  | 16 | %
|Interest expense                       |  |                                 | (88 | ) |      |   | (89 | )                              |  | -1 | %    |  |   | (248  | ) |  |          | (266  | ) |  | -7 | %
|                                       |  |                                 |     |   |      |   |     |                                |  |    |      |  |   |       |   |  |          |       |   |  |    |  
|Other income, net                      |  | $                               | 350 |   |      | $ | 278 |                                |  | 26 | %    |  | $ | 996   |   |  | $        | 804   |   |  | 24 | %
|                                       |  |                                 |     |   |      |   |     |                                |  |    |      |  |   |       |   |  |          |       |   |  |    |  



Interest income
increased to approximately $438,000 and $1.2 million for the three and nine months ended September 30, 2005, respectively, from approximately $367,000 and $1.1 million for the same periods in 2004. The increase resulted from higher returns in the
current rising interest rate environment, partially offset by lower average investment balances in the first nine months of 2005 compared to the same period in 2004.



Interest expense decreased to approximately $88,000 and $248,000 for the three and nine months ended September 30, 2005 from
approximately $89,000 and $267,000 for the same periods in 2004. The decrease resulted from the lower average debt balances in the first nine months of 2005, partially offset by higher average interest rates on more recent debt-financing drawdowns.
We expect that our interest expense will increase in the future as a result of additional property and equipment-related debt financing combined with anticipated higher-interest rates and as a result of any draw downs on our credit facility.



Liquidity and Capital Resources



Since inception, we have financed our operations primarily through sales of
our convertible preferred stock and common stock, contract payments received under our corporate collaboration agreements and government grant awards, interest income and equipment financing arrangements. As of September 30, 2005, we had received
approximately $150.7 million from the sale of convertible preferred stock and



18



---

##### Table of Contents

common stock, approximately $99.8 million from contract payments received under our corporate collaboration agreements
and government grant awards, approximately $15.4 million from interest income and approximately $13.5 million from equipment financing arrangements. As of September 30, 2005, we had approximately $62.1 million in cash and investments, compared to
approximately $83.4 million as of December 31, 2004. Our funds are currently invested in U.S. Treasury and government agency obligations and corporate obligations.



Our operating activities used cash of approximately $21.0 million for the nine months ended September 30, 2005 compared to
approximately $9.9 million for the same period in 2004. Our net loss of approximately $22.9 million for the nine months ended September 30, 2005 was partially offset by non-cash charges of approximately $2.8 million related to stock-based
compensation, depreciation and amortization of investment premiums and discounts. Cash used for the same period in 2004 was primarily used to fund the net loss of $15.2 million, partially offset by non-cash charges of approximately $3.9 million
related to stock-based compensation, depreciation and amortization of investment premiums and discounts.



Our investing activities, excluding changes in our investments, for the nine months ended September 30, 2005, used cash of approximately $1.1 million,
compared to approximately $1.7 million for the same period in 2004, reflecting facility and capital expenditures as we continued to enhance and improve upon our laboratory capabilities.



Cash provided by financing activities was approximately $1.2 million for the nine months ended September 30, 2005 and 2004.
Financing activities for 2005 included approximately $201,000 in proceeds from equipment loans, net of scheduled payments on new and existing debt, and $967,000 in proceeds from the sale of our common stock related to stock option exercises and
stock purchases made under our 2000 Employee Stock Purchase Plan. Financing activities for 2004 included approximately $227,000 in scheduled payments on new and existing debt, net of proceeds from equipment loans, and $1.4 million in proceeds from
the sale of our common stock related to stock option exercises and stock purchases made under our 2000 Employee Stock Purchase Plan.



In April 2004, we entered into a $3.5 million equipment line of credit agreement for facility improvements and capital purchases, which was scheduled to
expire in April 2005, but has been extended through December 2005. As of September 30, 2005, we had utilized approximately $2.2 million of the line of credit, leaving approximately $1.3 million available for future draws. In July 2005, we entered
into a loan and security agreement with Silicon Valley Bank for a $35.0 million line of credit. Under the terms of the agreement, we have the option of making up to two draws through May 31, 2006, with a minimum initial draw of $15.0 million. As of
October 31, 2005, we had not utilized the line of credit.



We
believe that our existing cash and investment securities and anticipated cash flow from our existing collaboration with Roche will be sufficient to support our current operating plan into at least the fourth quarter of 2006. We expect to obtain
additional financing from time to time, or focus our spending on priority programs to provide for the proper alignment of resources and maintenance of sufficient levels of financial reserves. 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 any new collaborations, our rights and obligations under any new collaboration agreements and our ability to generate revenues under any new collaborations;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the extent to which clinical and other development activities are funded by our current collaborators, Roche and the NCI;
| | - |  | -------------------------------------------------------------------------------------------------------------------------



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



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



| |  |  | our ability to maintain or extend our existing collaborations with Roche and the NCI;
| | - |  | -------------------------------------------------------------------------------------



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



19



---

##### Table of Contents

| |  |  | 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;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | our ability to obtain regulatory approvals for our product candidates and the costs and timing of doing so;
| | - |  | -----------------------------------------------------------------------------------------------------------



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



| |  |  | any need to build commercial infrastructure to market our products; and
| | - |  | -----------------------------------------------------------------------



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



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



We expect that additional financing will be required in the future to fund operations. We expect to finance future cash needs through the public or
private sale of equity securities, debt financings, additional collaboration or licensing arrangements, government grant awards or any combination of the foregoing or other arrangements. In September 2003, we filed a registration statement on Form
S-3 to offer to sell common stock in one or more offerings up to a dollar amount of $75.0 million. In December 2003, we completed a registered direct offering of 3,115,000 shares of common stock at a price of $9.00 per share. We received
approximately $26.0 million in net proceeds after placement agent fees and other offering costs. As of September 30, 2005, approximately $47.0 million remained available on the Form S-3. In December 2004, we filed an additional registration
statement on Form S-3 to offer to sell common stock and/or warrants in one or more offerings up to a dollar amount of $50.0 million. In aggregate, approximately $97.0 million remain available on both Forms S-3.



In July 2005, we entered into a loan and security agreement with Silicon
Valley Bank for a $35.0 million line of credit. Under the terms of the agreement, we have the option of making up to two draws through May 31, 2006, with a minimum initial draw of $15.0 million. The credit facility contains financial covenants,
including covenants requiring us to maintain: a ratio of unrestricted cash and cash equivalents, investments and eligible accounts to the aggregate principal amount outstanding under the line of credit of at least 1.3 to 1; at least six months
remaining months liquidity, which is calculated by dividing (i) cash and cash equivalents, investments and eligible accounts by (ii) our cash utilization calculated on a rolling three-month basis; and aggregate balances in its investment
and operating accounts with Bank or SVB Asset Management equal to the lesser of (a) the amount of the aggregate outstanding principal amount under the line of credit plus $5.0 million; and (b) 85% of the our aggregate cash and investment account
balances. As of October 31, 2005, we have not made any draws on the facility.



We have no current commitments to offer and sell any securities that may be offered or sold pursuant to the registration statements described above. 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. If additional funds are obtained by issuing equity securities, substantial dilution to existing stockholders may result. In addition, see Risk Factors
That May Affect Results of Operations and Financial Condition.



20



---

##### Table of Contents

As of September 30, 2005, our obligations and commitments to make future payments under contracts, such
as debt and lease agreements, and under contingent commitments were as follows:



|                                   |  |       |        |                 |   |           |  |           |       |               |   |       |  |   |      
|---------------------------------- |  | ----- | ------ | --------------- | - | --------- |  | --------- | ----- | ------------- | - | ----- |  | - | -----
|                                   |  | Total |        | Less than1 Year |   | 1-3 Years |  | 4-5 Years |       | After 5 Years
|(in thousands)                     |  |       |        |                 |   |           |  |           |       |              
|Equipment financing obligations    |  | $     | 4,357  |                 | $ | 2,202     |  | $         | 1,999 |               | $ | 156   |  | $ |     
|Operating leases                   |  |       | 9,662  |                 |   | 1,616     |  |           | 2,985 |               |   | 2,196 |  |   | 2,865
|                                   |  |       |        |                 |   |           |  |           |       |               |   |       |  |   |      
|Total contractual cash obligations |  | $     | 14,019 |                 | $ | 3,818     |  | $         | 4,984 |               | $ | 2,352 |  | $ | 2,865
|                                   |  |       |        |                 |   |           |  |           |       |               |   |       |  |   |      



Risk Factors That May Affect
Results of Operations and Financial Condition



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



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



We commenced operations in 1996 and are still
in an early stage of development. We have not commercialized any products, and we have incurred significant losses to date. As of September 30, 2005, we had an accumulated deficit of approximately $124.1 million. To date, our revenues have been
primarily from collaborations and government grant awards. Our expenses have consisted principally of costs incurred in research and development and from general and administrative costs associated with our operations. We have incurred net losses
since our inception, including a net loss of approximately $22.9 million for the nine months ended September 30, 2005. We expect our expenses to increase and to continue to incur operating losses for at least the next several years as we continue
our research and development efforts for our drug candidates and research programs. The amount of time necessary to successfully commercialize any of our drug 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 in the future to fund
operations. We do not know whether additional financing will be available when needed, or that, if available, we will obtain financing on favorable terms. We have consumed substantial amounts of cash to date and expect capital outlays and operating
expenditures to increase over the next several years as we expand our infrastructure and research and development activities.



We may raise additional financing through public or private equity offerings, debt financings, additional collaboration or licensing arrangements,
government grant awards or any combination of the foregoing or other arrangements. To the extent we raise additional capital by issuing equity securities, our stockholders may experience dilution.



In July 2005, we entered into a $35.0 million line of credit facility.
However, we may not be able to borrow funds under this credit facility if we are not able to meet various conditions, covenants and representations, including covenants requiring us to maintain:



| |  |  | a ratio of unrestricted cash and cash equivalents, investments and eligible accounts to the aggregate principal amount outstanding under the line of credit of at least 1.3 to 1;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



21



---

##### Table of Contents

| |  |  | at least six months remaining months liquidity, which is calculated by dividing (a) cash and cash equivalents, investments and eligible accounts by (b) our cash burn
calculated on a rolling three-month basis; and
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | aggregate balances in our investment and operating accounts with Silicon Valley Bank or SVB Asset Management equal to the lesser of (a) the amount of the aggregate outstanding
principal amount under the line of credit plus $5.0 million; and (b) 85% of our aggregate cash and investment account balances.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



We may need to raise additional capital in order to stay in compliance with these covenants. Further debt financing, if available, may subject us to similar or additional
restrictive covenants and significant interest costs.



To the
extent that we raise additional funds through collaboration and licensing arrangements, it may be necessary to relinquish some rights to our technologies, product candidates or marketing territories.



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. See Item 2. Managements Discussion and Analysis of Financial Condition and Result of Operations -Liquidity and Capital
Resources.



We believe that our existing cash and
investment securities and anticipated cash flow from our existing collaboration with Roche will be sufficient to support our current operating plan into at least the fourth quarter of 2006, although we may choose to obtain additional financing from
time to time. 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 any new collaborations, our rights and obligations under any new collaboration agreements and our ability to generate revenues under any new collaborations;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | the extent to which clinical and other development activities are funded by our current collaborators, Roche and the NCI;
| | - |  | -------------------------------------------------------------------------------------------------------------------------



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



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



| |  |  | our ability to maintain or extend our existing collaborations with Roche and the NCI;
| | - |  | -------------------------------------------------------------------------------------



| |  |  | 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;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | our ability to obtain regulatory approvals for our product candidates and the costs and timing of doing so;
| | - |  | -----------------------------------------------------------------------------------------------------------



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



| |  |  | any need to build commercial infrastructure to market our products; and
| | - |  | -----------------------------------------------------------------------



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



22



---

##### Table of Contents

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



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



We control neither the amount and timing of resources that our collaborators
devote to our programs or potential products, nor the scope, content and timing of the efforts that they conduct or permit under the collaborations. As a result, we do not know if our collaborators will dedicate sufficient resources or if the
development or commercialization efforts by our corporate partners will be successful. We also do not know if the development or commercialization efforts by our collaborators 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 particular, in our collaboration with Roche, we do not control the amount and timing of resources that Roche devotes to the epothilone program beyond limited
funding for certain Kosan activities specified under the contract, and we do not control the scope, content and timing of the preclinical studies, clinical trials and other development efforts that Roche conducts or permits under the program. For
example, we anticipate that Roche may pursue further clinical development of only one of our epothilone product candidates, and Roche may elect to cease development of KOS-862, our lead epothilone compound, in favor of further development of
KOS-1584, which is currently in Phase I clinical trials. In our collaboration with the NCI, we do not control the selection, conduct, timing and resources provided to clinical trials of geldanamycin analogs sponsored by the NCI. For these reasons,
we may choose to undertake product development efforts that are within the scope of our collaborations at our own expense. We also do not know whether our current collaborative partners or future collaborative partners, if any, might pursue
alternative technologies or develop alternative products either on their own or in collaboration with others, including our competitors, as a means for developing treatments for the diseases targeted by collaborative arrangements with us. In
addition, business combinations or significant changes in a collaborators business strategy may adversely affect a collaborators willingness or ability to continue the collaboration with us.



Failure by our corporate partners to develop or commercialize a compound or
product for which they have rights from us could materially harm our business, financial condition and results of operations. For example, if Roche does not successfully develop and commercialize a product from our epothilone program, we may not
receive any future milestone payments and will not receive any royalties under our collaboration with Roche.



If our collaborators fail to conduct the collaborative activities 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. If any of our existing collaboration agreements are terminated, we may be required to
seek new collaborators or to undertake product development and commercialization at our own expense. This may limit the number of product candidates we will be able to develop and commercialize, significantly



23



---

##### Table of Contents

increase our capital requirements and reduce the likelihood of successful product introduction. Disputes might also arise
with collaborators or licensors concerning rights to particular compounds or technologies. If we are unable to resolve these disputes in our favor, we could lose our rights to use those compounds or technologies.



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



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



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



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



Our products must satisfy rigorous standards of safety and efficacy before they can be approved by the FDA and international regulatory authorities for
commercial use. We will need to conduct significant additional research, preclinical testing and clinical trials before we can determine if our products are sufficiently safe and effective to file with the FDA and other regulatory agencies for
product approval. Clinical trials are expensive, and therefore, significant amounts of money will need to be spent testing our products.



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 animal and human testing are highly uncertain.



We must provide the FDA and foreign regulatory authorities with clinical data that demonstrate the safety and efficacy of our products before they can be
approved for commercial sale. As a result, commercialization of our product candidates depends upon successful completion of 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. For example, in October 2005, we discontinued a Phase II clinical study of KOS-862 in hormone-refractory prostate cancer because the study did
not meet the primary objective of tumor market response in the first



24



---

##### Table of Contents

stage of a two stage clinical trial, and we previously discontinued clinical studies of KOS-862 in patients with
non-small cell lung cancer and colorectal cancer. We could experience similar failures in other current or future clinical testing of our product candidates.



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 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.



We do not know whether clinical trials of our product candidates (including ongoing and anticipated clinical trials of KOS-862, KOS-1584, 17-AAG, KOS-953,
KOS-1022 or other product candidates) will begin on time or whether any of our clinical trials will be completed on schedule, or at all. We also do not know whether clinical trials will indicate that an earlier-stage compound, such as KOS-1584 or
KOS-1022, will be more appropriate for commercial development than a related compound that is at a later stage of clinical development, such as KOS-862 or KOS-953, respectively. Negative or inconclusive results or adverse medical events during a
clinical trial could cause a clinical trial to be suspended, repeated or terminated. Certain of the clinical trials of our product candidates are 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 related trial.



We have multiple product candidates in human clinical trials for the
treatment of cancer, KOS-862, KOS-1584, 17-AAG, KOS-953 and KOS-1022. Anticancer drugs generally 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. For example, in June 2004, we discontinued a Phase II clinical study of KOS-862 in colorectal cancer due to unanticipated cumulative drug toxicities in patients who had previously been treated with the cancer treatment oxaliplatin.
We also observed a higher incidence of adverse events resulting in patient withdrawal in our Phase II clinical study of KOS-862 in hormone-refractory prostate cancer than in our Phase II non-small cell lung cancer trial. We cannot predict whether
future trials of KOS-862, or other compounds, will demonstrate toxicity issues or adverse events resulting in a significant patient withdrawal.



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 may be suspended at any time if we, our collaborators, 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. For example, in September 2005, we temporarily suspended enrollment in our KOS-953 and KOS-1022
clinical trials in connection with a request by the FDA to amend the protocols and patient informed consents for those trials. We provided amended protocols and informed consents for those clinical trials to the FDA in response to certain of its
requested changes, but have not received a response. The FDA may require further changes to these protocols and informed consents, which changes may have a material adverse effect on the timing of, and our ability to conduct, the KOS-953 and
KOS-1022 clinical trials.



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 investigational institutional review board to conduct a clinical trial;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



25



---

##### Table of Contents

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



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



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



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



| |  |  | 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 our collaborators or we 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 and novelty 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. 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 products. 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.



26



---

##### Table of Contents

We do not know whether clinical trials for our product candidates (including ongoing and anticipated
clinical trials of KOS-862, KOS-1584, KOS-953, KOS-1022 or other product candidates) will demonstrate safety and efficacy sufficient to obtain the requisite regulatory approvals or will result in marketable products. Our failure to adequately
demonstrate the safety and efficacy of our products under development will prevent receipt of FDA and foreign approvals and, ultimately, commercialization of our products.



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



We do not have the ability to independently conduct clinical trials for our
products, and we rely on third parties such as contract research organizations, medical institutions and clinical investigators to perform this function. We also rely on Roche to conduct certain clinical trials for KOS-862 and potentially KOS-1584
and the NCI to conduct certain clinical trials for 17-AAG and KOS-1022. We may rely on future collaborators 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, 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 17-AAG for 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, and for a period of seven years in the United States. Our competitors may obtain orphan drug exclusivity for a
product containing 17-AAG before we do, in which case we would be excluded from that market. 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
collaborators or us, including requiring withdrawal of the product from the market.



27



---

##### Table of Contents

If any of our approved products, our collaborators or we 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 collaborators;
| | - |  | ------------------------------------------------------------------------------------------------------------------



| |  |  | 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 products 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.



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, the patent positions of biotechnology companies, including our patent position, 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. In particular, two of our
exclusively licensed patents, which cover KOS-862 and its use, are the subject of an interference proceeding with a patent application concerning epothilones C, D, E, and F filed by Gesellschaft für Biotechnologische Forschung (GBF). This
application is licensed to Bristol-Myers Squibb. Patents may be challenged, held unenforceable, invalidated or circumvented. Thus, any patents that we own or license from third parties may not provide protection against competitors.



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 and enforceable;
| | - |  | -------------------------------------------------------------------



| |  |  | any patents issued to us or our licensors and 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, drug 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



28



---

##### Table of Contents

broad to prevent others from practicing our technologies or from developing competing products and technologies. For
example, 17-AAG, the active pharmaceutical ingredient in the two most advanced product candidates in our Hsp90 inhibitor program, was originally disclosed in a now-expired third party patent. These two product candidates are the formulation of
17-AAG being studied by the NCI under our CRADA and KOS-953, our proprietary formulation of 17-AAG. Consequently, others can develop products containing 17-AAG. We are aware of at least two other companies that have been developing product
candidates containing or based on 17-AAG, and these companies have filed patent applications relating to their products in development. Other competitors may be currently developing, or may in the future develop, products containing or based on
17-AAG. 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.



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



Patents related to our lead compound, KOS-862, are the subject of an interference involving patent rights licensed to us. Oppositions have been filed in Europe against
patents granted to a third party that cover this compound. These proceedings or any other proceedings are costly, and an unfavorable outcome could prevent us from commercializing this compound.



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. Two of our exclusively licensed patents, which cover
KOS-862 and its use, are the subject of an interference proceeding with a patent application concerning epothilones C, D, E and F filed by GBF. GBF has licensed this patent application to Bristol-Myers Squibb, one of our competitors. Further, we
believe one or more interferences may be declared between patents and applications we own or have exclusively licensed and patents and applications owned by Novartis relating to epothilone biosynthetic genes; and patents and applications owned by
Abbott Laboratories or Biotica Technologies Ltd. relating to erythromycin PKS genes, methods for altering PKS genes, and erythromycin analogs. In April 2005, a hearing was held at the European Patent Office to address an opposition filed by Biotica
to one of our exclusively licensed patents related to the recombinant production of polyketides. Although the written decision has not yet been issued, at the hearing, the patent was maintained (upheld), but with narrowing amendments; the time for
Biotica to appeal the ruling has not yet expired. In addition, the European Patent Office has recently granted patents to GBF, which we believe to be licensed to Bristol-Myers Squibb and which, if valid in individual European countries, would cover
Epothilone D in those countries. Formal oppositions to these patents have been filed with the European Patent Office and we expect responses by GBF to those oppositions to continue into 2006.



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. 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



29



---

##### Table of Contents

be substantial and could include ongoing royalties. Furthermore, we cannot be certain that a license would be available
to us on satisfactory terms, if at all. Companies and others developing products that could compete with our product candidates, such as Bristol-Myers Squibb and Novartis in the area of potential epothilone products, may be particularly unwilling to
grant us a license at any price. If we are not able to obtain necessary licenses, we may not be able to manufacture or commercialize, which could 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 drug candidates that we are developing or desire to develop; methods of treatment or
administration involving our drug candidates; formulations of our drug 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.



The biotechnology industry is characterized by extensive litigation regarding patents and other intellectual property rights. We are aware of patents and
published patent applications that, if valid, and if we are unsuccessful in circumventing or acquiring the rights to these patents, may block our ability to commercialize products based on the drug candidates that we are developing or pursue our
polyketide synthase (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 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



30



---

##### Table of Contents

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



Currently, we are
the sole manufacturer of the active pharmaceutical ingredient for KOS-862, we rely on contract manufacturers for the active pharmaceutical ingredient for KOS-1584, we use a single outside contractor to formulate drug product for KOS-862 and drug
product for KOS-1584 is formulated at our facilities and by an outside contractor. We maintain limited inventories of formulated drug product for KOS-862 and KOS-1584 at our facilities in Hayward, California and at the facilities of an outside
contractor. Limited inventories of formulated drug product for KOS-862 are also maintained by Roche.



In our Hsp90 inhibitor program, we currently use two manufacturers to make the active pharmaceutical ingredients for 17-AAG, KOS-953 and KOS-1022. We
formulate the final drug product for KOS-953 at our own facility and through contract manufacturers. We formulate the final drug product for KOS-1022 through contract manufacturers. The NCI formulates drug product for 17-AAG. We maintain a limited
inventory of KOS-953 and KOS-1022 at our facilities in Hayward, California, and we also maintain a limited inventory at the facilities of an outside contractor. The NCI is not obligated to maintain an inventory of either the active pharmaceutical
ingredient or formulated drug product for 17-AAG or KOS-1022.



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. 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 products, including:



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



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



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



| |  |  | the delay of product shipments due to U.S. custom regulations or third-party carriers used to transport our products, and damage to our products 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
products;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  |  | difficulties in scaling-up production of our products 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



31



---

##### Table of Contents

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. Our access to any key intermediates, active pharmaceutical ingredient or formulated drug product for our product candidates sourced or
inventoried solely through our facilities in Hayward, California may be subject to interruption in the event of an earthquake.



As discussed above, we rely upon outside contractors to manufacture and supply to us key intermediates, active pharmaceutical ingredients and formulated
drug product for our product candidates. Our dependence upon others for the manufacture of our product candidates and components thereof may adversely affect our ability to continue in a timely manner clinical development of our product candidates
and may adversely affect any future profit margins and our ability to commercialize any products that we may develop on a timely and competitive basis. 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 or timeframe 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.



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 employees and recruiting qualified scientific personnel to perform future research and development work, as well as manufacturing and key management personnel, will be critical to our success. We may also need to hire personnel with
expertise in clinical testing, government regulation, marketing, law and finance. In the past, we have experienced turnover among our management. In addition, none of our employees have employment commitments for any fixed period of time and could
leave our employment at will. 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 collaborations and develop our products and core technologies to the extent otherwise possible.



In December 2004, the Financial Accounting Standards Board, or FASB, issued Statement No. 123 (revised 2004)
Share-Based Payment, or SFAS 123R, which will require us to record a charge to earnings for the compensation cost relating to share-based payment transactions, including stock options and employee stock purchase plans, effective January
1, 2006. We are currently evaluating option valuation methodologies and assumptions permitted by the FASB for purposes of implementing the change in accounting treatment. This change will have a negative impact on our financial results.



32



---

##### Table of Contents

Our 1996 Stock Option Plan is expected to expire on June 12, 2006. New regulations implemented by the
NASDAQ National Market require shareholder approval for all stock option plans, and new regulations implemented by the New York Stock Exchange prohibit NYSE member organizations from giving a proxy to vote on equity-compensation plans unless the
beneficial owner of the shares has given voting instructions. As a result of these regulations, we will not be able to grant stock options to employees after our 1996 Stock Option Plan expires unless our stockholders approve a new plan. If a new
stock option plan is not approved, we may incur increased compensation costs, be required to change our equity compensation strategy or find it difficult to attract, retain and motivate employees, each of which could materially and adversely affect
our business.



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 or currently possess technologies or products that are superior alternatives to ours. For example, competing epothilones in clinical development include those being developed by
Bristol-Myers Squibb (reported to be in Phase III clinical trials), Novartis AG (reported to be in Phase II clinical trials) and Schering AG (reported to be in Phase I clinical trials). Both Conforma Therapeutics and Infinity Pharmaceuticals have
initiated Phase I clinical trials with compounds containing or based on 17-AAG. Further, our competitors in the polyketide gene-engineering field may be more effective at implementing their technologies to develop commercial products or may hold or
develop patents or other proprietary rights that may prevent us from practicing our technologies and pursuing our programs. Some of these competitors have entered into collaborations with leading companies within our target markets to produce
polyketides for commercial purposes.



Any products that we
develop through our technologies will compete in multiple, highly competitive markets. Development of pharmaceutical products requires significant investment and resources. 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 compounds with attractive pharmaceutical properties and to secure and protect intellectual property rights based on our innovations;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  |  | the speed at which we develop our product candidates;
| | - |  | -----------------------------------------------------



| |  |  | our ability to design and successfully execute appropriate clinical trials;
| | - |  | ---------------------------------------------------------------------------



| |  |  | the timing and scope of regulatory approvals;
| | - |  | ---------------------------------------------



| |  |  | our ability to manufacture and sell commercial quantities of future products to the market;
| | - |  | -------------------------------------------------------------------------------------------



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



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



33



---

##### Table of Contents

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 in the future 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.



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



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



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



We have adopted a rights agreement under which all stockholders have the
right to purchase shares of a new series of preferred stock at an exercise price of $70.00 per one one-hundredth of a share, if a person acquires more than 20% of our common stock. The rights plan could make it more difficult for a person to



34



---

##### Table of Contents

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.



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



Our officers, directors and their affiliates together
controlled approximately 23% of our outstanding common stock as of September 30, 2005. As a result, these stockholders, if they act together, are able to exert a significant degree of influence over our management and affairs and over matters
requiring stockholder approval, including the election of directors and approval of significant corporate transactions. This concentration of ownership may delay or prevent a change in control of us and might affect the market price of our common
stock, even when a change may be in the best interests of all stockholders. In addition, the interests of this concentration of ownership may not always coincide with our interests or the interests of other stockholders, and accordingly, they could
cause us to enter into transactions or agreements, which we would not otherwise consider.



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



The trading price of our common stock has been, and is likely to continue to be, highly volatile. During the period from September 30, 2004 through
September 30, 2005, our common stock traded between $3.98 and $9.65 on the NASDAQ National Market. The trading price of our common stock could be subject to wide fluctuations in price in response to various factors, many of which are beyond our
control, including:



| |  |  | 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 by our collaborators or us;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | 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 by our collaborators or us in obtaining regulatory approvals for our product candidates;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



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



| |  |  | announcements of expirations, terminations or amendments of collaborations, licenses or government research grants, or announcements that we have entered into new collaboration,
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 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



35



---

##### Table of Contents

operating performance. In the past, following periods of volatility in the market price of a companys securities,
securities class-action litigation has often been instituted against that company. If this type of litigation were instituted against us, we would be faced with substantial costs and managements attention and resources would be diverted, which
could in turn seriously harm our business, financial condition and results of operations.



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



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



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



| |  |  | the success rate of our efforts leading to milestone payments and royalties under our collaboration agreement with Roche or any future collaboration or license agreements;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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



| |  |  | general and industry specific economic conditions, which may affect our collaborators research and development expenditures; and
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------



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



We expect a large portion of our expenses to be relatively fixed, including
expenses for facilities, equipment and personnel. Accordingly, if revenues decline or do not grow due to expiration, termination or amendment of current or future collaboration agreements, licenses 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.



Changes in the accounting treatment of stock options will adversely affect our results of operations.



Changes in the accounting treatment of stock options will require us to account for employee stock options as compensation expense on our financial
statements. In December 2004, FASB issued SFAS 123R, which will require us to record a charge to earnings for the compensation cost relating to share-based payment transactions, including stock options and employee stock purchase plans, effective
January 1, 2006. We are currently evaluating option valuation methodologies and assumptions permitted by the FASB for purposes of implementing the change in accounting treatment. This change will have a negative impact on our financial results.



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



Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, on an annual basis, our management is required to report on, and
our independent auditors to attest to, the effectiveness of our internal controls



36



---

##### Table of Contents

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, 2004, there may be changes in our
systems, processes or operations that will effect 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 controls 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 assessment, investor confidence and our stock price could be adversely affected.



37



---

##### Table of Contents

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 maximize the income we receive from our investments
without significantly increasing risk. Some of the securities that we invest in may have market risk. This means that a change in prevailing interest rates may cause the principal amount of the investments to fluctuate. To minimize this risk in the
future, we intend to maintain our portfolio of cash equivalents and investments in a variety of securities, including commercial paper, money market funds, government and non-government debt securities and investment-grade corporate obligations.
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%, as of September 30, 2005 rates, the fair value of our portfolio would decline by approximately $214,000 on that date.



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 September 30, 2005 (dollars in thousands):



|                          |  |      |        |   |      |   |        |  
|------------------------- |  | ---- | ------ | - | ---- | - | ------ | -
|                          |  | 2005 |        |   | 2006 |  
|Cash and cash equivalents |  | $    | 18,988 |   |      | $ |       |  
|Average interest rates    |  |      | 3.58   | % |      |   |        |  
|                          |  |     
|Short-term investments    |  |      | 11,443 |   |      |   | 28,734 |  
|Average interest rates    |  |      | 2.18   | % |      |   | 2.97   | %
|                          |  |     
|Long-term investments     |  |      | 949    |   |      |   | 1,973  |  
|Average interest rates    |  |      | 0.65   | % |      |   | 3.00   | %



We did not hold any
derivative instruments as of September 30, 2005, and we have never held such instruments in the past. In addition, we had outstanding debt, consisting of borrowings under equipment financings, of $4.0 million as of September 30, 2005, with a range
of interest rates from 6.31% to 8.90%.



Item 4:Controls and Procedures



Evaluation of Disclosure Controls and Procedures. Based on their evaluation as of September 30, 2005, our chief executive officer and chief financial officer have concluded that the Companys disclosure controls and procedures
(as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act)) are effective to ensure that information required to be disclosed by us in reports that we file or submit under the
Exchange Act is recorded, processed, summarized and reported within the time periods specified by the Securities and Exchange Commissions rules and forms.



Changes in Internal Controls over Financial Reporting.There were no changes in our internal controls over financial reporting (as defined in Rule 13a-15(f)
under the Exchange Act) during the quarter ended September 30, 2005 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.



Limitations on the Effectiveness of Controls. The Companys management, including
our chief executive officer and chief financial officer, does not expect that our disclosure controls and procedures or our internal controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can
provide only reasonable, not absolute, assurance that the objectives of the control system are



38



---

##### Table of Contents

met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits
of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company
have been detected.



39



---

##### Table of Contents

PART II. OTHER INFORMATION



Item 5:Other Information



Upon the recommendation of the Corporate Governance and Nominating Committee of the Board of Directors, on July 26, 2005, the Board of Directors approved the following changes to the compensation of the members of the
Strategic Advisory Committee (the Committee):



| |  |  | the chairman of the Committee will receive an annual retainer of $25,000, but will not receive any fee for meetings attended; and
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------



| |  |  | the other members of the Committee will receive a fee of $2,000 for each meeting attended, but will not receive an annual retainer.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------



The members of the Committee remain Peter Davis, Ph.D., Charles J. Homcy, M.D. and
Christopher T. Walsh, Ph.D.



Item 6:Exhibits



|            |  |                                                                                                                                                                                                                                                           
|----------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  |                                                                                                                                                                                                                                                           
|3.1         |  | Amended and Restated Certificate of Incorporation. (1)                                                                                                                                                                                                    
|            | 
|3.2         |  | Amended and Restated Bylaws of Registrant. (2)                                                                                                                                                                                                            
|            | 
|4.1         |  | Form of Specimen 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)                                                                                                                                                                           
|            | 
|10.35       |  | Compensation of Strategic Advisory Committee of Board of Directors                                                                                                                                                                                        
|            | 
|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 the Chief Financial Officer of Kosan Biosciences Incorporated, as required by Rule 13a-14(b) or Rule 15d-14(b) and Section 1350 of Chapter 63
of Title 18 of the United Stated Code (18 U.S.C. 1350). (5)

---

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

|(5) | This certification accompanies the Quarterly Report on Form 10-Q to which it relates, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, and is not deemed filed
with the Securities and Exchange Commission and is not to be incorporated by reference into any filing of Kosan Biosciences Incorporated under the Securities Act or the Exchange Act (whether made before or after the date of the Quarterly Report on
Form 10-Q), irrespective of any general incorporation language contained in such filing.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



40



---

##### Table of Contents

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
|                 |  |                               
|November 8, 2005 |  | By:                            |  | /s/ Daniel V. Santi                                       
|                 |  |                                |  | Daniel V. Santi, M.D., Ph.D.                              
|                 |  |                                |  | Chairman and Chief Executive Officer                      
|                 |  |                               
|November 8, 2005 |  | By:                            |  | /s/ Susan M. Kanaya                                       
|                 |  |                                |  | Susan M. Kanaya                                           
|                 |  |                                |  | Senior Vice President, Finance and Chief Financial Officer



41



---

##### Table of Contents

EXHIBIT INDEX



|            |  |                                                                                                                                                                                                                                                           
|----------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit No. |  |                                                                                                                                                                                                                                                           
|3.1         |  | Amended and Restated Certificate of Incorporation. (1)                                                                                                                                                                                                    
|            | 
|3.2         |  | Amended and Restated Bylaws of Registrant. (2)                                                                                                                                                                                                            
|            | 
|4.1         |  | Form of Specimen 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)                                                                                                                                                                           
|            | 
|10.35       |  | Compensation of Strategic Advisory Committee of Board of Directors                                                                                                                                                                                        
|            | 
|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 the Chief Financial Officer of Kosan Biosciences Incorporated, as required by Rule 13a-14(b) or Rule 15d-14(b) and Section 1350 of Chapter 63
of Title 18 of the United Stated Code (18 U.S.C. 1350). (5)

---

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

|(5) | This certification accompanies the Quarterly Report on Form 10-Q to which it relates, pursuant to Section 906 of the Sarbanes Oxley Act of 2002, and is not deemed filed
with the Securities and Exchange Commission and is not to be incorporated by reference into any filing of Kosan Biosciences Incorporated under the Securities Act or the Exchange Act (whether made before or after the date of the Quarterly Report on
Form 10-Q), irrespective of any general incorporation language contained in such filing.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------