##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549
  FORM 10-K
 x
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
 For the fiscal year ended December 31, 2003 OR o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 Commission file number 000-22171 KOS PHARMACEUTICALS, INC.  FLORIDA
    
    65-0670898(State or Other Jurisdiction of Incorporation or Organization)
    
    (I.R.S. Employer Identification No.)
 1001 Brickell Bay Drive,
25th Floor, Miami, Florida
33131   Companys Telephone Number, Including Area Code: (305) 577-3464 Securities registered pursuant to section 12(g) of the Act:
Common Stock, $.01 par value Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes ü No o Indicate by check mark if disclosures of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrants knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ] Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes ü No o The aggregate market value of Kos Pharmaceuticals, Inc. Common Stock, $.01
par value, held by non-affiliates, computed by reference to the price at which
the stock was sold as of February 23, 2004: $843,795,560. Number of shares of Common Stock of Kos Pharmaceuticals, Inc. issued and
outstanding as of February 23, 2004: 36,909,431. Documents Incorporated by Reference Definitive Proxy Statement for the Companys 2004 Annual Meeting of Shareholders
(incorporated in Part III to the extent provided in Items 10, 11, 12, 13 and 14 hereof).




---



TABLE OF CONTENTS  PART IITEM 1. BUSINESSITEM 2. PROPERTIESITEM 3. LEGAL PROCEEDINGSITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERSPART IIITEM 5. MARKET FOR THE COMPANYS COMMON STOCK AND RELATED SHAREHOLDER MATTERSITEM 6. SELECTED CONSOLIDATED FINANCIAL DATAITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSFORWARD-LOOKING INFORMATION: CERTAIN CAUTIONARY STATEMENTSITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATAITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURESITEM 9A. CONTROLS AND PROCEDURESPART IIIPART IVITEM 15. EXHIBITS, FINANCIAL SCHEDULES AND REPORTS ON FORM 8-KSIGNATURESEXHIBIT INDEXSUBSIDIARIES OF THE COMPANYCONSENT OF ERNST & YOUNG LLPNOTICE REGARDING CONSENT OF ARTHUR ANDERSEN LLPCERTIFICATION OF PRESIDENT & CEOCERTIFICATION OF CHIEF FINANCIAL OFFICERCERTIFICATION OF PRESIDENT & CEO SECTION 906CERTIFICATION OF CFO SECTION 906    Table of Contents  TABLE OF CONTENTS PagePART IItem 1.
    
    Business
    
    
    1Item 2.
    
    Properties
    
    
    14Item 3.
    
    Legal Proceedings
    
    
    14Item 4.
    
    Submission of Matters to a Vote of Securities Holders
    
    
    16PART IIItem 5.
    
    Market for the Registrants Common Stock and Related Shareholder
Matters
    
    
    17Item 6.
    
    Selected Consolidated Financial Data
    
    
    18Item 7.
    
    Managements Discussion and Analysis of Financial Condition and
Results of Operations
    
    
    19Forward-Looking Information: Certain Cautionary Statements
    
    
    30Item 7A.
    
    Quantitative and Qualitative Disclosures about Market Risk
    
    
    47Item 8.
    
    Consolidated Financial Statements and Supplementary Data
    
    
    47Item 9.
    
    Changes in and Disagreements with Accountants on Accounting and
Financial Disclosures
    
    
    76Item 9A.
    
    Controls and Procedures
    
    
    76PART III
    
    
    
    
    77PART IVItem 15.
    
    Exhibits, Financial Schedules and Reports on Form 8-K
    
    
    78Signatures
    
    
    
    
    82




---



##### Table of Contents






PART I




ITEM 1. BUSINESS.

Kos Pharmaceuticals, Inc. (Kos or the Company) is a fully-integrated
specialty pharmaceutical company engaged in the development and
commercialization of proprietary prescription products for the treatment of
chronic cardiovascular and respiratory diseases. Kos manufactures its currently
marketed products, Niaspanand Advicor, and markets them directly through its
own specialty sales force and through a sales force provided by a contract
sales organization through December 31, 2003. Kos products under development
directed to cardiovascular disease consist of controlled-release, once-a-day,
oral dosage formulations. The Companys respiratory products under development
consist of aerosolized inhalation formulations to be used primarily with its
proprietary inhalation devices.

The Company believes that substantial market opportunities exist for
developing drugs that are reformulations of existing approved prescription
pharmaceutical products, but which offer certain safety advantages (such as
reduced side effects) or patient compliance advantages (such as once-a-day
rather than multiple daily dosing regimens) compared with existing formulations
of such products. Kos believes that developing proprietary products based on
currently approved drugs, rather than new chemical entities, may reduce
regulatory and development risks and, because physicians are generally familiar
with the safety and efficacy of such products, may facilitate the marketing of
such products. All of Kos products currently under development require new
drug application filings with the U.S. Food and Drug Administration, (the
FDA). Although such new drug application filings are more expensive and time
consuming than abbreviated new drug applications, products that require a new
drug application approval offer several advantages compared with generic
products, including the potential for higher gross margins, limited competition
resulting from significant clinical and formulation development challenges, and
potential for a thirty six-month exclusivity protection from generic
competition.

Recent Development

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

Kos Business Strategy

The principal elements of the Companys business strategy are as follows:



| | (i)   |  | develop or acquire products with unrealized commercial
potential where safety or patient compliance may be improved;                        
| | ----- |  | --------------------------------------------------------------------------------------------------------------------------------------------
|
| | (ii)  |  | focus on the large, rapidly growing cardiovascular and
respiratory markets, which include many chronic diseases requiring
long-term therapy;
|
| | (iii) |  | develop proprietary formulations of currently approved
pharmaceutical compounds;                                                            
|
| | (iv)  |  | manage internally the clinical development of its products;                                                                                 

1



---



##### Table of Contents





| | (v)   |  | manufacture its products internally, or where necessary or
prudent, using a contract manufacturer;                                                
| | ----- |  | --------------------------------------------------------------------------------------------------------------------------------------------------
|
| | (vi)  |  | market its products directly through its specialty sales
force, which Kos may supplement with a contract sales organization
or other partners; and
|
| | (vii) |  | leverage its core competencies through corporate and
academic alliances.                                                                          

Marketed Products

Niaspan

On July 28, 1997, the Company received clearance from the FDA to market
Niaspanfor the treatment of mixed lipid disorders. Niaspanis the only
once-a-day prescription formulation of a niacin product ever approved by the
FDA for the treatment of mixed lipid disorders. Kos began commercializing
Niaspanin the United States in September 1997. On November 3, 2003, the
Companys European marketing and distribution partner, Merck KGaA, launched the
sale of Niaspanin the United Kingdom.

Niacin, the active ingredient in Niaspan, is a water soluble vitamin long
recognized by the National Institutes of Health and the American Heart
Association as an effective agent for the treatment of multiple lipid
disorders, including elevated low-density lipoprotein, commonly referred to as
LDL or bad cholesterol, total cholesterol, and triglycerides and depressed
high-density lipoprotein, commonly referred to as HDL or good cholesterol.
Based principally on the results of the Companys clinical studies evaluating
Niaspan, as well as other long-term interventional studies evaluating niacin
for the reduction of coronary events, Niaspanis indicated for the following:
(i) reduce elevated total cholesterol, LDL cholesterol, and apolipoprotein B,
and increase low HDL cholesterol; (ii) reduce very high serum triglycerides,
which are fatty substances in the blood that contribute to heart disease; (iii)
reduce elevated total and LDL cholesterol when used in combination with a
bile-acid binding resin, which is a different class of drugs that reduces bad
cholesterol; (iv) reduce recurrent nonfatal myocardial infarction, or the
recurrence of nonfatal heart attacks; and (v) promote the regression or slow
the progression of atherosclerosis, which is a medical condition involving the
narrowing of the arteries to the heart, when combined with bile-binding resins.
In addition, the FDA-approved prescribing information for Niaspanreferences
its ability to significantly reduce lipoprotein (a), which is an independent
risk factor for coronary heart disease, although no studies have been conducted
showing the clinical benefits of exclusively lowering levels of lipoprotein
(a).

During
the past ten years, researchers have established through several
long-term clinical outcome studies that reducing LDL cholesterol results in
approximately a 30% reduction in cardiac events, such as nonfatal heart attacks
and cardiac death. Such studies, however, also have revealed that despite a
significant reduction in LDL cholesterol levels, approximately 70% of cardiac
events were not avoided when compared with placebo, suggesting that there may
be other lipid risk factors that contribute to morbidity and mortality in such
patients. Accordingly, throughout this period, considerable scientific evidence
has continued to emerge showing that many lipid risk factors contribute to
coronary heart disease and, in particular, that niacin has powerful utility in
addressing such multiple cholesterol disorders.

A study published in the August 1999 issue of The New England Journal of
Medicine and conducted by the United States Department of Veteran Affairs
showed that raising HDL cholesterol reduced significantly the incidence of
morbidity and mortality following a fibrate. Specifically, the trial results
showed that even a 6% increase in HDL resulted in a 22% reduction in the
incidence of coronary heart disease death and nonfatal heart attacks and a 26%
reduction in stroke in patients with coronary heart disease who had depressed
levels of HDL, but normal levels of LDL and triglycerides. More recently, a
study published in the November 2001 issue of The New England Journal of
Medicine concluded that the combination of statin and niacin therapy was
strikingly favorable in treating coronary heart disease

2



---



##### Table of Contents



patients, virtually halting atherosclerosis progression and reducing
cardiac events by up to 90%. The results from these studies are consistent with
conclusions from previous epidemiological studies demonstrating that for each
1% increase in HDL cholesterol, the risk of developing coronary heart disease
decreases by 2% to 3%, whereas a 1% decrease in LDL cholesterol results in only
a 1% decrease in coronary heart disease risk. Consequently, Kos believes that
agents that further increase HDL cholesterol could potentially improve the
benefits with respect to morbidity and mortality.

During 2001, Kos sponsored a study that evaluated the effects of Niaspan
on lipids and blood sugar levels in 148 diabetic patients. The Company
sponsored this trial because previous reports had shown that niacin can raise
blood sugar levels in diabetic patients, thereby discouraging the use of niacin
in diabetics despite the low HDL and abnormal triglycerides observed in
diabetics. The results of this study, which was published in the July 22, 2002,
issue of the Archives of Internal Medicine, showed that Niaspanincreased HDL
by up to 24% and decreased triglycerides by as much as 30%, with minimal effect
on glucose control. Based on these study results, in 2002 Kos submitted a
supplemental new drug application to the FDA to seek an additional
indication for Niaspan for the treatment of dyslipidemia in patients with type 2
diabetes. Although the FDA acknowledges that Niaspan can be
safely used in diabetic patients, the FDA did not grant a formal
indication for diabetic dyslipidemia because of the lack of outcome
data with Niaspan. In January 2004, Kos withdrew this
supplemental new drug application with the FDA. The FDA recommends
that physicians and patients should monitor blood sugar levels
following treatment with Niaspan.

In 2002, Kos submitted another supplemental new drug application to the
FDA for Niaspanto expand the current label to include positive results in
reducing the risk of stroke or transient ischemic attack (sometimes referred to
as ministrokes) in patients with a previous heart attack and elevated
cholesterol levels. This supplemental new drug application for Niaspanis based
on results from a landmark double-blinded, placebo-controlled, long-term
secondary prevention study known as the Coronary Drug Project. The
morbidity/mortality study, sponsored by the National Heart, Lung, and Blood
Institute, suggested that people taking niacin had significantly fewer strokes
and ministrokes compared with patients taking a placebo. The FDA did
not grant a claim for stroke for Niaspan, again principally
because of the lack of outcome data showing the benefits of
Niaspan administration on stroke.

During 2003, Kos continued to benefit from the revised guidelines
established by the expert panel of the National Cholesterol Education Program
and published in the May 2001 edition of the Journal of the American Medical
Association. These revised guidelines not only emphasize the importance of
aggressively treating LDL cholesterol, but also advocate treating lipid
abnormalities beyond LDL cholesterol. Specifically, the revised National
Cholesterol Education Program guidelines increase the threshold for defining
low HDL cholesterol from 35 to 40 mg/dL, and lower the thresholds for
triglyceride classifications to give more attention to moderate disorders.
Moreover, the latest National Cholesterol Education Program parameters raise
the cardiac risk levels for people with diabetes to the equivalent of people
with coronary heart disease. Finally, the expert panel increased its
recommendation of the number of patients who should be taking cholesterol
modifiers to 36 million patients (of which only 13 million patients are
currently taking such medications), an almost three-fold increase since the
previous guidelines were first published in 1993.

The Company currently markets Niaspanin the United States directly to
specialist physicians within the cardiovascular market who specialize in
treating patients with coronary heart disease and who are among the leading
prescribers of lipid-altering medications. Such lipid-management specialists,
whose primary focus is on treating the 14 million Americans who are estimated
by the American Heart Association to have coronary heart disease, consist
principally of cardiologists, endocrinologists, and internists. Of the 14
million Americans estimated to have coronary heart disease, about 40% have low
levels of HDL cholesterol as their primary lipid abnormality. Kos believes that
patients with low HDL or multiple lipid disorders would benefit from Niaspan
therapy. Many such patients are candidates for combination therapy using
principally an HMG-CoA reductase inhibitor, or statin, to reduce LDL combined
with Niaspanto raise HDL, lower triglycerides, and enhance the statins LDL
efficacy. Since the launch of Niaspan, Kos has found that many lipid
specialists are receptive to using combination therapy to treat their
refractory patients in order to address all of the lipids that may contribute
to a

3



---



##### Table of Contents



coronary event. During 2003, over 70% of the approximately 20,000
cardiologists present in the U.S. cardiovascular market prescribed Niaspanand
since 1997 more than 140,000 physicians have prescribed Niaspanat least once.

In addition to a larger field sales force, Kos continued to increase its
promotional commitment to Niaspanduring 2003. Such promotional efforts consist
of investments in medical education grants, symposia, and expert advisory
boards to establish the importance of modulating multiple lipid risk factors in
an effort to thwart coronary heart disease. Such continued investment in the
product is expected to add awareness and expand usage by targeted physicians.

In addition to promoting Niaspanas the drug of choice to treat HDL
cholesterol and multiple lipid disorders, Kos informs physicians as to the
manner in which Niaspanachieves its safety and efficacy profile. This
marketing initiative is implemented through direct office visits with selected
physicians, medical journal reprints, medical seminars, and clinical discussion
groups. The Company also educates patients on the benefits and proper use of
Niaspanthrough brochures and product sample packs. Information delivered by
Kos to physicians and patients includes a discussion about the flushing side
effects of Niaspan, including the importance of a proper dose titration and
adherence to the prescribed dosing regimen to reduce this side effect. Although
most patients taking Niaspanwill flush occasionally, Kos believes that the
combination of Niaspansformulation, its patented dosing regimen, and proper
dose titration should result in an incidence of flushing episodes tolerable for
most patients. Niaspanspatented dosing regimen provides for the drug to be
taken once-a-day at night; therefore, any flushing episodes will normally occur
while the patient is sleeping. The Company believes that flushing during the
night will not cause the discomfort or embarrassment that often accompanies the
multiple daytime flushing episodes that occur with immediate-release niacin.

Advicor

On December 17, 2001, Kos received clearance from the FDA to market
Advicortablets. The approval of Advicormarks the first time that the FDA has
approved a combination product for the safe and efficacious treatment of
cholesterol disorders. Kos began detailing Advicorto physicians on January 28,
2002. Advicoris a single tablet formulation containing Niaspanand lovastatin.
Kos believes that a once-a-night tablet with the combined complementary
properties of Niaspanand lovastatin represents an effective method for
treating patients with mixed lipid disorders.

Advicoris indicated for the treatment of primary hypercholesterolemia and
mixed dyslipidemia in patients previously treated with either component and who
require additional lipid modification for LDL and HDL cholesterol, and
triglycerides beyond that achieved by the individual components. Advicoris not
indicated for initial therapy. In multicenter clinical trials, Advicorwas
generally well-tolerated with a safety profile comparable to that of Niaspan
and lovastatin alone. The most frequently reported adverse events included
flushing, upset stomach, and rash. As with other lipid-altering drugs, periodic
monitoring of liver enzymes is recommended as is observation for rare but
serious adverse events such as myopathy. Advicoris contraindicated for
pregnant or nursing women or for patients with liver problems or active peptic
ulcer.

The launch of Advicorin January 2002 was supported not only by the
significant inroads made in educating the medical community about the
importance of treating multiple lipid disorders, but also by the increasing
scientific evidence showing that many lipid risk factors contribute to coronary
heart disease. During 2001, Kos contributed to the advancement of such
scientific data by sponsoring a Phase IV clinical study, known as ADVOCATE,
that compared the potency of Advicorwith the two best-selling statins in
modulating multiple lipid risk factors. The results of this 316-patient study
were presented at the March 2002 meeting of the American College of Cardiology
and published in the March 15, 2003 issue of the American Journal of
Cardiology, and showed that AdvicorsLDL efficacy is comparable to the leading
statin drugs while its efficacy in all other lipid parameters is superior.
Specifically, patients

4



---



##### Table of Contents



receiving 1000mg/40mg of Advicor(its workhorse dose) showed reductions
in LDL, triglycerides and lipoprotein (a) of 39%, 30% and 16%, respectively,
while experiencing increases in HDL of 20%. In comparison, patients receiving
10mg of atorvastatin, the workhorse dose of Lipitor®, exhibited a 38% and
15% reduction in LDL cholesterol and triglycerides, respectively, while
experiencing increases in HDL of only 3% and an undesirable increase in
lipoprotein (a) of 5%. During 2002, Kos completed another Phase
IV study, called IMPACT, with a
focus on safety, which included about 5,000 patients and 1,000 doctors. The
results of this study showed less than 0.5% incidence in elevated liver
functions tests and no drug-related myopathy events were reported. The data
from these two studies provide compelling evidence of the potency of Advicorto
offer physicians a convenient single tablet therapy when the individual
components have not achieved the desired therapeutic response for treating
patients with multiple lipid disorders.

As with Niaspan, Kos markets Advicordirectly to specialist and primary
care physicians within the cardiovascular market who specialize in treating
patients with coronary heart disease and who are among the leading prescribers
of lipid-altering medications. The Company believes that patients requiring
treatment for primary hypercholesterolemia or mixed dyslipidemia who require
additional lipid modification for LDL and HDL cholesterol and triglycerides,
beyond that achieved by the individual drug components, would benefit from
Advicortherapy. Kos also believes that this patented once-a-night product will
offer improvements in patient compliance compared with taking each component of
the drug independently under its recommended dosing regimen. Moreover, based on
market research and on historical Niaspanprescribing trends, Kos has found
that many lipid specialists are receptive to using combination therapy to treat
their refractory patients in order to address all of the lipids that may
contribute to a coronary event.

Because Niaspanis one of the two active ingredients in Advicor, most
patients taking Advicorwill flush occasionally. As with its promotional and
educational efforts for Niaspan, Kos strives to educate patients and physicians
about the benefits and proper use of Advicor. These efforts are mostly
conducted through office visits with selected physicians, medical journal
reprints, medical seminars and clinical discussion groups. The Company also
educates patients on the benefits of and proper use of Advicorthrough
brochures and product samples. Consequently, Kos believes that its patented
dosing regimen and proper dose titration should result in tolerable flushing
incidents for most patients. Further, because Advicor, like Niaspan, is also
taken once-daily at night, any flushing episode should occur while the patient
is sleeping, thereby avoiding the discomfort and embarrassment that accompanies
the multiple daytime flushing episodes that occur with other niacin
preparations.

Through late 2001, Kos was subject to the terms of a co-promotion
agreement with DuPont Pharmaceuticals Company (DuPont) to co-promote Advicor.
Under the terms of the agreement, Kos received from DuPont a $20-million equity
investment during 2000. DuPont was to share half of the cost of medical
education, clinical studies, and promotion programs, and it was to match its
field force detailing efforts with physicians, which is when its sales
representatives meet with physicians to educate them about the therapeutic
benefits of its products. In return, DuPont was to receive approximately half
of the gross profit on the sale of Advicor. On October 1, 2001, DuPonts parent
company, E. I. du Pont de Nemours, sold DuPont to Bristol-Myers Squibb Company
(BMS). On December 17, 2001, Kos entered into an agreement with BMS pursuant
to which its agreement with DuPont was terminated and BMS paid Kos a one-time,
$45 million settlement. Moreover, in connection with this settlement, Kos also
regained full marketing rights to the Advicorproduct, including the right to
all product profits and the ability to enter into partnership arrangements with
other parties.

Products Under Development

Although the Company has obtained clearance from the FDA to market Niaspan
and Advicor, its other products under development are at an earlier stage of
development. The drug development and approval process takes many years and
requires the expenditure of substantial resources. There can be no

5



---



##### Table of Contents



assurance that the Company will be able to successfully formulate any of
its products under development as planned, or that Kos will be successful in
demonstrating the safety and efficacy of such products under development in
human clinical trials. These trials may be costly and time-consuming. The
Company may not be able to obtain the regulatory approvals necessary to
continue testing or to market any or all of its products under development.
Thus, there can be no assurances that any of its products under development
will be developed and commercialized in a timely manner, or in accordance with
its plans or projections, or at all. Kos may determine to discontinue the
development of any or all of its products under development at any time.

Solid-Dose Drug Delivery Systems

The Company continues to conduct research on novel solid-dose drug
delivery systems. During 2003, Kos filed supplemental New Drug Applications,
supported by clinical trials, for additional indications for Niaspanand
expects to file more supplemental New Drug Applications during 2004 for new
dosage forms of Niaspanand Advicor. Utilizing its considerable knowledge
obtained from formulating both Niaspanand Advicor, Kos also continues to make
progress in developing innovative solid-dose delivery systems that could be
used to produce a variety of compounds. The Company expects to file three new
drug applications with the FDA that are expected to produce new products after
2007.
 The first new drug application
product (known as KS-01-019) is a dual component therapy for dyslipidemia that is expected to be
more potent than Advicorwith respect to lowering LDL
cholesterol and is expected to reach the market in 2007.


 The second
new drug application product (known as KS-01-017) is a dual regulator of glucose and lipids that is
expected to be equally potent to Niaspanin modulating multiple lipids, while
also reducing blood sugar levels on par with some widely utilized oral
anti-diabetic medications. This product, which is currently in
formulation development, is expected to enter human clinical trials
in 2005.
The third new drug application product (known as KS-01-018) is expected to reach the market in
2009 and is a product for peripheral arterial disease. With this product, Kos
expects to affect a disease that is mostly under-treated because there are no
highly effective products currently available.

Kos is also working on a gastric retention drug delivery platform. The
gastric retention platform encompasses technology in-licensed from Purdue
Research Foundation, an affiliate of Purdue University, which grants Kos
exclusive commercialization rights to technology invented at Purdue for the
development of gastric retention drug delivery systems for pharmaceutical
products. To date, Kos has internally developed a prototype system which has
been studied in animals. The technology can be out-licensed or internally
developed for delivery of both soluble and insoluble drugs. Further, the
technology could potentially be out-licensed as a drug delivery system.

Additionally, Kos has initiated a program to discover and develop new
chemical entities to promote reverse cholesterol transport. The Company
believes that by smart targeting key steps and enzyme systems in the HDL
metabolic pathway, it can identify candidate molecules with a high probability
of success. Drugs with properties similar to that of the native A-I proteins
that is associated with HDL represent another potential approach. A preliminary
evaluation in humans of an intravenous from of the A-I protein suggests that it
can promote regression of cholesterol plaque. These Kos development projects
are being carried out in collaboration with investigators at several well-known
academic research centers, including Boston University, Tufts University, the
Southern California Institute for Research and Education, and the University of
Pennsylvania. The Companys early work on this area has already resulted in
several candidate drugs that look quite promising.

Kos will continue to develop its solid-dose drug delivery system platform
in the future, and may seek one or more developmental partners to further such
efforts.

Metered-Dose Inhalation Devices and Other Device Products

Complementing its formulation capabilities, the Company has developed a
line of inhalation devices that are proprietary, state-of-the art and useful
for delivering small and large molecules. The principal features of the devices
are three-fold: 1) improved coordination of inhalation with actuation of

6



---



##### Table of Contents



medication, thereby offering possible benefits in patient compliance and
uniform dose administration; 2) improved ergonomics, which leads to increased
patient compliance; and 3) reduced drug retention, due to improved design and
mechanics of the devices. To date, Kos has focused its development efforts on
three metered-dose inhaler devices; a breath-coordinated inhaler, a
breath-actuated inhaler and a spacerless metered-dose inhaler device that
generates low plume force. Each of these devices offers distinct benefits and
may be deployed on an a la carte basis depending on potential partners
interest. Kos is also developing a proprietary inhalation dose counter designed
to indicate when sufficient doses no longer remain in the aerosol canister,
thereby alerting the patient to obtain a refill prescription. The Company is
also continuing efforts to develop a compact portable nebulizer earmarked for
products requiring large dosages to be administered into the respiratory
airwaves. In 2002, nine patents were issued supporting various elements of the
inhalation delivery technology. In 2003, the Company had seven device patents
issued. Kos currently intends to use the inhalation dose-counter on all of its
proprietary inhalation devices.

Advanced Inhalation Delivery Research

Leveraging its unique aerosol formulation expertise, Kos continues to
formulate proteins, such as recombinant insulin, for delivery to the lungs
using its proprietary metered-dose inhaler device. During 2002, Kos completed
proof-of-principle studies in humans demonstrating that its recombinant insulin
product is bioavailable in the lungs (approximately 15%) while exhibiting
excellent dose-to-dose reproducibility. Kos believes that such compelling
results may be attractive to potential development partners for not only
developing this product, but also for other proteins/peptides, possibly on a
contract formulation basis. As the Company continues to generate data
demonstrating the performance and efficacy of delivering such proteins via the
lung through its metered-dose inhaler devices, Kos expects to attract
development partners skilled in developing biotherapeutic compounds to complete
the clinical development of the products for certain diseases. The Company also
intends to offer to formulate other peptides for other partners on a contract
basis.

Sales and Marketing

Kos markets its branded proprietary products through its own specialty
sales force and through a sales force provided by a contract sales organization
pursuant to a contract sales agreement Kos that terminated December 31, 2003. A
fundamental element of Kos product selection strategy is to focus on products
where a relatively concentrated group of specialist physicians account for a
significant portion of the prescriptions for the therapeutic indication
addressed by its products. The Company believes that such specialist physicians
will be the most receptive to the patient compliance, safety, or other
therapeutic advantages that its products will seek to offer. Accordingly, Kos
believes that significant market gains can be achieved with such products
through the use of a relatively small, well-trained sales force concentrating
its detailing efforts on informing such specialist physicians about the
scientific basis for the therapeutic advantages of its products.

As of December 31, 2003, the Company had a sales and marketing
organization consisting of approximately 523 personnel. The majority of its
sales and marketing personnel have considerable previous experience with major
pharmaceutical companies detailing products to cardiovascular physicians. Kos
began actively detailing Niaspanduring September 1997 and Advicoron January
28, 2002. Kos believes that the sizable increase in sales force personnel will
allow the Company to reach a greater physician audience while, at the same
time, increase the amount of repeat visits made to its physician target list.

On October 23, 2002, the Company signed an exclusive international
commercialization agreement with Merck KGaA (Merck), to market the Niaspan
and Advicorproducts outside the United States, Canada and Japan (the Merck
Agreement). Under the terms of the Merck Agreement, Merck will provide Kos up
to $61 million in licensing, milestone and reimbursement payments, including
$15

7



---



##### Table of Contents



million of upfront payments, of which $12.5 million are reimbursable to
Merck if Kos fails to achieve certain regulatory milestones. The milestone
payments are dependent on the achievement of certain regulatory approvals and
sales thresholds. The Company will also receive 25% of net sales of the
products in the territory covered by the agreement, which includes the cost of
goods sold. Merck will be responsible for conducting Phase IV clinical studies
and commercialization activities while Kos is responsible for obtaining initial
marketing authorization in all European countries and the supply and
manufacturing of the products. Through December 31, 2003, Kos has received $15
million in upfront and reimbursement payments from Merck. Of this amount, $0.2
million was offset against research and development expenses during the year
ended December 31, 2003. The majority of these upfront payments, however, will
be recognized as revenue in future periods upon achievement of certain
regulatory milestones.

On August 20, 2003, Kos announced an exclusive development and
commercialization agreement with Oryx Pharmaceuticals, Inc. (Oryx), for the
commercialization of Niaspanand Advicorin Canada. Under the agreement, Oryx
is responsible for obtaining marketing authorization for Niaspanand Advicorin
Canada and for all promotional investments, and Kos is responsible for
manufacturing and supplying Advicorand Niaspanfollowing receipt of marketing
authorization for such products in Canada. Approval to market Niaspanand
Advicorin Canada is not expected until at least next year. If and when
marketing approval is obtained, Kos will share the revenues from sales of
Niaspanand Advicorin Canada with Oryx.

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

Kos continues to aggressively pursue other collaborative opportunities,
including acquiring or licensing the use of selected products and technologies
from third parties; product co-marketing arrangements; joint ventures; and
other strategic alliances. Many existing pharmaceutical products or products
currently under development may be suitable candidates for specialty
promotional or co-promotional campaigns. Accordingly, Kos intends to attempt to
identify licensing, co-promotion, and product acquisition opportunities that
can complement its future product portfolio. In situations where third-party
drug delivery technologies are complementary to its drug development
formulation capabilities, Kos may pursue licensing rights for such technology.
Lastly, the Company currently intends to establish strategic alliances with
corporate partners with respect to its respiratory products. There can be no
assurance, however, that any of the collaborative opportunities can be
established on terms acceptable to Kos or at all.

Patents and Proprietary Rights

The Company actively seeks, when appropriate and available, protection for
its products and proprietary information by means of United States and foreign
patents, trademarks, trade secrets, copyrights, and contractual arrangements.
Patent protection in the pharmaceutical field, however, can involve complex
legal and factual issues. Moreover, broad patent protection for new
formulations or new methods of use of existing chemical entities is sometimes
difficult to obtain and often of limited usefulness, primarily because the
active ingredient and many of the formulation techniques have been

8



---



##### Table of Contents



known for some time. Consequently, some patents claiming new formulations
or new methods of use for old drugs may not provide meaningful protection
against competition. Nevertheless, Kos intends to seek patent protection when
appropriate and available and otherwise to rely on regulatory-related
exclusivity and trade secrets to protect certain of its products, technologies
and other scientific information. There can be no assurance, however, that any
steps taken to protect such proprietary information will be effective.

Existing Patents and Patent Applications

In the United States, Kos owns 58 patents, filed 36 additional patent
applications, and has been licensed four patents. In addition, the Company has
received patents and filed patent applications in foreign jurisdictions.

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

The U.S. Patent and Trademark Office has issued U.S. Patents 6,129,930,
6,080,428, 6,406,715, and 6,676,967 to Kos with claims relating to Niaspans
and Advicorscomposition and method-of-use consistent with the recommended
once-a-day dosing regimen. On February 7, 1997, Kos entered into a
cross-licensing agreement with a generic manufacturer. The Company subsequently
purchased the patents that were the subject of such original agreement and
agreed to continue paying a royalty to the generic manufacturer on terms
similar to those contained in the original agreement.

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

Barr Laboratories Litigation

On January 23, 2002, the Company received notice from Barr Laboratories,
Inc. (Barr) that it had filed with the FDA an Abbreviated New Drug
Application (ANDA) that, if approved, would allow Barr to market a generic
version of the Companys 1000 mg Niaspanproduct. As a result, on March 4,
2002, the Company filed a patent infringement lawsuit against Barr in the
Southern District of New York (SDNY). On March 11, 2002, the Company filed an
amended complaint (the Amended Complaint). In this lawsuit, the Company
asserted that Barr has infringed Kos 6,080,428 and 6,129,930 patents. On March
25, 2002, Barr answered the Amended Complaint (the Answer) by denying that
the 428 and

9



---



##### Table of Contents



930 patents are valid and infringed, and seeking a declaratory judgment
to that effect. On August 19, 2002, Barr amended its Answer to add
counterclaims requesting a declaratory judgment that two other patents owned by
Kos, U.S. Patent Number 5,126,145 and 5,268,181, are not infringed, and that
the 181 patent is invalid.

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

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

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

There can be no assurance that Kos will be successful in defending its
patents in the Barr litigation. If Kos is not successful in defending its
patents, Barr and other competitors may be able to produce and market generic
versions of its Niaspanproducts which could be sold at prices lower than those
charged by Kos. This would have a material adverse effect on its business and
financial results. Kos is not able at this time to estimate the economic impact
if Kos is not successful in defending its patents.

Andrx Laboratories Litigation

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

10



---



##### Table of Contents



Protection of Intellectual Property

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

Kos also relies on trade secrets and other unpatented proprietary
information in its product development activities. To the extent that Kos
maintains a competitive technological position, by relying on trade secrets and
unpatented know-how, such competitive technological position may be compromised
if others independently develop the same or similar technologies. Kos seeks to
protect trade secrets and proprietary knowledge in part through confidentiality
agreements with its employees, consultants, advisors, and collaborators.
Nevertheless, these agreements may not effectively prevent disclosure of Kos
confidential information and may not provide the Company with an adequate
remedy in the event of unauthorized disclosure of such information. If Kos
employees, scientific consultants, or collaborators develop inventions or
processes independently that may be applicable to Kos products under
development, disputes may arise about ownership of proprietary rights to those
inventions and processes. Such inventions and processes will not necessarily
become the Companys property, but may remain the property of those persons or
their employers. Protracted and costly litigation could be necessary to enforce
and determine the scope of the Companys proprietary rights. Failure to obtain
or maintain patent and trade secret protection, for any reason, would have a
material adverse effect on Kos.

Kos engages in collaborations, sponsored research agreements, and other
arrangements with academic researchers and institutions that have received and
may receive funding from U.S. government agencies. As a result of these
arrangements, the U.S. government or certain third parties may have rights in
certain inventions developed during the course of the performance of such
collaborations and agreements as required by law or such agreements. Several
legislative bills affecting patent rights have been introduced in the United
States Congress. These bills address various aspects of patent law, including
publication, patent term, re-examination subject matter, and enforceability. It
is not certain whether any of these bills will be enacted into law or what form
such new laws may take. Accordingly, the effect of such potential legislative
changes on its intellectual property estate is uncertain.

Niaspan, Advicorand Kos are the Companys principal registered
trademarks, although other applications for registration of trademarks and
service marks are currently pending in the Patent and Trademark Office and
additional applications are in the process of being filed.

Manufacturing

Kos currently manufactures its Niaspanand Advicorproducts in a single
manufacturing plant in Edison, New Jersey that has been inspected and approved
by the FDA for both products. Kos began manufacturing Niaspanin the Edison
facility during the second quarter of 2001. Although both products

11



---



##### Table of Contents



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

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

The Company intends to continue to contract the packaging of its
manufactured products to third parties. Kos may begin in-house packaging
operations once product sales volumes justify the capital expenditures required
to establish such capabilities. Certain of the Companys raw materials,
including the active ingredients in Niaspanand Advicorare currently obtained
from single sources of supply. Kos does not have a contractual supply
arrangement with the sole supplier of the active ingredient in Niaspanor with
the supplier of the lovastatin component of Advicor. Kos intends, to the extent
possible, to identify multiple sources for all of its key raw materials,
including the active ingredients in Niaspanand Advicor, although an alternate
source for at least one such material will not be available because of the
suppliers patent.

Competition

The Companys products compete with currently existing or future
prescription pharmaceuticals and vitamins in the United States, Europe, and
elsewhere. Kos estimates that its existing Niaspanand Advicorprescriptions
account for approximately 3.2% of the total prescriptions currently being
written in the United States for cholesterol-lowering pharmaceutical compounds.
Competition among these products is based on, among other things, efficacy,
safety, reliability, availability, price, and patent position. In addition,
academic institutions, government agencies, and other public and private
organizations conducting research may seek patent protection, discover new
drugs, or establish collaborative arrangements for drug research. Most of Kos
competitors have substantially greater financial, technical, and human
resources than those available to the Company, including combined field sales
forces approximating 17,000 representatives currently active within the
dyslipidemia market, compared with the Companys approximately
440 person field
sales force and may be better equipped to develop, manufacture, and market
products. Moreover, there are numerous manufacturers of niacin preparations
indicated for use as vitamin supplements or, in immediate-release form, for
treatment of hyperlipidemia.

The Companys cardiovascular and respiratory products, when developed and
marketed, will also compete in most cases with well established products
containing the same active ingredient already being marketed by medium-sized
and large pharmaceutical companies in the United States.

Employees

As of December 31, 2003, Kos had 912 employees. No employee is represented
by a union. Kos believes its employee relations are good. Kos also regularly
employs the services of outside consultants with respect to regulatory,
scientific, and certain administrative and commercial matters. Kos expects to
continue to require the services of such outside consultants.

12



---



##### Table of Contents



Available Information

The Companys Internet address is www.kospharm.com. Kos makes available
free of charge on or through its Internet website its annual report on Form
10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and
amendments to those reports filed or furnished pursuant to Section 13(a) or
15(d) of the Exchange Act as soon as reasonably practicable after such material
was electronically filed with, or furnished to, the SEC.

13



---



##### Table of Contents






ITEM 2. PROPERTIES.

The Company leased the following properties as of December 31, 2003:

|              |  |                                             |  |             |        |          |  |                    |  |                |           | 
|------------- |  | ------------------------------------------- |  | ----------- | ------ | -------- |  | ------------------ |  | -------------- | --------- | 
|              |  |                                             |  |             |        |          |  | Lease Expiration   |  |                |           | 
|              |  |                                             |  |             |        |          |  | (Including Renewal |  | Minimum Annual
|Location      |  | Use                                         |  | Square Feet |        | Options) |  | Rent              
|              |  |                                             |  |             |        |          |  |                   
|Miami, FL     |  | Corporate offices                           |  |             | 13,400 |          |  | December 2004      |  | $              | 471,000   | 
|Hollywood, FL |  | Manufacturing, research
and admin. offices  |  |             | 23,500 |          |  | November 2004      |  |                | 315,000   | 
|Weston, FL    |  | Research and admin. offices                 |  |             | 50,000 |          |  | October 2008       |  |                | 1,400,000 | 
|Edison, NJ    |  | Manufacturing, research,
and admin. offices |  |             | 54,200 |          |  | October 2006       |  |                | 574,000   | 
|Raleigh, NC   |  | Device engineering offices                  |  |             | 6,000  |          |  | August 2009        |  |                | 66,000    | 

The Company has entered into an agreement to lease approximately 90,000
square feet of additional property located in Cranbury, New Jersey for
corporate and research use (the Cranbury Lease). The Cranbury Lease has a
ten-year term commencing on the month following substantial completion of the
facilities (substantial completion is expected to occur in mid-2004) and its
minimum annual rent is $2,297,000. The Company believes that its existing
facilities and facilities included in the Cranbury Lease are adequate to meet
its current needs and that there is sufficient additional space at or in close
proximity to its present facilities to accommodate its near-term requirements.




ITEM 3. LEGAL PROCEEDINGS.

On August 5, 1998, a purported class action lawsuit was filed in the
United States District Court for the Northern District of Illinois, Eastern
Division, against the Company, the members of the Companys Board of Directors,
certain officers of Kos, and the underwriters of the Companys October 1997
offering of shares of Common Stock. In its complaint, the plaintiff asserts, on
behalf of itself and a putative class of purchasers of the Companys Common
Stock during the period from July 29, 1997, through November 13, 1997, claims
under: (i) sections 11, 12(a)(2) and 15 of the Securities Act of 1933; (ii)
sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and Rule 10b-5
promulgated thereunder; and (iii) for common law fraud, negligent
misrepresentation and breach of fiduciary duty. The claims in the lawsuit
relate principally to certain statements made by the Company, or certain of its
representatives, concerning the efficacy, safety, sales volume and commercial
viability of the Niaspanproduct. The complaint sought unspecified damages and
costs, including attorneys fees and costs and expenses. Upon Kos motion, the
case was transferred to the United States District Court for the Southern
District of Florida. The Company filed a motion to dismiss the complaint
against the Company and the individual Kos defendants on January 7, 1999. On
May 24, 1999, the United States District Court for the Southern District of
Florida dismissed the lawsuit with prejudice. The plaintiffs filed an appeal on
June 7, 1999, with the United States Circuit Court of Appeals for the 11th
Circuit. On July 16, 2002, the 11th Circuit Court of Appeals affirmed the
District Courts dismissal of the plaintiffs claims with prejudice. The
plaintiffs petitioned the Court of Appeals for a rehearing of the appeal, which
was denied by the Court of Appeals. Recently, one of the plaintiffs filed a
Petition for Writ of Certiorari to the United States Supreme Court from the
11th Circuit decision, which was denied by the United States Supreme Court.

On January 23, 2002, the Company received notice from Barr Laboratories,
Inc. (Barr) that it had filed with the FDA an Abbreviated New Drug
Application (ANDA) that, if approved, would allow Barr

14



---



##### Table of Contents



to market a generic version of the Companys 1000 mg Niaspanproduct. As a
result, on March 4, 2002, the Company filed a patent infringement lawsuit
against Barr in the Southern District of New York (SDNY). On March 11, 2002,
the Company filed an amended complaint (the Amended Complaint). In this
lawsuit, the Company asserted that Barr has infringed Kos 6,080,428 and
6,129,930 patents. On March 25, 2002, Barr answered the Amended Complaint (the
Answer) by denying that the 428 and 930 patents are valid and infringed,
and seeking a declaratory judgment to that effect. On August 19, 2002, Barr
amended its Answer to add counterclaims requesting a declaratory judgment that
two other patents owned by Kos, U.S. Patent Number 5,126,145 and 5,268,181, are
not infringed, and that the 181 patent is invalid.

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

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

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

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

15



---



##### Table of Contents



From time to time, the Company is a party to other legal proceedings in
the course of its business. The Company, however, does not expect such other
legal proceedings to have a material adverse effect on its business or
financial condition.




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

No matters were submitted to a vote of the Companys security holders during
the quarter ended December 31, 2003.

16



---



##### Table of Contents



PART II 
 ITEM 5. MARKET FOR THE COMPANYS COMMON STOCK AND RELATED SHAREHOLDER MATTERS. The Companys Common Stock, par value $.01 per share, commenced trading on
March 7, 1997, on the Nasdaq National Market under the symbol KOSP. As of
March 1, 2004, there were 437 registered shareholders of record of the
Companys Common Stock. The following table sets forth, for the fiscal periods indicated, the
range of high and low prices for trades of the Companys Common Stock on the
Nasdaq National Market System. Year Ended December 31, 2003
    
    High
    
    LowFirst Quarter
    
    $
    20.89
    
    
    $
    15.51Second Quarter
    
    
    27.10
    
    
    
    16.79Third Quarter
    
    
    42.86
    
    
    
    22.50Fourth Quarter
    
    
    47.73
    
    
    
    32.42
 Year Ended December 31, 2002
    
    High
    
    LowFirst Quarter
    
    $
    35.27
    
    
    $
    19.30Second Quarter
    
    
    29.16
    
    
    
    15.50Third Quarter
    
    
    20.70
    
    
    
    10.03Fourth Quarter
    
    
    24.16
    
    
    
    10.38
 The Company has not declared or paid any cash dividends on its Common
Stock. The Company currently anticipates that it will retain future earnings,
if any, to fund the development and growth of its business and does not intend
to pay dividends on its Common Stock in the foreseeable future. 17




---



##### Table of Contents



ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA. The following consolidated selected financial data of the Company for the
five years ended December 31, 2003 should be read in conjunction with
Managements Discussion and Analysis of Financial Condition and Results of
Operations and the consolidated financial statements and related notes
thereto. See Item 8. Consolidated Financial Statements and Supplementary
Data. Year Ended December 31,2003
    
    2002
    
    2001
    
    2000
    
    1999(in thousands, except share data)Statement of Operations:Revenues, net(1)
    
    $
    293,907
    
    
    $
    172,693
    
    
    $
    91,447
    
    
    $
    60,174
    
    
    $
    36,340Cost of sales
    
    
    20,038
    
    
    
    15,362
    
    
    
    7,646
    
    
    
    5,932
    
    
    
    5,406273,869
    
    
    
    157,331
    
    
    
    83,801
    
    
    
    54,242
    
    
    
    30,934Operating expenses:Research and development
    
    
    52,203
    
    
    
    43,981
    
    
    
    30,974
    
    
    
    26,459
    
    
    
    25,619Selling, general and administrative
    
    
    156,469
    
    
    
    130,145
    
    
    
    83,587
    
    
    
    56,831
    
    
    
    56,843Total operating expenses(2)
    
    
    208,672
    
    
    
    174,126
    
    
    
    114,561
    
    
    
    83,290
    
    
    
    82,462Income (loss) from operations
    
    
    65,197
    
    
    
    (16,795
    )
    
    
    (30,760
    )
    
    
    (29,048
    )
    
    
    (51,528
    )Other:Interest income, net
    
    
    614
    
    
    
    160
    
    
    
    242
    
    
    
    323
    
    
    
    169Interest expense-related parties
    
    
    (3,321
    )
    
    
    (4,039
    )
    
    
    (6,081
    )
    
    
    (6,560
    )
    
    
    (3,207
    )Other income (expense)(2)
    
    
    (197
    )
    
    
    (142
    )
    
    
    38,985
    
    
    
    20
    
    
    
    14Total other expense
    
    
    (2,904
    )
    
    
    (4,021
    )
    
    
    33,146
    
    
    
    (6,217
    )
    
    
    (3,024
    )Income (loss) before provision for
income taxes(1)
    
    
    62,293
    
    
    
    (20,816
    )
    
    
    2,386
    
    
    
    (35,265
    )
    
    
    (54,552
    )Provision for income taxes
    
    
    2,879
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net income (loss)
    
    $
    59,414
    
    
    $
    (20,816
    )
    
    $
    2,386
    
    
    $
    (35,265
    )
    
    $
    (54,552
    )Net income (loss) per share(3)Basic
    
    $
    2.71
    
    
    $
    (1.01
    )
    
    $
    0.12
    
    
    $
    (1.84
    )
    
    $
    (3.06
    )Diluted
    
    
    1.53
    
    
    
    (1.01
    )
    
    
    0.10
    
    
    
    (1.84
    )
    
    
    (3.06
    )Weighted average common stock and common
stock equivalents used in computing
net income (loss) per share(3)Basic
    
    
    21,913,928
    
    
    
    20,582,205
    
    
    
    20,221,089
    
    
    
    19,202,877
    
    
    
    17,842,879Diluted
    
    
    41,033,325
    
    
    
    20,582,205
    
    
    
    22,798,632
    
    
    
    19,202,877
    
    
    
    17,842,879
 December 31,2003
    
    2002
    
    2001
    
    2000
    
    1999(in thousands)Balance Sheet:Cash and marketable securities
    
    $
    259,958
    
    
    $
    19,572
    
    
    $
    45,319
    
    
    $
    6,125
    
    
    $
    4,336Working capital (deficit)
    
    
    248,059
    
    
    
    (54,644
    )
    
    
    27,160
    
    
    
    (1,911
    )
    
    
    (2,354
    )Total assets
    
    
    337,614
    
    
    
    69,441
    
    
    
    82,941
    
    
    
    29,648
    
    
    
    26,258Total long-term debt(4)
    
    
    30,000
    
    
    
    34,025
    
    
    
    95,082
    
    
    
    72,000
    
    
    
    62,089Accumulated deficit
    
    
    (233,947
    )
    
    
    (293,361
    )
    
    
    (272,545
    )
    
    
    (274,931
    )
    
    
    (239,666
    )Shareholders
equity (deficit)
    
    
    239,627
    
    
    
    (74,709
    )
    
    
    (58,439
    )
    
    
    (65,090
    )
    
    
    (53,195
    )
  (1)
    
    For 2003, includes the effect of a $11.1 million revenue
benefit and $9.9 million benefit to income before provision for income
taxes resulting from a change in accounting estimate. See Note 2 of Notes
to Consolidated Financial Statements for information concerning this
change in accounting estimate.(2)
    
    For 2001, includes the effect of a $45 million settlement
received from Bristol Myers Squibb Company, of which $6 million was
recorded as reimbursement of operating expenses and $39 million as other
income. See Note 2 of Notes to Consolidated Financial Statements for
information concerning this settlement payment.(3)
    
    See Note 2 of Notes to Consolidated Financial
Statements for information concerning the
computation of net income (loss) per share.(4)
    
    For 2002, excludes $50 million of debt due to
Michael Jaharis, Chairman Emeritus of the Companys
Board of Directors and its principal shareholder,
as such debt matures on December 31, 2003.
 18




---



##### Table of Contents



ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. Executive Overview Kos is a fully-integrated specialty pharmaceutical company engaged in the
development and commercialization of proprietary prescription products for the
treatment of chronic cardiovascular and respiratory diseases. Kos manufactures
its lead products, Niaspanand Advicor,and currently markets them directly
through its own specialty sales force and co-promotion partner. The Companys
products under development directed to cardiovascular disease consist of
controlled-release, once-a-day, oral dosage formulations, and the Companys
respiratory products under development consist of aerosolized inhalation
formulations to be used primarily with Kos proprietary inhalation devices. The Companys current business strategy is based upon developing drugs
that are reformulations of existing approved prescription pharmaceutical
products, but which offer certain safety advantages or patient compliance
advantages compared with existing formulations of such products. The principal elements of Kos current business strategy are as follows:  (i)
    
    develop or acquire products with unrealized commercial
potential where safety or patient compliance may be improved;(ii)
    
    focus on the large, rapidly growing cardiovascular and
respiratory markets, which include many chronic diseases requiring
long-term therapy;(iii)
    
    develop proprietary formulations of currently approved
pharmaceutical compounds;(iv)
    
    manage internally the clinical development of its products;(v)
    
    manufacture its products internally, or where necessary or
prudent, using a contract manufacturer;(vi)
    
    market its products directly through the Companys specialty
sales force, which Kos may supplement with a contract sales
organization or other partners; and(vii)
    
    leverage its core competencies through corporate and
academic alliances. On July 28, 1997, Kos received clearance from the FDA to market the
Niaspanproduct for the treatment of mixed lipid disorders. Niaspanis the only
once-a-day prescription formulation of a niacin product ever approved by the
FDA for the treatment of mixed lipid disorders. Kos currently markets the
Niaspanproduct directly to specialist physicians within the cardiovascular
market who specialize in treating patients with coronary heart disease and who
are among the leading prescribers of lipid-altering medications. Such
lipid-management specialists, whose primary focus is on treating the 14
million Americans who are estimated by the American Heart Association to have
coronary heart disease, consist principally of cardiologists, endocrinologists,
and internists. On December 17, 2001, Kos received clearance from the FDA to market the
Advicorproduct (extended-release niacin/lovastatin tablets). The approval of
the Advicorproduct marks the first time that the FDA has approved a
combination product for the safe and efficacious treatment of cholesterol
disorders. The Company began detailing the Advicorproduct to physicians on
January 28, 2002. As with the Niaspanproduct,the Company currently markets
the Advicorproduct directly to specialist and primary care physicians within
the cardiovascular market who specialize in treating patients with coronary
heart disease and who are among the leading prescribers of lipid-altering
medications. In measuring the Companys results of operations, managements primary
focus is on revenue growth of the Niaspanand Advicorproducts and net income
growth. Net sales of the Companys Niaspanand 19




---



##### Table of Contents



Advicorproducts increased to $293.9 million for the year ended December
31, 2003, from $172.7 million for the same period in 2002. This increase in
revenue was primarily attributable to increases in unit volume and prices for
the Companys products during the 2003 period, and to a change in product
return estimates (as described below in this Managements Discussion and
Analysis of Financial Condition and Results of Operations). Net income for the
year ended December 31, 2003 increased to $59.4 million from a net loss of
$20.8 million for the same period in 2002. This dramatic turnaround in net
income generation was primarily attributable to the revenue growth experienced
by the Companys Niaspanand Advicorproducts, including, as previously
mentioned, the effect of a change in accounting estimate. Because Kos current business strategy is mostly dependent on the
reformulation of existing compounds, the Companys business could be subject to
significant competitive pressures. As such, Kos critical success factors
include its ability to continue to increase the amount of revenue generated by
the Niaspanand Advicorproducts and its ability to successfully develop and/or
acquire new products or drugs. The Companys ability to continue to increase
revenue is primarily dependent on its ability to increase prescriptions for its
marketed products, and to maintain a competitive product pricing and
differentiation strategy. The Company intends to utilize proceeds derived from
the Companys public offering of Common Stock in the fourth quarter of 2003 to
acquire other products or companies, to in-license complimentary products, and
to fund working capital needs for general corporate purposes. The Companys
ability to complete new drug and product acquisitions on favorable terms will
be a critical factor in the Companys ability to increase revenues in future
periods. Protection of the Companys intellectual property rights will also be
critical to the Companys success in future periods, including its ability to
obtain and maintain patents, enforce those patents, preserve trade secrets, and
operate without infringing the proprietary rights of third parties. General A predecessor corporation to the Company was formed in July 1988 under the
name of Kos Pharmaceuticals, Inc. principally to conduct research and
development on new formulations of existing prescription pharmaceutical
products. In June 1993, Aeropharm Technology, Inc. (Aeropharm), a then
majority-owned subsidiary of the Company, was formed to conduct research and
development activities on aerosolized products, dispensed in metered-dosed
inhalers, for the treatment of respiratory diseases. During June 1996, this
predecessor corporation acquired the outstanding minority interest in
Aeropharm; changed its name to Kos Holdings, Inc. (Holdings); established the
Company as a wholly-owned subsidiary under the name of Kos Pharmaceuticals,
Inc.; and, effective as of June 30, 1996, transferred all of its existing
assets, liabilities, and intellectual property, other than certain net
operating loss carryforwards, to the Company. Accordingly, all references in
this Form 10-K filing to the Companys business include the business and
operations of Holdings until June 30, 1996. On March 12, 1997, the Company completed an initial public offering
(IPO) of its Common Stock. From inception through the IPO, the Company had
not recorded any significant revenues; and the Company had funded its
operations exclusively through equity contributions and a loan from its
majority shareholder. Through December 31, 2003, the Company had accumulated a
deficit from operations of approximately $233.9 million. In connection with the
transfer of operations from Holdings to the Company on June 30, 1996, net
operating loss carryforwards amounting to approximately $51.0 million and
related tax benefits were retained by Holdings and not transferred to the
Company. Consequently, as of December 31, 2003, the Company had approximately
$146.7 million of net operating loss carryforwards and $41.2 million of other
deductible temporary differences between the book and tax bases of assets and
liabilities which may be used to offset future taxable net income, if any. Recent Developments On March 8, 2004, the Company announced that it had entered into a product
acquisition agreement with Aventis Pharmaceuticals Holdings Inc. and a supply
agreement with Aventis Pharmaceuticals, Inc. (collectively Aventis) to
acquire global rights to the Azmacort(triamcinolone acetonide) inhalation
aerosol franchise (collectively the Aventis Agreement). Azmacortis an
inhaled corticosteroid that alleviates inflammation in the lungs and is used as
prophylactic therapy for the maintenance treatment of asthma. Under the terms
of the Aventis Agreement, Kos will pay Aventis $200 million in cash and has
agreed to pay a royalty on future sales of another version of the product to be
developed. Under the terms of the supply agreement, Aventis has agreed to
supply finished product to Kos for a period of five years.
The Company expects to close this transaction by the end of the first
quarter 2004, pending the completion of the Federal Trade Commissions
Hart-Scott-Rodino review and approval process. On November 25, 2003, the Company sold 3,750,000 shares of Common Stock
pursuant to a registration statement filed with the Securities and Exchange
Commission. On December 22, 2003, the 20




---



##### Table of Contents



Company sold an additional 650,000 shares to cover over allotments. Net
proceeds to the Company resulting from the sale of these 4,400,000 shares of
Common Stock totaled $184,277,000. See Liquidity and Capital Resources for
additional discussion regarding this issuance of shares of Common Stock. On November 4, 2003, the Company and Takeda Pharmaceuticals North America,
Inc. (Takeda) announced a three-year agreement to co-promote Niaspanand
Advicorin the United States. Pursuant to this agreement, Takeda will utilize
its U.S.-based sales force to promote Niaspanand Advicorin addition to its
own product. Takeda is responsible for providing a promotional effort that is
expected to significantly increase the amount of product details for Niaspan
and Advicorperformed per year, and for all costs associated with its sales
force, including promotional materials and samples. The Company is responsible
for manufacturing and supplying both products and will collect and record all
sales associated with its products. Takeda will receive a royalty on
incremental net sales of the products in the United States above a certain
baseline amount. This co-promotion arrangement has a three-year term commencing
January 2004 and provides for residual payments to Takeda after the three
years, if the parties do not renew the agreement. On August 20, 2003, the Company announced an exclusive development and
commercialization agreement with Oryx Pharmaceuticals, Inc. (Oryx) for the
commercialization of Niaspanand Advicorin Canada. Under the agreement, Oryx
is responsible for obtaining marketing authorization for Niaspanand Advicorin
Canada and for all promotional investments, and the Company will be responsible
for manufacturing and supplying Niaspanand Advicorfollowing receipt of
marketing authorization for such products in Canada. In December 2003, Oryx
filed New Drug Submissions with Health Canada for regulatory clearance to
market Niaspanand Advicorin Canada. Market clearance is expected in Canada
during the second half of 2005. If and when marketing approval is obtained, the
Company will share the revenues from sales of Niaspanand Advicorin Canada
with Oryx. On October 23, 2002, the Company signed an exclusive international
commercialization agreement with Merck KGaA (Merck) to market the Niaspanand
Advicorproducts outside the United States, Canada and Japan (the Merck
Agreement). Under the terms of the Merck Agreement, Merck will provide Kos up
to $61 million in licensing, milestone and reimbursement payments, including
$15 million of upfront payments, of which $12.5 million are refundable to Merck
by Kos if it fails to achieve certain regulatory milestones. The milestone
payments are dependent on the achievement of certain regulatory approvals and
sales thresholds. Kos will also receive 25% of net sales of the products in the
territory, which includes the cost of goods sold. Merck will be responsible for
conducting Phase IV clinical studies and commercialization activities while Kos
is responsible for obtaining initial marketing authorization in all major
European countries and for the supply and manufacturing of the products. As of
December 31, 2003, Kos had received $15 million in upfront and reimbursement
payments from Merck. Of this amount, $0.2 million was offset against research
and development expenses during the year ended December 31, 2003. The majority
of these payments, however, will begin to be recognized as revenue in future
periods upon Kos achieving certain regulatory milestones. On November 3, 2003,
Merck launched the sale of Niaspanin the United Kingdom. In January 2004, the
Company received tentative approval to market Niaspanin thirteen European
countries. 21




---



##### Table of Contents



Results of Operations Critical Accounting Policies The Companys significant accounting policies are described in Note 2 to
Consolidated Financial Statements. The Company believes that its most critical
accounting policies include revenue recognition and the estimation of
allowances principally related to product returns, managed care rebates,
chargebacks, reimbursements relating to Medicaid and Medicare, and accounting
for income taxes. The allowances are based upon consideration of a variety of
factors, including but not limited to actual return experience by product type,
the market for the product, estimated customer inventory levels by product, and
other current and projected economic conditions. Actual product returns,
managed care rebates, chargebacks, reimbursements relating to Medicaid and
Medicare, other allowances incurred, and managements expectations regarding
the continuing need for a valuation allowance on deferred income tax assets are
dependent upon future events. The Companys management periodically reviews
these policies and estimates, the effect of which is reflected as a component
of net income in the period in which the change is known. Other than the change
described below associated with the Companys estimate of its product return
exposure, such changes to these estimates have not been material to the
Companys results of operations during the years ended December 31, 2003, 2002
and 2001. The Company periodically evaluates the volume of its Niaspanand Advicor
products that are in customer inventories or elsewhere in the distribution
channel to determine whether increased risk of product returns exists. For the
period from the introduction of its products through December 31, 2002, Kos
return risk expectations were consistently based on its limited product return
experience given the early stage nature of its products and of the Company.
Accordingly, Kos established a specific return risk estimate based on estimated
inventory levels in the distribution channel that was used to determine the
amount of revenue that could be recorded during a given period. During the year
ended December 31, 2003, as a result of the significant history of minimal
returns for both products since their introduction, Kos revised its return risk
estimates to reflect the historically low product return patterns. This change
in accounting estimate resulted in the Company recognizing as revenue all
product shipments made during the year ended December 31, 2003, as well as
$11.1 million of its prior period product shipments not recognized as revenue
because of its previous product return risk exposure estimates. The impact of
this change in estimate increased the Companys reported revenues, net income,
and basic and diluted earnings per share by $11.1 million, $9.9 million, and
$0.45 per share and $0.24 per share, respectively, for the year ended December
31, 2003. The Company will continue to monitor wholesaler inventory levels,
and, if the Companys product return risk exceeds acceptable levels, the
Company may be required to not recognize the revenue and related costs
associated with the excess inventory until such return risk is mitigated. The Company follows Statement of Financial Accounting Standards (SFAS)
No. 109, Accounting for Income Taxes, which requires, among other things,
recognition of future tax benefits and liabilities measured at enacted rates
attributable to temporary differences between financial statement and income
tax bases of assets and liabilities and to tax net operating loss carryforwards
to the extent that realization of said benefits is more likely than not. The
Company has generated an accumulated deficit since inception of approximately
$233.9 million. Excluding the impact of the BMS Payment, as discussed below,
the Company generated full-year income before provision for income taxes for
the first time in 2003. As of December 31, 2003, the Company had approximately
$146.7 million of net operating loss carryforwards and $41.2 million of other
deductible temporary differences between the book and tax bases of assets and
liabilities. These items result in a net deferred tax asset of approximately
$73.8 million as of December 31, 2003. The net deferred tax asset has been
fully reserved by establishing a valuation allowance as of December 31, 2003.
Management has re-evaluated the continuing need for a valuation 22




---



##### Table of Contents



allowance against deferred tax assets and, based on the history of net
losses, concluded that there is not sufficient evidence as of December 31, 2003
to determine that the Company will more likely than not realize all or a
portion of its deferred tax assets. However, if in the future management
concludes that some or all of its deferred tax assets will more likely than
not be realized, then the Company will be required to recognize such assets by
reversing the applicable portion of the valuation allowance. The Company
recorded a provision for income taxes of $2.9 million for the year ended
December 31, 2003, to reflect $1.3 million in federal alternative minimum tax
and $1.6 million in state income tax liabilities that cannot be offset by
utilizing the Companys net operating loss carryforwards. Years Ended December 31, 2003 and 2002 The Companys reported revenue increased to $293.9 million for the year
ended December 31, 2003, from $172.7 million for the same period in 2002. This
increase in revenue was principally attributable to increases in unit volume
and price for the Companys products during the 2003 period as compared to the
2002 period, and to the change in product return estimates (as described
above). Gross profit (reported product sales less cost of product sold) for the
year ended December 31, 2003, was $273.9 million, compared with $157.3 million
for the 2002 period. The Companys research and development expenses increased to $52.2 million
for the year ended December 31, 2003, from $44.0 million for the same period in
2002. The increased expenses related primarily to an increase of $4.2 million
in personnel and personnel-related costs, and to a $3.1 million increase
principally associated with expenses related to Advicorclinical studies. These
increases were partially offset by decreases of $0.9 million in medical
education costs which were greater during the 2002 period in support of the
commercial launch of the Advicorproduct, of $0.9 million associated with
formulation costs for products under development, and of $0.2 million in offset
expenses resulting from Merck reimbursement payments. Selling, general and administrative expenses increased to $156.5 million
for the year ended December 31, 2003, from $130.1 million for the same period
in 2002. Within this category, selling expenses increased to $124.3 million for
the 2003 period from $108.5 million for the comparable 2002 period. The growth
in selling expenses was primarily related to increases of $13.9 million in
sales force operating costs in support of the Niaspanand Advicorproducts, and
of $2.3 million in royalty expenses. General and administrative expenses
increased to $32.2 million for the year ended December 31, 2003, from $21.6
million for the year ended December 31, 2002. This increase in general and
administrative expenses was primarily related to increases of $3.7 million in
personnel and personnel related costs, of $3.2 million in professional fees, of
$2.5 million associated with a warrant award and with a modification made to a
stock option grant previously made to a former employee, and of $1.2 million in
other costs associated with the expanded activities of the Company. As of December 31, 2003, the Company was subject to the terms of the
December 19, 2002, $30 million credit facility (the Additional Standby
Facility), and the December 21, 1999, $50 million credit facility (the
Standby Facility), with Michael Jaharis, Chairman Emeritus of the Companys
Board of Directors and its principal shareholder. During 2003, the Company was
also subject to the terms of the September 1, 1999, $50 million credit facility
(the Supplemental Credit Facility) with Mr. Jaharis and with a transferee of
Mr. Jaharis wife until its conversion into Common Stock during the fourth
quarter of 2003. See Liquidity and Capital Resources for additional
discussion regarding this debt conversion. Interest expense under the Companys
credit facilities totaled $3.3 million and $4.0 million for the years ended
December 31, 2003 and 2002, respectively. The decrease in interest expense is
mostly attributable to a decrease in outstanding borrowings, and to a decrease
in the Companys borrowing rate, which is based on the prime rate. 23




---



##### Table of Contents



The Company recorded a $2.9 million income tax provision for the year
ended December 31, 2003 to reflect $1.3 million of federal alternative minimum
tax and $1.6 million of state income tax liabilities that cannot be offset by
utilizing the Companys net operating loss carryforwards. The Company recorded net income of $59.4 million for the year ended
December 31, 2003, compared with a net loss of $20.8 million for the year ended
December 31, 2002. Years Ended December 31, 2002 and 2001 The Companys reported revenue, including the effect of Niaspanand
Advicorshipments not recognized as revenue during the period resulting from
the Companys product return risk expectations described above, increased to
$172.7 million for the year ended December 31, 2002, from $91.4 million for
2001. This increase in revenue was mostly related to increases in prescription
volume for the Companys Niaspanproduct during 2002 as compared to 2001, as
well as to the market introduction, during late January 2002, of the Companys
Advicorproduct. More specifically, Niaspanand Advicorrevenue for the years
ended December 31, 2002 and 2001, were as follows: Year EndedDecember 31,2002
    
    2001(in millions)Product shipments
    
    $
    176.8
    
    
    $
    87.4Prior period product shipments
recorded as revenue during period
    
    
    7.0
    
    
    
    3.8Current period product shipments
not recognized as revenue
    
    
    (11.1
    )
    
    
    (7.0
    )Reported product sales
    
    $
    172.7
    
    
    $
    84.2
 The increase in Niaspanand Advicorproduct sales during the year ended
December 31, 2002, were partially offset by the absence, during the 2002
period, of $7.2 million in co-promotion revenue associated with the terms of a
co-promotion agreement with Abbott Laboratories, Inc. (Abbott), for the
promotion and marketing of Abbotts Mavik and Tarka products within the United
States (the Abbott Agreement). Under the terms of the Abbott Agreement, the
Company received an increasing percentage of revenue based on sales thresholds.
Kos and Abbott agreed to terminate the Abbott Agreement effective January 1,
2002. Accordingly, revenue for the year ended December 31, 2002, does not
reflect co-promotion revenue associated with the Abbott Agreement. Gross profit (reported product sales less cost of product sold) for the
year ended December 31, 2002, was $157.3 million, compared with $76.6 million
for the 2001 period (before the $7.2 million of co-promotion revenue discussed
above). Through December 17, 2001, the Company was subject to an agreement with
DuPont Pharmaceuticals Company (DuPont) for the purpose of co-promoting the
Companys Advicorproduct in the United States and Canada (the DuPont
Agreement). Under the terms of the DuPont Agreement, the Company and DuPont
would have shared in the future development and commercialization of the
Advicorproduct. Specifically, DuPont had agreed (i) to make equity investments
in the Company up to $30 million through the date of FDA approval of the
Advicorproduct; (ii) to pay the Company $17.5 million in milestone payments
upon FDA approval of the Advicorproduct; (iii) to fund up to $32.5 million for
future clinical development of the Advicorproduct; and (iv) to share equally
in the costs associated with promoting the Advicorproduct and share equally in
product profits after deducting a royalty to the Company. On May 31, 2000,
DuPont made a $20-million equity investment in the 24




---



##### Table of Contents



Company in exchange for 1,250,000 shares of the Companys Common Stock. On
June 7, 2001, DuPonts parent company, E.I. du Pont Nemours, announced that it
had entered into an agreement to sell DuPont to Bristol-Myers Squibb Company
(BMS) and on October 1, 2001, BMS completed its acquisition of DuPont. On
December 17, 2001, the Company entered into an agreement with BMS pursuant to
which the DuPont Agreement was terminated and BMS paid Kos $45 million (the
BMS Payment). Of the total settlement received from BMS, approximately $6
million pertained to co-promotion expenses due and unpaid by DuPont prior to
the termination of the DuPont Agreement. The remaining settlement amount, or
approximately $39 million, was recorded as other income for the year ended
December 31, 2001. On January 28, 2002, following the termination of the DuPont Agreement,
the Company began commercializing its Advicorproduct. Accordingly, results of
operations for the year ended December 31, 2002, reflect the Companys
significant efforts in connection with the commercial launch of this new
product. The Companys research and development expenses increased to $44.0 million
for the year ended December 31, 2002, from $31.0 million for the year ended
December 31, 2001. The increased expense related primarily to increases of $3.6
million in personnel and personnel related costs, $3.3 million in medical
education costs in support of the Niaspanand Advicorproducts, and of $2.5
million in formulation development costs for products under development.
Research and development expenses were also affected by the absence, during the
2002 period, of a $3.9 million contribution made by DuPont during the 2001
period pursuant to the DuPont Agreement, which agreement was terminated on
December 17, 2001. Under the terms of the DuPont Agreement, DuPont shared
equally with the Company in costs associated with the clinical development,
medical education, and promotional efforts of the Companys Advicorproduct.
This growth in research and development expenses was partially offset by a
decrease of $1.5 million in clinical study costs as a result of the substantial
completion, during the 2002 period, of an Advicorclinical trial. Selling, general and administrative expenses increased to $130.1 million
for the year ended December 31, 2002, from $83.6 million for the year ended
December 31, 2001. Within this category, selling expenses increased to $108.5
million for the 2002 period from $69.6 million for the comparable 2001 period.
The growth in selling expenses was primarily related to increases of $21.2
million in sales force operating costs, of $13.5 million in marketing costs, of
$4.1 million in royalty expenses, of $1.5 million in fees associated with a
contract sales organizations assistance in the promotion of the Companys
Niaspanand Advicorproducts, of $0.8 million in medical education grants, and
by the absence, during the 2002 period, of a $4.2 million contribution made by
DuPont during the 2001 period pursuant to the DuPont Agreement. Because of the
termination of the Abbott Agreement, selling expenses for the year ended
December 31, 2002, also exclude the effect of co-promotion expenses associated
with such co-promotion arrangement, which totaled $7.0 million for the year
ended December 31, 2001. General and administrative expenses increased to $21.6
million for the 2002 period, from $14.0 million for the 2001 period. This
increase in general and administrative expenses related primarily to an
increase of $2.7 million in personnel and personnel related costs, of $2.2
million in patent costs, and $2.7 million in other costs associated with the
expanded activities of the Company. Interest expense under the Companys credit facilities totaled $4.0
million and $6.1 million for the years ended December 31, 2002 and 2001,
respectively. The Company incurred a net loss of $20.8 million for the year ended
December 31, 2002, compared with net income of $2.4 million for the year ended
December 31, 2001. Liquidity and Capital Resources At December 31, 2003, the Company had cash and cash equivalents of $260
million (of which $17.8 million was pledged as collateral for the Companys
letters of credit facility with a major institutional 25




---



##### Table of Contents



bank) and working capital of $248.1 million. The Companys primary uses of
cash to date have been to fund selling, general and administrative expenses,
and research and development expenses, including clinical trials. Net cash provided by operating activities was $55.6 million in 2003,
compared to net cash used in operating activities of $1.2 million in 2002, and
$7.1 million of net cash provided by operations in 2001. The increase in net
cash provided by operations in 2003 was primarily a result of the increase in
net income as adjusted for non-cash items. Working capital uses of cash during
2003 included increases in trade accounts receivable, inventories, prepaid
expenses and other current assets, and advance payments from customers,
partially offset by increases in accounts payable, accrued expenses and advance
payments received on a license agreement. The increase in net cash used in
operating activities in 2002 was primarily a result of the net loss associated
with the absence during 2002 of the BMS payment, which was received in late
2001. Working capital sources of cash in 2002 included decreases in the
Companys current non-cash assets, except for trade accounts receivable which
increased in line with the Companys historical growth in net sales, as well as
increases in the Companys current liabilities. Net cash used in investing activities was $11.0 million in 2003, compared
to $6.7 million in 2002, and $4.3 million in 2001. The increases in net cash
used in investing activities were a result of the Companys expansion of its
production capacity and its overall infrastructure throughout 2003, 2002 and
2001. As of December 31, 2003, the Companys investment in equipment and
leasehold improvements, net of depreciation and amortization, was $17.8
million. The Company expects to increase the level of capital expenditures
during 2004 mostly to provide increased production capacity and to accommodate
the Companys increasing operational needs. In 2003, net cash provided by financing activities was $195.8 million,
compared to cash used in financing activities of $17.8 million in 2002, and to
net cash provided by financing activities of $36.4 million in 2001. The
increase in 2003 was primarily related to the net proceeds from the Companys
stock offering (as described below) and to shares of Common Stock issued from
the exercise of stock options and employee participation in the employee stock
purchase plan. These amounts were offset by a payment against borrowings
previously made under the Standby Facility. In 2002, the $17.8 million used in
financing activities was primarily associated with net payments of $21 million
against borrowings previously made under the Standby Facility and Additional
Standby Facility. On December 19, 2002, the Company entered into an agreement with Michael
Jaharis, Chairman Emeritus of the Companys Board of Directors and its
principal shareholder, whereby Mr. Jaharis agreed to replace the previous
$30-million credit facility extended to the Company on July 1, 1998 (which was
to expire on December 31, 2002), with a new facility expiring on June 30, 2008
(the Additional Standby Facility). In connection with this new credit
arrangement, the Company granted to Mr. Jaharis non-detachable warrants to
purchase 1,000,000 shares of the Companys Common Stock at an exercise price
based on the market price of the Companys Common Stock on the date that the
first draw under this facility occurs. The Company had no borrowings
outstanding under the Additional Standby Facility as of December 31, 2003.
Borrowings, when outstanding, will bear interest at the prime rate (4.0% as of
December 31, 2003), and will be subject to the terms and conditions of
borrowings made under the Supplemental Credit Facility, which in addition to
including standard and customary loan covenants and conditions, also includes
the condition that the death of the lender shall not have occurred, that
lender, his spouse, children and entities they control continue to own at least
40% of the Common Stock of the Company, and that no material adverse change
shall have occurred to the Company or its financial operations. On September 1, 1999, the Company formally agreed to the terms of an
additional $50-million funding arrangement initially entered into with Mr.
Jaharis on October 7, 1998 (the Supplemental Credit Facility). On July 21,
2001, the Company replaced its existing $50 million promissory note payable to
Mr. Jaharis with two, $25 million, promissory notes, one payable in the name of
Mr. Jaharis and the other 26




---



##### Table of Contents



payable in the name of Mr. Jaharis wife. With this promissory note
replacement, all of Mr. Jaharis existing rights and obligations under the
Supplemental Credit Facility, with respect to one-half of the outstanding
amount, were transferred to Mrs. Jaharis, and were subsequently transferred by
Mrs. Jaharis to a limited partnership (the Limited Partnership) that she
controls. All other terms and conditions of the Supplemental Credit Facility
remained unchanged. Borrowings under the Supplemental Credit Facility were
convertible at $4.91 per share and accrued interest at the prime rate. On
November 25, 2003, $6.1 million of the Supplemental Credit Facility was
converted into 1,250,000 shares of Common Stock and subsequently sold pursuant
to the equity offering described below. On December 31, 2003, the remaining
$43.9 million balance was converted into 8,933,299 shares of the Common Stock.
The Supplemental Credit Facility terminated as of December 31, 2003. On December 21, 1999, Mr. Jaharis agreed to extend another $50-million
loan to the Company (the Standby Facility). Borrowings made under the Standby
Facility totaled $30 million as of December 31, 2003, are due June 30, 2005,
and are also subject to most of the terms and conditions of borrowings made
under the Supplemental Credit Facility. In addition to including standard and
customary loan covenants and conditions, the Standby Facility includes the
conditions that the death of lender shall not have occurred, that lender, his
spouse and children, and entities they control continue to own at least 40% of
the Common Stock of the Company, and that no material adverse change shall have
occurred to the Company or its financial operations. Borrowings made under the
Standby Facility are not, however, convertible into shares of the Companys
Common Stock. In lieu of a conversion feature, the Company has granted to Mr.
Jaharis non-detachable warrants to purchase 6,000,000 shares of the Companys
Common Stock at $5.00 per share, which approximated the market value of the
Companys Common Stock on the effective date of the Standby Facility. The
warrants are exercisable at any time until June 30, 2006. The exercise of a
significant number of the warrants issued under the Standby Facility will cause
material dilution to existing shareholders of the Company. The Company recorded $3.3 million and $4.0 million of interest expense for
the years ended December 31, 2003 and 2002, respectively, related to its credit
facilities with Mr. Jaharis and his transferees. In January 2002, the Securities and Exchange Commission declared effective
a shelf registration statement (the Shelf Registration) filed by the Company
for the sale, from time to time, of up to $200 million of its Common Stock,
Preferred Stock, stock options, warrants and other rights to purchase Common
Stock or Preferred Stock. On October 10, 2003, the Company filed a new shelf
registration statement that covered the shares of the earlier Shelf
Registration (the Amended Shelf Registration) and which allowed the Limited
Partnership to sell up to 1,500,000 shares of the Companys Common Stock in a
public offering; and on October 31, 2003, the Company further amended the
Amended Shelf Registration to register an aggregate of 1,350,000 shares of
Company Common Stock held by BMS and the Companys Chairman. The Amended Shelf
Registration was declared effective by the Securities and Exchange Commission
on October 31, 2003. On November 25, 2003, the Company sold 3,750,000 shares of
Common Stock and the Limited Partnership sold 1,250,000 shares of Common Stock
(converted from the Supplemental Credit Facility) pursuant to the Amended Shelf
Registration. On December 22, 2003, the Company sold an additional 650,000
shares of Common Stock and the Companys Chairman sold 100,000 shares of Common
Stock to cover over-allotments as permitted in the Amended Shelf Registration.
Net proceeds to the Company resulting from the sale of the 4,400,000 shares of
Common Stock totaled $184.3 million. Proceeds from the offerings, other than
the proceeds pertaining to the selling shareholders, are expected to be used to
acquire other products or companies, to in-license complimentary products, and
to fund working capital needs for general corporate purposes. Although the Company currently anticipates that, including the capital
available to the Company under the Additional Standby Facility and the Standby
Facility, it has or has access to an amount of working capital that will be
sufficient to fund the Companys operations for the next twelve months, the 27




---



##### Table of Contents



Companys cash requirements during this period will be substantial and may
exceed the amount of working capital available to the Company. The Companys
ability to fund its operating requirements and maintain an adequate level of
working capital will depend primarily on its ability to continue to generate
substantial growth in sales of its Niaspanand Advicorproducts, its ability to
continue to access its credit facilities, and on its ability to control
operating expenses. The Companys failure to generate substantial growth in the
sales of Niaspanand Advicor, control operating expenses, or meet the
conditions necessary for the Company to obtain funding under the Additional
Standby Facility and the Standby Facility, and other events  including the
progress of the Companys research and development programs; the costs and
timing of seeking regulatory approvals of the Companys products under
development; the Companys ability to obtain regulatory approvals in the United
States and abroad; the Companys ability to manufacture products at an
economically feasible cost; costs in filing, prosecuting, defending, and
enforcing patent claims and other intellectual property rights; the extent and
terms of any collaborative research, manufacturing, marketing, joint venture,
or other arrangements; and changes in economic, regulatory, or competitive
conditions or the Companys planned business  could cause the Company to
require additional capital. In the event that the Company must raise additional
capital to fund its working capital needs, it may seek to raise such capital
through loans, the issuance of debt securities or equity securities, each of
which would require the consent of the Companys current lender. To the extent
the Company raises additional capital by issuing equity securities or obtaining
borrowings convertible into equity, ownership dilution to existing shareholders
will result, and future investors may be granted rights superior to those of
existing shareholders. Moreover, additional capital may not be available to the
Company on acceptable terms, or at all. Contractual Obligations The following table summarizes our significant contractual obligations at
December 31, 2003, and the effect such obligations are expected to have on our
liquidity and cash flows in future periods. This table excludes amounts already
recorded on our balance sheet as current liabilities as of December 31, 2003. Payments Due by Period(in millions)Less than 1 year
    
    1-3 years
    
    3-5 years
    
    More than 5 years
    
    TotalOperating lease obligations
    
    $
    6.7
    
    
    $
    12.6
    
    
    $
    8.0
    
    
    $
    16.2
    
    
    $
    43.5Employment agreements
    
    
    1.1
    
    
    
    1.8
    
    
    
    0.2
    
    
    
    
    
    
    
    3.1Long term obligations
    
    
    
    
    
    
    30.0
    
    
    
    
    
    
    
    
    
    
    
    30.0Total
    
    $
    7.8
    
    
    $
    44.4
    
    
    $
    8.2
    
    
    $
    16.2
    
    
    $
    76.6
 Purchase orders or contracts for the purchase of raw materials and other
goods and services are not included in the table above. The Companys purchase
orders are based on its current manufacturing needs and are fulfilled by its
vendors within a short period of time. The Company does not have any
significant agreements for the purchase of raw materials or other goods
specifying minimum quantities or set prices. Contractual obligations such as sponsored research and licensing
agreements that are contingent upon the achievement of certain milestones are
not included in the table above. Such arrangements are not considered
contractual obligations until the milestone is met by the third party, and in
most cases, are cancelable at the option of the Company. As of December 31,
2003, assuming all future milestones were met, additional required payments
related to sponsored research and licensing agreements would be approximately
$1.8 million. 28




---



##### Table of Contents



Obligations associated with Takeda and with a contract sales organization
(CSO) are based upon net sales of the Company and are not included in the
table above. The Company will pay Takeda a royalty on incremental net sales of
the Companys Niaspanand Advicorproducts in the United States above a certain
baseline amount. This co-promotion arrangement has a three-year term commencing
January 2004 and provides for residual payments to Takeda after the three
years, if the parties do not renew the agreement. The Company will pay the CSO
a royalty based on net sales of the Companys Niaspanand Advicorproducts
during a five-year period beginning January 1, 2002. The royalty amounts
payable to the CSO are subject to a cumulative minimum of $50 million over the
term of the Contract Sales Force Agreement, not to exceed $65 million over such
contract term. As of December 31, 2003, in connection with the Merck Agreement, Kos had
received $15 million of upfront payments of which $12.5 million are refundable
to Merck by Kos if it fails to achieve certain regulatory milestones.
Refundable amounts under the Merck Agreement are not included in the table
above. The expected timing of payment of the obligations discussed above is
estimated based on current information. Timing of payments and actual amounts
paid may be different depending on changes to agreed-upon amounts for some
obligations. Amounts disclosed as contingent or milestone-based obligations are
dependent on the achievement of the milestones or the occurrence of the
contingent events and can vary significantly. 29




---



##### Table of Contents



FORWARD-LOOKING
INFORMATION: CERTAIN CAUTIONARY STATEMENTS Statements contained in this Managements Discussion and Analysis of
Financial Condition and Results of Operations and elsewhere in this report may
contain information that includes or is based upon forward-looking statements
within the meaning of the Securities Litigation Reform Act of 1995.
Forward-looking statements present the Companys expectations or forecasts of
future events. These statements can be identified by the fact that they do not
relate strictly to historical or current facts. They frequently are accompanied
by words such as anticipate, estimate, expect, project, intend,
plan, believe, and other words and terms of similar meaning. In particular,
these include statements relating to the Companys ability to: increase the
amount of the sales of its products, including the success of its relationship
with Takeda; successfully develop and commercialize new products under
development and within expected timeframes; continue its strong financial
performance and that of its products; increase its stock price; protect the
strength of its patents; achieve a successful conclusion to the ongoing
litigation with Barr Laboratories, Inc. and Andrx Laboratories, Inc.;
commercialize its products outside the United States and the success of its
relationship with Merck; achieve its goals for future sales levels, operating
margins, earnings growth, and shareholder value; meet the conditions necessary
to obtain funding under its funding arrangements; increase the level of capital
expenditures in future periods; and meet its expectations regarding future
capital needs. These forward-looking statements are subject to risks and
uncertainties which may cause actual results to differ materially from those
projected in a forward-looking statement. These risks and uncertainties include
the continued market acceptance of the Advicorproduct, the expected continued
growth in sales of the Niaspanproduct, the ability of Kos to continue to build
awareness for Advicorwithin the medical community, the ability of the Company
to generate increasing sales of Advicorwithout diminishing the sales of
Niaspan, the success of the Companys relationship with Takeda, the Companys
ability to commercialize its products outside the United States and the success
of its relationship with Merck, the Companys ability to attract and retain
sales professionals, the Companys ability to successfully develop and
commercialize new products under development and within expected timeframes,
the Companys ability to increase its stock price, grow revenue, control
expenses, and grow earnings and shareholder value, the Companys ability to
meet the conditions necessary to obtain funding under its funding arrangements,
the Companys ability to retain sufficient cash, available credit, and access
to capital from third parties to be able to repay its credit obligations on a
timely basis and meet its expectations regarding future capital needs, the
protection afforded by the Companys patents, the effect of conditions in the
pharmaceutical industry and the economy in general, as well as certain other
risks including those set forth below and elsewhere in this report and in other
reports filed by the Company with the Securities and Exchange Commission.
Further, certain forward-looking statements are based upon assumptions of
future events, which may not prove to be accurate. All forward-looking
statements included herein are made only as of the date such statements are
made, and the Company does not undertake any obligation to publicly update or
correct any forward-looking statements to reflect events or circumstances that
subsequently occur or which the Company hereafter becomes aware of. Subsequent
written and oral forward looking-statements attributable to the Company or to
persons acting on its behalf are expressly qualified in their entirety by the
cautionary statements set forth below and elsewhere in this report and in other
reports filed by the Company with the Securities and Exchange Commission. Market Acceptance and Sales Growth ofNiaspanandAdvicor The Companys success depends primarily upon its ability to successfully
market and sell increasing quantities of the Niaspanand Advicorproducts. The
Companys ability to successfully sell increasing quantities of the Niaspanand
Advicorproducts will depend significantly on the continued acceptance of the
Niaspanproduct by physicians and their patients despite the introduction of
Advicor. As a consequence of the on-going commercialization of the Advicor
product, which is a combination product including Niaspanand a statin,
prescription levels for Niaspanmay be adversely affected to the extent a
significant number of physicians prescribe Advicoras a substitute product for
their patients who are 30




---



##### Table of Contents



currently taking Niaspan. Such substitution could have an adverse effect
on the growth of the combined revenue generated from the sale of the Companys
products. The Company believes that intolerable flushing and potential liver
toxicity associated with other currently available formulations of niacin are
the principal reasons why physicians generally have been reluctant to prescribe
or recommend such formulations. Flushing episodes are often characterized by
facial redness, tingling or rash, and are a side effect that often occurs when
humans ingest niacin. Currently available formulations of niacin generally
either require, in the case of immediate-release niacin, the patient to take
niacin several times per day, resulting in multiple flushing episodes, or
result, in the case of sustained-release niacin, in liver toxicity. Although
most patients taking the Niaspanand Advicorproducts will sometimes flush, the
formulation and dosing regimen for Niaspanand Advicorhave been designed to
maximize patient acceptance and minimize the occurrence of flushing and liver
toxicity. If, however, a significant number of patients using the Niaspanand
Advicorproducts were to suffer episodes of flushing that they consider
intolerable or to suffer other side effects, physicians may discontinue
prescribing the Niaspanand Advicorproducts or patients may stop taking
Niaspanand Advicor, which would have a material adverse effect on the Company.
Unanticipated side effects or unfavorable publicity concerning the Niaspanor
Advicorproducts or any other product incorporating technology similar to that
used in the Niaspanor Advicorproducts also could have an adverse effect on
the Companys ability to obtain regulatory approvals or to achieve acceptance
by prescribing physicians, managed care providers, or patients, any of which
would have a material adverse effect on the Company. On January 28, 2002, the Company began commercializing the Advicor
product. The Companys ability to successfully sell increasing quantities of
the Advicorproduct will depend significantly on the increasing acceptance of
the Advicorproduct by physicians and their patients. If a significant number
of patients using the Advicorproduct were to suffer episodes of flushing that
they consider intolerable or to suffer more serious side effects, such as
rhabdomyolysis or myopathy, physicians may discontinue prescribing the Advicor
product or patients may stop taking Advicor, which would have a material
adverse effect on the Company. Rhabdomyolysis is a rare disease in which
serious muscle damage results in release of muscle cell contents into the
bloodstream, which may be fatal. Myopathy is a disorder of muscle tissue or
muscles that can result from endocrine disorders, metabolic disorders,
infection or inflammation of the muscles, and from certain drugs. There have
been several cases where Niaspan(one of the principal ingredients in Advicor)
or Advicorhave been identified as possible causes of myopathy. Unanticipated
side effects or unfavorable publicity concerning the Advicorproduct or any
other product incorporating technology similar to that used in the Advicor
product also could have an adverse effect on the Companys ability to maintain
regulatory approvals or to achieve acceptance by prescribing physicians,
managed care providers, or patients, any of which would have a material adverse
effect on the Company. In addition, Advicormay prove to be difficult to successfully sell
because the cholesterol market is dominated by competitors with significantly
larger sales forces and with significantly greater marketing resources than
those available to the Company. Further, Advicoris a combination of two
well-known cholesterol drugs, niacin and lovastatin, that have been available
for a significant period of time. Although the combination of these drugs is
highly effective in improving all of the major components of cholesterol, it is
possible that physicians may not prescribe Advicorbecause it is not as new as
more recently introduced compounds, such as the potent statin products marketed
by the Companys competitors. Also, because Advicoris a combination of two
currently available drugs, Advicorhas been approved by the FDA for the
improvement of cholesterol disorders in patients who were not able to achieve
desired cholesterol improvements by taking either Niaspanor lovastatin alone.
Consequently, although such an approved treatment indication is standard for
combination drugs such as Advicor, it is possible that physicians will not
prescribe Advicoruntil they have first prescribed either Niaspan, lovastatin,
or another statin alone and subsequently determined that their patients need
Advicorto achieve desired cholesterol improvements. Similarly the Companys
ability to successfully sell increasing 31




---



##### Table of Contents



quantities of the Advicorproduct may be adversely affected by the
November 2002 release of Zetia, part of a new class of cholesterol-lowering
agents, and by the September 2003 release of Crestor, a new, highly powerful
statin product. Zetia is being marketed by Merck/Schering-Plough
Pharmaceuticals, which is a joint venture between Merck & Co., Inc. and
Schering-Plough Corporation, and Crestor is marketed by AstraZeneca.
Merck/Schering-Plough Pharmaceuticals and AstraZeneca are competitors with
substantially greater resources than Kos. Zetia is part of a new class of
cholesterol-lowering agents that inhibit the intestinal absorption of
cholesterol. Crestor is a type of statin drug that is highly effective in
reducing LDL cholesterol, but is less effective in modifying HDL cholesterol,
triglycerides and other forms of cholesterol. The Companys future sales of
Advicormay also be affected by the potential release of several other new
combination statin drugs in the future. Further, there are at least nine
versions of generic lovastatin, one of the components of Advicor, that have
been launched into the cholesterol market, which could adversely affect demand
for Advicor. Consequently, the Companys effort to sell increasing quantities
of the Advicorproduct may be unsuccessful. History of Operating Losses; Uncertainty of Future Profitability To date, the Company has dedicated most of its financial resources to the
development and commercialization of the Niaspanand Advicorproducts, the
development of other products, and general and administrative expenses. The
Company has generated an accumulated deficit as of December 31, 2003, of
approximately $233.9 million. Excluding the impact of the BMS Payment, the
Company generated full-year income before provision for income taxes for the
first time in 2003. The Companys ability to achieve and maintain profitability
will depend, among other things, on the commercial success of the Niaspanand
Advicorproducts; on the Companys ability to successfully exploit the
Companys manufacturing and sales and marketing capabilities; on the Companys
ability to complete the development of, and obtain regulatory approvals for,
and achieve market acceptance for the Companys products under development; and
on the Companys ability to maintain sufficient funds to finance the Companys
activities. As of December 31, 2003, the Company had approximately $146.7
million of net operating loss carryforwards and $41.2 million of other
deductible temporary differences between the book and tax bases of assets and
liabilities. If the Company is unable to achieve or sustain profitability,
however, its carryforwards may not be utilized. Barr Laboratories Litigation On January 23, 2002, the Company received notice from Barr Laboratories,
Inc. (Barr) that it had filed with the FDA an Abbreviated New Drug
Application (ANDA) that, if approved, would allow Barr to market a generic
version of the Companys 1000 mg Niaspanproduct. As a result, on March 4,
2002, the Company filed a patent infringement lawsuit against Barr in the
Southern District of New York (SDNY). On March 11, 2002, the Company filed an
amended complaint (the Amended Complaint). In this lawsuit, the Company
asserted that Barr has infringed Kos 6,080,428 and 6,129,930 patents. On March
25, 2002, Barr answered the Amended Complaint (the Answer) by denying that
the 428 and 930 patents are valid and infringed, and seeking a declaratory
judgment to that effect. On August 19, 2002, Barr amended its Answer to add
counterclaims requesting a declaratory judgment that two other patents owned by
Kos, U.S. Patent Numbers 5,126,145 and 5,268,181, are not infringed, and that
the 181 patent is invalid. On July 9, 2002, the Company received notice from Barr that it had filed
an ANDA with the FDA that would, if approved, allow Barr to market generic
versions of the Companys 500 mg and 750 mg Niaspanproducts. On August 13,
2002, the Company filed a second patent infringement lawsuit against Barr also
in the SDNY. Again, the Company asserted that Barr has infringed the 428 and
930 patents. On September 3, 2002, Barr answered the complaint by denying
infringement and alleging that the patents are invalid. Barr also sought a
declaratory judgment that the 428, 930, 145, and 181 patents are not
infringed, and that the 428, 930, and 181 patents are invalid. The two cases
were consolidated on September 23, 2002. 32




---



##### Table of Contents



On September 30, 2002, the Company received notice from Barr that it had
filed a Supplemental Paragraph IV Certification relating to Kos 6,406,715
patent. The Company filed a third lawsuit on November 12, 2002, against Barr in
the SDNY asserting infringement of this patent. On December 3, 2002, Barr
answered the complaint by denying that the 715 patent is valid and infringed,
and seeking a declaratory judgment of invalidity. Barr also sought a
declaratory judgment that the 428, 930, 145, and 181 patents are not
infringed, and that the 428, 930 and 181 patents are invalid. The third case was consolidated with the first two on January 23, 2003. On
March 4, 2003, Kos replied to Barrs declaratory judgment counterclaims by
denying that Kos patents are invalid or not infringed. Kos also sought a
declaratory judgment that one or more of Barrs products will infringe the 145
and 181 patents. During the course of the litigation, Barr has also suggested
claims of anti trust and unenforceability. Kos has received several notices
from Barr Laboratories that Barr has filed a Supplemental Paragraph IV
Certification to each ANDA to provide for U.S. Patent No. 6,676,967. The first
notice was received by Kos on January 21, 2004 and the latest on February 23,
2004. Kos is currently evaluating its options. This current litigation is costly and time consuming, and the Company
cannot assure that it will be successful. In addition, such litigation may
result in financial losses or harm to the Companys reputation, and may divert
management resources and attention from its operations. If Barr is successful
in this litigation, the Companys 428, 930 and 181 and 715 patents could be
found to be invalid, unenforceable or not infringed. If such patents are
invalid, unenforceable or not infringed, the Company would be unable to prevent
Barr from marketing a generic version of the Niaspanproduct, which would have
a material adverse effect on the Company. The Company would also be unable to
prevent other companies from introducing generic and other competing products
into the market place. Furthermore, there could be an increased risk that other
companies would challenge the Companys proprietary rights or claim that the
Companys products infringe on their patents. Future Capital Needs; Uncertainty of Additional Funding. In order to finance the Companys operations, as of December 31, 2003, the
Company had $30 million in outstanding borrowings from Michael Jaharis, the
Companys principal shareholder, director, and Chairman Emeritus. The Company
can borrow up to an additional $50 million from Mr. Jaharis under agreements
currently in place; provided that the conditions of borrowings have been
satisfied including, without limitation, that the death of lender shall not
have occurred,


the lender, his spouse, children and entities they control continue
to own at least 40% of the Common Stock of the Company, and no
material adverse change shall have occurred to the Company or its
financial condition.


 The repayment of funds borrowed from Mr. Jaharis are secured by
the pledge of all of the Companys assets to him. As a result, if the Company
is unable to repay the loans as they become due, the Company could be forced to
liquidate the Companys assets or transfer all of such assets to Mr. Jaharis.
The Company has spent, and will continue to be required to spend, substantial
funds to continue research and development activities, including clinical
trials of the Companys products under development, and to commercialize the
Niaspanand Advicorproducts and the Companys other products under
development, if regulatory approvals are obtained for such products under
development. The Company believes that it has sufficient resources, including funds
available to it under loans from Mr. Jaharis and the proceeds of the public
offering completed in the last quarter of 2003, to fund the Companys
operations through at least the next twelve months. Even with the proceeds from
these sources, however, the Company may need or elect to raise additional
capital prior to such date. The Companys ability to fund its operating
requirements and maintain an adequate level of working capital for the next
twelve months will depend primarily on: the near-term commercial success of
Niaspanand Advicor;its ability to meet the conditions necessary to obtain
funding under its lines of credit, including, without limitation, that the
death of the lender shall not have occurred, the lender, his spouse, children and entities they control continue
to own at least 40% of the Common Stock of the Company, and no
material adverse change shall have occurred to the Company or its
financial condition; the problems, delays, expenses and
complications frequently encountered by companies at this stage of development;
the progress of the Companys research, development, and clinical trial
programs; the costs and timing of seeking regulatory approvals of the Companys
products under development; the Companys ability to obtain such 33




---



##### Table of Contents



regulatory approvals; costs in filing, prosecuting, defending, and
enforcing patent claims and other intellectual property rights; the extent and
terms of any collaborative research, manufacturing, marketing, or other
arrangements; and changes in economic, regulatory, or competitive conditions or
the Companys planned business. Estimates about the adequacy of funding for the
Companys activities are based on certain assumptions, including assumptions
regarding the marketing and sales success of the Niaspanand Advicorproducts,
the regulatory and commercial success of the Advicorproduct, and that testing
and regulatory procedures relating to the Companys other products under
development can be conducted at projected costs and within projected time
frames. To the extent these assumptions prove to be inaccurate, the Company may
have insufficient resources to fund its operations as currently planned. To satisfy the Companys capital requirements, it may seek to raise funds
in the public or private capital markets. The Companys ability to raise
additional funds in the public markets may be adversely affected if sales of
the Niaspanand Advicorproducts do not increase rapidly; if the results of the
clinical trials for the Companys products under development are not favorable;
or if regulatory approval for any of the Companys products under development
is not obtained. The Company may seek additional funding through corporate
collaborations and other financing vehicles. If adequate funds are not
available to the Company, or if available, their terms are unacceptable, the
Company may be required to significantly reduce its marketing activities for
the Niaspanand Advicorproducts or curtail significantly one or more of the
Companys research or development programs or the Company may be required to
obtain funds through arrangements with future collaborative partners or others
that may require the Company to relinquish rights to the Niaspanor Advicor
products or to some or all of the Companys technologies or products under
development or take significant cost-reducing actions or both. If the Company
is successful in obtaining additional financing, the terms of the financing may
have the effect of diluting or adversely affecting the holdings or the rights
of the holders of the Companys securities. Registration Rights The Company has granted certain registration rights to its controlling
shareholder, Mr. Jaharis, his spouse, and their transferees, and to Kos
Investments, Inc. and Kos Holdings, Inc., which entitle such persons and
entities to cause the Company to effect an unlimited number of registrations
under the Securities Act of 1933 of sales of up to an aggregate of
24,503,368
shares of the Companys common stock owned or controlled by such persons or
entities or that could be acquired by such person or entities upon exercise or
conversion of securities they currently hold. These registration rights
generally would also permit the holders of such rights to include shares in any
registration statement otherwise filed by the Company. By exercising these
registration rights, these persons and entities could cause a large number of
shares to be registered and become freely tradeable without restrictions under
the Securities Act (except for those purchased in the offering by the Companys
affiliates) immediately upon the effectiveness of such registration. Such sales
may have an adverse effect on the market price of the Companys common stock
and could impair the Companys ability to raise additional capital. Limited Sales and Marketing Resources Although the Company and Takeda currently market the Niaspanand Advicor
products and the Company intends to market its products under development
primarily through the Companys own specialty sales force or through
co-promotion partners, substantial resources will continue to be required for
Kos to promote the sale of its products. Because its current marketing
resources are limited, the Company may be unable to devote sufficient resources
to the Niaspanand Advicorproducts, or to the Companys products under
development or to be acquired or licensed, or to achieve increasing market
acceptance of such products. The Companys failure to expend the resources to
adequately promote the Niaspanand Advicorproducts or its other products under
development would have a material adverse effect on the Companys business and
results of operations. 34




---



##### Table of Contents



Moreover, because the Company has fewer sales persons than its
competitors, the Companys sales force may be unable to detail successfully
physicians who prescribe lipid-altering or other medications. The Company may
not be able to retain its current sales representatives. Even if the Company
hires additional representatives, they may not be immediately effective in
promoting the sale of the Niaspanand Advicorproducts. As a result, Kos may be
unable to generate significantly increased sales of the Niaspanor Advicor
products. The failure of the Companys sales representatives to generate
increased sales of the Niaspanand Advicorproducts would have a material
adverse effect on operating results. Control by Existing Shareholder Michael Jaharis, the Companys principal shareholder and a director, owns,
directly or indirectly, 13,681,720 shares of the Companys Common Stock as of
December 31, 2003, or approximately 37.2% of the common stock outstanding.
Accordingly, Mr. Jaharis can control the outcome of certain shareholder votes,
including votes concerning the election of directors, the adoption or amendment
of provisions in the Companys Articles of Incorporation, and the approval of
mergers and other significant corporate transactions. This level of
concentrated ownership by one person may have the effect of delaying or
preventing a change in the management or voting control of Kos. In addition, a
line of credit gives Mr. Jaharis the right to exercise warrants to purchase six
million shares of the Companys Common Stock at $5.00 per share. The warrants
are non-detachable and can be exercised only through the conversion of
principal and interest accumulated under the line of credit. If this warrant
exercise was to occur, Mr. Jaharis direct or indirect ownership of the
Companys Common Stock would increase to 19,681,720 shares, or approximately
46.0% of the common stock outstanding, assuming the warrant exercise had
occurred as of December 31, 2003. Competition and Technological Change Many products are commercially available for the treatment of elevated LDL
cholesterol, and the manufacturers of such products, individually and
collectively, have significantly greater financial resources and sales and
manufacturing capabilities than those available to Kos, including combined
field sales forces exceeding 18,000 persons, compared with the Companys
approximately 440 person field sales force and the sales force of its
co-promotion partners. The Companys direct competitors and their respective
competitive products include, among others:  
    
    Abbott (Tricor)
    
    Bristol-Myers Squibb (Pravachol)
    
    Merck (Zocor and Mevacor)
    
    Novartis (Lescol)
    
    Pfizer (Lipitor and Lopid)
    
    Sankyo (Welchol)
    
    Merck/Schering-Plough (Zetia)
    
    AstraZeneca (Crestor) The Company estimates that the existing Niaspanand Advicorprescriptions
account for slightly more than 3.2% of the total prescriptions currently being
written in the United States for cholesterol-lowering pharmaceutical compounds.
In addition, Zetia, part of a new class of cholesterol-lowering agents that
inhibit the intestinal absorption of cholesterol, was launched in November 2002
by Merck/Schering-Plough Pharmaceuticals, and Crestor, a new highly powerful
statin product, was launched during September 2003 by AstraZeneca. Both
Merck/Schering-Plough Pharmaceuticals and AstraZeneca are competitors who have
substantially greater resources than those available to Kos. Further, other new
combination statin drugs may be marketed during succeeding years. Finally,
there are at least nine versions of generic lovastatin, one of the components
of Advicor, currently being marketed in the cholesterol market. The existence
of distributors of generic lovastatin and the competitive environment 35




---



##### Table of Contents



they create may inhibit the Niaspanand Advicorproducts from competing
successfully or from achieving increased sales. Moreover, the active ingredient
in Niaspan, niacin, is available in several other formulations, most of which
do not require a prescription. Although the Company believes that there are no
other currently available niacin formulations that have been approved by the
FDA specifically for once-a-day dosing, physicians may decide to prescribe or
recommend some of these unapproved niacin formulations, using the Niaspan
products dosing regimen, to try to achieve the same results as Niaspan.
Substitution of other niacin formulations for the Niaspanproduct could have a
material adverse effect on the Companys business and results of operations.
Moreover, manufacturers of other niacin formulations could promote their
products using the Niaspanproducts dosing regimen and could promote the sale
of their products to treat the indications for which the Company has received
clearance to market Niaspan. Although such promotion would be a violation of
FDA regulations, the significant occurrence of such practices would have a
material adverse effect on the Company. Moreover, many established
pharmaceutical and biotechnology companies, universities, and other research
institutions with resources significantly greater than Kos may develop
products that directly compete with the Companys products. Even if the
Companys products under development prove to be more effective than those
developed by other entities, such other entities may be more successful in
marketing their products than Kos because of greater financial resources,
stronger sales and marketing efforts, and other factors. If these entities are
successful in developing products that are safer, more effective, or less
costly than the products developed by Kos, the Companys products may be unable
to compete successfully with any of those products. International Commercialization Agreement with Merck KGaA On October 23, 2002, the Company signed an exclusive international
commercialization agreement with Merck to market the Niaspanand Advicor
products outside the United States, Canada and Japan. Under terms of the Merck
Agreement, Merck will provide Kos up to $61 million in licensing, milestone and
reimbursement payments, including $15 million in upfront payments. Kos is
responsible for obtaining initial marketing authorization in all European
countries and the supply and manufacturing of the products. Pursuant to the Merck Agreement, if marketing authorization is not
obtained for Niaspanor Advicorin certain countries and within certain
timeframes, Merck will have the right to terminate the agreement, and Kos will
be required to refund to Merck up to $12.5 million of the upfront payments. In
addition, other milestone payments payable to Kos under the Merck Agreement are
dependent on the achievement of marketing authorization of Niaspanin certain
countries, the achievement of marketing authorization of Advicorin certain
countries, and achieving certain net sales thresholds of Niaspanand Advicor. In 1999, Kos received marketing approval for Niaspanin the United
Kingdom, and in 2002, submitted Advicorfor marketing approval in the United
Kingdom. We entered Niaspaninto the European Unions Mutual Recognition
Procedure (MRP) in September 2003. In January 2004, the MRP for Niaspanwas
successfully completed with the Company receiving tentative approval to market
Niaspanin thirteen European countries. There is no certainty that final
marketing authorization for the Niaspanand Advicorproducts will be obtained
under the MRP, or, with respect to Advicor, at all, and there could be delays
in the granting of such authorizations. Consequently, Kos may be required to
reimburse Merck for up to $12.5 million of the upfront payments and may not
receive any of the milestone payments under the Merck Agreement. No Assurance of Adequate Third-Party Reimbursement The Companys ability to commercialize successfully its products under
development is dependent in part on the extent to which appropriate levels of
reimbursement for the Niaspanand Advicorproducts, or for the other products
it sells are obtained from government authorities, private health insurers, and
managed care organizations such as health maintenance organizations or HMOs.
The Company estimates that, through December 31, 2003, approximately $471.9
million, or 72%, of the Companys cumulative 36




---



##### Table of Contents



Niaspanand Advicorrevenue has been subjected to the reimbursement rules
of such organizations. Managed care organizations and other third-party payors
are increasingly challenging the pricing of pharmaceutical products. The trend
toward managed healthcare in the United States, the growth of organizations
such as HMOs, and legislative proposals to reform healthcare and government
insurance programs could significantly influence the purchase of pharmaceutical
products, resulting in lower prices and reduced demand for Niaspan, the Advicor
product, or the Companys products under development. Such cost containment
measures and potential legislative reform could affect the Companys ability to
sell Niaspan, Advicor, or its products under development and may have a
material adverse effect on the Company. Significant uncertainty exists about
the reimbursement status of newly approved pharmaceutical products. Although
the Company has obtained approvals for reimbursement for the cost of Niaspan
and Advicorfrom many third-party payors, such approvals, in the United States
and in foreign countries, may be discontinued for Niaspan, or unavailable for
Advicoror any of the Companys products under development. The unavailability
or inadequacy of third-party reimbursement for Niaspan, Advicor, or the
Companys products under development or to be acquired or licensed, may reduce
the demand for, or negatively affect the price of, these products, which would
have a material adverse effect on the Company. Dependence on Collaborators The Company relies on various third parties for certain aspects of the
development, manufacture and promotion of the Companys present
and planned
products. There can be no assurance that the Company will be able to enter into
future collaborative arrangements on favorable terms, or at all. Even if the
Company is successful in entering into such collaborative agreements, there can
be no assurance that any such arrangement will be successful. The success of
any such arrangement is dependent on, among other things, the skills,
experience and efforts of the third partys employees responsible for the
project, the third partys commitment to the arrangement, and the financial
condition of the third party, all of which are beyond the control of the
Company. Dependence on Key Personnel The Companys success is dependent on the Companys ability to attract and
retain highly qualified scientific, management, and sales personnel. In April
2001, the Company hired its current President and Chief Executive Officer,
Adrian Adams. The loss of Mr. Adams as the Companys President and Chief
Executive Officer could have a material adverse effect on its operations and
business. Due to intense competition for personnel from other companies,
academic institutions, government entities, and other organizations, the
Company may be unsuccessful in attracting and retaining key personnel. The loss
of key personnel, or the inability to attract and retain the additional,
highly-skilled employees required for the expansion of Kos activities, could
adversely affect its business and operating results. Products Under Development Although the Company has obtained clearance from the FDA to market the
Niaspanand Advicorproducts, the Company may be unsuccessful in effectively
formulating any of its other products as planned. Further, the Company may not
be successful in demonstrating the safety and efficacy of such products in
human clinical trials. These trials may be costly and time-consuming. The
administration of any product the Company develops may produce undesirable side
effects that could result in the interruption, delay or suspension of clinical
trials, or the failure to obtain FDA or other regulatory approval for any or
all targeted indications. Even if regulatory approval is secured, the Companys
products under development may later produce adverse effects that limit or
prevent their widespread use or that necessitate their withdrawal from the
market. The Company may discontinue the development of any of its products
under development at any time. 37




---



##### Table of Contents



Acquisition of Products As
part of the Companys growth strategy, the Company intends to acquire and develop
additional product candidates or approved products. The success of this
strategy depends upon Kos ability to identify, select and acquire
pharmaceutical products that meet the criteria it has established. Any product
candidate the Company acquires will require additional research and development
efforts prior to commercial sale, including extensive pre-clinical and/or
clinical testing and approval by the FDA and corresponding foreign regulatory
authorities. All product candidates are prone to the risks of failure inherent
in pharmaceutical product development, including the possibility that the
product candidate will not be safe, non-toxic and effective or approved by
regulatory authorities. In addition, the Company cannot assure that any
approved products that the Company develops or acquires will be: manufactured
or produced economically; successfully commercialized; widely accepted in the
marketplace or that the Company will be able to recover its significant
expenditures in connection with the development or acquisition of such
products. In addition, proposing, negotiating and implementing an economically
viable acquisition is a lengthy and complex process. Other companies, including
those with substantially greater financial, marketing and sales resources, may
compete with the Company for the acquisition of product candidates and approved
products. The Company may not be able to acquire the rights to additional
product candidates and approved products on terms that it finds acceptable, or
at all. In addition, if the Company acquires product candidates from third
parties, the Company will be dependent on third parties to supply such products
to the Company for sale. The Company could be materially adversely affected by
the failure or inability of such suppliers to meet performance, reliability and
quality standards. Patents and Trademarks; Interference The Companys ability to commercialize any of its products under
development will depend, in part, on the Companys or on its licensors ability
to obtain patents, enforce those patents, preserve trade secrets, and operate
without infringing on the proprietary rights of third parties. In addition, the
patents that the Company has been issued or for which Kos has applied relating
to Niaspan, Advicorand certain of the Companys products under development are
based on, among other things, the extended-release nature of the niacin active
ingredient. If the indications treated by Niaspan, Advicorand such other
products under development could be treated using drugs without such
extended-release properties, such patents and patent applications may not
prevent the use of other niacin-based drugs for the treatment of such
indications, which would have a material adverse effect on the Company.
Further, the Company would be adversely affected if:  
    
    The patent applications licensed to or owned by Kos do not result in issued patents;
    
    Meaningful patent protection is not secured for any particular technology; or
    
    Any patents that have been or may be issued to Kos or the
Companys licensors, including the patents covering the Companys
Niaspanproduct, are invalid, unenforceable or not infringed. In general, the U.S. patents and patent applications owned by or licensed
to Kos are directed to compositions and their methods of use. Protection of the
chemical entity is not available for the active ingredient in Niaspan, or
either of the active ingredients in Advicor. Moreover, the active ingredient in
Niaspan, niacin, is currently sold in the United States and other markets for
lipid altering indications and for other uses. The additional active ingredient
in Advicor, lovastatin, is also currently sold in the United States and other
markets for lipid altering indications. Even in jurisdictions where the use of
the active ingredients in Niaspanand Advicorfor lipid altering and other
indications may be covered by the claims of method-of-use or composition
patents owned by or licensed to Kos, off-label sales might occur, especially if
another company markets the active ingredient at a price that is less than the
price of Niaspanor Advicor, thereby potentially reducing the sales of such
products. 38




---



##### Table of Contents



The U.S. Patent and Trademark Office (the PTO) has issued U.S. Patent
numbers 6,129,930, 6,080,428, 6,406,715 and 6,676,967 to the Company with claims
related to Niaspansand Advicorscomposition and method-of-use consistent
with the recommended once-a-day regime. On February 7, 1997, the Company
entered into an agreement with a generic manufacturer pursuant to which the
Company and the manufacturer granted cross-licenses to each other under their
respective patents. The Company has subsequently purchased the patents that
were the subject of the cross-license agreement and agreed to continue paying a
royalty to the manufacturer on terms similar to those contained in the
cross-license agreement. The Company has received patents and has filed patent applications
covering technologies pertaining to propellant-driven aerosol formulations that
do not contain chlorofluorocarbons. The Company is aware that certain European
and U.S. patents have been issued with claims covering products that contain
certain propellant-driven aerosol formulations that do not contain
chlorofluorocarbons. It may be argued that certain or all of the Companys
aerosol products under development may use a formulation covered by such
European or U.S. patents. If that is shown to be the case, the Company would be
prevented from making, using or selling such products unless Kos obtains a
license under such patents, which license may not be available on commercially
reasonable terms, or at all, or unless such patents are determined to be
invalid in Europe or invalid or unenforceable in the United States. The
Companys development of products that may be covered by such patents and its
failure to obtain licenses under such patents in the event such patents are
determined to be valid and enforceable could have an adverse effect on the
Companys business. On January 23, 2002, the Company received notice from Barr Laboratories,
Inc. (Barr) that it had filed with the FDA an Abbreviated New Drug
Application (ANDA) that would, if approved, allow Barr to market a generic
version of the Companys 1000 mg Niaspanproduct. As a result, on March 4,
2002, the Company filed a patent infringement lawsuit against Barr in the
Southern District of New York (SDNY). On March 11, 2002, the Company filed an
amended complaint (the Amended Complaint). In this lawsuit, the Company
asserted that Barr has infringed the 428 and 930 patents. On March 25, 2002,
Barr answered the Amended Complaint by denying that the 428 and 930 patents
are valid and infringed, and seeking a declaratory judgment to that effect. On
August 19, 2002, Barr amended its answer to add counterclaims requesting a
declaratory judgment that two other patents owned by Kos, U.S. Patent Numbers
5,126,145 and 5,268,181, are not infringed, and that the 181 patent is
invalid. On July 9, 2002, the Company received notice from Barr that it had filed
an ANDA with the FDA that would, if approved, allow Barr to market generic
versions of the Companys 500 mg and 750 mg Niaspanproducts. On August 13,
2002, the Company filed a second patent infringement lawsuit against Barr also
in the SDNY. Again, the Company asserted that Barr has infringed the 428 and
930 patents. On September 3, 2002, Barr answered the complaint by denying
infringement and alleging that the patents are invalid. Barr also sought a
declaratory judgment that the 428, 930, 145, and 181 patents are not
infringed, and that the 428, 930, and 181 patents are invalid. The two cases
were consolidated on September 23, 2002. On September 30, 2002, the Company received notice from Barr that it had
filed a Supplemental Paragraph IV Certification relating to Kos 715 patent.
The Company filed a third lawsuit on November 12, 2002, against Barr in the
SDNY asserting infringement of this patent. On December 3, 2002, Barr answered
the complaint by denying that the 715 patent is valid and infringed, and
seeking a declaratory judgment of invalidity. Barr also sought a declaratory
judgment that the 428, 930, 145, and 181 patents are not infringed, and
that the 428, 930 and 181 patents are invalid. The third case was consolidated with the first two on January 23, 2003. On
March 4, 2003, Kos replied to Barrs declaratory judgment counterclaims by
denying that Kos patents are invalid or not infringed. Kos also sought a
declaratory judgment that one or more of Barrs products will infringe the 145
and 181 patents. During the course of the litigation, Barr has also suggested
claims of anti trust and 39




---



##### Table of Contents



unenforceability. Kos has received several notices from Barr Laboratories
that Barr has filed a Supplemental Paragraph IV Certification to each ANDA to
provide for U.S. Patent No. 6,676,967. The first notice was received by Kos on
January 21, 2004 and the latest on February 23, 2004. Kos is currently
evaluating its options. On August 6, 2003, the Company filed a trademark infringement lawsuit
against Andrx Corporation and Andrx Laboratories, Inc. (Andrx) in the U.S.
District Court for the District of New Jersey based on Andrxs use of the mark
Altocor for its cholesterol product. In conjunction with its complaint, the
Company also filed a Motion for Preliminary Injunction the same day. Andrx
filed an Opposition to the Motion for Preliminary Injunction on August 28,
2003. Andrx answered the Companys Complaint on September 2, 2003. The Company
filed its Reply in support of its Motion for Preliminary Injunction on
September 8, 2003. Oral argument on the Motion for Preliminary Injunction was
held on September 17, 2003. An Order denying the Motion for Preliminary
Injunction was entered September 23, 2003. The Company filed a Notice of Appeal
to the Order denying the Preliminary Injunction on September 30, 2003, and a
Motion for Expedited Consideration of the Appeal on October 3, 2003, in the
Third Circuit. Andrx filed a Motion in Opposition of Expedited Consideration on
October 10, 2003, and the Company replied October 15, 2003. The Companys
Motion for Expedited Review of the Appeal was granted on October 31, 2003. On
November 24, 2003, the Company filed its Third Circuit Appellate Brief, Andrx
filed a Brief in Opposition December 5, 2003, and the Company filed its Reply
Brief December 15, 2003. There can be no assurance that the Company will be successful in defending
its patents in the Barr litigation. If the Company is not successful in
defending its patents, Barr and other competitors may be able to produce and
market generic version of its Niaspanproducts, which could be sold at prices
lower than those charged by the Company. This would have a material adverse
effect on the Companys business and financial results. The Company is unable
to estimate the economic impact if it is not successful in defending its
patents. Because the patent positions of pharmaceutical and biotechnology companies
are highly uncertain and involve complex legal and factual questions, the
patents owned and licensed by Kos, or any future patents, may not prevent other
companies from developing competing products or ensure that others will not be
issued patents that may prevent the sale of the Companys products or require
licensing and the payment of significant fees or royalties. Furthermore, to the
extent that (1) any of the Companys future products or methods are not
patentable, (2) such products or methods infringe upon the patents of third
parties, or (3) the Companys patents or future patents fail to give Kos an
exclusive position in the subject matter to which those patents relate, the
Company will be adversely affected. The Company may be unable to avoid
infringement of third party patents and may have to obtain a license, or defend
an infringement action and challenge the validity of the patents in court. A
license may be unavailable on terms and conditions acceptable to the Company,
if at all. Patent litigation is costly and time consuming, and the Company may
be unable to prevail in any such patent litigation or devote sufficient
resources to even pursue such litigation. If the Company does not obtain a
license under such patents, or if it is found liable for infringement and if it
is not able to have such patents declared invalid, the Company may be liable
for significant money damages, may encounter significant delays in bringing
products to market, or may be precluded from participating in the manufacture,
use, or sale of products or methods of treatment requiring such licenses. Government Regulation; No Assurances of Regulatory Approval The Companys research and development activities, preclinical studies,
clinical trials, and the manufacturing and marketing of the Companys products
are subject to extensive regulation by the FDA. The drug development and
approval process takes many years and requires the expenditure of substantial
resources. Data obtained from preclinical and clinical activities are
susceptible to varying interpretations that could delay, limit, or prevent
regulatory approval. Although the Company may consult the FDA for 40




---



##### Table of Contents



guidance in developing protocols for clinical trials, despite such
consultation, the FDA may find the clinical trials inadequate or not
well-controlled. They may also reject the results of those trials altogether.
In addition, delays or rejections of applications for regulatory approval may
result from changes in or additions to FDA regulations concerning the drug
approval process. Thus, regulatory reviews may be untimely and regulatory
approvals could be denied for products developed by the Company. Even if
regulatory approval of a product is obtained, the approval will be limited as
to the indicated uses for which it may be promoted or marketed. In addition, a
marketed drug, its bulk chemical supplier, its manufacturer, and its
manufacturing facilities are subject to continual regulatory review and
periodic inspections, and later discovery of previously unknown problems with a
product, supplier, manufacturer, or facility may result in restrictions on such
products or manufacturers, which may require a withdrawal of the product from
the market. Failure to comply with the applicable regulatory requirements in
the United States or abroad can, among other things, result in fines,
suspensions of regulatory approvals, seizure of products, product recalls,
operating restrictions, and criminal prosecution, any of which could have a
material adverse effect on Kos. Outside the United States, the Companys research and development
activities, preclinical studies, clinical trials, and the manufacturing and
marketing of the Companys products are subject to extensive foreign
regulation. In the European Union, the approval of new drugs is governed by the
central approval or mutual recognition procedures of the European Medicines
Evaluation Agency (EMEA). In 1999, the Company received marketing approval
for Niaspanin the United Kingdom, and in 2002, submitted Advicorfor marketing
approval in the United Kingdom. Pursuant to the Merck Agreement, the Company is
responsible for obtaining initial marketing authorization for the Niaspanor
Advicorproducts in all countries in the European Union. There could be delays
or rejections in applications for regulatory approval in Europe and in other
countries, as well a requirement of completion of additional preclinical and
clinical studies. The process of obtaining regulatory approval could be costly.
In addition, competitors of the Company may obtain regulatory approval for
similar products. Even if regulatory approval of a product is obtained, the
approval will be limited as to the indicated uses for which it may be promoted
or marketed, and the product will be subject to a continual regulatory review
and inspections, which, if previously unknown problems are discovered, may
result in restrictions on the products and manufacturers, which may require a
withdrawal of the product from the market. In addition, individual countries
will have pricing, third party reimbursement and labeling approvals necessary
for the manufacture, distribution, use and sale of products with which the
Company must comply. Moreover, because the legislative and regulatory
environment continues to evolve in the U.S. and abroad, it is difficult to
predict the impact of legislation and regulations on the Company and its
products. In July 2001, the Division of Drug Marketing, Advertising, and
Communication at the FDA issued a warning letter to Kos related to an
advertisement the Company ran in a healthcare section of TIME magazine. The
advertisement, which the Company intended to run only one time, was designed to
increase awareness of the Companys Niaspan product. In its warning letter, the
FDA objected to the advertisement on the grounds that the advertisement failed
to reflect a fair balance of the contraindications, warnings, precautions, and
side effects of the Companys Niaspan product. The FDA also objected to the
advertisement on the grounds that the advertisement overstated the efficacy of
the Niaspan product in light of its approved labeling. Subsequent to this
event, the Company reached agreement with the FDA to remedy their objections by
placing a new advertisement with content that adequately characterizes the
risks and other safety implications for the product. The Companys business is also subject to regulation under state, federal
and local laws, rules, regulations, and policies relating to the protection of
the environment and health and safety, including those governing the use,
generation, manufacture, storage, air emission, effluent discharge, handling,
and disposal of certain materials. The Company believes that it is in
compliance in all material respects with all such laws, rules, regulations, and
policies applicable to Kos. However, non-compliance with such environmental and
health and safety laws and regulations in the future would require Kos to incur 41




---



##### Table of Contents



significant costs to comply. The Companys research and development
involves the controlled use of hazardous materials. Although the Company
believes that its safety procedures for handling and disposing of such
materials comply with the standards prescribed by applicable state, federal,
and local regulations, the risk of contamination or injury from these materials
cannot be completely eliminated. In the event of such contamination or injury,
the Company could be held liable for any damages that result and any such
liability could exceed its resources and materially adversely affect the
Companys business, financial condition and results of operations. Manufacturing On December 29, 2003, the FDA issued the Company a warning letter related
to a routine, unannounced inspection of the Companys principal manufacturing
facility located in Edison, New Jersey. The letter cited four deficiencies in
the Companys quality systems. The Company is working diligently to remedy
these deficiencies, and plans to cooperate fully with the FDA to take any
corrective action that may be required to further assure the quality of the
Companys products. Based upon the observations noted in the December warning
letter, the Company is not currently in compliance with cGMP. Although
such status does not prohibit Kos from producing product for
commercial sale, this status may result
in a delay in the approval by the FDA of any pending Company sponsored
regulatory applications. It may also contribute to a delay in the Companys
marketing partners receipt of final product approval in certain foreign
countries. Further, if appropriate corrective actions are not taken in response
to the issues raised in the December warning letter, the FDA, upon
re-inspection of the Companys Edison manufacturing facility, may impose
additional regulatory sanctions that may include withdrawal or seizure from the
market of Kos products. The Companys manufacturing facilities are and will continue to be subject
to ongoing, periodic inspection by the FDA and state agencies to ensure
compliance with cGMP. The Companys failure to follow and document the
Companys adherence to such cGMP regulations or other regulatory requirements
may lead to significant delays in the availability of the Companys products,
including the Niaspanand Advicorproducts, for commercial use or clinical
study, may result in the termination or hold of a clinical study, or may delay
or prevent filing or approval of marketing applications for Kos products. The Company also may encounter problems with, among other things, the following:  
    
    achieving consistent and acceptable production yield and costs;
    
    meeting product release specifications;
    
    quality control and assurance;
    
    shortages of qualified manufacturing personnel;
    
    shortages of raw materials;
    
    shortages of key contractors; and
    
    ongoing compliance with FDA and other regulations. Any of the foregoing could result in the Company being unable to
manufacture and supply sufficient quantities of its Niaspan and Advicor
products to meet the demands of its customers, or to fulfill orders from its
international marketing partner. In addition, the resolution of the concerns
raised by the FDA in its recent warning letter could result in the Company
being required to implement manufacturing, testing or other procedures that
could materially reduce the efficiency of the Companys manufacturing and
supply capability and could reduce the amount of quantities of the Companys
products that the Company has available for sale. The Companys failure for any
reason to manufacture and supply sufficient quantities of the Niaspan and
Advicor products would have a material adverse impact on the Company and its
financial condition. The extent of such adverse effect would depend on the
nature, timing, scope 42




---



##### Table of Contents



and duration of the
manufacturing issues. Although the Company is currently in
discussions with a contract manufacturer, the Company does not currently
have a qualified backup manufacturing capability with a third party. Failure to comply with applicable manufacturing regulations could also
result in sanctions being imposed on the Company, including fines, injunctions,
civil penalties, failure of regulatory authorities to grant marketing approval
of the Companys products, delays, suspension or withdrawal of approvals,
license revocation, seizures or recalls of products, operating restrictions and
criminal prosecutions, any of which could harm the Companys business. If the
Company is unable to manufacture its products for any reason, the Companys
options for outsourcing manufacturing are currently limited. It would take a
substantial period of time for a contract manufacturing facility that has not
been producing the Companys particular products to begin producing them under
cGMP regulations. Limited Manufacturing Experience; Risk of Scale-Up The Company currently manufactures the Niaspanand Advicorproducts in one
manufacturing plant in Edison, New Jersey that has been inspected and approved
by the FDA for both Niaspanand Advicor. Although both products have been
approved for manufacture in the Edison facility, the Company has limited
experience in manufacturing products for commercial sale in the Edison facility
and inefficiencies may exist in the manufacturing process. The Company may need
to further scale-up certain of the Companys current manufacturing processes to
achieve production levels consistent with the commercial sale of its products
for both the U.S. and international use. Further, modifications to the
facilities, systems, and procedures may be necessary to maintain capacity at a
level sufficient to meet market demand or to maintain compliance with current
good manufacturing practices regulations and other regulations prescribed by
various regulatory agencies including the Occupational Safety and Health
Administration and the Environmental Protection Agency. The Companys failure
to successfully further scale-up, expand in connection with manufacture for
commercial sale, or modify the Companys manufacturing process or to comply
with current good manufacturing practices regulations and other regulations
could delay the approval of its products under development or limit its ability
to meet the demand for its products, any of which would have a material adverse
effect on Kos. Such occurrences may require Kos to acquire alternative means of
manufacturing the Companys products, which may not be available on a timely
basis, on commercially practicable terms, or at all. Dependence on Single Sources of Supply Some materials used in the Companys products, including the active
ingredients in Niaspanand Advicor, are currently sourced from single qualified
suppliers. The Company has not established arrangements with alternative
suppliers for these ingredients, although the Company believes that it can
obtain an alternative supply of lovastatin, one of the two active ingredients
in Advicor, if necessary. Although the Company has maintained a business
relationship with its niacin supplier since 1993, and has not experienced
difficulty to date in acquiring niacin, or other materials for product
development, additional product validations and regulatory submissions would be
required if supply interruptions were to occur in the future or if the Company
had to obtain substitute materials. Similarly, the Companys source for
lovastatin is relatively inexperienced as a supplier of such ingredient.
Although the Company has maintained a business relationship with its lovastatin
supplier since 1997, and this supplier is experienced as a supplier of other
pharmaceutical grade active ingredients, this supplier may be unable to meet
the Companys requirements for lovastatin on a sustained basis, at an
acceptable quality standard, or at a commercially viable price. In such an
event, the Company would be forced to obtain an alternative supplier of
lovastatin. Any interruption of raw material supply, for any reason, in any of
the required ingredients for the Companys products could have a material
adverse effect on Kos ability to manufacture its products or to obtain or
maintain regulatory approval of such products. In the event that the Company consummates its transaction with Aventis and
acquires the Azmacortproduct, the Company will rely on Aventis to manufacture
and supply adequate quantities of the finished 43




---



##### Table of Contents



Azmacortproduct. Although there is one other company that is currently
qualified to manufacture and supply the Azmacortproduct, the Company does not
have any contractual arrangement with such other entity. As a result, the
Company will rely solely on Aventis to supply the Company with the Azmacort
product, and the Company cannot provide any assurances that Aventis will be
able to produce sufficient quantities of the Azmacortproduct to meet the
Companys requirements. The Azmacortproduct can be difficult to produce and
requires the assembly of several different components, the unavailability of
any of which can result in an interruption in the supply of finished Azmacort
products to the Company. The manufacture and assembly of each of the
components, in addition to the qualification of the raw materials used in the
finished Azmacortproduct, is subject to regulatory approval. If Kos, Aventis
or Aventis suppliers are unable to maintain the regulatory approval for such
components, raw materials or finished product, or are unable to manufacture and
store them in compliance with applicable regulatory requirements, Aventis may
not be able to supply the Company with sufficient quantities of the finished
Azmacortproduct. The Company is dependent on the performance by Aventis and
its suppliers for the manufacture and supply of the finished Azmacortproducts,
and the Company cannot provide any assurance of their willingness or ability to
perform their manufacturing responsibilities in the future. Any interruption of
supply, for any reason, of the finished Azmacortproduct to the Company would
have a material adverse effect on the Companys financial condition and results
of operations. Risk of Product Liability Claims; No Assurance of Adequate Insurance Manufacturing, marketing, selling, and testing Niaspan, Advicor, and the
Companys products under development or to be acquired or licensed, entails a
risk of product liability. On August 8, 2001, Bayer AG, removed its statin
product, Baycol, from the market because of multiple deaths attributed to a
rare form of a muscle disorder called rhabdomyolysis. As a result of the
removal of Baycol from the market, however, the side affects of statin products
have been subject to increased scrutiny. Although the statin component of
Advicorhas been approved by the FDA and marketed for nearly 16 years and is a
different drug compound than that which was used in Baycol, to the extent that
patients who take Advicordevelop serious adverse side affects, such as
rhabdomyolysis, or associate the adverse events experienced by some Baycol
patients with all other statin products, including the Companys Advicor
product, it would have a material adverse effect on the Companys business. The
Company could be subject to product liability claims in the event that its
products or products under development fail to perform as intended. Even
unsuccessful claims could result in the expenditure of funds in litigation and
the diversion of management time and resources and could damage the Companys
reputation and impair the marketability of its products. While the Company
currently maintains liability insurance, the Company may not be able to
maintain such insurance at a commercially reasonable cost. If a successful
claim were made against the Company, and the amount of insurance were
inadequate to cover the costs of defending against or paying such a claim, or
the damages payable by Kos, the Company would experience a material adverse
effect on its business, financial condition, and results of operations and on
the price of the Companys Common Stock. Possible Stock Price Volatility The stock market, including the Nasdaq National Market, on which the
Companys shares are listed, has from time to time experienced significant
price and volume fluctuations that may be unrelated to the operating
performance of particular companies. In addition, the market price of the
Companys Common Stock, like the stock prices of many publicly traded
pharmaceutical and biotechnology companies, has been and may continue to be
highly volatile. 44




---



##### Table of Contents



The following table sets forth, for the fiscal periods indicated, the
range of high and low prices for trades of the Companys Common Stock on the
Nasdaq National Market System. High
    
    LowYear Ended December 31, 2000First Quarter
    
    $
    22.13
    
    
    $
    5.30Second Quarter
    
    
    18.56
    
    
    
    10.00Third Quarter
    
    
    17.88
    
    
    
    10.75Fourth Quarter
    
    
    25.13
    
    
    
    13.63Year Ended December 31, 2001First Quarter
    
    $
    21.13
    
    
    $
    14.31Second Quarter
    
    
    38.00
    
    
    
    16.75Third Quarter
    
    
    40.69
    
    
    
    23.45Fourth Quarter
    
    
    36.90
    
    
    
    23.45Year Ended December 31, 2002First Quarter
    
    $
    35.27
    
    
    $
    19.30Second Quarter
    
    
    29.16
    
    
    
    15.50Third Quarter
    
    
    20.70
    
    
    
    10.03Fourth Quarter
    
    
    24.16
    
    
    
    10.38Year Ended December 31, 2003First Quarter
    
    $
    20.89
    
    
    $
    15.51Second Quarter
    
    
    27.10
    
    
    
    16.79Third Quarter
    
    
    42.86
    
    
    
    22.50Fourth Quarter
    
    
    47.73
    
    
    
    32.42
 The sale by the Companys controlling shareholder or members of the
Companys management of shares of Common Stock, announcements of technological
innovations or new commercial products by the Company or its competitors,
developments or disputes concerning patent or proprietary rights, publicity
regarding actual or potential medical results relating to the Niaspanand
Advicorproducts or to products under development by Kos or its competitors,
regulatory developments in either the United States or foreign countries,
public concern as to the safety of pharmaceutical and biotechnology products,
and economic and other external factors, as well as the trend of prescriptions
for the Niaspanproduct and the Advicorproduct after its launch and the
period-to-period fluctuations in sales or other financial results, among other
factors, may have a significant impact on the market price of the Companys
Common Stock. Anti-Takeover Provisions Certain provisions of the Companys Articles of Incorporation and Bylaws
generally permit removal of directors only for cause by a 60% vote of the
shareholders, require a 60% vote of the shareholders to amend the Companys
Articles of Incorporation and Bylaws, require a demand of at least 50% of the
Companys shareholders to call a special meeting of shareholders, and prohibit
shareholder actions by written consent. Certain of such provisions also allow
the Board of Directors to authorize the issuance of Preferred Stock with rights
superior to those of the Common Stock. Moreover, provisions of the Florida
Business Corporation Act, to which the Company is subject, prohibit the voting
of shares that are acquired in certain takeovers without the approval of the
Board of Directors or the approval by a majority 45




---



##### Table of Contents



of the corporations voting shares. Accordingly, the forgoing provisions
could prevent the removal of the Companys current directors and management, or
discourage a third party from attempting to acquire, or make it more difficult
for a third party to acquire, control of Kos. 46




---



##### Table of Contents






ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

The Companys exposure to market risk is limited primarily to fluctuating
interest rates associated with variable rate indebtedness that is subject to
interest rate changes in the United States. The Company does not use, nor has
it historically used, derivative financial instruments to manage or reduce
market risk. At December 31, 2003, the Company had $30 million of variable rate
indebtedness bearing interest at the prime rate (4.00% at December 31, 2003).




ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

Consolidated financial statements and supplementary data required by this
item can be found at the pages listed in the following index.

PageFinancial Statements:Report of Independent Certified Public Accountants
    
    
    48Report of Predecessor Independent Certified Public Accountants
    
    
    49Consolidated Balance Sheets at December 31, 2003 and 2002
    
    
    50Consolidated Statements of Operations for the years ended
December 31, 2003, 2002, and 2001
    
    
    51Consolidated Statements of Shareholders Equity (Deficit) for
the years ended December 31, 2003, 2002, and 2001
    
    
    52Consolidated Statements of Cash Flows for the years ended
December 31, 2003, 2002, and 2001
    
    
    53Notes to Consolidated Financial Statements
    
    
    54Financial Statement Schedule:*Report of Independent Certified Public Accountants on Schedule II
    
    
    74Report of Predecessor Independent Certified Public Accountants on Schedule II
    
    
    75Schedule II. Valuation and Qualifying Accounts
    
    
    76




| 
|-
|*

47



---



##### Table of Contents



REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS To the Shareholders of Kos Pharmaceuticals, Inc. We have audited the accompanying consolidated balance sheets of Kos
Pharmaceuticals, Inc. (a Florida corporation) and subsidiaries as of December
31, 2003 and 2002, and the related consolidated statements of operations,
shareholders equity (deficit) and cash flows for the years then ended. These
financial statements are the responsibility of the Companys management. Our
responsibility is to express an opinion on these financial statements based on
our audits. The financial statements of Kos Pharmaceuticals, Inc. for the year
ended December 31, 2001 were audited by other auditors who have ceased
operations and whose report dated February 7, 2002, expressed an unqualified
opinion on those statements. We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Kos
Pharmaceuticals, Inc. and subsidiaries as of December 31, 2003 and 2002, and
the consolidated results of their operations and their cash flows for the years
then ended in conformity with accounting principles generally accepted in the
United States. /s/ Ernst & Young LLP Miami, Florida,
February 10, 2004,
except for Note 14, as to which the
date is March 8, 2004 48




---



##### Table of Contents



The following audit report of Arthur Andersen LLP is a copy of the
original report dated February 7, 2002 included in our Annual Report on Form
10-K for the year ended December 31, 2001, and has not been reissued by Arthur
Andersen LLP. We are including this copy of the Arthur Andersen LLP audit
report pursuant to Rule 2-02(e) of Regulation S-X under the Securities Act of
1933. REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS To the Shareholders of Kos Pharmaceuticals, Inc.: We have audited the accompanying consolidated balance sheets of Kos
Pharmaceuticals, Inc. (a Florida corporation) and subsidiary as of December 31,
2001 and 2000, and the related consolidated statements of operations,
shareholders deficit and cash flows for each of the three years in the period
ended December 31, 2001. These financial statements are the responsibility of
the Companys management. Our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Kos Pharmaceuticals, Inc.
and subsidiary as of December 31, 2001 and 2000, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2001, in conformity with accounting principles generally accepted
in the United States. ARTHUR ANDERSEN LLP Miami, Florida,
February 7, 2002. 49




---



##### Table of Contents



KOS PHARMACEUTICALS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS December 31,2003
    
    2002ASSETSCurrent Assets:Cash and cash equivalents
    
    $
    259,957,534
    
    
    $
    19,572,046Trade accounts receivable, net
    
    
    39,558,637
    
    
    
    24,087,997Inventories
    
    
    6,406,125
    
    
    
    5,927,014Prepaid expenses and other current assets
    
    
    10,123,004
    
    
    
    5,894,293Total current assets
    
    
    316,045,300
    
    
    
    55,481,350Fixed Assets, net
    
    
    17,841,356
    
    
    
    12,527,801Other Assets
    
    
    3,727,457
    
    
    
    1,431,636Total assets
    
    $
    337,614,113
    
    
    $
    69,440,787LIABILITIES AND SHAREHOLDERS EQUITY (DEFICIT)Current Liabilities:Accounts payable
    
    $
    7,784,968
    
    
    $
    7,187,521Accrued expenses
    
    
    45,406,332
    
    
    
    34,548,708Advance payments from customers
    
    
    
    
    
    
    9,128,668Advance payment received on license agreement
    
    
    14,770,794
    
    
    
    9,203,125Current portion of notes payable to Shareholder
    
    
    
    
    
    
    50,000,000Current portion of capital lease obligations
    
    
    24,614
    
    
    
    56,989Total current liabilities
    
    
    67,986,708
    
    
    
    110,125,011Notes Payable to Shareholder
    
    
    30,000,000
    
    
    
    34,000,000Capital Lease Obligations, net of current portion
    
    
    
    
    
    
    24,910Commitments and Contingencies (Notes 1, 11 and 13)Shareholders Equity (Deficit):Preferred stock, $.01 par value, 10,000,000 shares authorized,
none issued and outstanding
    
    
    
    
    
    
    Common stock, $.01 par value, 50,000,000 shares authorized,
36,791,290 and 20,807,859 shares issued and outstanding as of
December 31, 2003 and 2002, respectively
    
    
    367,913
    
    
    
    208,079Additional paid-in capital
    
    
    473,601,791
    
    
    
    219,138,285Restricted stock grant
    
    
    (394,895
    )
    
    
    (694,521
    )Accumulated deficit
    
    
    (233,947,404
    )
    
    
    (293,360,977
    )Total shareholders equity (deficit)
    
    
    239,627,405
    
    
    
    (74,709,134
    )Total liabilities and shareholders equity (deficit)
    
    $
    337,614,113
    
    
    $
    69,440,787
 The accompanying notes are an integral part of these financial statements. 50




---



##### Table of Contents



KOS PHARMACEUTICALS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS For the Year Ended December 31,2003
    
    2002
    
    2001Revenues, net
    
    $
    293,907,409
    
    
    $
    172,692,718
    
    
    $
    91,447,043Cost of sales
    
    
    20,038,529
    
    
    
    15,361,756
    
    
    
    7,645,600273,868,880
    
    
    
    157,330,962
    
    
    
    83,801,443Operating expenses:Research and development
    
    
    52,202,981
    
    
    
    43,980,867
    
    
    
    30,974,279Selling, general and administrative
    
    
    156,469,215
    
    
    
    130,144,643
    
    
    
    83,587,439Total operating expenses
    
    
    208,672,196
    
    
    
    174,125,510
    
    
    
    114,561,718Income (loss) from operations
    
    
    65,196,684
    
    
    
    (16,794,548
    )
    
    
    (30,760,275
    )Other:Interest income, net
    
    
    613,984
    
    
    
    160,274
    
    
    
    241,748Interest expense-related parties
    
    
    (3,320,668
    )
    
    
    (4,039,550
    )
    
    
    (6,080,572
    )Other (expense) income
    
    
    (197,606
    )
    
    
    (142,340
    )
    
    
    38,985,340Total other (expense) income
    
    
    (2,904,290
    )
    
    
    (4,021,616
    )
    
    
    33,146,516Income (loss) before provision for income taxes
    
    
    62,292,394
    
    
    
    (20,816,164
    )
    
    
    2,386,241Provision for income taxes
    
    
    2,878,821
    
    
    
    
    
    
    
    Net income (loss)
    
    $
    59,413,573
    
    
    $
    (20,816,164
    )
    
    $
    2,386,241Basic earnings (loss) per share of Common Stock
    
    $
    2.71
    
    
    $
    (1.01
    )
    
    $
    0.12Diluted earnings (loss) per share of Common Stock
    
    $
    1.53
    
    
    $
    (1.01
    )
    
    $
    0.10Weighted average shares of Common Stock and
Common Stock equivalents outstanding:Basic
    
    
    21,913,928
    
    
    
    20,582,205
    
    
    
    20,221,089Diluted
    
    
    41,033,325
    
    
    
    20,582,205
    
    
    
    22,798,632
 The accompanying notes are an integral part of these financial statements. 51




---



##### Table of Contents



KOS PHARMACEUTICALS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY (DEFICIT) Common Stock
    
    Additional Paid-in
    
    Restricted
    
    AccumulatedShares
    
    Amount
    
    Capital
    
    Stock Grant
    
    Deficit
    
    TotalBalance at December 31, 2000
    
    
    19,947,061
    
    
    $
    199,471
    
    
    $
    209,641,721
    
    
    $
    
    
    
    $
    (274,931,054
    )
    
    $
    (65,089,862
    )Common Stock issued to employees
under Kos Savings Plan
    
    
    24,491
    
    
    
    245
    
    
    
    586,627
    
    
    
    
    
    
    
    
    
    
    
    586,872Issuance of Common Stock to employees
under Stock Purchase Plan
    
    
    79,479
    
    
    
    795
    
    
    
    1,149,941
    
    
    
    
    
    
    
    
    
    
    
    1,150,736Exercise of stock options
    
    
    374,672
    
    
    
    3,746
    
    
    
    2,319,443
    
    
    
    
    
    
    
    
    
    
    
    2,323,189Restricted stock grant
    
    
    66,668
    
    
    
    667
    
    
    
    1,197,357
    
    
    
    (1,198,024
    )
    
    
    
    
    
    
    Compensation expense on restricted
Common Stock grant
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    203,503
    
    
    
    
    
    
    
    203,503Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,386,241
    
    
    
    2,386,241Balance at December 31, 2001
    
    
    20,492,371
    
    
    
    204,924
    
    
    
    214,895,089
    
    
    
    (994,521
    )
    
    
    (272,544,813
    )
    
    
    (58,439,321
    )Common Stock issued to employees
under Kos Savings Plan
    
    
    42,353
    
    
    
    424
    
    
    
    760,891
    
    
    
    
    
    
    
    
    
    
    
    761,315Issuance of Common Stock to employees
under Stock Purchase Plan
    
    
    77,003
    
    
    
    770
    
    
    
    1,624,184
    
    
    
    
    
    
    
    
    
    
    
    1,624,954Exercise of stock options
    
    
    196,132
    
    
    
    1,961
    
    
    
    1,646,621
    
    
    
    
    
    
    
    
    
    
    
    1,648,582Compensation expense on restricted
Common Stock grant
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    300,000
    
    
    
    
    
    
    
    300,000Compensation cost on Common
Stock warrants award
    
    
    
    
    
    
    
    
    
    
    211,500
    
    
    
    
    
    
    
    
    
    
    
    211,500Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (20,816,164
    )
    
    
    (20,816,164
    )Balance at December 31, 2002
    
    
    20,807,859
    
    
    
    208,079
    
    
    
    219,138,285
    
    
    
    (694,521
    )
    
    
    (293,360,977
    )
    
    
    (74,709,134
    )Issuance of Common Stock
    
    
    4,400,000
    
    
    
    44,000
    
    
    
    184,232,585
    
    
    
    
    
    
    
    
    
    
    
    184,276,585Conversion of Note Payable to
Shareholder to Common Stock
    
    
    10,183,299
    
    
    
    101,833
    
    
    
    49,898,167
    
    
    
    
    
    
    
    
    
    
    
    50,000,000Common Stock issued to employees
under Kos Savings Plan
    
    
    45,449
    
    
    
    454
    
    
    
    1,078,873
    
    
    
    
    
    
    
    
    
    
    
    1,079,327Issuance of Common Stock to employees
under Stock Purchase Plan
    
    
    125,267
    
    
    
    1,253
    
    
    
    1,981,565
    
    
    
    
    
    
    
    
    
    
    
    1,982,818Exercise of stock options
    
    
    1,229,416
    
    
    
    12,294
    
    
    
    13,604,654
    
    
    
    
    
    
    
    
    
    
    
    13,616,948Compensation expense on restricted
Common Stock grant
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    299,626
    
    
    
    
    
    
    
    299,626Compensation cost on Common
Stock warrants and modification of
stock option grant
    
    
    
    
    
    
    
    
    
    
    2,534,231
    
    
    
    
    
    
    
    
    
    
    
    2,534,231Tax benefit of stock option exercises
    
    
    
    
    
    
    
    
    
    
    1,133,431
    
    
    
    
    
    
    
    
    
    
    
    1,133,431Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    59,413,573
    
    
    
    59,413,573Balance at December 31, 2003
    
    
    36,791,290
    
    
    $
    367,913
    
    
    $
    473,601,791
    
    
    $
    (394,895
    )
    
    $
    (233,947,404
    )
    
    $
    239,627,405
 The accompanying notes are an integral part of these financial statements. 52




---



##### Table of Contents



KOS PHARMACEUTICALS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS For the Year Ended December 31,2003
    
    2002
    
    2001Cash Flows from Operating Activities:Net Income (Loss)
    
    $
    59,413,573
    
    
    $
    (20,816,164
    )
    
    $
    2,386,241Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities -
Provision for doubtful accounts
    
    
    217,143
    
    
    
    150,000
    
    
    
    75,000Depreciation and amortization
    
    
    3,310,964
    
    
    
    2,110,538
    
    
    
    3,489,113Provision for inventory obsolescence
    
    
    770,538
    
    
    
    480,000
    
    
    
    1,050,000Reimbursement recognized under license agreement
    
    
    (229,206
    )
    
    
    
    
    
    
    Loss from disposals of fixed assets
    
    
    197,606
    
    
    
    131,806
    
    
    
    140,560Common Stock issued to employees under Kos Savings Plan
    
    
    1,079,327
    
    
    
    761,315
    
    
    
    586,872Compensation expense on restricted stock grant
    
    
    299,626
    
    
    
    300,000
    
    
    
    203,503Compensation cost on Common Stock warrants and options
    
    
    2,534,231
    
    
    
    211,500
    
    
    
    Tax benefit of stock option exercises
    
    
    1,133,431
    
    
    
    
    
    
    
    Changes in operating assets and liabilities:Trade accounts receivable
    
    
    (15,687,783
    )
    
    
    (11,796,995
    )
    
    
    (2,913,268
    )Inventories
    
    
    (1,249,649
    )
    
    
    1,325,155
    
    
    
    (6,956,116
    )Prepaid expenses and other current assets
    
    
    (4,228,711
    )
    
    
    2,072,165
    
    
    
    (4,693,732
    )Other assets
    
    
    (74,152
    )
    
    
    10,592
    
    
    
    178,150Accounts payable
    
    
    597,447
    
    
    
    2,490,167
    
    
    
    1,684,493Accrued expenses
    
    
    10,857,624
    
    
    
    9,692,282
    
    
    
    9,502,707Advance payments from customers
    
    
    (9,128,668
    )
    
    
    2,437,476
    
    
    
    2,368,732Advance payment received on license agreement
    
    
    5,796,875
    
    
    
    9,203,125
    
    
    
    Net cash provided by (used in) operating activities
    
    
    55,610,216
    
    
    
    (1,237,038
    )
    
    
    7,102,255Cash Flows from Investing Activities:Capital expenditures and deposits on fixed
assets to be acquired
    
    
    (11,043,794
    )
    
    
    (6,729,750
    )
    
    
    (4,302,309
    )Purchases of marketable securities
    
    
    (13,564,297
    )
    
    
    
    
    
    
    Sales of marketable securities
    
    
    13,564,297
    
    
    
    
    
    
    
    Net cash used in investing activities
    
    
    (11,043,794
    )
    
    
    (6,729,750
    )
    
    
    (4,302,309
    )Cash Flows from Financing Activities:Net proceeds from issuance of Common Stock
    
    
    184,276,585
    
    
    
    
    
    
    
    Proceeds from issuance of Common Stock to employees
under Stock Purchase Plan
    
    
    1,982,818
    
    
    
    1,624,954
    
    
    
    1,150,736Net proceeds from exercise of stock options
    
    
    13,616,948
    
    
    
    1,648,582
    
    
    
    2,323,189Borrowings under Notes Payable to Shareholder
    
    
    
    
    
    
    18,000,000
    
    
    
    33,000,000Payments of Notes Payable to Shareholder
    
    
    (4,000,000
    )
    
    
    (39,000,000
    )
    
    
    Payments under capital lease obligations
    
    
    (57,285
    )
    
    
    (53,253
    )
    
    
    (80,757
    )Net cash provided by (used in) financing activities
    
    
    195,819,066
    
    
    
    (17,779,717
    )
    
    
    36,393,168Net increase (decrease) in cash and cash equivalents
    
    
    240,385,488
    
    
    
    (25,746,505
    )
    
    
    39,193,114Cash and Cash Equivalents, beginning of period
    
    
    19,572,046
    
    
    
    45,318,551
    
    
    
    6,125,437Cash and Cash Equivalents, end of period
    
    $
    259,957,534
    
    
    $
    19,572,046
    
    
    $
    45,318,551Supplemental Disclosure of Cash Flow Information:Interest paid
    
    $
    3,075,218
    
    
    $
    3,833,472
    
    
    $
    6,050,458Income taxes paid
    
    
    2,459,898
    
    
    
    130,702
    
    
    
    Supplemental Disclosure of Non-cash Information:Conversion of Note Payable to Shareholder to Common Stock
(See Note 8)
    
    $
    50,000,000
    
    
    $
    
    
    
    $
    Acquisition of equipment under capital lease obligations
    
    
    
    
    
    
    
    
    
    
    166,764
 The accompanying notes are an integral part of these financial statements. 53




---



##### Table of Contents



KOS PHARMACEUTICALS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. General Kos Pharmaceuticals, Inc. (Kos or the Company) develops prescription
pharmaceutical products principally for the cardiovascular and respiratory
markets. On July 28, 1997, the Company received clearance from the U.S. Food and
Drug Administration (FDA) to market Niaspan®for the treatment of mixed lipid
disorders, a condition in which a patient is observed to have several
abnormalities in the levels of the fatlike substances, called lipids, that
contribute to heart disease. Niaspanis the only once-a-day prescription and
the first extended-release formulation of any type of product with niacin as
the active ingredient ever approved by the FDA for the treatment of mixed lipid
disorders. Niaspanis indicated for the following: (i) reduce elevated total
cholesterol, low-density lipoprotein cholesterol, commonly referred to as LDL
or bad cholesterol, and apolipoprotein B, another lipid particle, and
increase low high-density lipoprotein cholesterol, commonly referred to as HDL
or good cholesterol; (ii) reduce very high serum triglycerides, which are
fatty substances in the blood that contribute to heart disease; (iii) reduce
elevated total and LDL cholesterol when used in combination with a bile-binding
resin, which is a different class of drugs that reduces bad cholesterol; (iv)
reduce recurrent nonfatal myocardial infarction, or the recurrence of nonfatal
heart attacks; and (v) promote the regression or slow the progression of
atherosclerosis, which is a medical condition involving the narrowing of the
arteries to the heart, when combined with bile-binding resins. Additionally,
Niaspansprescribing information references its ability to significantly
reduce lipoprotein (a), which is referred to as the very bad cholesterol and
is an independent risk factor for coronary heart disease. On January 28, 2002, the Company launched Advicor®, a new solid-dose drug
containing Niaspanand lovastatin, which is a currently marketed
cholesterol-lowering drug, for the treatment of mixed lipid disorders. The
Company believes that a once-a-night tablet with the combined complementary
properties of its Niaspanproduct and lovastatin represents an effective method
for treating patients with mixed lipid disorders. The Company is currently developing several other products in solid-dose
and inhaled dosage forms. No assurance can be given that the Companys products can be successfully
marketed, that products under development can be successfully formulated or
manufactured at acceptable cost and with appropriate quality, or that required
regulatory approvals will be obtained. The Company is subject to a number of
other risks including, but not limited to, uncertainties related to market
acceptance, future capital needs and uncertainty of additional funding,
including its ability to meet all of the conditions necessary to obtain funding
under its credit facilities with Michael Jaharis; uncertainties related to the
protection afforded by the Companys patents and patent applications;
uncertainties related to foreign regulatory approvals; uncertainties related to
patents and trademarks, including interference and risk of infringement;
uncertainties related to competition and technological changes, government
regulation, dependence on product development collaborators, limited
manufacturing experience and risk of scale-up, dependence on single sources of
supply; and no assurances of adequate third party reimbursement. The likelihood
of the success of the Company also must be considered in light of the
uncertainty caused by problems, expenses, complications, and delays frequently
encountered in connection with the development of new business ventures. 54




---



##### Table of Contents



2. Summary of Significant Accounting Policies Basis of Presentation The consolidated financial statements include the results of the Company
and its subsidiaries, Aeropharm Technology, Inc. and Kos Life Sciences, Inc.
All intercompany accounts and transactions have been eliminated in
consolidation. Use of Estimates The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities, the disclosure of contingent assets and liabilities at the date of
the financial statements, and the reported amounts of revenues and expenses
during the reporting period. Significant estimates and assumptions made by
management in the preparation of the accompanying financial statements include
the allowance for doubtful accounts; reserves for inventory obsolescence,
product returns, chargebacks, rebates, discounts and other sales allowances;
estimation of customer inventory levels; and the valuation allowance on
deferred income taxes. Actual results could differ from those estimates. Cash and Cash Equivalents The Company considers all highly liquid investments purchased with an
original maturity of 90 days or less to be cash equivalents. As of December 31,
2003, $17,800,000 of cash and cash equivalents were pledged as collateral on
outstanding letters of credit. Allowance for Doubtful Accounts The Company specifically analyzes its trade receivables and provides
reserves for items determined not to be collectable. In addition, the Company
provides general reserves for a portion of receivables where items, generally
based on age, are deemed to represent a significant risk of loss. Historically,
the Company has not had significant write-offs. Inventories Inventories are stated at the lower of cost or market. Cost is determined
using the first-in, first-out method. Components of inventory cost include raw
materials, labor, and manufacturing overhead. The Company considers factors
such as the amount of inventory on hand, estimated time required to sell such
inventories, remaining shelf life, and current market conditions to determine
whether inventories are stated at the lower of cost or market. Certain raw materials used by the Company in the manufacture of its
Niaspanand Advicorproducts are available from a limited number of suppliers.
The Company is dependent on its suppliers to allocate a sufficient portion of
their capacity to meet the Companys needs. Long-Lived Assets The Company evaluates the recoverability of long-lived assets whenever
events or changes in circumstances indicate that the carrying amount of an
asset may not be recoverable. Recoverability of assets to be held and used is
measured by the comparison of the carrying amount of the assets to the
estimated undiscounted future cash flows associated with them. At the time such
evaluations indicate that the future undiscounted cash flows of certain
long-lived assets are not sufficient to recover the carrying value of such
assets, the assets are adjusted to their fair values. 55




---



##### Table of Contents



The Company evaluates the recoverability of long-lived assets held for
sale by comparing the assets carrying amount with its fair value less cost to
sell. No assets were held for sale as of December 31, 2003 or 2002. Fair Value of Financial Instruments As of December 31, 2003 and 2002, the carrying amount of cash and cash
equivalents, trade accounts receivable, and accounts payable approximates fair
value due to the short term nature of these accounts. The fair value of notes
payable to shareholder is determined using interest rates in effect as of the
balance sheet date and, because interest expense is payable utilizing variable
rates that re-price frequently, the carrying value approximates fair value. Concentration of Credit Risk The Company maintains its cash and cash equivalents with a major financial
institution. The Company performs periodic evaluations of the relative credit
standing of this institution to limit its credit risk exposure. The Company conducts a significant amount of its sales with a limited
number of large pharmaceutical wholesalers and warehousing chains. Accordingly,
86% of the trade accounts receivable before allowances at December 31, 2003,
were represented by five of these customers. The Company performs periodic
evaluations of the financial condition of all customers to limit its credit
risk exposure, but does not obtain collateral. The Company has no significant
off-balance-sheet concentrations of credit risk. Revenue Recognition Sales and the related cost of sales are recognized at the time product
arrives at the customers location. The Companys largest customers are
distributors who warehouse product and, in turn, sell that product to retailers
and others. Net sales consist of gross sales to the Companys customers less
provisions for expected returns from customers, customer discounts, and rebates
and chargebacks to managed care organizations with whom the Company has
contracts. These provisions totaled $82,967,000, $44,369,000, and $19,542,000
for the years ended December 31, 2003, 2002, and 2001, respectively. Included
in Accrued expenses in the accompanying consolidated balance sheets are
$20,283,000 and $11,070,000, at December 31, 2003 and 2002, respectively,
related to these provisions. Accounting for Product Returns  Impact on Revenue Recognition The Company periodically evaluates the volume of its Niaspanand Advicor
products that are in customer inventories or elsewhere in the distribution
channel to determine whether increased risk of product returns exists. For the
period from the introduction of its products through December 31, 2002, Kos
return risk expectations were consistently based on its limited product return
experience given the early stage nature of its products and of the Company.
Accordingly, Kos established a specific return risk estimate based on estimated
inventory levels in the distribution channel that was used to determine the
amount of revenue that could be recorded during a given period. During the
quarter ended March 31, 2003, as a result of the significant history of minimal
returns for both products since their introduction, Kos revised its return risk
estimates to reflect the historically low product return patterns. This change
in accounting estimate resulted in the Company recognizing as revenue all
product shipments made during the year ended December 31, 2003, as well as
$11.1 million of its prior period product shipments not previously recognized
as revenue because of its previous product return risk exposure estimates. The
impact of this change in estimate increased the Companys reported revenues,
net income, and basic and diluted earnings per share by $11.1 million, $9.9
million, and $0.45 per share and $0.24 per share, respectively, for the year
ended December 31, 2003. The Company will continue to monitor wholesaler
inventory levels, and, if the Companys product return risk exceeds acceptable
levels, the Company may 56




---



##### Table of Contents



be required to not recognize the revenue and related costs associated with
the excess inventory until such return risk is mitigated. Advance Payment Received on License Agreement On October 23, 2002, the Company signed an exclusive international
commercialization agreement with Merck KGaA (Merck) to market the Companys
Niaspanand Advicorproducts outside the United States, Canada and Japan. Under
terms of the agreement, Merck will provide Kos up to $61 million in licensing,
milestone and reimbursement payments, including $15 million of upfront
payments, of which $12.5 million are refundable to Merck by Kos if it fails to
achieve certain regulatory milestones. The milestone payments are dependent on
the achievement of certain regulatory approvals and sales thresholds. Kos will
also receive 25% of net sales of the products in the territory, which includes
the cost of goods sold. Merck will be responsible for conducting Phase IV
clinical studies and commercialization activities while Kos is responsible for
obtaining initial marketing authorization in all major European countries and
for the supply and manufacturing of the products. Through December 31, 2003,
Kos has received $15 million in upfront and reimbursement payments from Merck.
Of this amount, $229,000 was offset against research and development expenses
during the year ended December 31, 2003. The majority of these payments,
however, will be recognized as revenue in future periods upon Kos achieving
certain regulatory milestones. Co-Promotion and Strategic Alliance Arrangements During 1999, the Company entered into a co-promotion collaboration
agreement with Knoll Pharmaceutical Company (Knoll), for the promotion and
marketing of Knolls Mavik and Tarka products (Mavik® and Tarka® are registered
trademarks of Abbott Laboratories) within the United States (the Knoll
Agreement). Under the terms of the Knoll Agreement, the Company was to receive
an increasing percentage of revenue based on sales thresholds. The Company
recorded $7.2 million of co-promotion revenue as a result of the Knoll
Agreement for the year ended December 31, 2001. On March 2, 2001, Abbott
Laboratories (Abbott) announced that it had finalized its acquisition of
BASFs pharmaceutical business, which included the global operations of Knoll.
The Company and Abbott agreed to terminate the Knoll Agreement effective
January 1, 2002. The Company entered into an agreement, effective May 3, 2000, with DuPont
Pharmaceuticals Company (DuPont) to form a strategic alliance for the purpose
of co-promoting the Companys Advicorproduct in the United States and Canada
(the DuPont Agreement). Under the terms of the DuPont Agreement, the Company
and DuPont would have shared in the future development and commercialization of
the Advicorproduct. Specifically, DuPont had agreed (i) to make equity
investments in the Company of up to $30 million through the date of FDA
approval of the Advicorproduct; (ii) to pay the Company $17.5 million in
milestone payments upon FDA approval of the Advicorproduct; (iii) to fund up
to $32.5 million for future clinical development of the Advicorproduct; and
(iv) to share equally in the costs associated with promoting the Advicor
product and share equally in product profits after deducting a royalty to the
Company. On May 31, 2000, DuPont made a $20-million equity investment in the
Company in exchange for 1,250,000 shares of the Companys Common Stock. On June
7, 2001, DuPonts parent company, E.I. du Pont Nemours, announced that it had
entered into an agreement to sell DuPont to Bristol-Myers Squibb Company
(BMS) and on October 1, 2001, BMS completed its acquisition of DuPont. On
December 17, 2001, the Company entered into an agreement with BMS pursuant to
which the DuPont Agreement was terminated and BMS paid Kos $45 million (the
BMS Payment). The BMS Payment, offset by approximately $6 million of
promotional expenses due to Kos by BMS at the time of termination, was recorded
as Other Income in the accompanying consolidated statements of operations for
the year ended December 31, 2001. On October 17, 2003, the Company entered into a three-year agreement with
Takeda Pharmaceuticals North America, Inc. (Takeda) to co-promote Niaspanand
Advicorin the United States. Pursuant to this 57




---



##### Table of Contents



agreement, Takeda will utilize its U.S.-based sales force to promote
Niaspanand Advicorin addition to its own product. Takeda is responsible for
providing a promotional effort that is expected to significantly increase the
amount of product details performed per year, and for all costs associated with
its sales force, including promotional materials and samples. The Company is
responsible for manufacturing and supplying both products and will collect and
record all sales associated with its products. Takeda will receive a royalty on
incremental net sales of the products in the United States above a certain
baseline amount. This co-promotion arrangement has a three-year term commencing
January 2004 and provides for residual payments to Takeda after the three
years, if the parties do not renew the agreement. Fixed Assets Fixed assets are stated at cost, less accumulated depreciation and
amortization. Depreciation and amortization are provided using the
straight-line method over the estimated useful lives of the assets or lease
terms as follows: YearsFurniture and equipment
    
    5Computer software and hardware
    
    3-5Laboratory and manufacturing equipment
    
    10Leasehold improvements
    
    Shorter of 7-10years or lives ofleases
 Effective January 1, 2002, the Company made certain prospective changes in
the estimated useful lives of most of its fixed assets. This change was made to
better reflect how the assets are expected to be used over time and to provide
a better matching of revenues and expenses. The effect of this change on net
loss for 2002 was not material. Research and Development Expenses All research and development expenses are reflected in the Companys
consolidated statements of operations as incurred. Advertising Expense The Company records the cost of its advertising efforts when services are
performed or goods are delivered. The Company recorded $6,829,000, $7,279,000,
and $6,781,000 in advertising expense for the years ended December 31, 2003,
2002, and 2001, respectively. 58




---



##### Table of Contents



Net Income (Loss) Per Share Basic earnings (loss) per share is determined by dividing the Companys
net income (loss) by the weighted average number of shares of Common Stock
outstanding. Diluted income (loss) per share also includes dilutive Common
Stock equivalents outstanding after applying the treasury stock method to
outstanding stock options and warrants and the if converted method to
convertible debt. A reconciliation of the numerator and denominator of the
basic and diluted earnings per share computation is as follows: 2003
    
    2002
    
    2001Numerator:Net income (loss)
    
    $
    59,413,573
    
    
    $
    (20,816,164
    )
    
    $
    2,386,241Interest expense from convertible debt
    
    
    3,320,668
    
    
    
    N/A
    
    
    
    N/ADiluted net income (loss)
    
    $
    62,734,241
    
    
    $
    (20,816,164
    )
    
    $
    2,386,241Denominator:Basic weighted average number of
shares outstanding
    
    
    21,913,928
    
    
    
    20,582,205
    
    
    
    20,221,089Effect of dilutive securities:Stock options
    
    
    3,078,860
    
    
    
    
    
    
    
    2,577,543Non-detachable warrants (See Note 8)
    
    
    6,000,000
    
    
    
    
    
    
    
    Convertible debt (See Note 8)
    
    
    10,032,113
    
    
    
    
    
    
    
    Other Common Stock warrants
shares outstanding (See Note 11)
    
    
    8,424
    
    
    
    
    
    
    
    Diluted weighted average number of
shares outstanding
    
    
    41,033,325
    
    
    
    20,582,205
    
    
    
    22,798,632Basic earnings (loss) per share of
Common Stock
    
    $
    2.71
    
    
    $
    (1.01
    )
    
    $
    0.12Diluted earnings (loss) per share of
Common Stock
    
    
    1.53
    
    
    
    (1.01
    )
    
    
    0.10
 The following Common Stock equivalents have been excluded from the
calculation of weighted average shares outstanding because their impact is
antidilutive: 2003
    
    2002
    
    2001Stock options
    
    
    167,000
    
    
    
    6,544,822
    
    
    
    Non-detachable warrants (See Note 8)
    
    
    
    
    
    
    6,000,000
    
    
    
    6,000,000Convertible debt (See Note 8)
    
    
    
    
    
    
    10,183,299
    
    
    
    10,183,299Total
    
    
    167,000
    
    
    
    22,728,121
    
    
    
    16,183,299
 Income Taxes The Company follows Statement of Financial Accounting Standards (SFAS)
No. 109, Accounting for Income Taxes, which requires, among other things,
recognition of future tax benefits measured at enacted rates attributable to
deductible temporary differences between financial statement and income tax
bases of assets and liabilities and to tax net operating loss carryforwards to
the extent that realization of said benefits is more likely than not. As of
December 31, 2003, the Company had available approximately $146.7 million of
net operating loss carryforwards that expire between 2004 and 2021. 59




---



##### Table of Contents



The composition of the net deferred tax assets is as follows: December 31,2003
    
    2002Current:Reserves and accruals
    
    $
    9,958,726
    
    
    $
    6,240,490Other
    
    
    5,705,542
    
    
    
    3,527,680Total Current
    
    
    15,664,268
    
    
    
    9,768,170Non-current:Tax net operating loss carryforwards
    
    
    57,891,594
    
    
    
    88,368,824Intangible assets
    
    
    1,353,588
    
    
    
    1,679,393Property and equipment, principally
due to depreciation
    
    
    (1,097,220
    )
    
    
    (148,495
    )Total Non-current
    
    
    58,147,962
    
    
    
    89,899,72273,812,230
    
    
    
    99,667,892Valuation allowance
    
    
    (73,812,230
    )
    
    
    (99,667,892
    )$
    
    
    
    $
    
 The Company has an accumulated deficit as of December 31, 2003, of
approximately $233.9 million. Excluding the impact of the BMS Payment, the
Company generated full-year income before provision for income taxes for the
first time in 2003. Management has re-evaluated the continuing need for a
valuation allowance against deferred tax assets and, based on the history of
net losses, concluded that there is not sufficient evidence as of December 31,
2003, to conclude that the Company will more likely than not realize all or a
portion of its deferred tax assets. However, if in the future management
concludes that some or all of its deferred tax assets will more likely than
not be realized, then the Company will be required to recognize such assets by
reversing all or the applicable portion of the valuation allowance. There was no provision for income taxes for the years ended December 31,
2002 and 2001. Although the Company has sufficient net operating losses to
offset taxable income, the use of net operating losses is limited under federal
alternative minimum tax rules to 90% of taxable income. Similar rules apply to
state taxing jurisdictions where state income tax is based on an apportionment
of federal taxable income. Consequently, the Company recorded a provision for
income taxes of $2,878,821 for the year ended December 31, 2003 to reflect
$1,259,368 in federal alternative minimum tax and $1,619,453 in state income
tax liabilities that cannot be offset by utilizing the Companys net operating
loss carryforwards. A reconciliation between the statutory federal income tax
expense and the income tax expense at the Companys effective rate for the
years ended December 31, 2003, 2002 and 2001 is set forth below: December 31,2003
    
    2002
    
    2001Computed expected income tax based
on statutory federal income tax rate
    
    $
    21,802,338
    
    
    $
    (7,285,657
    )
    
    $
    835,184State income taxes, net of federal benefit
    
    
    2,614,495
    
    
    
    (749,384
    )
    
    
    85,905Non deductible expenses
    
    
    2,928,564
    
    
    
    1,133,120
    
    
    
    434,417Change in valuation allowance
    
    
    (25,855,662
    )
    
    
    6,901,921
    
    
    
    (1,355,506
    )Other
    
    
    1,389,086
    
    
    
    
    
    
    
    Provision for income taxes
    
    $
    2,878,821
    
    
    $
    
    
    
    $
    
 60




---



##### Table of Contents



Reporting of Comprehensive Income or Loss SFAS No. 130 Reporting Comprehensive Income, establishes standards for
reporting and display of comprehensive income and its components in a full set
of financial statements. Comprehensive income or loss refers to revenues,
expenses, gains and losses that are not included in net income or loss but
rather are recorded directly in stockholders equity, such as certain
unrealized gain or loss items. The Companys reported net income (loss) equals
comprehensive income (loss) for all periods presented. Accounting for Stock-Based Compensation As permitted by SFAS No. 148, Accounting for Stock-Based Compensation
(SFAS 148), which amended SFAS No. 123, Accounting for Stock-Based
Compensation, the Company accounts for options issued to employees and to
outside directors (after June 30, 2000) under Accounting Principles Board
(APB) Opinion No. 25 Accounting for Stock Issued to Employees (APB 25).
Except for compensation cost of $774,000, included in Selling, general and
administrative in the accompanying consolidated statements of operations,
related to the modification of a terminated employees options in 2003, no
compensation cost has been recognized on options issued to employees because
the exercise price of such options was not less than the market value of the
Common Stock on the date of grant. Had compensation cost for options issued to
employees been determined consistent with SFAS 148, the Companys net income
(loss) and net income (loss) per share would have been the Pro forma amounts
shown in the following table: 2003
    
    2002
    
    2001Net income (loss):As reported
    
    $
    59,413,573
    
    
    $
    (20,816,164
    )
    
    $
    2,386,241Option modification expense
under APB 25
    
    
    774,368
    
    
    
    
    
    
    
    Stock-based employee
compensation expense
under fair value method
    
    
    (22,373,131
    )
    
    
    (14,837,272
    )
    
    
    (7,850,363
    )Pro forma
    
    $
    37,814,810
    
    
    $
    (35,653,436
    )
    
    $
    (5,464,122
    )Net income (loss) per share:As reported:Basic
    
    $
    2.71
    
    
    $
    (1.01
    )
    
    $
    0.12Diluted
    
    
    1.53
    
    
    
    (1.01
    )
    
    
    0.10Pro forma:Basic
    
    $
    1.73
    
    
    $
    (1.73
    )
    
    $
    (0.27
    )Diluted
    
    
    1.02
    
    
    
    (1.73
    )
    
    
    (0.27
    )Number of shares used in
calculation:As reported:Basic
    
    
    21,913,928
    
    
    
    20,582,205
    
    
    
    20,221,089Diluted
    
    
    41,033,325
    
    
    
    20,582,205
    
    
    
    22,798,632Pro forma:Basic
    
    
    21,913,928
    
    
    
    20,582,205
    
    
    
    20,221,089Diluted
    
    
    40,332,908
    
    
    
    20,582,205
    
    
    
    20,221,089
 61




---



##### Table of Contents



Recent Accounting Pronouncements In January 2003, the Financial Accounting Standards Board (FASB) issued
Interpretation No. 46, Consolidation of Variable Interest Entities on
Interpretation of ARB No. 51 (FIN 46), to expand upon and strengthen
existing accounting guidance that addresses when a company should include in
its financial statements the assets, liabilities and activities of another
entity. In December 2003, the FASB issued FIN 46(R) to clarify certain
provisions of FIN 46 and to modify the effective date of such provisions for
public companies. Until now, a company generally has included another entity in
its consolidated financial statements only if it controlled the entity through
voting interests. FIN 46 changes that by requiring a variable interest entity,
as defined, to be consolidated by a company if that company is subject to a
majority of the expected losses (as defined) from the variable interest
entitys activities or entitled to receive a majority of the entitys residual
returns or both. FIN 46 also requires disclosures about variable interest
entities that the company is not required to consolidate but in which it has a
significant variable interest. Based on the revised guidance, all public
companies must apply the provisions of FIN 46(R) to variable interests commonly
referred to as special-purpose entities (an SPE), where such interests were
created prior to February 1, 2003, no later than periods ending after December
15, 2003. Interests created in non-SPE variable interest entities after January
31, 2003 but before December 31, 2003 are subject to the provisions of the
original FIN 46 in 2003, but the provisions of FIN 46(R) must be adopted no
later than the first reporting period ending after March 15, 2004. The
provisions of FIN 46(R) must be applied to all variable interests created after
December 31, 2003 upon initial involvement with the variable interest entity.
The adoption of FIN 46 is not expected to have a material impact on the
Companys financial position, results of operations or cash flows. In November 2002, the Emerging Issues Task Force (EITF) of the FASB
reached consensus on EITF 00-21 Revenue Arrangements with Multiple
Deliverables (EITF 00-21). EITF 00-21 addresses how to determine whether an
arrangement involving multiple deliverables contains more than one unit of
accounting. EITF 00-21 also provides guidance regarding the separation of
deliverables in a multiple deliverable arrangement and the allocation of total
arrangement consideration to the discrete units of accounting for situations
not governed by existing, higher-level authoritative literature. EITF 00-21 is
effective for revenue arrangements entered into in periods (including quarterly
periods) beginning after June 30, 2003. Companies are permitted, but not
required, to apply the consensus guidance to existing arrangements as a
cumulative effect of change in accounting principle in accordance with APB
Opinion No. 20, Accounting Changes. The adoption of EITF 00-21 did not impact
the Companys financial position or results of operations because the Company
does not currently have any multiple-deliverables revenue arrangements. 3. Trade Accounts Receivable, net Trade accounts receivable consist of the following: December 31,2003
    
    2002Trade accounts receivable
    
    $
    40,081,737
    
    
    $
    24,393,954Less allowance for doubtful accounts
    
    
    (523,100
    )
    
    
    (305,957
    )Trade accounts receivable, net
    
    $
    39,558,637
    
    
    $
    24,087,997
 62




---



##### Table of Contents



4. Inventories Inventories consist of the following: December 31,2003
    
    2002Raw materials
    
    $
    1,775,488
    
    
    $
    1,433,004Work in process
    
    
    3,440,691
    
    
    
    1,619,223Finished goods
    
    
    1,189,946
    
    
    
    2,874,787Total inventories
    
    $
    6,406,125
    
    
    $
    5,927,014
 5. Fixed Assets, net Fixed assets consist of the following: December 31,2003
    
    2002Furniture and equipment
    
    $
    2,386,196
    
    
    $
    1,449,187Computer software and hardware
    
    
    8,617,067
    
    
    
    4,128,678Laboratory and manufacturing equipment
    
    
    12,326,359
    
    
    
    10,963,445Leasehold improvements
    
    
    10,675,350
    
    
    
    9,353,818Fixed assets, gross
    
    
    34,004,972
    
    
    
    25,895,128Less accumulated depreciation and amortization
    
    
    (16,163,616
    )
    
    
    (13,367,327
    )Fixed assets, net
    
    $
    17,841,356
    
    
    $
    12,527,801
 The Company recorded depreciation expense of $3,310,964, $2,110,538, and
$2,766,244 for the years ended December 31, 2003, 2002, and 2001, respectively. 6. Goodwill In late 1999, the Company acquired, for total consideration of $1.1
million, substantially all of the assets and intellectual property of IEP
Group, Inc. (the IEP Acquisition). In connection with this transaction, the
Company recorded goodwill of $803,000 representing the excess of the cost of
the assets acquired over their estimated fair value. The pre-acquisition
results of IEP Group, Inc. (IEP) were not material to the Companys results
of operations. During the fourth quarter of 2001, in accordance with the
provisions of SFAS No. 121, Accounting for the Impairment of Long-Lived Assets
and Long-Lived Assets to be Disposed of, the Company recorded a goodwill
impairment loss of $642,551, based on its determination of fair-value of such
goodwill. Prior to recording such impairment loss, the Company had recognized
amortization expense of $80,318 for the year ended December 31, 2001.
Accordingly, the Company recorded $722,869 of amortization expense during the
year ended December 31, 2001. 63




---



##### Table of Contents



7. Accrued Expenses The components of accrued expenses are as follows: December 31,2003
    
    2002Managed care rebates and chargebacks
    
    $
    18,189,658
    
    
    $
    8,681,834Employee commissions and bonuses
    
    
    8,008,725
    
    
    
    6,650,500Royalties
    
    
    2,875,583
    
    
    
    2,817,476Sales returns and allowances
    
    
    2,092,942
    
    
    
    2,387,986Employee vacations
    
    
    2,690,128
    
    
    
    2,033,998All other
    
    
    11,549,296
    
    
    
    11,976,914Total accrued expenses
    
    $
    45,406,332
    
    
    $
    34,548,708
 8. Notes Payable to Shareholder On December 19, 2002, the Company entered into an agreement with Michael
Jaharis, Chairman Emeritus of the Companys Board of Directors and its
principal shareholder, whereby Mr. Jaharis agreed to replace the previous
$30-million credit facility extended to the Company on July 1, 1998 (which was
to expire on December 31, 2002), with a new facility expiring on June 30, 2008
(the Additional Standby Facility). In connection with this new credit
arrangement, the Company granted to Mr. Jaharis non-detachable warrants to
purchase 1,000,000 shares of the Companys Common Stock at an exercise price
based on the market price of the Companys Common Stock on the date that the
first draw under this facility occurs. The Company had no borrowings
outstanding under the Additional Standby Facility as of December 31, 2003.
Borrowings, when outstanding, will bear interest at the prime rate (4.0% as of
December 31, 2003), and will be subject to the terms and conditions of
borrowings made under the Supplemental Credit Facility, as defined below. On September 1, 1999, the Company formally agreed to the terms of a
$50-million funding arrangement initially entered into with Mr. Jaharis on
October 7, 1998 (the Supplemental Credit Facility). On July 21, 2001, the
Company replaced its existing $50 million promissory note payable to Mr.
Jaharis with two, $25 million, promissory notes, one payable in the name of Mr.
Jaharis and the other payable in the name of Mr. Jaharis wife. With this
promissory note replacement, all of Mr. Jaharis existing rights and
obligations under the Supplemental Credit Facility, with respect to one-half of
the outstanding amount, were transferred to Mrs. Jaharis, and were subsequently
transferred by Mrs. Jaharis to a limited partnership (the Limited
Partnership) that she controls. All other terms and conditions of the
Supplemental Credit Facility remained unchanged. Borrowings under the
Supplemental Credit Facility were convertible at $4.91 per share and accrued
interest at the prime rate. On November 25, 2003, in connection with an equity
offering of the Companys Common Stock pursuant to an effective shelf
registration statement, the limited partnership controlled by Mrs. Jaharis
exercised its right to convert $6,137,500 of borrowings outstanding under the
Supplemental Credit Facility into 1,250,000 shares of the Companys Common
Stock. Those shares were then sold by such limited partnership as part of the
equity offering. The Company did not receive any proceeds from such sale by the
limited partnership controlled by Mrs. Jaharis. On December 31, 2003, all then
remaining borrowings under the Supplemental Credit Facility, which totaled
$43,862,500 and bore interest at the prime rate, were converted into shares of
the Companys Common Stock. The Supplemental Credit Facility terminated as of
December 31, 2003. On December 21, 1999, Mr. Jaharis agreed to extend another $50-million
loan to the Company (the Standby Facility). Borrowings made under the Standby
Facility totaled $30 million as of December 31, 2003, are due June 30, 2005,
and are also subject to most of the terms and conditions of borrowings made
under the Supplemental Credit Facility, including the condition that the death
of lender shall not have 64




---



##### Table of Contents



occurred. In lieu of a conversion feature, the Company has granted to Mr.
Jaharis non-detachable warrants to purchase 6,000,000 shares of the Companys
Common Stock at $5.00 per share, which approximated the market value of the
Companys Common Stock on the effective date of the Standby Facility. The
warrants are exercisable at any time until June 30, 2006. The exercise of a
significant number of the warrants issued under the Standby Facility will cause
material dilution to existing shareholders of the Company. As of December 31, 2003, all of the Companys assets were pledged as
collateral for the Additional Standby Facility and the Standby Facility. The Company recorded $3,321,000, $4,040,000 and $6,081,000 of interest
expense for the years ended December 31, 2003, 2002 and 2001, respectively,
related to its credit facilities with Mr. Jaharis and his transferees. 9. Major Customers Sales to customers that were at least 10% of the Companys net sales are
as follows: December 31,2003
    
    2002
    
    2001Customer A
    
    $
    94,496,344
    
    
    $
    56,694,295
    
    
    $
    24,361,312Customer B
    
    
    75,371,320
    
    
    
    38,504,032
    
    
    
    14,313,878Customer C
    
    
    60,620,703
    
    
    
    32,514,268
    
    
    
    19,666,663Total
    
    $
    230,488,367
    
    
    $
    127,712,595
    
    
    $
    58,341,853
 10. Selected Quarterly Financial Information (Unaudited) The following table summarizes selected quarterly financial data of the
Company for the years ended December 31, 2003 and 2002 (in thousands, except
per share data): First
    
    Second
    
    Third
    
    Fourth
    
    FullQuarter(1)
    
    Quarter
    
    Quarter
    
    Quarter
    
    Year(1)2003Revenues, net
    
    $
    68,275
    
    
    $
    64,851
    
    
    $
    73,506
    
    
    $
    87,276
    
    
    $
    293,907Cost of sales
    
    
    4,242
    
    
    
    4,468
    
    
    
    5,144
    
    
    
    6,185
    
    
    
    20,038Operating expenses
    
    
    50,604
    
    
    
    47,670
    
    
    
    52,174
    
    
    
    58,225
    
    
    
    208,672Income from operations
    
    
    13,429
    
    
    
    12,713
    
    
    
    16,188
    
    
    
    22,866
    
    
    
    65,197Net income
    
    
    12,650
    
    
    
    11,156
    
    
    
    14,706
    
    
    
    20,902
    
    
    
    59,414Basic income per share(2)
    
    $
    0.61
    
    
    $
    0.53
    
    
    $
    0.68
    
    
    $
    0.86
    
    
    $
    2.71Diluted income per share(2)
    
    
    0.35
    
    
    
    0.31
    
    
    
    0.37
    
    
    
    0.49
    
    
    
    1.532002Revenues, net
    
    $
    33,886
    
    
    $
    38,254
    
    
    $
    45,536
    
    
    $
    55,017
    
    
    $
    172,693Cost of sales
    
    
    3,629
    
    
    
    3,520
    
    
    
    4,445
    
    
    
    3,768
    
    
    
    15,362Operating expenses
    
    
    45,537
    
    
    
    44,093
    
    
    
    40,359
    
    
    
    44,136
    
    
    
    174,125Loss from operations
    
    
    (15,280
    )
    
    
    (9,359
    )
    
    
    732
    
    
    
    7,113
    
    
    
    (16,794
    )Net income (loss)
    
    
    (16,215
    )
    
    
    (10,343
    )
    
    
    (347
    )
    
    
    6,089
    
    
    
    (20,816
    )Basic income (loss) per
share(2)
    
    $
    (0.79
    )
    
    $
    (0.50
    )
    
    $
    (0.02
    )
    
    $
    0.29
    
    
    $
    (1.01
    )Diluted income (loss) per
share(2)
    
    
    (0.79
    )
    
    
    (0.50
    )
    
    
    (0.02
    )
    
    
    0.18
    
    
    
    (1.01
    )
 (1)
    
    Includes the impact of the change in estimate
described in Note 2 which increased revenues, net income, and basic and
diluted earnings per share by $11.1 million, $9.9 million and $0.45 per
share and $0.24 per share, respectively, for the year ended December
31, 2003.(2)
    
    Quarterly earnings per share are calculated on an
individual basis and, because of rounding and changes in the weighted
average shares outstanding during the year, the summation of each
quarter may not equal the amount calculated for the year as a whole.
 65




---



##### Table of Contents



11. Commitments and Contingencies Letter of Credit Facility The Company is subject to the terms of a $18-million letter of credit
facility with a bank (the Letter of Credit Facility). Under the terms of the
Letter of Credit Facility, letters of credit outstanding must not exceed 90% of
the Companys cash balance kept at such bank. As of December 31, 2003 and 2002,
letters of credit outstanding totaled $16,040,000 and $15,540,000,
respectively. Purchase Commitments During the normal course of its business, the Company enters into
short-term purchase commitments for the acquisition of goods and services
needed to run its operations. As of December 31, 2003, the Company had open
purchase commitments totaling $8,321,000. Employment and Royalty Agreements As of December 31, 2003, the Company had employment and/or royalty
agreements with three of its current or former officers, including a deferred
compensation agreement with one of its current officers providing for annual
payments of not less than $400,000 per year for life upon the officers
retirement. The liability under this deferred compensation agreement is being
accrued over the officers remaining periods of employment so that, on the
expected date of the officers retirement, the then-present value of the annual
payments will have been accrued. Included in Accrued expenses as of December
31, 2003 and 2002, in the accompanying consolidated balance sheets are
$1,021,000 and $521,000, respectively, related to this deferred compensation
agreement. Salary and benefits expense recorded under the employment agreements
totaled $1,763,000, $1,626,000 and $1,326,000, during the years ended December
31, 2003, 2002 and 2001, respectively. Future minimum payments under the employment agreements are as follows: Year Ending December 31,
    
    Amount2004
    
    $
    1,095,0002005
    
    
    1,095,0002006
    
    
    761,0002007
    
    
    187,000Total
    
    $
    3,138,000
 Royalty agreements entitle a current and a former officer to royalties,
not to exceed an aggregate of $5.5 million, on sales of the Companys products.
The aggregate maximum of royalty expense allowable under the agreement with the
former officer was met during the year ended December 31, 2003. Royalty
expenses from this royalty agreement during the years ended December 31, 2003,
2002 and 2001 were $384,000, $1,727,000, and $842,000, respectively, and are
included in Selling, general and administrative in the accompanying
consolidated statements of operations. No royalties have been incurred pursuant
to the royalty agreement with the current officer of the Company. The Company, in connection with the IEP Acquisition, is also subject to a
royalty consideration on net sales of future products developed by IEP
utilizing technology acquired through such acquisition. In accordance with the
terms of the IEP Acquisition, the Company is required to make minimum annual
royalty payments of $50,000 from 2002 through 2009. 66




---



##### Table of Contents



Lease Commitments The Company has various operating leases that expire through 2014 for the
rental of office space, laboratory facilities, and vehicles. Future minimum
commitments under these agreements are as follows: Year Ending December 31,
    
    Amount2004
    
    $
    6,666,0002005
    
    
    6,390,0002006
    
    
    6,221,0002007
    
    
    4,450,0002008
    
    
    3,570,000Thereafter
    
    
    16,217,000Total
    
    $
    43,514,000
 As of December 31, 2003 and 2002, standby letters of credit of $3,540,000
and $3,040,000, respectively, were outstanding under the Letter of Credit
Facility in favor of the lessors as collateral for these leases provided to the
Company. Rent and other expenses incurred under the operating leases were
$7,401,000, $5,690,000 and $4,234,000, during the years ended December 31,
2003, 2002 and 2001, respectively. Licensing Agreements The Company has certain license agreements (the License Agreements) with
third parties (the Licensees) for the development of future products. Under
the License Agreements, the Company is required to make payments to the
Licensees in order to secure exclusive rights to develop, manufacture, sell,
and/or sublicense future products developed through the License Agreements. In
connection with the License Agreements, the Company recorded licensing expense
of approximately $562,000, $250,000 and $275,000, for the years ended December
31, 2003, 2002 and 2001, respectively, and is reflected in Research and
development in the accompanying consolidated statements of operations. In order to maintain its rights under the License Agreements, the Company
is required to pay certain future milestone payments and licensing fees. In the
event that no milestone event occurs, the Company generally would not be
required to make any milestone payment. The Company anticipates, based on the
development efforts that have been conducted to date, that it will be required
to make future minimum payments as follows: Year Ending December 31,
    
    Amount2004
    
    $
    155,0002005
    
    
    30,0002006
    
    
    30,0002007
    
    
    30,0002008
    
    
    30,000Thereafter
    
    
    230,000Total
    
    $
    505,000
 On February 7, 1997, the Company entered into an agreement with an
unaffiliated generic drug manufacturer pursuant to which the parties agreed to
resolve the effects, as between themselves, of a potential interference
proceeding by the United States Patent and Trademark Office by granting cross
licenses under their respective patent applications and patents, regardless of
whether such licenses would be required. In connection with this licensing
agreement, the Company initially recognized $3,000,000 as a licensing expense
for the year ended December 31, 1997. As further consideration for entering
into the 67




---



##### Table of Contents



agreement, the Company agreed to pay the generic manufacturer certain
royalties on the net sales of the Niaspanand Advicorproducts, subject to a
cap on such royalty payments in the United States and a separate cap on such
payments for sales outside the United States. The Company recorded $2,500,000
of royalty expense from this agreement for each of the years ended December 31,
2003, 2002 and 2001. These royalty expenses are included in Selling, general
and administrative in the accompanying consolidated statements of operations.
The Company has purchased the patents that were the subject of such original
agreement and agreed to continue paying a royalty to the generic manufacturer
on terms similar to those contained in the original agreement. Sponsored Research The Company has on-going research agreements with a university and a
research center. The Company is primarily responsible for funding the projects,
and the university or research center is responsible for providing personnel,
equipment, and facilities to conduct the research activities. Future minimum
payments under the sponsored research agreements are as follows: Year Ending December 31,
    
    Amount2004
    
    $
    429,0002005
    
    
    425,0002006 and thereafter
    
    
    447,000Total
    
    $
    1,301,000
 The Company also funds, from time to time and at its sole discretion,
other research programs conducted at other universities and research centers.
Expenses recorded under the Companys sponsored research programs totaled
approximately $967,000, $854,000 and $536,000, during the years ended December
31, 2003, 2002 and 2001, respectively, and are reflected in Research and
development in the accompanying consolidated statements of operations. Development Agreements The Company has development agreements with various third parties (the
Development Agreements). As dictated by the Development Agreements, the
Company is responsible for funding all required development activities. In
order to maintain its rights under the Development Agreements, the Company is
required to pay certain future milestone payments and development fees. In the
event that no milestone event occurs, the Company generally would not be
required to make any milestone payment. Expenses recorded under these and other development agreements totaled
approximately $307,000, $800,000 and $68,000, during the years ended December
31, 2003, 2002 and 2001, respectively, and are reflected in Research and
development in the accompanying consolidated statements of operations. Contract Sales Organization On December 17, 2001, the Company entered into an agreement with a
contract sales organization (the CSO), whereby the CSO provided the Company
with an approximately 150-person field sales organization for a two-year term
beginning on January 1, 2002 (the Contract Sales Force Agreement). The
Contract Sales Force Agreement complemented the Companys existing sales force.
Under the terms of the Contract Sales Force Agreement, the Company will pay the
CSO a royalty based on net sales of the Companys Niaspanand Advicorproducts
during a five-year period beginning January 1, 2002. The royalty amounts
payable to the CSO are subject to a cumulative minimum of $50 million over the
term of the Contract Sales Force Agreement, not to exceed $65 million over such
contract term. Royalty expenses recorded under the Contract Sales Force
Agreement totaled approximately $6,875,000 and $3,204,000 for the years ended
December 31, 2003 and 2002, respectively, and are included in Selling,
general and administrative in the accompanying consolidated statements of
operations. 68




---



##### Table of Contents



Further, in 2002, the Company also granted the CSO warrants to purchase
150,000 shares of the Companys Common Stock at $32.79 per share, which
approximated the market value of the Companys Common Stock on the effective
date of the Contract Sales Force Agreement. The warrants vested equally over
the two-year period during which the CSO provided services to the Company. In
accordance with EITF Issue No. 96-18, Accounting for Equity Instruments That
Are Issued to Other Than Employees for Acquiring, or in Conjunction with
Selling, Goods or Services, the compensation cost associated with this warrant
grant was initially measured at the date of issuance using the Black-Scholes
valuation model. The compensation cost was then re-measured each reporting
period using the then applicable valuation assumptions, for increases or
decreases in the quoted market value of the shares of the Companys Common
Stock through the last measurement date of December 31, 2003. The Company
recorded compensation expense associated with this warrant grant of $1,760,000
and $212,000 for the years ended December 31, 2003 and 2002, respectively.
Compensation expenses for the warrant grant are included in Selling, general
and administrative in the accompanying consolidated statements of operation. Employee Benefit Plans The Companys Internal Revenue Code Section 401(k) Plan, known as the Kos
Savings Plan, became effective on January 1, 1994. Each full-time employee who
has completed at least 90 days of service with the Company and has attained age
21 is eligible to make pre-tax elective deferral contributions each year not
exceeding the lesser of a specified statutory amount or 15% of the employees
compensation for the year. Beginning in 1999, the Company began matching
employee contributions to the Kos Savings Plan. The Companys matching
contribution to the Kos Savings Plan is made in the form of shares of
previously unissued Common Stock. The Company matches employee contributions up
to 50% of an employees 401(k) contribution, and not to exceed 3% of such
employees compensation or $5,500 per employee for any given year. An employee
is always 100% vested in the employees elective deferral contributions to the
Kos Savings Plan and is vested up to 100% in the Company matching contribution
portion of such plan at 25% vesting per year of employment. The Company
recorded $1,079,000, $761,000 and $587,000, in expenses related to its match of
employee contributions to the Kos Savings Plan for the years ended December 31,
2003, 2002 and 2001, respectively, and are included in Selling, general and
administrative in the accompanying consolidated statements of operations. On February 15, 1999, the Company implemented the Kos Pharmaceuticals,
Inc. 1999 Employee Stock Purchase Plan (the Stock Purchase Plan). Under the
Stock Purchase Plan, an eligible employee may purchase Common Stock at a 15%
discount by contributing to the Stock Purchase Plan, through payroll
deductions, up to 10% of such employees annual compensation. Each employees
total contributions are limited to $25,000 per year. Employee payroll
deductions are accumulated for six-month periods at the end of which shares of
the Companys Common Stock are purchased under the Stock Purchase Plan. All
full-time employees of the Company with at least 90 days of continuous service
at the beginning of each six-month offering period are eligible to participate
in that offering period. As of December 31, 2003, the Company had issued
509,403 shares of Common Stock under the Stock Purchase Plan and had 490,597
shares reserved for future issuance. 12. Shareholders Equity (Deficit) Preferred Stock The Company is authorized to issue 10,000,000 shares of undesignated
preferred stock. Such shares of preferred stock may be issued by the Company in
the future, without shareholder approval, upon such terms as the Companys
Board of Directors may determine. Common Stock In January 2002, the Securities and Exchange Commission declared effective
a shelf registration statement (the Shelf Registration) filed by the Company
for the sale, from time to time, of up to $200 69




---



##### Table of Contents



million of its Common Stock, Preferred Stock, stock options, warrants and
other rights to purchase Common Stock or Preferred Stock. On October 10, 2003,
the Company filed a new registration statement that covered the shares of the
earlier Shelf Registration (the Amended Shelf
Registration) and which allowed the
Limited Partnership to sell up to 1,500,000 shares of the Companys Common
Stock in a public offering; and on October 31, 2003, the Company further
amended the Amended Shelf Registration to register an aggregate of 1,350,000
shares of Company Common Stock held by BMS and the Companys Chairman. The
Amended Shelf Registration was declared effective by the Securities and
Exchange Commission on October 31, 2003. On November 25, 2003, the Company sold
3,750,000 shares of Common Stock and the Limited Partnership sold 1,250,000
shares of Common Stock (converted from the Supplemental Credit Facility)
pursuant to the Amended Shelf Registration. On December 22, 2003, the Company
sold an additional 650,000 shares of Common Stock and the Companys Chairman
sold 100,000 shares of Common Stock to cover over-allotments as permitted in
the Amended Shelf Registration. Net proceeds to the Company resulting from the
sale of the 4,400,000 shares of Common Stock totaled $184,277,000. Proceeds
from the offerings, other than the proceeds pertaining to the selling
shareholders, are expected to be used to acquire other products or companies,
to in-license complimentary products, and to fund working capital needs and for
general corporate purposes. Stock Option Plan During 1996, the Board of Directors of the Company adopted the Kos
Pharmaceuticals, Inc. 1996 Stock Option Plan (the Plan). As of December 31,
2003, a maximum of 12,000,000 shares of Common Stock may be issued pursuant to
stock options granted or to be granted under the Plan. All directors, officers,
employees, and certain related parties of the Company designated by the Board
are eligible to receive options under the Plan. Options granted under the Plan
vest over four years from the date of grant. The maximum term of any option is
ten years from the date of grant. All options expire within 30 days of
termination of employment. The Plan is administered by a committee appointed by
the Board of Directors of the Company. Each outside director of the Company is granted an option to purchase
15,000 shares of Common Stock upon election to the Board, receives options to
purchase 30,000 shares effective on each directors anniversary date and 10,000
shares effective on the date of the Companys Annual Shareholders Meeting. The
exercise price of such options is the fair market value of the underlying
Common Stock on the date the option is granted. The Company considered the
provisions of SFAS No. 123 Accounting for Stock-Based Compensation (SFAS
123) using the Black-Scholes method to approximate the related charge to
expense for all options granted to outside directors through June 30, 2000.
Subsequent to June 30, 2000, the Company adopted the provisions of FIN 44,
which allows grantors to account for options to outside directors under APB 25.
The Company provides the required disclosures of pro forma net income (loss)
and related per share amounts under the fair value method in Note 2 hereto in
accordance with SFAS 123 as amended by SFAS 148. Assumptions used in the
calculation of the fair value of employee stock options are as follows: Risk-FreeGrant
    
    Volatility
    
    Interest
    
    Expected
    
    ExpectedDate
    
    Rate
    
    Rate
    
    Dividends
    
    Term (Years)2001
    
    
    70.0
    %
    
    
    4.11
    %
    
    
    
    
    
    
    52002
    
    
    66.0
    %
    
    
    4.20
    %
    
    
    
    
    
    
    52003
    
    
    61.0
    %
    
    
    2.98
    %
    
    
    
    
    
    
    5
 70




---



##### Table of Contents



Based on calculations using the Black-Scholes option valuation model, the
weighted average grant date fair value of options was $12.28, $13.04 and $12.51
for the years ended December 31, 2003, 2002 and 2001, respectively. As of
December 31, 2003, the Company had outstanding options to purchase 8,088,267
shares of Common Stock to employees, consultants, management and directors.
Detail of option activity is as follows: Exercise PricesNumber of
    
    
    
    
    
    
    
    
    
    
    
    
    
    WeightedShares
    
    Range
    
    AverageOutstanding, December 31, 2000
    
    
    4,360,587
    
    
    $
    0.60
    
    
    
    
    
    
    $
    27.25
    
    
    $
    10.23Granted
    
    
    1,000,200
    
    
    
    15.75
    
    
    
    
    
    
    
    36.50
    
    
    
    20.27Exercised
    
    
    (374,672
    )
    
    
    4.88
    
    
    
    
    
    
    
    19.88
    
    
    
    6.21Canceled
    
    
    (284,233
    )
    
    
    4.88
    
    
    
    
    
    
    
    32.58
    
    
    
    14.54Outstanding, December 31, 2001
    
    
    4,701,882
    
    
    
    0.60
    
    
    
    
    
    
    
    36.50
    
    
    
    12.47Granted
    
    
    2,182,775
    
    
    
    10.48
    
    
    
    
    
    
    
    27.21
    
    
    
    21.64Exercised
    
    
    (196,132
    )
    
    
    5.06
    
    
    
    
    
    
    
    22.22
    
    
    
    8.45Canceled
    
    
    (143,703
    )
    
    
    5.06
    
    
    
    
    
    
    
    30.91
    
    
    
    19.33Outstanding, December 31, 2002
    
    
    6,544,822
    
    
    
    0.60
    
    
    
    
    
    
    
    36.50
    
    
    
    15.46Granted
    
    
    3,103,375
    
    
    
    15.91
    
    
    
    
    
    
    
    44.15
    
    
    
    21.87Exercised
    
    
    (1,229,416
    )
    
    
    4.28
    
    
    
    
    
    
    
    34.10
    
    
    
    11.09Canceled
    
    
    (330,514
    )
    
    
    5.06
    
    
    
    
    
    
    
    34.10
    
    
    
    19.89Outstanding, December 31, 2003
    
    
    8,088,267
 Options Outstanding
    
    Options ExercisableNumber
    
    Weighted
    
    Weighted
    
    NumberOutstanding
    
    Average
    
    Average
    
    Exercisable
    
    WeightedRange of
    
    December 31,
    
    Remaining
    
    Exercise
    
    December 31,
    
    AverageExercise Prices
    
    2003
    
    Contractual Life
    
    Price
    
    2003
    
    Exercise Price$0.60
    
    
    300,000
    
    
    2.5 years
    
    $
    0.60
    
    
    
    300,000
    
    
    $
    0.604.28 to 6.24
    
    
    487,258
    
    
    4.8 years
    
    
    5.20
    
    
    
    487,258
    
    
    
    5.207.00 to 10.50
    
    
    146,825
    
    
    4.0 years
    
    
    7.30
    
    
    
    143,825
    
    
    
    7.2410.67 to 16.00
    
    
    1,444,594
    
    
    6.3 years
    
    
    13.25
    
    
    
    883,222
    
    
    
    12.7916.09 to 24.05
    
    
    4,895,788
    
    
    8.3 years
    
    
    20.27
    
    
    
    1,058,649
    
    
    
    20.1024.24 to 35.58
    
    
    602,289
    
    
    8.5 years
    
    
    29.05
    
    
    
    210,878
    
    
    
    26.4436.50 to 44.15
    
    
    211,513
    
    
    9.7 years
    
    
    42.72
    
    
    
    20,000
    
    
    
    36.508,088,267
    
    
    7.5 years
    
    $
    18.38
    
    
    
    3,103,832
    
    
    $
    13.74
 At December 31, 2003, 1,003,511 shares remain reserved for issuance under
the Plan, and options to purchase 3,103,832 shares of Common Stock were
exercisable. Restricted Common Stock Grant On April 26, 2001, the Company entered into an employment agreement with
one of its officers (the April Employment Agreement). Under the terms of the
April Employment Agreement, the Company made a restricted grant to the officer
of 66,668 shares of Common Stock, valued at approximately $1,200,000, or $17.97
per share (the fair market of the Common Stock on the effective date of the 71




---



##### Table of Contents



agreement). The restricted stock grant vests 25% on each anniversary date
of the April Employment Agreement. The Company recorded $300,000, $300,000 and
$203,000, of compensation expense related to the April Employment Agreement for
the years ended December 31, 2003, 2002 and 2001, respectively, and are
included in Selling, general and administrative in the accompanying
consolidated statements of operations. 13. Legal Proceedings On August 5, 1998, a purported class action lawsuit was filed in the
United States District Court for the Northern District of Illinois, Eastern
Division, against the Company, the members of the Companys Board of Directors,
certain officers of Kos, and the underwriters of the Companys October 1997
offering of shares of Common Stock. In its complaint, the plaintiff asserts, on
behalf of itself and a putative class of purchasers of the Companys Common
Stock during the period from July 29, 1997, through November 13, 1997, claims
under: (i) sections 11, 12(a)(2) and 15 of the Securities Act of 1933; (ii)
sections 10(b) and 20(a) of the Securities Exchange Act of 1934, and Rule 10b-5
promulgated thereunder; and (iii) for common law fraud, negligent
misrepresentation and breach of fiduciary duty. The claims in the lawsuit
relate principally to certain statements made by the Company, or certain of its
representatives, concerning the efficacy, safety, sales volume and commercial
viability of the Niaspanproduct. The complaint sought unspecified damages and
costs, including attorneys fees and costs and expenses. Upon Kos motion, the
case was transferred to the United States District Court for the Southern
District of Florida. The Company filed a motion to dismiss the complaint
against the Company and the individual Kos defendants on January 7, 1999. On
May 24, 1999, the United States District Court for the Southern District of
Florida dismissed the lawsuit with prejudice. The plaintiffs filed an appeal on
June 7, 1999, with the United States Circuit Court of Appeals for the
11th Circuit. On July 16, 2002, the 11th
Circuit Court of Appeals affirmed the District Courts dismissal of the
plaintiffs claims with prejudice. The plaintiffs petitioned the Court of
Appeals for a rehearing of the appeal, which was denied by the Court of
Appeals. Recently, one of the plaintiffs filed a Petition for Writ of
Certiorari to the United States Supreme Court from the 11th
Circuit decision, which was denied by the United States Supreme Court. On January 23, 2002, the Company received notice from Barr Laboratories,
Inc. (Barr) that it had filed with the FDA an Abbreviated New Drug
Application (ANDA) that, if approved, would allow Barr to market a generic
version of the Companys 1000 mg Niaspanproduct. As a result, on March 4,
2002, the Company filed a patent infringement lawsuit against Barr in the
Southern District of New York (SDNY). On March 11, 2002, the Company filed an
amended complaint (the Amended Complaint). In this lawsuit, the Company
asserted that Barr has infringed Kos 6,080,428 and 6,129,930 patents. On March
25, 2002, Barr answered the Amended Complaint (the Answer) by denying that
the 428 and 930 patents are valid and infringed, and seeking a declaratory
judgment to that effect. On August 19, 2002, Barr amended its Answer to add
counterclaims requesting a declaratory judgment that two other patents owned by
Kos, U.S. Patent Number 5,126,145 and 5,268,181, are not infringed, and that
the 181 patent is invalid. On July 9, 2002, the Company received notice from Barr that it had filed
an ANDA with the FDA that would, if approved, allow Barr to market generic
versions of the Companys 500 mg and 750 mg Niaspanproducts. On August 13,
2002, the Company filed a second patent infringement lawsuit against Barr also
in the SDNY. Again, the Company asserted that Barr has infringed the 428 and
930 patents. On September 3, 2002, Barr answered the complaint by denying
infringement and alleging that the patents are invalid. Barr also sought a
declaratory judgment that the 428, 930, 145, and 181 patents are not
infringed, and that the 428, 930, and 181 patents are invalid. The two cases
were consolidated on September 23, 2002. On September 30, 2002, the Company received notice from Barr that it had
filed a Supplemental Paragraph IV Certification relating to Kos 6,406,715
patent. The Company filed a third lawsuit on
November 12, 2002, against Barr in the SDNY asserting infringement of this
patent. On December 3, 72




---



##### Table of Contents



2002, Barr answered the complaint by denying that the
715 patent is valid and infringed, and seeking a declaratory judgment of
invalidity. Barr also sought a declaratory judgment that the 428, 930, 145,
and 181 patents are not infringed, and that the 428, 930 and 181 patents
are invalid. The third case was consolidated with the first two on January 23, 2003. On
March 4, 2003, Kos replied to Barrs declaratory judgment counterclaims by
denying that Kos patents are invalid or not infringed. Kos also sought a
declaratory judgment that one or more of Barrs products will infringe the 145
and 181 patents. During the course of the litigation, Barr has also suggested
claims of anti trust and unenforceability. Kos has received several notices
from Barr Laboratories that Barr has filed a Supplemental Paragraph IV
Certification to each ANDA to provide for U.S. Patent No. 6,676,967. The first
notice was received by Kos on January 21, 2004 and the latest on February 23,
2004. Kos is currently evaluating its options. On August 6, 2003, the Company filed a trademark infringement lawsuit
against Andrx Corporation and Andrx Laboratories, Inc. (Andrx) in the U.S.
District Court for the District of New Jersey based on Andrxs use of the mark
Altocor for its cholesterol product. In conjunction with its complaint, the
Company also filed a Motion for Preliminary Injunction the same day. Andrx
filed an Opposition to the Motion for Preliminary Injunction on August 28,
2003. Andrx answered the Companys Complaint on September 2, 2003. The Company
filed its Reply in support of its Motion for Preliminary Injunction on
September 8, 2003. Oral argument on the Motion for Preliminary Injunction was
held on September 17, 2003. An Order denying the Motion for Preliminary
Injunction was entered September 23, 2003. The Company filed a Notice of Appeal
to the Order denying the Preliminary Injunction on September 30, 2003, and a
Motion for Expedited Consideration of the Appeal on October 3, 2003, in the
Third Circuit. Andrx filed a Motion in Opposition of Expedited Consideration on
October 10, 2003, and the Company replied October 15, 2003. The Companys
Motion for Expedited Review of the Appeal was granted on October 31, 2003. On
November 24, 2003, the Company filed its Third Circuit Appellate Brief, Andrx
filed a Brief in Opposition on December 5, 2003 and the Company filed its Reply
Brief on December 15, 2003. From time to time, the Company is a party to other legal proceedings in
the course of its business. The Company, however, does not expect such other
legal proceedings to have a material adverse effect on its business or
financial condition. 14. Subsequent Event On March 8, 2004, the Company announced that it had entered into a product
acquisition agreement with Aventis Pharmaceuticals Holdings Inc. and a supply
agreement with Aventis Pharmaceuticals, Inc. (collectively Aventis) to
acquire global rights to the Azmacort(triamcinolone acetonide) inhalation
aerosol franchise (collectively the Aventis Agreement). Azmacortis an
inhaled corticosteroid that alleviates inflammation in the lungs and is used as
prophylactic therapy for the maintenance treatment of asthma. Under the terms
of the Aventis Agreement, Kos will pay Aventis $200 million in cash and has
agreed to pay a royalty on future sales of another version of the product to be
developed. Under the terms of the supply agreement, Aventis has agreed to
supply finished product to Kos for a period of five years. The Company expects
to close this transaction by the end of the first quarter 2004, pending the
completion of the Federal Trade Commissions Hart-Scott-Rodino review and
approval process. 73




---



##### Table of Contents



REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS To the Shareholders of Kos
Pharmaceuticals, Inc. We have audited the consolidated financial statements of Kos
Pharmaceuticals, Inc. and subsidiaries as of December 31, 2003 and 2002 and for each of the
years then ended, and have issued our report thereon dated
February 10, 2004, except for Note 14, as to which the date
is March 8, 2004
(included elsewhere in this Form 10-K). Our audits also included the financial
statement schedule listed in Item 15(a) of this Form 10-K for the years ended
December 31, 2003 and 2002. This schedule is the responsibility of the
Companys management. Our responsibility is to express an opinion based on our
audits. In our opinion, the financial statement schedule referred to above,
when considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein. /s/ Ernst & Young LLP Miami, Florida,
February 10, 2004 74




---



##### Table of Contents



The following audit report of Arthur Andersen LLP is a copy of the
original report dated February 7, 2002 included in our Annual Report on Form
10-K for the year ended December 31, 2001, and has not been reissued by Arthur
Andersen LLP. We are including this copy of the Arthur Andersen LLP audit
report pursuant to Rule 2-02(e) of Regulation S-X under the Securities Act of
1933. REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS ON SCHEDULE II To the Shareholders of Kos Pharmaceuticals, Inc.: We have audited in accordance with auditing standards generally accepted
in the United States, the financial statements included in this Form 10-K, and
have issued our report thereon dated February 7, 2002. Our audits were made for
the purpose of forming an opinion on the basic financial statements taken as a
whole. The accompanying Schedule II is the responsibility of the Companys
management and is presented for purposes of complying with the Securities and
Exchange Commissions rules and is not part of the basic financial statements.
This schedule has been subjected to the auditing procedures applied in the
audits of the basic financial statements and, in our opinion, fairly states, in
all material respects, the financial data required to be set forth therein in
relation to the basic financial statements taken as a whole. ARTHUR ANDERSEN LLP Miami, Florida,
February 7, 2002. 75




---



##### Table of Contents



KOS PHARMACEUTICALS, INC. AND SUBSIDIARIES SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
(in thousands) Balance atBalance at
    
    Charged to Costs
    
    
    
    
    
    EndDescription
    
    Beginning of Period
    
    and Expenses
    
    Deductions
    
    of PeriodAllowance for Doubtful Accounts:Fiscal year ended December 31, 2001
    
    $
    200
    
    
    $
    75
    
    
    $
    81
    
    
    $
    194Fiscal year ended December 31, 2002
    
    
    194
    
    
    
    150
    
    
    
    38
    
    
    
    306Fiscal year ended December 31, 2003
    
    
    306
    
    
    
    217
    
    
    
    
    
    
    
    523
 
 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES. On March 6, 2002, the Audit Committee of the Board of Directors decided to
no longer engage Arthur Andersen LLP as the Companys independent certified
public accountants. The Company previously disclosed this change in its
Certifying Accountant in filings on Form 8-K and in the Companys definitive
proxy statement, which filings occurred on March 12 and March 19, 2002,
respectively. On April 25, 2002, the appointment of Ernst & Young LLP as the
Companys independent certified public accountants for the fiscal year ending
December 31, 2002, was ratified by the shareholders of the Company. 
 ITEM 9A. CONTROLS AND PROCEDURES. The Companys management, under the supervision and with the participation
of the Companys Chief Executive Officer (CEO) and Chief Financial Officer
(CFO), has evaluated the effectiveness of the Companys disclosure controls
and procedures as defined in Securities and Exchange Commission (SEC) Rule
13a-15(e) as of the end of the period covered by this report. Management has
concluded that the Companys disclosure controls and procedures are effective
to ensure that information the Company is required to disclose in reports that
it files or submits under the Securities Exchange Act is communicated to
management, including the CEO and CFO, as appropriate, to allow timely
decisions regarding required disclosure and is recorded, processed, summarized,
and reported within the time periods specified in the SECs rules and forms. 76




---



##### Table of Contents



PART III The information required in Item 10 (Directors and Executive Officers of
the Registrant), Item 11 (Executive Compensation), Item 12 (Security Ownership
of Certain Beneficial Owners and Managers and Equity Compensation Plan
Information), Item 13 (Certain Relationships and Related Transactions), and
Item 14 (Principal Accountant Fees and Services) is incorporated by reference
to the Companys definitive proxy statement for the 2004 Annual Meeting of
Shareholders to be filed with the Securities and Exchange Commission. 77




---



##### Table of Contents



PART IV




ITEM 15. EXHIBITS, FINANCIAL SCHEDULES AND REPORTS ON FORM 8-K.




|    |  |          |  |                                                                                                                                                      
|--- |  | -------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------
|(a) |  | 1.       |  | The Financial Statements filed as part of this report are
listed separately in the index to Financial Statements beginning on
page 47 of this report.
|    |  |          |  |                                                                                                                                                      
|    |  | 2.       |  | The following Financial Statement Schedules are
filed herewith:                                                                                      
|    |  |          |  |                                                                                                                                                      
|    |  | Schedule |  | Description                                                                                                                                          
|    |  |          |  |                                                                                                                                                      
|    |  | II       |  | Valuation and Qualifying Accounts for the Year
Ended December 31, 2003                                                                               
|    |  |          |  |                                                                                                                                                      
|    |  | 3.       |  | The following exhibits are filed herewith:                                                                                                           

|         |  |                                                                                                                                                                                                                                                                                                                             
|-------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit  |  |                                                                                                                                                                                                                                                                                                                             
|Number   |  | Exhibit Description                                                                                                                                                                                                                                                                                                         
|         |  |                                                                                                                                                                                                                                                                                                                             
|1.1(1)   |  | Underwriting Agreement dated November 19,
2003, among the Company, the Selling Shareholders named
therein, and Goldman, Sachs and Co., Banc of America
Securities LLC, SG Cowen Securities Corporation, Deutsche Bank
Securities, Inc., SunTrust Capital Markets, Inc., Natexis
Bleichroeder Inc. and Ryan, Beck & Co., Inc.
|         |  |                                                                                                                                                                                                                                                                                                                             
|3.1(2)   |  | Amended and Restated Articles of
Incorporation of the Company                                                                                                                                                                                                                                                               
|         |  |                                                                                                                                                                                                                                                                                                                             
|3.2(2)   |  | Amended and Restated Bylaws of the
Company                                                                                                                                                                                                                                                                                  
|         |  |                                                                                                                                                                                                                                                                                                                             
|4.1      |  | See Exhibits 3.1 and 3.2 for provisions of the
Amended and Restated Articles of Incorporation and Amended and
Restated Bylaws of the Company defining the rights of holders
of Common Stock of the Company                                                                                                                  
|         |  |                                                                                                                                                                                                                                                                                                                             
|4.2(3)   |  | Form of Common Stock certificate of the
Company                                                                                                                                                                                                                                                                             
|         |  |                                                                                                                                                                                                                                                                                                                             
|10.1(2)* |  | Nonqualified Stock Option Agreement by
and between the Company and Daniel M. Bell dated as of June
20, 1996.                                                                                                                                                                                                                
|         |  |                                                                                                                                                                                                                                                                                                                             
|10.2(2)* |  | Employment Agreement dated as of June
15, 1996, between David J. Bova and the Company                                                                                                                                                                                                                                       
|         |  |                                                                                                                                                                                                                                                                                                                             
|10.3(2)* |  | Kos Pharmaceuticals, Inc. 1996 Stock
Option Plan                                                                                                                                                                                                                                                                            
|         |  |                                                                                                                                                                                                                                                                                                                             
|10.4(4)* |  | Kos Pharmaceuticals, Inc. 1999 Employee
Stock Purchase Plan.                                                                                                                                                                                                                                                                
|         |  |                                                                                                                                                                                                                                                                                                                             
|10.15(5) |  | Revolving Credit and Loan Agreement
dated December 21, 1999, between the Company and Michael
Jaharis.                                                                                                                                                                                                                       
|         |  |                                                                                                                                                                                                                                                                                                                             
|10.16(6) |  | Third Amended and Restated Registration
Rights Agreement effective as of December 19, 2002, by and
between the Company, Kos Holdings, Inc., Kos Investments,
Inc., and Michael Jaharis.                                                                                                                                     
|         |  |                                                                                                                                                                                                                                                                                                                             
|10.17(5) |  | Promissory Note dated December 21,
1999, in favor of Michael Jaharis.                                                                                                                                                                                                                                                       

78



---



##### Table of Contents



|           |  |                                                                                                                                      
|---------- |  | -------------------------------------------------------------------------------------------------------------------------------------
|Exhibit    |  |                                                                                                                                      
|Number     |  | Exhibit Description                                                                                                                  
|           |  |                                                                                                                                      
|           |  |                                                                                                                                      
|10.18(5)   |  | Non-Detachable Common Stock Purchase
Warrant.                                                                                        
|           |  |                                                                                                                                      
|10.19(6)   |  | Revolving Credit and Loan Agreement
dated as of December 19, 2002, between Kos Pharmaceuticals and
Michael Jaharis.                  
|           |  |                                                                                                                                      
|10.20(6)   |  | Revolving Credit Promissory Note dated
December 19, 2002 in favor of Michael Jaharis.                                                
|           |  |                                                                                                                                      
|10.21(6)   |  | Non-Detachable Common Stock Purchase
Warrant dated December 19, 2002.                                                                
|           |  |                                                                                                                                      
|10.22(6)   |  | Second Amended and Restated Security
Agreement dated December 19, 2002, by and between the Company
and Michael Jaharis.              
|           |  |                                                                                                                                      
|10.24(7)   |  | Stock Purchase Agreement dated May 3,
2000, between the Company and DuPont Pharmaceuticals Company.                                  
|           |  |                                                                                                                                      
|10.25(8)*  |  | Employment Agreement dated April 26,
2001, between the Company and Adrian Adams.                                                     
|           |  |                                                                                                                                      
|10.26(9)*  |  | Management Agreement dated December
13, 2001, between the Company and Daniel M. Bell.                                                
|           |  |                                                                                                                                      
|10.27(9)+  |  | Master Services Agreement effective
December 17, 2001, between the Company, Innovex LP and
PharmaBio Development, Inc.               
|           |  |                                                                                                                                      
|10.28(9)+  |  | Investment and Royalty Agreement
effective December 17, 2001, between the Company, Innovex LP
and PharmaBio Development, Inc.        
|           |  |                                                                                                                                      
|10.29(9)   |  | Warrant Agreement dated January 1,
2002, between the Company and PharmaBio Development, Inc.                                         
|           |  |                                                                                                                                      
|10.30(10)+ |  | Distribution, Patent & Trademark
License, Marketing and Supply Agreement, dated October 23,
2002, between the Company and Merck KGaA.
|           |  |                                                                                                                                      
|10.31(11)+ |  | Co-Promotion Agreement dated as of
October 29, 2003 between the Company and Takeda
Pharmaceuticals North America, Inc.               
|           |  |                                                                                                                                      
|21         |  | Subsidiaries of the Company.                                                                                                         
|           |  |                                                                                                                                      
|23.1       |  | Consent of independent certified public
accountants, Ernst & Young LLP.                                                              
|           |  |                                                                                                                                      
|23.2       |  | Notice Regarding Consent of Arthur Andersen LLP.                                                                                     
|           |  |                                                                                                                                      
|24         |  | Powers of Attorney (included on signature page
hereto).                                                                              
|           |  |                                                                                                                                      
|31.1       |  | Certification by Adrian Adams, President and
Chief Executive Officer, pursuant to Exchange Act Rules 13a-14
and 15d-14.              
|           |  |                                                                                                                                      
|31.2       |  | Certification by Christopher P. Kiritsy, Chief
Financial Officer, pursuant to Exchange Act Rules 13a-14 and
15d-14.                  
|           |  |                                                                                                                                      

79



---



##### Table of Contents



|        |  |                                                                                                                                                                                
|------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |  |                                                                                                                                                                                
|Number  |  | Exhibit Description                                                                                                                                                            
|        |  |                                                                                                                                                                                
|        |  |                                                                                                                                                                                
|32.1    |  | Certification by Adrian Adams, President and
Chief Executive Officer, pursuant to 18 U.S.C. Section 1350,
as adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002.
|        |  |                                                                                                                                                                                
|32.2    |  | Certification by Christopher P. Kiritsy, Chief
Financial Officer, pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.    

|     |  |                                                                                                                                                                                                              
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    
|(1)  |  | Filed with the Companys Current Report on
Form 8-K filed with the Securities and Exchange Commission on
November 20, 2003, and incorporated herein by reference.                                            
|     |  |                                                                                                                                                                                                              
|(2)  |  | Filed with the Companys Registration
Statement on Form S-1 (File No. 333-17991), as amended, filed
with the Securities and Exchange Commission on December 17,
1996, and incorporated herein by reference.  
|     |  |                                                                                                                                                                                                              
|(3)  |  | Filed with the Companys Registration
Statement on Form 8-A filed with the Securities and Exchange
Commission on February 25, 1997, and incorporated herein by
reference.                                    
|     |  |                                                                                                                                                                                                              
|(4)  |  | Filed with the Companys Registration
Statement on Form S-8 (File No. 333-70317), filed with the
Securities and Exchange Commission on January 8, 1999, and
incorporated herein by reference.                
|    
|(5)  |  | Filed with the Companys Annual Report on
Form 10-K filed with the Securities and Exchange Commission
for the Companys year ended December 31, 1999, and
incorporated herein by reference.                  
|     |  |                                                                                                                                                                                                              
|(6)  |  | Filed with the Companys Annual Report on
Form 10-K filed with the Securities and Exchange Commission
for the Companys year ended December 31, 2002, and
incorporated herein by reference.                  
|    
|(7)  |  | Filed with the Companys Quarterly Report on
Form 10-Q filed with the Securities and Exchange Commission
for the Companys three-month period ended June 30, 2000, and
incorporated herein by reference.     
|     |  |                                                                                                                                                                                                              
|(8)  |  | Filed with the Companys Quarterly Report on
Form 10-Q filed with the Securities and Exchange Commission
for the Companys three-month period ended September 30, 2001,
and incorporated herein by reference.
|     |  |                                                                                                                                                                                                              
|(9)  |  | Filed with the Companys Annual Report on
Form 10-K filed with the Securities and Exchange Commission
for the Companys year ended December 31, 2001, and
incorporated herein by reference.                  
|     |  |                                                                                                                                                                                                              
|(10) |  | Filed with the Companys Current Report on
Form 8-K filed with the Securities and Exchange Commission on
November 4, 2002, and incorporated herein by reference.                                             
|     |  |                                                                                                                                                                                                              
|(11) |  | Filed with the Companys Current Report on
Form 8-K filed with the Securities and Exchange Commission on
November 3, 2003, and incorporated herein by reference.                                             

80



---



##### Table of Contents



|  |  |                                                                                                                                                                                                          
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|+ |  | Certain confidential material contained in the
document has been omitted and filed separately with the
Securities and Exchange Commission pursuant to Rule 406 of the
Securities Act of 1933, as amended.
|* |  | Denotes management contract or compensatory plan
or arrangement.                                                                                                                                         



|(b) |  | On October 28, 2003, the Company filed a Report on Form 8-K,
reporting in Item 12 therein the issuance of a press release by the
Company on October 28, 2003.                                                                                                                                                                         
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|   
|    |  | On November 4, 2003, the Company filed a Report on Form 8-K
reporting in Item 12 therein the issuance of a press release by the
Company and a joint press release by the Company and Takeda
Pharmaceuticals North America, Inc., each on November 4, 2003.                                                                            
|   
|    |  | On November 5, 2003, the Company filed a Report on Form 8-K
submitting a copy of the Co-Promotion Agreement dated as of October
29, 2003 between Kos Pharmaceuticals, Inc. and Takeda
Pharmaceuticals North America, Inc.                                                                                                             
|   
|    |  | On November 20, 2003, the Company filed a Report on Form 8-K
submitting a copy of an Underwriting Agreement entered into among
the Company, certain selling shareholders, and the underwriters
named therein on November 19, 2003 and reporting in Item 5 therein
the issuance of a press release by the Company on November 20,
2003.

81



---



##### Table of Contents






SIGNATURES

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

| |  |                           |  |                                      
| |  | ------------------------- |  | -------------------------------------
| |  | KOS PHARMACEUTICALS, INC.
| |  |                           |  |                                      
| |  | By:                       |  | /s/ Adrian Adams                     
| |  |                           |  |                                      
| |  |                           |  | Adrian Adams                         
| |  |                           |  | President and Chief Executive Officer

POWER OF ATTORNEY

KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Adrian Adams and Juan F. Rodriguez and each of
them, his true and lawful attorney-in-fact and agents, with full power of
substitution and resubstitution for him and in his name, place and stead, in
any and all capacities, to sign any and all amendments to this Report on Form
10-K, and to file the same, with all exhibits thereto, and other documents in
connection therewith, with the Securities and Exchange Commission, granting
unto said attorneys-in-fact and agents full power and authority to do and
perform each and every act and thing requisite and necessary to be done in and
about the premises, as fully to all intents and purposes as he might or could
do in person, hereby ratifying and confirming all that each of said
attorneys-in-fact or his substitute or substitutes, any lawfully do or cause to
be done by virtue hereof.

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.

|                                                     |  |                                                                                 |  |               
|---------------------------------------------------- |  | ------------------------------------------------------------------------------- |  | --------------
|Signature                                            |  | Title                                                                           |  | Date          
|                                                     |  |                                                                                 |  |               
|/s/ Michael Jaharis

Michael Jaharis                 |  | Chairman Emeritus of the Board
of Directors                                     |  | March 15, 2004
|                                                     |  |                                                                                 |  |               
|/s/ Daniel M. Bell

Daniel M. Bell                   |  | Chairman of the Board
of Directors                                              |  | March 15, 2004
|                                                     |  |                                                                                 |  |               
|/s/ Robert E. Baldini

Robert E. Baldini             |  | Vice Chairman of the Board                                                      |  | March 15, 2004
|                                                     |  |                                                                                 |  |               
|/s/ Adrian Adams

Adrian Adams                       |  | President, Chief Executive
Officer, and Director
(Principal Executive Officer)  |  | March 15, 2004
|                                                     |  |                                                                                 |  |               
|/s/ Christopher P. Kiritsy

Christopher P. Kiritsy   |  | Executive Vice President, Chief
Financial Officer
(Principal Financial Officer) |  | March 15, 2004
|                                                     |  |                                                                                 |  |               
|/s/ Juan F. Rodriguez

Juan F. Rodriguez             |  | Senior Vice President, Controller
(Principal Accounting Officer)                |  | March 15, 2004
|                                                     |  |                                                                                 |  |               
|/s/ John Brademas

John Brademas                     |  | Director                                                                        |  | March 15, 2004
|                                                     |  |                                                                                 |  |               
|/s/ Steven Jaharis

Steven Jaharis                   |  | Director                                                                        |  | March 15, 2004
|                                                     |  |                                                                                 |  |               
|/s/ Nicolaos E. Madias

Nicolaos E. Madias           |  | Director                                                                        |  | March 15, 2004
|                                                     |  |                                                                                 |  |               
|/s/ Mark Novitch

Mark Novitch                       |  | Director                                                                        |  | March 15, 2004
|                                                     |  |                                                                                 |  |               
|/s/ Frederick B. Whittemore

Frederick B. Whittemore |  | Director                                                                        |  | March 15, 2004

82



---



##### Table of Contents






EXHIBIT INDEX

|               |  |                                                                                                                                                                                
|-------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit
Number |  | Description                                                                                                                                                                    
|               |  |                                                                                                                                                                                
|21             |  | Subsidiaries of the Company.                                                                                                                                                   
|               |  |                                                                                                                                                                                
|23.1           |  | Consent of independent certified public accountants, Ernst & Young LLP.                                                                                                        
|               |  |                                                                                                                                                                                
|23.2           |  | Notice Regarding Consent of Arthur Andersen LLP                                                                                                                                
|               |  |                                                                                                                                                                                
|31.1           |  | Certification by Adrian Adams, President and Chief Executive Officer,
pursuant to Exchange Act Rules 13a-14 and 15d-14.                                                        
|               |  |                                                                                                                                                                                
|31.2           |  | Certification by Christopher P. Kiritsy, Chief Financial Officer,
pursuant to Exchange Act Rules 13a-14 and 15d-14.                                                            
|               |  |                                                                                                                                                                                
|32.1           |  | Certification by Adrian Adams, President and Chief Executive Officer,
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
|               |  |                                                                                                                                                                                
|32.2           |  | Certification by Christopher P. Kiritsy, Chief Financial Officer,
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.    

83