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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549
  FORM 10-K
 þ
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the fiscal year ended December 31, 2004 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.)
 1 Cedar Brook Drive, Cranbury, New Jersey 08512-3618
(Address of Principal Executive Offices, Zip Code) Registrants Telephone Number, Including Area Code: (609) 495-0500 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 o No þ 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. o Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule
12b-2 of the Act). Yes þ 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 June 30, 2004:
$647,061,222. Number of shares of Common Stock of Kos Pharmaceuticals, Inc. issued and outstanding as of
March 2, 2005: 40,272,783. Documents Incorporated by Reference Definitive Proxy Statement for the Companys 2005 Annual Meeting of Shareholders
(incorporated in Part III to the extent provided in Items 10, 11, 12, 13 and 14 hereof).




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TABLE OF CONTENTS PagePART IItem 1.
    
    Business
    
    1Item 2.
    
    Properties
    
    18Item 3.
    
    Legal Proceedings
    
    18Item 4.
    
    Submission of Matters to a Vote of Securities Holders
    
    20PART IIItem 5.
    
    Market for the Companys Common Stock and Related ShareholderMatters
    
    21Item 6.
    
    Selected Consolidated Financial Data
    
    22Item 7.
    
    Managements Discussion and Analysis of Financial Condition andResults of Operations
    
    23Forward-Looking Information: Certain Cautionary Statements
    
    38Item 7A.
    
    Quantitative and Qualitative Disclosures about Market Risk
    
    57Item 8.
    
    Consolidated Financial Statements and Supplementary Data
    
    57Item 9.
    
    Changes in and Disagreements with Accountants on Accounting andFinancial Disclosures
    
    94Item 9A.
    
    Controls and Procedures
    
    94PART III
    
    
    
    96PART IVItem 15.
    
    Exhibits and Financial Schedules
    
    97Signatures
    
    
    
    101Amended and Restated BylawsEmployment Agreement - Adrian AdamsSummary Term Sheet of Board CompensationSubsidiariesConsent of Ernst & Young LLPSection 302 Certification of CEOSection 302 Certification of CFOSection 906 Certification of CEOSection 906 Certification of CFOSummary Sheet of 2005 Named Executive Officer Compensation




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PART I 
 ITEM 1. BUSINESS. As used in this Form 10-K, Kos Pharmaceuticals, Kos, we, us, our, or the Company
refer to Kos Pharmaceuticals, Inc. and all of its subsidiaries taken as whole. Kos is a fully-integrated specialty pharmaceutical company engaged in the development and
commercialization of proprietary prescription products for the treatment of chronic cardiovascular,
metabolic and respiratory diseases. Kos manufactures its lead products, Niaspan® and Advicor®,and
currently markets them directly through its own sales force and co-promotion partner in the U.S.
and through its commercialization partner and license arrangements outside of the U.S., Canada and
Japan. On March 8, 2004, the Company announced that it had entered into a product acquisition
agreement with Aventis Pharmaceuticals Holdings Inc. (the Azmacort Acquisition Agreement) and a
finished product supply agreement (the Azmacort Supply Agreement and together with the Azmacort
Acquisition Agreement, the Aventis Agreements) with Aventis Pharmaceuticals Inc. (collectively
with Aventis Pharmaceuticals Holdings Inc., Aventis) to acquire global rights to the Azmacort®
(triamcinolone acetonide) inhalation aerosol franchise. The transaction was completed on March 31,
2004. Accordingly, Kos began recording revenue for all sales related to the Azmacortproduct
beginning April 1, 2004. The Companys cardiovascular and metabolic products under development
consist of controlled-release, oral solid 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 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 its core strategy of 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 or supplemental new drug application filings with the U.S. Food and Drug Administration
(the FDA). Although 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-month exclusivity protection from generic competition. Recent Developments As discussed above, during 2004 the Company entered into the Aventis Agreements for the
acquisition of rights to the Azmacortproduct. 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 Agreements, Kos paid Aventis $206.1 million in
cash and has agreed to pay a royalty on future sales of another version of the product if developed
in the future. Under the terms of the Azmacort Supply Agreement, Aventis agreed to supply finished
product to Kos for a period of five years. On February 7, 2005, Kos announced that it had made an initial $4 million equity investment in
Triad Pharmaceuticals, Inc. (Triad), a privately held drug discovery and design pharmaceutical
company focused on developing molecules for a variety of diseases, including orally active
therapies for cardiovascular disorders, diabetes and cancer. The investment in Triad is expected to
total $8 million. 1




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This equity investment builds on Kos existing sponsored research arrangement with Triad, in
which Triad is designing and synthesizing certain new chemical entities to potentially regulate HDL
(the good) cholesterol. This new alliance with Triad is expected to broaden Kos research and
development efforts to include the discovery and synthesis of new chemical entities in a
cost-effective way, thus leveraging Kos existing competency in drug delivery and development. The equity investment in Triad consists of two $4 million tranches, with the second $4 million
investment in Triad to be made by August 1, 2006, if Triad achieves specified milestones relating
to its research and development activities. Upon completion of the additional $4 million
investment, Kos would have an approximately 27% fully diluted ownership interest in Triad.
Additionally, the principal stockholder of Triad, which is a limited partnership formed by the wife
of Michael Jaharis (the Triad Limited Partnership), the principal stockholder and Chairman
Emeritus of Kos, is investing an additional $8 million on similar terms and conditions as the Kos
investment as part of a $16 million round of financing for Triad. The Triad Limited Partnership
owns, or has the right to vote, approximately 48% of the outstanding common stock of Triad on a
fully diluted basis. As part of the investment, Kos is entitled to designate three persons, and the
Triad Limited Partnership is entitled to designate seven persons, to Triads 13-member Board of
Directors. Adrian Adams, the President and Chief Executive Officer of the Company, has been
appointed by the Company to the Triad Board of Directors and has been elected by the directors of
Triad as Chairman. The Company will appoint two additional persons to the Triad Board at a later
date. Michael Jaharis, Steven Jaharis and Kevin T. Ferro, directors of Kos, have been appointed by
the Triad Limited Partnership to the Triad Board of Directors. In connection with the closing of
the investment in Triad, Christopher P. Kiritsy, Kos Executive Vice President, Corporate
Development and CFO, has accepted the position of President and Chief Executive Officer of Triad
and has notified the Company that he will be resigning as Executive Vice President, Corporate
Development and CFO of Kos after his successor at the Company is found, which is expected to occur
during the second quarter of 2005. Triad conducts its research principally in the area of boronic acid inhibitors and the
development of ultra smart pro-drugs. Triad principally utilizes two platform technologies to
develop highly potent and selective, orally active agents and has applied its specificity profiling
and ultra-smart technology platforms in developing novel and highly selective inhibitors to a
variety of enzymes, including DPP IV for the treatment of type 2 diabetes and candidate compounds
designed to raise HDL cholesterol. 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 or where greater utilization of a product could
be attained through increasing awareness of the products features and benefits;(ii)
    focus on the large, rapidly growing cardiovascular, respiratory and metabolic
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 its sales forces, which Kos may supplement
with a contract sales organization or other partners and through co-promotion and other
strategic 2




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alliances to extend the marketing reach of the Company to a broader group of doctors and patients; and(vii)
    leverage its core competencies through corporate, product 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 in the
U.S. 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. In November 2003, the
Companys European marketing and distribution partner, Merck KGaA (Merck), launched the sale of
Niaspanin the United Kingdom. Following this initial launch and the December 2003, completion of
the European Unions Mutual Recognition Procedure (MRP), Niaspanhas since been approved in a
total of 13 European markets, including such other markets as France, Germany, Austria, Ireland,
Belgium and the Netherlands. Merck and Kos have also initiated a second wave of the MRP for the
additional 10 European countries that were recently added to the list of European Union countries.
Niaspanhas also been approved in other countries outside the European Union, including Lebanon and
certain Latin American countries. 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, 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 last few 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 3




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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.
Another 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 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 Niaspanon 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
Niaspanfor the treatment of dyslipidemia in patients with type 2 diabetes. Although the FDA
acknowledges that Niaspancan 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 Niaspanwas 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. In late 2004, the results of a double-blinded, placebo-controlled clinical study referred to
as ARBITER 2, conducted by the Walter Reed Army Medical Center, showed that the combination of
Niaspanand a statin slows atherosclerosis progression 68% more than statin monotherapy as measured
by plaque build-up in the carotid artery. Additionally, the combination of Niaspanand statin
therapy demonstrated a 60% reduction of coronary events compared with a statin alone, suggesting a
favorable trend in this important clinical outcome measure. Plaque, the hard substance that forms
on arterial walls and increases heart disease risk, continued to progress in patients treated only
with statin therapy over the course of a year. Researchers attributed the reduction in event rate
and slowing of atherosclerosis in the Niaspan/statin group to the significant changes in HDL
cholesterol and triglyceride levels experienced by those patients. ARBITER 2 is the first study to
demonstrate the incremental, independent effect of adding an HDL-raising therapy to a statin in
slowing the progression of atherosclerosis compared with a statin alone. During 2004, Kos also 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, and from the update to these guidelines published
in the 4




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July 2004 edition of Circulation. 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 whom only 13 million patients are currently taking such
medications), an almost three-fold increase since the previous guidelines were first published in
1993. In addition to these guidelines, in February 2004, the American Heart Association issued new
guidelines regarding the prevention and treatment of cardiovascular disease in women. These
February 2004, guidelines encourage women to maintain an HDL cholesterol level above 50mg/dL,
increasing the number of women at risk from low HDL cholesterol by a factor of about 3, to
approximately 28 million women in the U.S. The Company currently markets Niaspanin the United States directly to physicians who
specialize in treating patients with coronary heart disease and/or 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 Niaspantherapy. 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 coronary event. During 2004, about 69% of the approximately 22,000
cardiologists present in the U.S. cardiovascular market prescribed Niaspanand in the last three
years more than 180,000 physicians have prescribed Niaspanat least once. In addition to a larger field sales force, including the sales force provided under Kos
co-promotion agreement with Takeda Pharmaceuticals North America, Inc. (Takeda), Kos continued to
increase its promotional commitment to Niaspanduring 2004. 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.
The 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 5




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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 approval from the FDA to market Advicortablets. The
approval of Advicormarked 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 Niaspanand 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 other lipid
parameters is superior. Specifically, patients 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
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
safety and efficacy 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. During 2004, the results of a study analyzing the impact of the Advicorproduct in patients
with metabolic syndrome (which is a group of health risk factors, such as low HDL, high blood
pressure, and elevated blood sugar, that put patients at greater risk of heart disease),
illustrated that Advicoris safe and effective for treating the cholesterol disorders commonly
associated with this disorder. This is of particular importance because about 47 million adult
Americans have metabolic syndrome. Kos believes that the results of this study expand the
treatment options available to physicians when treating patients that have metabolic syndrome and
also have cholesterol disorders. As with Niaspan, Kos markets Advicorin the United States directly to physicians who
specialize in treating patients with coronary heart disease and/or who are among the leading
prescribers of lipid-altering medications. Additionally, through its partnership with Takeda,
Takeda promotes Advicorto an 6




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additional 50,000 physicians, most of whom are primary care
physicians who treat lipid disorders. 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 Advicor
therapy. 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 Niaspan
prescribing 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 Advicor
will 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 that 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 one-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 Kos
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. Azmacort On March 31, 2004, Kos and Aventis signed the Aventis Agreements enabling Kos to acquire
global rights to the Azmacortproduct. The Azmacortproduct is an inhaled corticosteroid that
alleviates inflammation in the lungs and is used as prophylactic therapy for the maintenance
treatment of asthma. The Azmacortproduct can be used for mild-to-moderate asthma patients and is
the only drug in its class to incorporate a built-in spacer device, which improves the delivery of
the medicine to the lung. Spacers enhance the delivery of the medicine and make it easier to
coordinate the spray with breathing, while reducing local side effects. Azmacorthas more
cumulative patient days of therapy in the United States than any other inhaled corticosteroid, and
it has developed a strong patient allegiance over the last 20 years. To acquire the rights for the currently marketed chlorofluorocarbon (CFC) propellant
Azmacortproduct and the rights to an environmentally safe hydrofluoroalkane (HFA) propellant
product currently under development, Kos paid $206.1 million in cash and agreed to pay a royalty to
Aventis on future sales of its HFA triamcinolone product upon commercialization. Pursuant to the
Azmacort Supply Agreement, Aventis is responsible for the manufacture and supply of the CFC
propellant Azmacortproduct for commercial sale by Kos for at least five years following the date
of the Azmacortproducts acquisition from Aventis. 7




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The acquisition of the Azmacortproduct represents the first commercial product for Kos
respiratory franchise and an entry into the large and growing respiratory disease market, which is
one of the fastest growing pharmaceutical markets with sales exceeding $10 billion a year. This
market is attractive because of the future sales potential of Azmacortpartly resulting from the
complexity of developing and manufacturing respiratory products. The market for asthma products in
the United States was about $8 billion in 2004 and grew 14% from 2003. According to the American
Lung Association, an estimated 20 million Americans, or about 7% of the population, have been
diagnosed with different forms of asthma and close to 12 million had an asthma attack in the past
year. This disease accounts for about 15 million lost workdays for adults and incurs an estimated
annual economic cost of approximately $16 billion to our nation. Kos respiratory activities commenced in 1993 with the purchase of Aeropharm Technology, Inc.
(now Aeropharm Technology, LLC), which was subsequently complemented by Kos acquisition of IEP
Group, Inc. (now IEP Pharmaceutical Devices, LLC), a biomedical design and engineering company
focused on developing innovative, ergonomic, proprietary inhalation devices. Leveraging the
expertise of an inhalation research and development staff of 28 scientists, Kos has developed, and
is in the process of developing, innovative proprietary formulations and metered-dose inhalation
devices, including formulations specific to the newly acquired HFA propellant-based product. In addition to utilizing Kos current 425-person cardiovascular sales force to promote the
Azmacortproduct to general practitioners who prescribe Niaspan, Advicorand asthma products, the
Company also details this promotionally sensitive therapy to specialist physicians, such as
pulmonologists and allergists through an about 50-person specialty sales force. Products Under Development Although the Company has clearance from the FDA to market Niaspan, Advicorand Azmacort, 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 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. At the
end of 2004, Kos filed an investigational New Drug Application for its KS-01-017 product, which 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. Kos also expects to file supplemental New Drug
Applications during 2005 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 hopes 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
combination of the Niaspanproduct and simvastatin, the second most widely prescribed statin
worldwide for the treatment of dyslipidemia. This dual component therapy for dyslipidemia is
expected to be more potent than Advicorwith respect to lowering 8




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LDL cholesterol and is expected to reach the market after 2007. The second new drug
application is for its KS-01-017 product, which is expected to reach the market by 2010. 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. In
addition, Kos has licensed several gastric retention patents from Akina, LLC. To date, Kos has
internally developed prototype systems which have been evaluated in early proof of concept studies.
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 continues to develop 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 are
associated with HDL represent another potential approach. A preliminary evaluation in humans of an
intravenous form 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 and the Southern
California Institute for Research and Education. The Companys
early work on this area has already resulted in promising candidate drugs. Kos has a sponsored research program with Triad that gives the Company rights to certain HDL
molecules designed and developed by Triad. The sponsored research being performed by Triad, which
began during the fourth quarter of 2003, represents Kos first formal foray in the development of
new chemical entities in key areas of therapeutic interest, particularly HDL cholesterol
modulators. During 2004, Triad made considerable progress in identifying several promising chemical
compounds covering improved niacin analogs, certain enzyme inhibitors and apo A-l mimetics and
anticipates completing proof-of-principle preclinical efficacy studies by late 2006. Triad conducts
the sponsored research pursuant to its sponsored research and license agreements with Tufts
University. Michael Jaharis, the principal stockholder and Chairman Emeritus of Kos, is an
Emeritus Trustee of Tufts University. 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 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 spacer-less 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 has also developed a proprietary inhalation
electronic dose counter designed to indicate the absolute number of doses remaining in the aerosol
canister. Further, when sufficient doses no longer remain in the aerosol canister, this device
alerts the patient to obtain a refill prescription. The Company is also continuing 9




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efforts to develop a compact portable nebulizer earmarked for products requiring large dosages
to be administered into the respiratory airways. In 2002, nine patents were issued supporting
various elements of the inhalation delivery technology. In 2003, the Company had eight device
patents issued, and an additional patent was issued in 2004. Kos may use the inhalation
dose-counter on some or all of its proprietary inhalation devices. Respiratory and Advanced Inhalation Delivery Research As discussed above, the acquisition of the Azmacortproduct marked Kos first commercial entry
into the respiratory market. Kos intends to complete the development and seek regulatory approval
to market the environmentally-safe HFA propellant formulation of the Azmacortproduct, which will
complement the current CFC-propellant Azmacortproduct. Kos may also seek to enhance the current
Azmacortfranchise by complementing its spacer device with an internally developed electronic dose
counter. Leveraging its unique aerosol formulation expertise, Kos continues to formulate proteins, such
as recombinant human insulin, for delivery to the lungs using its proprietary metered-dose inhaler
device. During 2002, Kos completed phase I studies in humans demonstrating that its recombinant
insulin product is bioavailable in the lungs while exhibiting excellent dose-to-dose
reproducibility. During 2004, Kos completed a four-week, phase IIa human clinical trial evaluating
Kos inhaled insulin therapy for type 2 diabetic patients. The results of the phase IIa trial
demonstrated that Kos internally developed inhaled insulin formulation is comparable to the market
leading injectable insulin, Lantus, in controlling blood glucose levels, while also reducing blood
lipids such as LDL cholesterol and triglycerides. The successful completion of these phase I and
IIa studies support the safety and efficacy of Kos patient-friendly, excipient-free formulation.
Kos also expects to file supplemental New Drug Applications during 2005 for a new package
configuration for the Azmacortproduct. Kos excipient-free formulation coupled with Kos patented compact, hand-held Breath Actuated
Inhaler (BAI) device offers a precision lung delivery platform for insulin therapy. The Kos
formulation, which does not require refrigeration, contains no carriers or preservatives and
incorporates a crystalline, recombinant human insulin delivered by a standard, well-tested non-CFC,
environmentally friendly propellant. In clinical testing, patients and physicians were impressed
with the ease of use of the patented BAI delivery system in administering insulin therapy,
potentially improving patient compliance. Kos believes that such compelling results and attributes 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 plans 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 currently markets its branded proprietary products through its own sales forces and, for
Niaspanand Advicoronly, through a co-promotion arrangement with Takeda. A fundamental element of
Kos product selection strategy is to focus on a targeted marketing of products where a relatively
concentrated group of physicians account for a significant portion of the prescriptions for the
therapeutic indication addressed by its products. 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 physicians about the scientific basis
for the therapeutic advantages of its products. 10




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As of December 31, 2004, the Company had a sales and marketing organization consisting of
approximately 600 personnel, including about 475 sales representatives. The majority of its sales
and marketing personnel have considerable previous experience with major pharmaceutical companies
detailing products to cardiovascular, metabolic or respiratory disease-focused physicians. Kos
began actively detailing Niaspanduring September 1997, Advicorduring January 2002, and Azmacort
during August 2004. On October 23, 2002, the Company signed an exclusive international commercialization agreement
with Merck to market the Companys Niaspanand Advicorproducts outside the United States, Canada
and Japan (the Merck Agreement). Under terms of the Merck Agreement, Merck will provide Kos up
to $61.0 million in licensing, upfront, milestone and reimbursement payments. Kos, which
manufactures the product supplied to Merck, receives licensing revenue amounting to 25% of net
sales of the products in the territory, which includes the cost of goods sold, and upfront and
milestone payments upon the achievement of certain regulatory approvals and sales thresholds.
During the year ended December 31, 2004, Kos received $5.0 million from Merck related to the
attainment of certain milestones and, through December 31, 2004, has received $20.0 million in
upfront, reimbursement, and milestone payments from Merck, including $15.0 million of upfront and
reimbursement payments (of which $3.8 million is currently refundable to Merck if Kos fails to
achieve certain regulatory milestones). Merck is 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. The Companys policy with respect to the Merck Agreement is to (i) record licensing revenue as
the product sales are made by Merck; (ii) record milestone and upfront payments as licensing
revenue following milestone attainment by systematically recognizing such payments as revenue over
the then remaining agreement period, using the straight-line method; and (iii) record reimbursement
payments received from Merck by systematically recognizing such payments as an offset to operating
expenses over the then remaining agreement period, using the straight-line method. For the year ended December 31, 2004, the Company recorded $1.6 million of licensing revenue
and amortization of upfront and milestone payments received pursuant to the Merck Agreement. During
the years ended December 31, 2004 and 2003, the Company also recorded $0.3 million and $0.2
million, respectively, as an offset to research and development expenses pursuant to the Merck
Agreement. The Company expects to continue to recognize as revenue or as an offset to research and
development expenses over the remaining term of the Merck Agreement, the upfront, reimbursement and
milestones payments received from Merck. As of December 31, 2004, $18.4 million related to
upfront, reimbursement and milestone payments received from Merck are expected to be recognized as
licensing revenue or as an offset to research and development expenses in future periods. 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 Niaspan
and 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 Niaspanin Canada is expected in 2005 and Advicorby early 2006. If and
when marketing approval is obtained, Kos will share the revenues from sales of Niaspanand Advicor
in Canada with Oryx. On November 4, 2003, the Company jointly announced with Takeda an agreement to co-promote
Niaspanand Advicorin the United States. Under the agreement, Takeda will utilize its U.S.-based
sales force to promote Advicorand Niaspanin addition
to its own product, Actos. Takeda is
responsible for providing a promotional effort that will significantly increase the number of
product details performed per 11




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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 three-year
co-promotion arrangement commenced 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 some of
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,
primarily because the active ingredient and many of the formulation techniques have been 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, the Company owns 71 patents, has 27 pending patent applications, and has
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,
6,676,967, 6,746,691 and 6,818,229 to the Company with claims relating to Niaspansand Advicors
composition and method-of-use consistent with the recommended once-a-day dosing regimen. On 12




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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 Kos 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. 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 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. From January 21 through February 23, 2004, the Company received numerous notices from Barr
that it had filed a Supplemental Paragraph IV Certification to each ANDA to provide for the
6,676,967 patent. On March 26, 2004, the Company filed a patent infringement lawsuit against Barr
in the SDNY asserting 13




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infringement of this patent. On April 20, 2004 Barr answered the complaint by denying that
the 967 patent is valid and infringed and seeking a declaratory judgment of invalidity and
non-infringment. Barr also sought a declaratory judgment that the 715 patent is unenforceable; a
declaratory judgment that the 145, 181, 428, 715, and 930 patents are invalid; and a
declaratory judgment that the 145, 181, 428, and 930 patents are not infringed. The fourth
case was consolidated with the first three on May 10, 2004. From June 8, 2004 through July 19, 2004, the Company received numerous notices from Barr that
Barr had filed a Supplemental Paragraph IV Certification to each ANDA to provide for the 6,746,691
patent. On September 3, 2004, Barr filed a complaint seeking a declaratory judgment of invalidity
of the patent. On September 30, 2004, the Company answered the complaint by denying invalidity and
counterclaiming for infringement and seeking a declaratory judgment of infringement. Barr replied
on October 20, 2004, by denying infringement of any valid and enforceable claim of the patent. The
fifth case was consolidated with the first four on September 21, 2004. From November 22, 2004 through December 21, 2004, the Company received numerous notices from
Barr that Barr had filed a Supplemental Paragraph IV Certification for each ANDA to provide for the
6,818,229 patent. The Company is currently evaluating the notices. The Hatch-Waxman Act provides for an automatic stay of the FDAs authority to grant marketing
approval to Barr that would otherwise give Barr the right to market its generic niacin product.
This stay is currently set at thirty months and is scheduled to expire on March 30, 2005. Upon the
expiration of the thirty month stay, the FDA could grant final approval to Barr and Barr could
commence the distribution of its generic ER niacin products notwithstanding Kos patents unless Kos
were able to obtain an injunction prohibiting such activities by Barr. Kos believes that Barr may
be taking certain actions to prepare for the distribution of its generic ER niacin products prior
to resolution of the legal proceedings and that Barr could begin distributing such generic products
as soon as March 30, 2005, although Kos has no way of knowing whether or when Barr might begin such
distribution. On March 7, 2005, Kos sought a temporary restraining order and preliminary
injunction preventing Barr from distributing its generic ER niacin products until the resolution of
the pending litigation, however, there can be no assurance that such measures will be granted by
the court. If Kos is not able to obtain such a restraining order and injunction, Barr could
commence marketing and selling a generic alternative to Kos Niaspanproduct as soon as the FDA
gives final approval, which could occur as early as March 30, 2005. Although Kos could seek from
Barr recovery of any damages that Kos sustains in connection with any distribution activities
conducted by Barr of a product that infringes a valid and enforceable claim in Kos patents,
whether Kos is ultimately entitled to such damages would be determined by the court in connection
with ongoing legal proceedings between Kos and Barr. If Barr were to commence selling a generic
alternative to Kos Niaspanproduct prior to the resolution of the ongoing legal proceedings
between Kos and Barr, it would have a material adverse effect on Kos and its business, financial
condition and results of operations, and could result in the termination of its marketing
arrangements with Takeda and Oryx. In addition, Kos previously issued guidance regarding its
projected financial results for 2005 would no longer be accurate and Kos would have to revise such
guidance. There can be no assurance that Kos will be successful in defending its patents in the
litigation with Barr. If Kos is not successful in defending its patents, Barr and other competitors
may be able to produce, distribute and market generic versions of its Niaspanor Niaspan-based
products, which could be sold at prices lower than those charged by Kos. This would have a material
adverse effect on Kos business and financial results. 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 14




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Company also filed a Motion for Preliminary Injunction the same day. An Order denying the
Motion for Preliminary Injunction was entered September 23, 2003. On May 24, 2004 the Third Circuit
reversed the District Courts denial of the Companys Motion for Preliminary Injunction and
directed the District Court to enter a Preliminary Injunction enjoining Andrx from using the
Altocor mark. On June 10, 2004, the District Court entered a Consent Judgment permanently
enjoining Andrx from using the mark Altocor effective August 15, 2004. That same day the District
Court dismissed the trademark infringement lawsuit. In addition, Andrx made a one-time settlement
payment of $6.0 million to the Company. 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, consultants, advisors, 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. 15




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Niaspan, Advicor, Azmacortand 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. Although
both products have been approved for manufacture in the Edison facility, Kos has relatively limited
experience in manufacturing products for commercial sale in the Edison facility and may identify
inefficiencies that 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. In the event that the Company is not successful in its litigation with Barr, or if Barr
commences distribution of its generic ER niacin product prior to the resolution of such litigation,
then the Company may choose to enter into an arrangement with an authorized generic distributor
pursuant to which such distributor would distribute a generic version of Kos Niaspanproducts that
are manufactured by the Company. In such event, the Company would need to modify its manufacturing
processes to manufacture the generic version of its products instead of the branded versions. This
may result in the Company having inadequate supply of the generic version or the branded version,
or both. The Companys failure for any reason to manufacture and supply sufficient quantities of
either the branded or generic versions of its Niaspanproducts would have a material adverse impact
on the Company and its financial condition. The Company obtains the Azmacortproduct pursuant to the Azmacort Supply Agreement, which is scheduled to remain in effect until at least March 31,
2009. As such, the Company relies on Aventis to manufacture and supply adequate quantities of the
finished 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 relies solely on Aventis to supply the Company
with the Azmacortproduct, 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. On
February 15, 2005, the Company was informed by Aventis that it intends, by March 31, 2005, to close
on a transaction to sell the manufacturing plant where the Azmacortproduct is manufactured to a
third party. The third party will be obligated to fulfill the supply requirements and Kos and the
third party are currently discussing longer term and modified economic and supply arrangements. On December 29, 2003, the FDA issued the Company a warning letter related to a routine,
unannounced inspection of the Companys manufacturing facility located in Edison, New Jersey. The
letter cited four deficiencies in the Companys quality systems. The Company now has remedied
these deficiencies to the satisfaction of the FDA and has regained its FDA cGMP compliance status. 16




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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 under the terms of existing contracts with such suppliers. 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,
vitamins and therapies in the United States, Europe, and elsewhere. Kos estimates that its existing
Niaspanand Advicorprescriptions account for approximately 3.4% of the total prescriptions
currently being written in the United States for cholesterol-altering pharmaceutical compounds and
that its existing Azmacortprescriptions account for approximately 8% of the total prescriptions
currently being written in the United States for inhaled corticosteroid products. Competition for
cholesterol-lowering pharmaceutical compounds, therapies and inhaled corticosteroids is intense.
Competition among these products is based on, among other things, efficacy, safety, reliability,
availability, price, patent position, side effects, promotion and advertising. 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, marketing,
technical, and human resources than those available to the Company, including combined field sales
forces approximating 22,000 representatives currently active within the dyslipidemia and
respiratory markets, compared with the Companys approximately 475-person field sales forces and
may be better equipped to develop, manufacture, advertise and market products. Many of Kos
competitors can afford print and TV direct-to-consumer advertising (e.g., Crestor), enjoy the
advantage of greater patient awareness of competing products, such as statins, and enjoy the
cumulative benefits of prior marketing and advertising efforts that pre-date Kos promotional
efforts. The large size and rapid growth of the cholesterol and respiratory disease therapy markets
continues to encourage new product entries. Moreover, there are numerous manufacturers of niacin
preparations indicated for use as vitamin or dietary supplements or, in immediate-release form, for
treatment of hyperlipidemia, as well as there are numerous manufacturers of inhaled corticosteroids
for the treatment of asthma. 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, 2004, Kos had 1,053 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. 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. 17




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ITEM 2. PROPERTIES. The Company leased the following properties as of December 31, 2004: Lease Expiration(Including Renewal
    
    Minimum AnnualLocation
    
    Use
    
    Square Feet
    
    
    Options)
    
    RentCranbury, NJ
    
    Corporate, research and admin. offices
    
    
    71,600
    
    
    June 2014
    
    $
    2,425,000Hollywood, FL
    
    Manufacturing, research and admin. offices
    
    
    23,500
    
    
    November 2006
    
    
    331,000Weston, FL
    
    Research and admin. offices
    
    
    51,900
    
    
    October 2008
    
    
    872,000Edison, NJ
    
    Manufacturing, research, and admin. offices
    
    
    53,400
    
    
    October 2006
    
    
    563,000Raleigh, NC
    
    Device engineering offices
    
    
    6,000
    
    
    August 2009
    
    
    69,000
 The Company believes that its existing facilities 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 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. 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 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 the
Company, 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 the Companys 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, the
Company replied to Barrs declaratory judgment counterclaims by denying that the Companys patents 18




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are invalid or not infringed. The Company also sought a declaratory judgment that one or more
of Barrs products will infringe the 145 and 181 patents. On March 4, 2003, the Company replied
to Barrs declaratory judgment counterclaims by denying that the Companys patents are invalid or
not infringed. The Company also sought a declaratory judgment that one or more of Barrs products
will infringe the 145 and 181 patents. From January 21 through February 23, 2004, the Company received numerous notices from Barr
that it had filed a Supplemental Paragraph IV Certification to each ANDA to provide for the
6,676,967 patent. On March 26, 2004, the Company filed a patent infringement lawsuit against Barr
in the SDNY asserting infringement of this patent. On April 20, 2004, Barr answered the complaint
by denying that the 967 patent is valid and infringed and seeking a declaratory judgment of
invalidity and non-infringment. Barr also sought a declaratory judgment that the 715 patent is
unenforceable; a declaratory judgment that the 145, 181, 428, 715, and 930 patents are
invalid; and a declaratory judgment that the 145, 181,428, and 930 patents are not infringed.
The fourth case was consolidated with the first three on May 10, 2004. From June 8, 2004, through July 19, 2004, the Company received numerous notices from Barr that
Barr had filed a Supplemental Paragraph IV Certification to each ANDA to provide for the 6,746,691
patent. On September 3, 2004, Barr filed a complaint seeking a declaratory judgment of invalidity
of the patent. On September 30, 2004, the Company answered the complaint by denying invalidity and
counterclaiming for infringement and seeking a declaratory judgment of infringement. Barr replied
on October 20, 2004, by denying infringement of any valid and enforceable claim of the patent. The
fifth case was consolidated with the first four on September 21, 2004. From November 22, 2004, through December 21, 2004, the Company received numerous notices from
Barr that Barr had filed a Supplemental Paragraph IV Certification for each ANDA to provide for the
6,818,229 patent. The Company is currently evaluating the notices. The Hatch-Waxman Act provides for an automatic stay of the FDAs authority to grant marketing
approval to Barr that would otherwise give Barr the right to market its generic niacin product.
This stay is currently set at thirty months and is scheduled to expire on March 30, 2005. Upon the
expiration of the thirty month stay, the FDA could grant final approval to Barr and Barr could
commence the distribution of its generic ER niacin products notwithstanding Kos patents unless Kos
were able to obtain an injunction prohibiting such activities by Barr. Kos believes that Barr may
be taking certain actions to prepare for the distribution of its generic ER niacin products prior
to resolution of the legal proceedings and that Barr could begin distributing such generic products
as soon as March 30, 2005, although Kos has no way of knowing whether or when Barr might begin such
distribution. On March 7, 2005, Kos sought a temporary restraining order and preliminary
injunction preventing Barr from distributing its generic ER niacin products until the resolution of
the pending litigation, however, there can be no assurance that such measures will be granted by
the court. If Kos is not able to obtain such a restraining order and injunction, Barr could
commence marketing and selling a generic alternative to Kos Niaspanproduct as soon as the FDA
gives final approval, which could occur as early as March 30, 2005. Although Kos could seek from
Barr recovery of any damages that Kos sustains in connection with any distribution activities
conducted by Barr of a product that infringes a valid and enforceable claim in Kos patents,
whether Kos is ultimately entitled to such damages would be determined by the court in connection
with ongoing legal proceedings between Kos and Barr. If Barr were to commence selling a generic
alternative to Kos Niaspanproduct prior to the resolution of the ongoing legal proceedings
between Kos and Barr, it would have a material adverse effect on Kos and its business, financial
condition and results of operations, and could result in the termination of its marketing
arrangements with Takeda and Oryx. In addition, Kos previously issued guidance regarding its
projected financial results for 2005 would no longer be accurate and Kos would have to revise such
guidance. 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 19




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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. An Order
denying the Motion for Preliminary Injunction was entered September 23, 2003. On May 24, 2004, the
Third Circuit reversed the District Courts denial of the Companys Motion for Preliminary
Injunction and directed the District Court to enter a Preliminary Injunction enjoining Andrx from
using the Altocor mark. On June 10, 2004 the District Court entered a Consent Judgment permanently
enjoining Andrx from using the mark Altocor effective August 15, 2004. The same day the District
Court dismissed the trademark infringement lawsuit. In addition, as more fully fully described
elsewhere in this Form 10-K, Andrx made a one-time settlement payment of $6.0 million to the
Company. In addition, the Company is subject to the jurisdiction of various other federal regulatory
and enforcement departments and agencies, such as the U.S. Department of Health and Human Services,
the Federal Trade Commission and the Department of Justice. Individual states, acting through their
attorneys general, have become active as well, seeking to regulate the marketing of prescription
drugs under state consumer protection and false advertising laws. These regulatory authorities have
wide-ranging administrative powers to deal with any failure to comply with their ongoing regulatory
oversight. These powers include withdrawal of a license approval previously granted, product
recalls, seizure of products and other sanctions for non-compliance. Kos has recently learned that
the Office of the Inspector General of the U.S. Department of Health and Human Services, in
conjunction with the U.S. Department of Justice, is conducting an investigation of certain of Kos
sales practices but Kos has not been able to confirm the scope of the investigation. Kos has
engaged outside counsel to assist it in conducting its own internal investigation of its sales
practices but has not been able to reach any conclusions because of the preliminary and uncertain
nature of the information of which it is currently aware. Regulatory sanction following a failure
to comply with such ongoing regulatory oversight could have a material adverse effect on the
Companys business, financial condition and results of operations. While the Company has compliance
measures in place to maintain compliance with regulatory requirements, there can be no assurance
that employees will not deviate from the Companys policies and legal requirements in such a way
that it could have a material adverse effect on the Company. 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 SECURITY HOLDERS. No matters were submitted to a vote of the Companys security holders during the quarter ended
December 31, 2004. 20




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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, 2005, there were 449 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, 2004
    
    High
    
    
    LowFirst Quarter
    
    $
    59.41
    
    
    $
    37.06Second Quarter
    
    
    44.40
    
    
    
    29.55Third Quarter
    
    
    39.41
    
    
    
    28.00Fourth Quarter
    
    
    45.74
    
    
    
    33.45
 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
 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. 21




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##### Table of Contents



ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA. The following selected consolidated financial data of the Company for the five years ended
December 31, 2004, 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 31,2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000(in thousands, except share data)Statement of Operations:Net sales(1)
    
    $
    495,545
    
    
    $
    293,907
    
    
    $
    172,693
    
    
    $
    84,227
    
    
    $
    55,145Licensing revenue
    
    
    1,559
    
    
    
    
    
    
    
    
    
    
    
    7,220
    
    
    
    5,029Total revenue
    
    
    497,104
    
    
    
    293,907
    
    
    
    172,693
    
    
    
    91,447
    
    
    
    60,174Cost of sales
    
    
    36,926
    
    
    
    20,038
    
    
    
    15,362
    
    
    
    7,646
    
    
    
    5,932460,178
    
    
    
    273,869
    
    
    
    157,331
    
    
    
    83,801
    
    
    
    54,242Operating expenses:Research and development(2)
    
    
    111,064
    
    
    
    52,203
    
    
    
    43,981
    
    
    
    30,974
    
    
    
    26,459Selling, general and administrative
    
    
    235,718
    
    
    
    156,469
    
    
    
    130,145
    
    
    
    83,587
    
    
    
    56,831Total operating expenses(3)
    
    
    346,782
    
    
    
    208,672
    
    
    
    174,126
    
    
    
    114,561
    
    
    
    83,290Income (loss) from operations
    
    
    113,396
    
    
    
    65,197
    
    
    
    (16,795
    )
    
    
    (30,760
    )
    
    
    (29,048
    )Other expense (income):Interest income, net
    
    
    (2,388
    )
    
    
    (614
    )
    
    
    (160
    )
    
    
    (242
    )
    
    
    (323
    )Interest expense-related parties
    
    
    1,209
    
    
    
    3,316
    
    
    
    4,038
    
    
    
    6,051
    
    
    
    6,524Interest expense-other
    
    
    8
    
    
    
    4
    
    
    
    7
    
    
    
    30
    
    
    
    36Other expense (income)(3)
    
    
    (3,576
    )
    
    
    198
    
    
    
    136
    
    
    
    (38,985
    )
    
    
    (20
    )Total other expense (income)
    
    
    (4,747
    )
    
    
    2,904
    
    
    
    4,021
    
    
    
    (33,146
    )
    
    
    6,217Income (loss) before provision for
income taxes(1)
    
    
    118,143
    
    
    
    62,293
    
    
    
    (20,816
    )
    
    
    2,386
    
    
    
    (35,265
    )Provision for/(Benefit from) income taxes
    
    
    (24,176
    )
    
    
    2,879
    
    
    
    
    
    
    
    
    
    
    
    Net income (loss)
    
    $
    142,319
    
    
    $
    59,414
    
    
    $
    (20,816
    )
    
    $
    2,386
    
    
    $
    (35,265
    )Earnings (loss) per share(4)Basic
    
    $
    3.76
    
    
    $
    2.71
    
    
    $
    (1.01
    )
    
    $
    0.12
    
    
    $
    (1.84
    )Diluted
    
    
    3.13
    
    
    
    1.53
    
    
    
    (1.01
    )
    
    
    0.10
    
    
    
    (1.84
    )Weighted average Common Stock and Common
Stock equivalents used in computing
earnings (loss) per share(4)Basic
    
    
    37,897,597
    
    
    
    21,913,928
    
    
    
    20,582,205
    
    
    
    20,221,089
    
    
    
    19,202,877Diluted
    
    
    45,835,563
    
    
    
    41,033,325
    
    
    
    20,582,205
    
    
    
    22,798,632
    
    
    
    19,202,877
 December 31,2004
    
    
    2003
    
    
    2002
    
    
    2001
    
    
    2000(in thousands)Balance Sheet:Cash and marketable securities
    
    $
    258,703
    
    
    $
    259,958
    
    
    $
    19,572
    
    
    $
    45,319
    
    
    $
    6,125Working capital (deficit)
    
    
    245,103
    
    
    
    248,059
    
    
    
    (54,644
    )
    
    
    27,160
    
    
    
    (1,911
    )Total assets
    
    
    586,926
    
    
    
    335,521
    
    
    
    69,441
    
    
    
    82,941
    
    
    
    29,648Total long-term debt(5)
    
    
    209
    
    
    
    30,000
    
    
    
    34,025
    
    
    
    95,082
    
    
    
    72,000Accumulated deficit
    
    
    (91,628
    )
    
    
    (233,947
    )
    
    
    (293,361
    )
    
    
    (272,545
    )
    
    
    (274,931
    )Shareholders equity (deficit)
    
    
    435,142
    
    
    
    239,627
    
    
    
    (74,709
    )
    
    
    (58,439
    )
    
    
    (65,090
    )
   (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 2004, includes the effect of a one-time, $38 million in-process R&D write-off
associated with the acquisition of the Azmacort product.(3)
    
    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. For 2004, includes the effect of a $6 million settlement
received from Andrx, of which $2 million was recorded as reimbursement of operating expenses
and $4 million as other income.(4)
    
    See Note 2 of Notes to Consolidated Financial Statements for information concerning
the computation of earnings (loss) per share.(5)
    
    For 2004, excludes $19 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 June
30, 2005. For 2002, excludes $50 million of debt due to Michael Jaharis, as such debt matured
on December 31, 2003. 22




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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,
metabolic and respiratory diseases. Kos manufactures its lead products, Niaspan® and Advicor®, and
currently markets them directly through its own specialty sales force and co-promotion partner in
the U.S. and through its commercialization partner and license arrangements outside of the U.S.,
Canada and Japan. On March 8, 2004, the Company announced that it had entered into a product
acquisition agreement with Aventis Pharmaceuticals Holdings Inc. (the Azmacort Acquisition
Agreement) and a finished product supply agreement (the Azmacort Supply Agreement and together
with the Azmacort Acquisition Agreement, the Aventis Agreements) with Aventis Pharmaceuticals
Inc. (collectively with Aventis Pharmaceuticals Holdings Inc., Aventis) to acquire global rights
to the Azmacort® (triamcinolone acetonide) inhalation aerosol franchise. The transaction was
completed on March 31, 2004. Accordingly, Kos began recording revenue for all sales related to the
Azmacort product beginning April 1, 2004. The Companys cardiovascular and metabolic products under
development consist of controlled-release, oral solid dosage formulations, and the Companys
respiratory and metabolic products under development consist of aerosolized inhalation formulations
to be used primarily with Kos proprietary inhalation devices. The Companys current core business strategy is based upon developing drugs that are
reformulations of existing approved prescription pharmaceutical products, but which offer certain
safety 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 or where greater utilization of a product could
be attained through increasing the awareness of the products features and benefits;(ii)
    focus on the large, rapidly growing cardiovascular, metabolic 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 sales forces, which Kos may
supplement with a contract sales organization or other partners and through
co-promotion and other strategic alliances to extend the marketing reach of the Company
to new and existing patients; and(vii)
    leverage its core competencies through corporate and academic alliances. In measuring the Companys results of operations, managements primary focus is on revenue
growth of the Niaspan, Advicor, and Azmacort products, as well as net income growth. Net sales of
the Companys Niaspan and Advicor products increased to $427.3 million for the year ended December
31, 2004, from $293.9 million for the same period in 2003. This 45.4% increase in Niaspan
and Advicor 23




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revenue was primarily attributable to increases in unit volume and prices for the Companys
products during the 2004 period, partially offset by the impact of a change in product return
estimates (as described below in this Managements Discussion and Analysis of Financial Condition
and Results of Operations) in the first quarter of 2003. As mentioned above, the Company
began recording Azmacort revenue on April 1, 2004. Azmacort revenue through December 31, 2004
totaled $68.3 million. Net income for the year ended December 31, 2004, was $142.3 million compared
to net income of $59.4 million for the same period in 2003. The increase, in part, was also
attributable to a net benefit from income taxes of $24.2 million, principally related to the
reversal of the majority of the Companys deferred tax asset valuation allowance and to the
deferred income tax benefit associated with a $38.0 million charge related to the Aventis
transaction, as more fully described below. The increase in net income was partially offset by the
write-off, as a research and development expense, of approximately $38.0 million for the value of
in-process research and development associated with the assets acquired from Aventis, as more fully
described below. Because Kos current core business strategy is mostly dependent on the reformulation of
existing compounds or the development or acquisition of products with unrealized market potential,
the Companys business could be subject to significant competitive pressures by other products and
therapies in the rapidly growing markets for cardiovascular, metabolic and respiratory
treatments. As such, Kos critical success factors include its ability to continue to
increase the amount of revenue generated by the Niaspan, Advicor and Azmacort products, 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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.,
now Aeropharm Technology, LLC (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
loans from its majority shareholder. Through December 31, 2004, the Company had
accumulated a net deficit from operations of approximately $91.6 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. As of December 31, 2004, the 24




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Company had approximately $165.4 million of net operating loss carryforwards and $4.7 million
of tax credits. On July 28, 1997, Kos received clearance from the Food and Drug Administration (FDA) to
market the Niaspan product for the treatment of mixed lipid disorders. Niaspan is the only
once-a-day prescription formulation of a niacin product approved by the FDA for the treatment of
mixed lipid disorders. The Company and its co-promotion partner, Takeda Pharmaceuticals North
America, Inc. (Takeda), currently market Niaspan in the United States directly to physicians who
specialize in treating patients with coronary heart disease and/or who are among the leading
prescribers of lipid-altering medications. On December 17, 2001, Kos received clearance from the FDA to market the Advicor product
(extended-release niacin/lovastatin tablets). The approval of the Advicor product marked 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 Advicor product to physicians on January 28,
2002. As with Niaspan, Kos and Takeda market Advicor directly to physicians who specialize in
treating patients with coronary heart disease and/or who are among the leading prescribers of
lipid-altering medications. On March 31, 2004, the Company completed the acquisition of the Azmacort product from Aventis.
The Azmacort product is 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 Agreements, Kos paid Aventis approximately $206.1 million in cash and has agreed to pay a
royalty on future sales of a hydrofluoroalkane (HFA) version of the product in development. Under the terms of the
Azmacort Supply Agreement, Aventis has agreed to supply finished product to Kos for a period of
five years from the date of the Azmacort acquisition. The purchase price allocation resulted in the
recording of intangible assets of $154.4 million for developed and core technology value, $6.7
million for the value of certain other intangibles, $7.0 million for the value of inventory, and
$38.0 million for the value of in-process research and development. The $38.0 million value
assigned to in-process research and development of the acquired assets was recorded as a research
and development expense in the accompanying consolidated statement of operations for the year ended
December 31, 2004 (the In-process R&D Write-off). The In-process R&D Write-off resulted in the
Company also recording a $14.4 million deferred tax benefit to account for the difference between
the book and tax basis of accounting for this write-off. The remaining intangible assets are being
amortized over their estimated lives, ranging from five to 22 years. The Company began detailing
the Azmacort product in August 2004 and currently markets the Azmacort product in the United States
directly to specialist physicians, such as pulmonologists and allergists. The In-process R&D Write-off was determined by identifying the specific in-process research
and development projects that would be continued and for which (a) technological feasibility has
not been established as of the acquisition date, (b) there was no alternative future use, and (c)
the fair value was estimable with reasonable reliability. The acquired in-process research and development represents a single project, the HFA
formulation of Azmacort. The HFA formulation of
Azmacort does not use a chlorofluorocarbon (CFC)-based propellant and,
consequently, does not deplete the Ozone Layer. The Montreal Protocol on Substances that Deplete
the Ozone Layer (the Protocol) is an international treaty under which the production and
consumption of ozone-depleting substances is being phased out worldwide. Under the Protocol,
codified by the U.S. Congress into law in Title VI of the Clean Air Act, the production of CFCs in
the U.S. was banned as of January 1, 1996, unless a specific exemption is approved annually by the
international parties to the Protocol. In order to comply with the Clean Air Act and the Montreal
Protocol, the U.S. will eventually need to phase out CFC-propelled
Metered Dose Inhalers. 25




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##### Table of Contents



The Azmacort HFA formulation had not achieved technological feasibility as of the transaction
date. Among the technological matters to be resolved are: manufacturing controls and evidence of
dose proportionality between the 75 μg and 225 μg formulations. The Company believes it may have to invest up to $13.5 million during the 2005-2008 period to
achieve technological feasibility of the Azmacort HFA formulation. If the technological and
regulatory challenges are overcome, sales of the Azmacort HFA formulation could begin as early as
2009. The fair value of all of the in-process research and development was determined using the
income approach. This method starts with a forecast of all of the expected future net cash flows
associated with the in-process technology. These cash flows are then adjusted to present value by
applying an appropriate discount rate that reflects the risk factors associated with the cash flow
streams, some of which are more certain than others. The risk-adjusted discount rate utilized in
calculating the fair value of the Azmacort HFA formulation was 36%. Recent Developments The Company entered into a sponsored research agreement (the Sponsored Research Agreement)
and related license agreement (the License Agreement), each dated November 8, 2004, with Triad
Pharmaceuticals, Inc. (Triad), a privately-held drug discovery and design pharmaceutical company
focused on developing molecules for a variety of diseases, including orally active therapies for
diabetes, cancer and cholesterol disorders and now controlled by a limited partnership (the Triad
Limited Partnership) formed by the wife of Michael Jaharis, the Companys founder, principal
shareholder, and Chairman Emeritus of the Companys Board of Directors. At the time the agreements
were executed, Mr. Jaharis directly controlled Triad. Under the Sponsored Research Agreement,
Triad has agreed to perform research relating to the design and synthesis of molecules to increase
HDL cholesterol (the Field). The Sponsored Research Agreement has a two-year term ending
September 30, 2005, subject to extension, and provides for total payments by the Company during the
initial two-year term of $1.5 million. Triad commenced the sponsored research in 2003 in
anticipation of the execution of the definitive agreements. The Company paid $187,500 to Triad in
2003 and $937,500 in 2004 in connection with the Sponsored Research Agreement. Under the License
Agreement, Triad granted to the Company the right to obtain exclusive, worldwide, royalty-bearing
rights to all intellectual property in the Field developed during the term of the Sponsored
Research Agreement that ultimately is embodied in a patent claim, and non-exclusive rights to all
other intellectual property in the Field developed during the term of the Sponsored Research
Agreement (e.g., methods, processes, trade secrets and technical data) that is not otherwise the
subject of, or embodied in, a patent claim. During the term of the Sponsored Research Agreement,
Triad may not use the non-exclusive intellectual property in the Field for commercial purposes.
Following termination of the Sponsored Research Agreement, Triad will pay to the Company royalties
on income earned by Triad from the commercialization of any such non-exclusive intellectual
property within the Field. Triad conducts the sponsored research pursuant to its sponsored
research and license agreements with Tufts University. On February 1, 2005, the Company paid $4.0 million of a proposed aggregate $8.0 million
investment in Triad through the purchase of shares of a new series of convertible preferred stock
of Triad (the Series F Preferred Stock). Subject to the satisfaction of certain conditions,
including Triad achieving certain agreed-upon milestones relating to its research and development
activities by August 1, 2006, the Company will purchase an additional $4.0 million of Series F
Preferred Stock. The investment is part of a $16.0 million round of financing for Triad, with the
remaining $8.0 million being provided by the Triad Limited Partnership under similar terms and
conditions as the Companys investment. Assuming consummation of the second $4.0 million
investment, the Company would own approximately 27% and the Triad Limited Partnership would own or
have the right to vote approximately 48% of the outstanding common stock of Triad on a fully
diluted basis. Under the agreements related to the 26




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##### Table of Contents



investment, the Company is entitled to designate three persons, and the Triad Limited
Partnership is entitled to designate seven persons, to Triads thirteen member Board of Directors.
Adrian Adams, the President and Chief Executive Officer of the Company, has been appointed by the
Company to the Triad Board of Directors and has been elected by the directors of Triad as Chairman.
The Company will appoint two additional persons to the Triad Board at a later date. Michael
Jaharis, Steven Jaharis and Kevin T. Ferro, directors of Kos, have been appointed by the Triad
Limited Partnership to the Triad Board of Directors. In connection with the closing of the investment in Triad on February 1, 2005, Christopher P.
Kiritsy, Kos Executive Vice President, Corporate Development and CFO, notified the Company that he
will be resigning from the Company, after his successor as CFO is found, which is expected to occur
during the second quarter of 2005, and has accepted the position of President and Chief Executive
Officer of Triad. Additionally, pursuant to pre-existing contractual arrangements, Mr. Kiritsy
acquired directly from Mrs. Jaharis approximately 1% of the outstanding Triad stock on an as
converted basis, representing all of her remaining ownership interest in Triad. Mr. Kiritsy has
also received stock options to purchase 243,600 shares of Triad common stock under the Triad stock
option plan. The Triad common stock currently owned by Mr. Kiritsy and the Triad common stock
issuable upon exercise of stock options granted to Mr. Kiritsy are subject to voting agreements in
favor of the Triad Limited Partnership and Triad, respectively. Results of Operations Critical Accounting Policies The Companys significant accounting policies are described in Note 2 to the Consolidated
Financial Statements included in this Form 10-K. The Company believes that its most
critical accounting policies include revenue recognition, the estimation of allowances principally
related to product returns and discounts, managed care rebates, chargebacks, and reimbursements
relating to Medicaid and Medicare, accounting for income taxes, and managements estimate
of the useful lives and realizability of recorded intangible assets. The Company records accrual
estimates for sales returns and allowances mostly based on historical experience. The calculation
of rebates and chargebacks is based on existing contractual arrangements with indirect customers
(such as managed care providers, pharmacy benefit administrators, and government units) and on Kos
analysis of estimated product inventory levels in its distribution channel, which is derived
through the use of certain inputs. The Company believes that its estimation of sales allowances
related to product returns and discounts, managed care rebates, chargebacks, and reimbursements
associated with Medicaid and Medicare represent the best estimates of those amounts, and are based
on assumptions which the Company believes represent the most likely outcomes. The
most pertinent inputs used in the estimation of the Company sales allowances and accruals,
and product inventory levels in its distribution channel, include prescription data (derived from a third party publication), consumer price index (derived
from a third party publication), product best price (derived from the Companys contractual
arrangements), and average manufacturer price (AMP) (computational in nature using historical
data). Of these inputs, prescription data and AMP require significant estimation. The Company
believes that variances between estimates and actual results of prescription data and AMP may
reasonably vary between +/- 5% and +/- 5%, respectively. The following table reflects the potential
impact to revenue for the year ended December 31, 2004, based upon various combinations of these
reasonably likely outcomes in prescription data and AMP estimates (positive dollar amounts
represent potential decreases in revenue; negative dollar amounts represent potential increases in
revenue): 27




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##### Table of Contents



Impact on Niaspan, Advicor and Azmacort RevenueSensitivity Analysis of Possible Variations in Prescription and AMP Inputs(in millions, except % variance)Prescription VarianceAMP Variance
    
    (5%)
    
    
    (3%)
    
    
    (1%)
    
    
    0%
    
    
    1%
    
    
    3%
    
    
    5%(5%)
    
    $
    (1.7
    )
    
    $
    (1.8
    )
    
    $
    (1.8
    )
    
    $
    (1.9
    )
    
    $
    (1.9
    )
    
    $
    (2.0
    )
    
    $
    (2.0
    )(3%)
    
    
    (1.1
    )
    
    
    (1.1
    )
    
    
    (1.2
    )
    
    
    (1.2
    )
    
    
    (1.2
    )
    
    
    (1.3
    )
    
    
    (1.4
    )(1%)
    
    
    (0.3
    )
    
    
    (0.4
    )
    
    
    (0.4
    )
    
    
    (0.4
    )
    
    
    (0.5
    )
    
    
    (0.5
    )
    
    
    (0.6
    )0%
    
    
    0.1
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (0.1
    )
    
    
    (0.1
    )
    
    
    (0.2
    )1%
    
    
    0.5
    
    
    
    0.4
    
    
    
    0.4
    
    
    
    0.3
    
    
    
    0.3
    
    
    
    0.2
    
    
    
    0.23%
    
    
    1.2
    
    
    
    1.2
    
    
    
    1.1
    
    
    
    1.1
    
    
    
    1.1
    
    
    
    1.0
    
    
    
    1.05%
    
    
    2.0
    
    
    
    1.9
    
    
    
    1.9
    
    
    
    1.9
    
    
    
    1.8
    
    
    
    1.8
    
    
    
    1.7
 The Companys management periodically reviews the policies and estimates discussed above, the
effect of which is reflected as a component of net income in the period in which a change is
known. Other than the changes described below associated with the Companys estimate of
its product return exposure during the first quarter of 2003, and the adjustment to the deferred
tax asset valuation allowance as a result of the change in judgment about the realizability of such
asset, such changes to these estimates have not been material to the Companys results of
operations during the years ended December 31, 2004, 2003 and 2002. The Company periodically evaluates the volume of its Niaspan, Advicor, and Azmacort 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
internally-developed 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 the Niaspan and
Advicor 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 quarter ended March 31,
2003, as well as $11.1 million of prior period product shipments not recognized as revenue because
of Kos 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 (SFAS 109), which requires, among other things, recognition of future tax
benefits and liabilities measured at enacted tax 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. Through December 31, 2003, the Company had established a valuation allowance against its net
deferred tax assets because there was not sufficient evidence to conclude that the Company would
more 28




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##### Table of Contents



likely than not realize all or a portion of such assets. Management currently believes, based
on the Companys historical profitability and on its expected future profitability, that the
Company will generate sufficient taxable income to realize its deferred tax assets prior to the
expiration of any net operating loss carryforwards (NOLs) and, therefore, that the Company will
more likely than not realize most of its deferred tax assets. As of December 31, 2004, the Company had deferred tax assets of approximately $58.7 million
and a remaining valuation allowance of approximately $4.2 million (principally related to certain
state NOLs which may not be realized the Company), which resulted in net deferred tax assets of
approximately $54.5 million. Under SFAS 109, the valuation allowance should be adjusted when a
change in circumstances causes a change in judgment about the realizabilty of deferred tax assets.
The portion of the valuation allowance related to NOLs expected to be utilized to offset estimated
ordinary income in the current year is included in the computation of the estimated annual
effective tax rate. The portion of the valuation allowance related to other deferred tax assets,
including net operating losses expected to be utilized to offset ordinary income in future years,
is reversed as of the date of the change in circumstances. Accordingly, the benefit from income
taxes in the accompanying condensed consolidated statement of operations for the year ended
December 31, 2004, includes the reversal of $71.2 million of valuation allowance, of which $67.3
million represents the portion reversed through the effective tax rate for the period and $3.9
million relates to the reversal of valuation allowance on deferred tax assets expected to be
realized through ordinary income in future years. The benefit for income taxes also includes a
$14.4 million deferred benefit related to the In-process R&D Write-off. Included in the Companys $54.5 million of net deferred tax assets as of December 31, 2004,
were $12.5 million of federal NOLs available to offset future federal taxable income and $152.9
million of state NOLs available to offset future state taxable income. In addition, the Company had
$4.7 million of other tax credits to offset future federal income tax. If Kos is unable to generate
sufficient future taxable income through operating results, or if its estimates about future
profitability change significantly, increases or decreases to the valuation allowance will be
required through adjustments to income. Years Ended
December 31, 2004 and 2003 The Companys reported revenue increased 69% to $497.1 million for the year ended December 31,
2004, from $293.9 million for the same period in 2003. Revenues by product for the years
ended December 31, 2004 and 2003 and the respective change of the 2004 period over the prior year
period were as follows: Years Ended December 31,2004
    
    
    % of Revenues
    
    
    2003
    
    
    % of Revenues
    
    
    % Change(in mils.)
    
    
    
    
    
    
    (in mils.)Niaspan
    
    $
    319.1
    
    
    
    64.2
    
    
    $
    226.5
    
    
    
    77.1
    
    
    
    40.9Advicor
    
    
    108.2
    
    
    
    21.8
    
    
    
    67.4
    
    
    
    22.9
    
    
    
    60.5Azmacort
    
    
    68.3
    
    
    
    13.7
    
    
    
    
    
    
    
    
    
    
    
    N/AOther
    
    
    1.5
    
    
    
    0.3
    
    
    
    
    
    
    
    
    
    
    
    N/A$
    497.1
    
    
    
    100.0
    
    
    $
    293.9
    
    
    
    100.0
    
    
    
    69.1
 The increase in revenue was principally attributable to increases in unit volume and price for
the Companys Niaspan and Advicor products during the 2004 period as compared to the 2003 period.
Of the $92.6 million increase in Niaspan net sales during 2004, $52.8 million resulted from
increases in unit volume and $39.8 million resulted from increases in price. Of the $40.8 million
increase in Advicor net sales during 2004, $31.4 million resulted from increases in unit volume and
$9.4 million resulted from increases in price. Additionally, the 2004 period includes revenue for
the Azmacort product, for which 29




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##### Table of Contents



commercialization began on April 1, 2004. These increases were partially offset by the change
in product return estimates (as described above), which increased 2003 revenue by $11.1 million. As more fully described above, the Company records provisions for the estimation of allowances
principally related to managed care rebates, chargebacks related to Medicaid and Medicare and
product returns and discounts as components of revenues. An analysis of the Companys gross sales,
by product, subject to each of these provisions for the years ended December 31, 2004 and 2003,
follows: 2004
    
    
    2003Niaspan
    
    
    Advicor
    
    
    Azmacort
    
    
    Niaspan
    
    
    Advicor
    
    
    AzmacortProvisions
    
    Gross
    
    
    
    
    
    
    Gross
    
    
    
    
    
    
    Gross
    
    
    
    
    
    
    Gross
    
    
    
    
    
    
    Gross
    
    
    
    
    
    
    GrossFor
    
    Sales
    
    
    % of Total
    
    
    Sales
    
    
    % of Total
    
    
    Sales
    
    
    % of Total
    
    
    Sales
    
    
    % of Total
    
    
    Sales
    
    
    % of Total
    
    
    Sales
    
    
    % of Total(in mils.)
    
    
    
    
    
    (in mils.)
    
    
    
    
    
    (in mils.)
    
    
    
    
    
    (in mils.)
    
    
    
    
    
    (in mils.)
    
    
    
    
    
    (in mils.)Rebates
    
    $
    314.6
    
    
    
    70
    
    
    $
    52.5
    
    
    
    41
    
    
    $
    27.0
    
    
    
    28
    
    
    $
    208.7
    
    
    
    69
    
    
    $
    26.9
    
    
    
    37
    
    
    NA
    
    NAChargebacks
    
    
    90.3
    
    
    
    20
    
    
    
    7.7
    
    
    
    6
    
    
    
    23.9
    
    
    
    25
    
    
    
    42.3
    
    
    
    14
    
    
    
    1.1
    
    
    
    1
    
    
    NA
    
    NAReturns
    
    
    452.4
    
    
    
    100
    
    
    
    127.1
    
    
    
    100
    
    
    
    96.3
    
    
    
    100
    
    
    
    303.3
    
    
    
    100
    
    
    
    73.0
    
    
    
    100
    
    
    NA
    
    NADiscounts
    
    
    452.4
    
    
    
    100
    
    
    
    127.1
    
    
    
    100
    
    
    
    96.3
    
    
    
    100
    
    
    
    303.3
    
    
    
    100
    
    
    
    73.0
    
    
    
    100
    
    
    NA
    
    NA
 The
Company had accrual balances related to its managed care rebates and
chargebacks of $50.0 million and $18.2 million, as of
December 31, 2004 and 2003, respectively. Furthermore, the Company
had allowances against its trade accounts receivable for product returns and discounts of $2.8 million and $2.1 million, as of December 31, 2004 and 2003, respectively. Cost of sales increased 84% to $36.9 million for the year ended December 31, 2004, from
$20.0 million for the same period in 2003, primarily as result of increased unit sales of the
Niaspan and Advicor products, combined with the addition of the Azmacort product to the Companys
product portfolio on March 31, 2004. In 2004, cost of sales was approximately 7.5% of net sales,
as compared to 6.8% for the same period in 2003. The increase was primarily a result of changes in
the product mix, including the impact of the addition of Azmacort to the Companys product
offering, partially offset by price increases as described above. The Companys research and development expenses increased 113% to $111.1 million for the year
ended December 31, 2004, from $52.2 million for the same period in 2003. The increased
expenses related primarily to a one-time charge of $38.0 million related to the In-process R&D
Write-off, and to increases of $7.9 million principally associated with clinical studies for the
Companys products under development, of $7.4 million in personnel and personnel-related costs, and
of $1.9 million in medical educational programs in support of the Companys marketed products. Selling, general and administrative expenses increased 51% to $235.7 million for the year
ended December 31, 2004, from $156.5 million for the same period in 2003. Within this
category, selling expenses increased to $197.2 million for the 2004 period from $124.3 million for
the comparable 2003 30




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##### Table of Contents



period. The growth in selling expenses was primarily related to increases of $38.5
million in royalty expenses, of $20.6 million in sales force operating costs in support of the
Niaspan, Advicor, and Azmacort products and of $10.4 million of amortization related to the
Azmacort purchase. General and administrative expenses increased to $38.5 million for the year
ended December 31, 2004, from $32.2 million for the year ended December 31, 2003. This
increase in general and administrative expenses was primarily related to increases of $3.0 million
in personnel and personnel related costs, of $1.3 million in professional fees, and of $4.0 million
in other costs associated with the expanded activities of the Company. The increases were partially
offset by the impact of a $6.0 million trademark litigation settlement with Andrx Corporation and
Andrx Laboratories, Inc. of which $2.0 million representing a reimbursement of legal costs, was
recorded as an offset to general and administrative expenses. As previously described, the benefit for income taxes in the accompanying consolidated
statement of operations for the year ended December 31, 2004 includes the reversal of $71.2 million
of valuation allowance, of which $67.3 million represents the portion reversed through the
effective tax rate for the period and $3.9 million relates to the reversal of valuation allowance
on deferred tax assets expected to be realized through ordinary income in future years. The benefit
for income taxes also includes a $14.4 million deferred tax benefit related to the In-process R&D
Write-off. As of December 31, 2004, 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. Interest expense under the Companys credit facilities totaled
$1.2 million and $3.3 million for the years ended December 31, 2004 and 2003, respectively. The
decrease in interest expense is mostly attributable to a decrease in outstanding borrowings. The Companys net income increased 140% to $142.3 million for the year ended December 31,
2004, compared with $59.4 million for the year ended December 31, 2003. Years Ended December 31, 2003 and 2002 The Companys reported revenue increased 70% to $293.9 million for the year ended December 31,
2003, from $172.7 million for the same period in 2002. Revenues by product for the years
ended December 31, 2003 and 2002 and the respective change of the 2003 period over the prior year
period were as follows: Years Ended December 31,2003
    
    
    % of Revenues
    
    
    2002
    
    
    % of Revenues
    
    
    % Change(in mils.)
    
    
    
    
    
    (in mils.)Niaspan
    
    $
    226.5
    
    
    
    77.1
    
    
    $
    145.6
    
    
    
    84.3
    
    
    
    55.6Advicor
    
    
    67.4
    
    
    
    22.9
    
    
    
    27.1
    
    
    
    15.7
    
    
    
    148.7$
    293.9
    
    
    
    100.0
    
    
    $
    172.7
    
    
    
    100.0
    
    
    
    70.2
 The 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). Of the $80.9 million increase in Niaspan net sales
during 2003, $55.0 million resulted from increases in unit volume and $25.9 million resulted from
increases in price. Of the $40.3 million increase in Advicor net sales during 2003, $38.3 million
resulted from increases in unit volume and $2.0 million resulted from increases in price. 31




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##### Table of Contents



As more fully described above, the Company records provisions for the estimation of allowances
principally related to managed care rebates, chargebacks related to Medicaid and Medicare and
product returns and discounts as components of revenues. An analysis of the Companys gross sales,
by product, subject to each of these provisions for the years ended December 31, 2003 and 2002,
follows: 2003
    
    
    2002Niaspan
    
    
    Advicor
    
    
    Niaspan
    
    
    AdvicorProvisions
    
    Gross
    
    
    
    
    
    
    Gross
    
    
    
    
    
    
    Gross
    
    
    
    
    
    
    GrossFor
    
    Sales
    
    
    % of Total
    
    
    Sales
    
    
    % of Total
    
    
    Sales
    
    
    % of Total
    
    
    Sales
    
    
    % of Total(in mils.)
    
    
    
    
    
    (in mils.)
    
    
    
    
    
    (in mils.)
    
    
    
    
    
    (in mils.)Rebates
    
    $
    208.7
    
    
    
    69
    
    
    $
    26.9
    
    
    
    37
    
    
    $
    125.6
    
    
    
    68
    
    
    $
    11.2
    
    
    
    36Chargebacks
    
    
    42.3
    
    
    
    14
    
    
    
    1.1
    
    
    
    1
    
    
    
    22.0
    
    
    
    12
    
    
    
    0.1
    
    
    
    0Returns
    
    
    303.3
    
    
    
    100
    
    
    
    73.0
    
    
    
    100
    
    
    
    185.7
    
    
    
    100
    
    
    
    31.4
    
    
    
    100Discounts
    
    
    303.3
    
    
    
    100
    
    
    
    73.0
    
    
    
    100
    
    
    
    185.7
    
    
    
    100
    
    
    
    31.4
    
    
    
    100
 The
Company had accrual balances related to its managed care rebates and
chargebacks of $18.2 million and $8.7 million, as of December 31, 2003 and 2002, respectively. Furthermore, the Company had allowances against its trade accounts receivable for product returns and discounts of $2.1 million and $2.4 million, as of December 31, 2003 and 2002, respectively. Cost of sales increased 30% to $20.0 million for the year ended December 31, 2003, from
$15.4 million for the same period in 2002, primarily as a result of increased unit sales of the
Niaspan and Advicor products. In 2003, cost of sales was approximately 6.8% of net sales, as
compared to 8.9% for the same period in 2002. The decrease was primarily a result of the price
increases discussed above and, to a lesser extent, of increased efficiencies associated with the
Companys manufacturing processes. The Companys research and development expenses increased 19% 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 increases of $4.2 million in personnel and personnel-related costs,
and of $3.1 million principally associated with Advicor clinical 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 Advicor product, of $0.9 million
associated with formulation costs for products under development, and $0.2 million resulting from
Merck reimbursement payments. Selling, general and administrative expenses increased 20% 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 Niaspan and Advicor
products, 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. 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 could not 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. 32




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Liquidity and Capital Resources At December 31, 2004, the Company had cash and cash equivalents of $258.7 million and working
capital of $245.1 million. The Companys primary uses of cash to date have been to fund selling,
general and administrative expenses, research and development expenses, and the acquisition of the
Azmacort product. Net cash provided by operating activities was $196.4 million in 2004, compared to net cash
provided by operating activities of $55.6 million in 2003, and $1.2 million of net cash used in
operating activities in 2002. The increase in net cash provided by operating activities in 2004 was
primarily a result of the increase in net income adjusted for non-cash items, as well as increases
in working capital sources of cash. Working capital sources of cash during 2004 included
decreases in inventory as well as increases in accounts payable, accrued expenses and advance
payments received on license agreements, partially offset by increases in trade accounts
receivable, prepaid expenses and other current assets, and deferred tax assets. The net
cash provided by operating activities in 2003 was primarily a result of net income adjusted for
non-cash items partially offset by working capital uses of cash. Working capital uses of cash
during 2003 included increases in trade accounts receivable, inventories, prepaid expenses and
other current assets, and decreases in advance payments from customers, partially offset by
increases in accounts payable, accrued expenses and advance payments received on license
agreements. The net cash used in operating activities in 2002 was primarily a result of a
net loss adjusted for non-cash items partially offset by working capital sources of cash. Working
capital sources of cash in 2002 included decreases in the Companys current non-cash assets, except
for an increase in trade accounts receivable and increases in the Companys current liabilities. Net cash used in investing activities was $215.6 million in 2004, compared to $11.0 million in
2003, and $6.7 million in 2002. The significant increase in cash used in investing
activities during the year ended December 31, 2004, related principally to the purchase during the
2004 period of the Azmacort product, for $206.1 million. In 2004, net cash provided by financing activities was $18.0 million, compared to net cash
provided by financing activities of $195.8 million in 2003, and to net cash used in financing
activities of $17.8 million in 2002. The decrease in net cash provided by financing activities in
2004 was primarily related to the net proceeds received in 2003 from the Companys stock offering
(as described below), which were partially offset by the absence during the 2004 period of the
payments made during 2003 against borrowings previously made under the Standby Facility. The
decrease in cash provided by financing activities during the 2004 period as compared to 2003 was
also partially offset by an increase in cash received from the exercise of stock options and from
employee participation in the employee stock purchase plan during 2004. 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 the Additional Standby Facility expiring on June
30, 2008. 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, 2004. Borrowings, when outstanding, will
bear interest at the prime rate (5.25% as of December 31, 2004), 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 January 10, 33




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2005, Mr. Jaharis gifted his rights and obligations under the Additional Standby Facility to
his wife. All other terms and conditions of the Additional Standby Facility remain unchanged. On September 1, 1999, the Company formally agreed to the terms of an additional $50-million
Supplemental Credit Facility initially entered into with Mr. Jaharis on October 7, 1998.
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 controlled. 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 the 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 outstanding borrowings under the
Supplemental Credit Facility, which totaled $43,862,500 and bore interest at the prime rate, were
converted into 8,933,299 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
through the Standby Facility. Borrowings made under the Standby Facility totaled $19
million as of December 31, 2004, 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.
In lieu of a conversion feature, the Company 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.
Mr. Jaharis exercised 2,000,000 and 200,000 warrants to purchase shares of the Companys
Common Stock at $5.00 per share on October 13, 2004, and November 24, 2004, respectively. As of
December 31, 2004, warrants to purchase 3,800,000 shares of the Companys Common Stock remained
outstanding. On January 10, 2005, Mr. Jaharis gifted his rights and obligations under the
Standby Facility to his wife. All other terms and conditions of the Standby Facility remain
unchanged. 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 believes that on
or prior to the maturity date, it will have sufficient cash, available credit, and access to
capital from third parties to be able to repay the Standby Facility on a timely basis in the event
that Mrs. Jaharis does not elect to exercise all or a portion of the remaining non-detachable
warrants to purchase shares of the Companys Common Stock. However, the Company believes that, if
the market price of the Companys Common Stock continues to significantly exceed the warrant
exercise price established under the Standby Facility, which is $5.00 per share, through the end of
the warrant exercise period, Mrs. Jaharis will elect to exercise the warrants available under this
facility into shares of Kos Common Stock prior to the end of the warrant exercise period, thereby
relieving the Company of the obligation to repay such facility. If such warrant exercise were not
to take place for any reason, the Company would be required to utilize its cash flow from
operations and its then remaining borrowing capacity under its other facility with Mrs. Jaharis, if
such borrowing capacity is available at all, to repay borrowings due under the Standby Facility. 34




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The Company recorded $1.2 million and $3.3 million of interest expense for the years ended
December 31, 2004 and 2003, 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, were mostly used to finance the purchase of the Azmacort product from Aventis. Although the Company currently anticipates that, including the capital available to the
Company under the Additional Standby Facility through June 30,
2008 and the Standby Facility through June 30, 2005, 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 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 Niaspan, Advicor and Azmacortproducts, its ability to continue to access its credit
facilities, its ability to control operating expenses and on its ability to maintain the protection
afforded by its patents. The Companys failure to generate substantial growth in the sales
of Niaspan, Advicorand Azmacort, 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 maintain its compliance with FDA regulations and standards without adversely affecting
its manufacturing capability or ability to meet its production requirements or profit margins; 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 and the
outcome of lawsuits involving the Companys intellectual property; 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. 35




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Contractual Obligations The following table summarizes the Companys significant contractual obligations at December
31, 2004, and the effect such obligations are expected to have on Kos liquidity and cash flows in
future periods. This table excludes amounts already recorded on the Companys balance
sheet as current liabilities as of December 31, 2004. Payments Due by Period(in millions)Less
    
    
    
    
    
    
    
    
    
    
    Morethan 1
    
    
    1-3
    
    
    3-5
    
    
    than 5year
    
    
    years
    
    
    years
    
    
    years
    
    
    TotalOperating lease obligations
    
    $
    8.0
    
    
    $
    13.6
    
    
    $
    7.1
    
    
    $
    14.7
    
    
    $
    43.4Employment agreements
    
    
    1.4
    
    
    
    2.5
    
    
    
    1.9
    
    
    
    1.1
    
    
    
    6.9Short term obligations
    
    
    19.0
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    19.0Capital lease
    
    
    0.1
    
    
    
    0.2
    
    
    
    
    
    
    
    
    
    
    
    0.3Total contractual obligations
    
    $
    28.5
    
    
    $
    16.3
    
    
    $
    9.0
    
    
    $
    15.8
    
    
    $
    69.6
 As
of December 31, 2004, the only long-term obligations of the
Company subject to interest expense were its capital leases. The
Company will be subject to interest expense related to its capital
leases of $12,000 and $7,000 during 2005 and for the period from 2006
through 2007, respectively. 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 or operating needs and are fulfilled by its vendors within a short period of
time. As of December 31, 2004, the Company had commitments for raw materials with two of its
vendors totaling approximately $2.0 million. 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,
2004, assuming all future milestones were met, additional required payments related to sponsored
research and licensing agreements would be approximately $2.0 million. 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). As of December 31, 2004, in connection with the Merck
Agreement, Kos had received $20.0 million in upfront, reimbursement, and milestone payments from
Merck, including $15.0 million of upfront and reimbursement payments (of which $3.8 million is
currently refundable to Merck if Kos fails to achieve certain regulatory milestones). Refundable
amounts under the Merck Agreement are not included in the table above. On November 4, 2003, the Company and Takeda announced a three-year agreement to co-promote
Niaspan and Advicor in the United States. 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 Niaspan and Advicor 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. The Company
will pay the CSO a royalty based on net sales of the Companys Niaspan and Advicorproducts during
a five-year period beginning January 1, 2002 (the CSO Agreement). The royalty amounts
payable to the CSO are subject to a cumulative minimum of $50 million over the term of the CSO
Agreement, not to exceed $65 million over such contract term. Through December 31, 2004,
the Company had incurred $28.6 million in royalties related to the CSO Agreement. 36




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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. 37




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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 its co-promotion and
commercialization partners; respond to competitive pressures from competing therapies for the
treatment of cardiovascular, respiratory and other conditions that are the focus of the Companys
products; 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.; commercialize its products outside the United States and
the success of its relationship with Merck KGaA (Merck); achieve its goals for future sales
levels, operating margins, earnings growth, and shareholder value; continue to manufacture and
supply sufficient quantities of Niaspanand Advicorand to source an adequate supply of Azmacort;
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 that 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 Advicor product,
the expected continued growth in sales of the Niaspan product (assuming, for example, no generic
entry of competing products), the ability of Kos to continue to build awareness for Niaspanand
Advicor within the medical community, the ability of the Company to generate increasing sales of
Advicor without diminishing the sales of Niaspan, the success of the Companys co-promotion
relationship with Takeda Pharmaceuticals North America, Inc. (Takeda), the Companys ability to
commercialize its products outside the United States and the success of its relationship with Merck
and Oryx Pharmaceuticals, Inc. (Oryx), the Companys ability to avoid the re-importation of the
Companys products into the United States at prices that are lower than those maintained by the
Company in the United States, the Companys ability to attract and retain sales professionals, the
Companys ability to successfully develop (both internally and through sponsored research
arrangements with third parties) and commercialize new products under development and within
expected timeframes, the market acceptance of the Azmacort product, the growth in sales of the
Azmacort product, the Companys ability to build awareness of Azmacort within the medical
community, the Companys ability to continue to manufacture and supply sufficient quantities of
Niaspan and Advicor and to source and maintain an adequate supply of Azmacort, 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,
changes in the business and regulation of health care reimbursement, the Companys ability to
maintain compliance with FDA standards without adversely affecting its manufacturing capability or
ability to meet its production requirements, the Companys ability to ensure compliance with
prescription drug sales and marketing laws and regulations, changes in the regulatory environment
governing the Companys compliance with FDA, Patent Trademark Office, tax and competition issues,
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 38




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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 of which the Company hereafter becomes aware.
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 of Niaspan and Advicor The Companys success depends in part upon its ability to successfully market and sell
increasing quantities of the Niaspan and Advicor products. The Companys ability to
successfully sell increasing quantities of the Niaspan and Advicor products will depend
significantly on the continued acceptance of the Niaspan product by physicians and their patients
despite the commercialization of Advicor. As a consequence of the on-going
commercialization of the Advicor product, which is a combination product including Niaspan and
lovastatin, a statin-class compound, prescription levels for Niaspan may be adversely affected to
the extent a significant number of physicians prescribe Advicor as a substitute product for their
patients who are 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.
Further, there are numerous versions of niacin currently available as a dietary supplement.
The Companys ability to successfully sell increasing quantities of the Niaspan and Advicor
products may be affected by the substitution of niacin dietary supplements for its products. Sales
could also be affected by competition from the sale of other statin products and other
cardiovascular therapies. The Company believes that intolerable flushing and potential liver
toxicity associated with other currently available dietary supplement 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 and at high dosages, resulting in multiple
flushing episodes, or result, in the case of sustained-release niacin, in liver toxicity.
Although most patients taking the Niaspan and Advicor products will sometimes flush, the
formulation and dosing regimen for Niaspan and Advicor have been designed to maximize patient
acceptance and minimize the occurrence of flushing and liver toxicity. If, however, a
significant number of patients using the Niaspan and Advicor products were to suffer episodes of
flushing that they consider intolerable or to suffer other side effects, physicians may discontinue
prescribing the Niaspan and Advicor products or patients may stop taking Niaspan and Advicor, which
would have a material adverse effect on the Company. Unanticipated side effects or
unfavorable publicity concerning the Niaspan or Advicor products or any other product incorporating
technology similar to that used in the Niaspan or Advicor products also could have an adverse
effect on the Companys ability to maintain and/or 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 Advicor product will depend
significantly on the increasing acceptance of the Advicor product by physicians and their
patients. If a significant number of patients using the Advicor product 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 Advicor have been identified as possible causes of
myopathy. Unanticipated side effects or unfavorable publicity concerning the Advicor
product or any other product 39




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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, Advicor may prove to be difficult to successfully sell beyond current levels
because the market for cholesterol therapies is dominated by competitors with significantly larger
sales forces and with significantly greater marketing resources than those available to the
Company. Further, Advicor is 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 Advicor because it is not as new as
more recently introduced compounds, such as the potent statin products marketed by the Companys
competitors. Also, because Advicor is a combination of two currently available drugs,
Advicor has 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 Niaspan or 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 Advicor until
they have first prescribed either Niaspan, lovastatin, or another statin alone and subsequently
determined that their patients need Advicor to achieve desired cholesterol improvements.
Similarly the Companys ability to successfully sell increasing quantities of the Advicor
product may be adversely affected by, among other things, the November 2002 release of Zetia, part
of a new class of cholesterol-lowering agents, by the September 2003 release of Crestor, a new,
highly powerful statin product, or by the August 2004 introduction of Vytorin, a new, dual
component therapy possessing significant potency with respect to reducing LDL cholesterol.
Although Zetia, Crestor and Vytorin possess limited potency with respect to increasing HDL
cholesterol, the increased focus of the medical community in treating LDL cholesterol could
adversely affect the utilization of the Companys products, in which the differentiated feature is
modulating other lipid risk factors that have been implicated in heart disease, but are not as well
established as LDL cholesterol in contributing to coronary heart disease. Zetia and
Vytorin are 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. Zetia
is highly effective in reducing LDL cholesterol, but it has minimal effect in reducing HDL
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. Vytorin is a combination product of the statin Zocor and Zetia that possesses
significant potency with respect to reducing LDL cholesterol, but is less effective in increasing
HDL cholesterol. Further, there are at least nine versions of generic lovastatin, one of the
components of Advicor, that have been launched into the large and growing market for cholesterol
therapies, which could adversely affect demand for Advicor. The sale of other well-known
statin therapies and other cholesterol drugs is driven by competitors with stronger promotion and
name recognition for their products. Consequently, the Companys effort to sell increasing
quantities of the Advicor product may be unsuccessful. Integration and Sales Growth of Azmacort 40




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There can be no assurance that the Company will be able to continue to profitably manage and
integrate the Azmacort product into the Companys sales and marketing campaigns without substantial
expenses, delays or other operational or financial problems. The Companys effort to commercialize
the Azmacort product may require management to devote a disproportionate amount of its resources
toward the commercialization and growth of Azmacort, which may divert management, sales personnel
and financial resources from the Companys other products. This could have a material adverse
effect on the Companys business, operating results and financial condition. There can be no
assurance that Azmacort will achieve the level of revenues that were derived from the sale of such product prior to
its acquisition by Kos, or that the Company will achieve its anticipated revenues and earnings.
Prior to the acquisition of the Azmacort product by the Company, the product had experienced
declining sales levels and increased competition from other products. The failure of the Company to
manage the commercialization of the Azmacort product in a way that reverses the declining trend in
the sales of such product, the failure of the Company to achieve substantial growth in the sales of
the Azmacort product, and the failure of the Company to source sufficient quantities of Azmacort
from Aventis or its assignee could have a material adverse effect on the Companys business,
operations and financial condition. Uncertainty of Future Profitability To date, the Company has dedicated most of its financial resources to the development and
commercialization of the Niaspan and Advicor products, the development of other products, the
acquisition of the Azmacort product on March 31, 2004 and general and administrative expenses.
The Company has generated an accumulated deficit as of December 31, 2004, of $91.6
million. Excluding the impact of a $45.0 million settlement received from Bristol Myers
Squibb Company in 2001, the Company generated full-year net income for the first time in 2003.
The Companys ability to maintain profitability will depend, among other things, on the
commercial success of the Niaspan, Advicor and Azmacort products; on the Companys ability to
successfully exploit the Companys manufacturing and sales and marketing capabilities; on the
Companys ability to obtain patents, enforce and maintain those patents, preserve trade secrets,
and operate without infringing on the proprietary rights of third parties; 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; on the successful outcome of the litigation with Barr
Laboratories, Inc.; on the Companys ability to maintain exclusivity in 2005 for its Niaspan
product; and on the Companys ability to maintain sufficient funds to finance the Companys
activities. As of December 31, 2004, the Company had approximately $165.4 million of net
operating loss carryforwards and $4.7 million of other tax credits. If the Company is
unable to sustain profitability, however, its carryforwards and tax credits may not be utilized. Patents and Trademarks; Litigation with Barr Laboratories, Inc. 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 had issued or for which Kos has applied relating to
Niaspan, Advicor and 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, Advicor and 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; 41




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
    Meaningful patent protection is not secured for any particular technology; or
    Any patents that have been or may be issued to the Company or the Companys
licensors, including the patents covering the Companys Niaspan product, 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 Niaspan and Advicor for 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 or dietary supplement sales might occur, especially if another company
markets the active ingredient at a price that is less than the price of Niaspan or Advicor, thereby
potentially reducing the sales of such products. The U.S. Patent and Trademark Office (the PTO) has issued U.S. Patent numbers 6,129,930,
6,080,428, 6,406,715, 6,676,967, 6,746,691 and 6,818,229 to the Company with claims related to
Niaspans and Advicors composition 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, if approved, would allow
Barr to market a generic version of the Companys 1000 mg Niaspan product. 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. 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 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 the
Company, 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
Niaspan products. On August 13, 2002, the Company filed a second patent infringement lawsuit
against 42




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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 the Companys 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, the
Company replied to Barrs declaratory judgment counterclaims by denying that the Companys patents
are invalid or not infringed. The Company also sought a declaratory judgment that one or more of
Barrs products will infringe the 145 and 181 patents. On March 4, 2003, the Company replied to
Barrs declaratory judgment counterclaims by denying that the Companys patents are invalid or not
infringed. The Company also sought a declaratory judgment that one or more of Barrs products will
infringe the 145 and 181 patents. From January 21 through February 23, 2004, the Company received numerous notices from Barr
that if had filed a Supplemental Paragraph IV Certification to each ANDA to provide for the
6,676,967 patent. On March 26, 2004, the Company filed a patent infringement lawsuit against Barr
in the SDNY asserting infringement of this patent. On April 20, 2004, Barr answered the complaint
by denying that the 967 patent is valid and infringed and seeking a declaratory judgment of
invalidity and non-infringment. Barr also sought a declaratory judgment that the 715 patent is
unenforceable; a declaratory judgment that the 145, 181, 428, 715, and 930 patents are
invalid; and a declaratory judgment that the 145, 181,428, and 930 patents are not infringed.
The fourth case was consolidated with the first three on May 10, 2004. From June 8, 2004 through July 19, 2004, the Company received numerous notices from Barr that
Barr had filed a Supplemental Paragraph IV Certification to each ANDA to provide for the 6,746,691
patent. On September 3, 2004, Barr filed a complaint seeking a declaratory judgment of invalidity
of the patent. On September 30, 2004, the Company answered the complaint by denying invalidity and
counterclaiming for infringement and seeking a declaratory judgment of infringement. Barr replied
on October 20, 2004, by denying infringement of any valid and enforceable claim of the patent. The
fifth case was consolidated with the first four on September 21, 2004. From November 22, 2004 through December 21, 2004, the Company received numerous notices from
Barr that Barr had filed a Supplemental Paragraph IV Certification for each ANDA to provide for the
6,818,229 patent. The Company is currently evaluating the notices. 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, 43




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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. Marketing of Generic Niacin Product Prior to Resolution of Litigation with Barr Laboratories, Inc. The Hatch-Waxman Act provides for an automatic stay of the FDAs authority to grant marketing
approval to Barr that would otherwise give Barr the right to market its generic niacin product.
This stay is currently set at thirty months and is scheduled to expire on March 30, 2005. Upon the
expiration of the thirty month stay, the FDA could grant final approval to Barr and Barr could
commence the distribution of its generic ER niacin products notwithstanding Kos patents unless Kos
were able to obtain an injunction prohibiting such activities by Barr. Kos believes that Barr may
be taking certain actions to prepare for the distribution of its generic ER niacin products prior
to resolution of the legal proceedings and that Barr could begin distributing such generic products
as soon as March 30, 2005, although Kos has no way of knowing whether or when Barr might begin such
distribution. On March 7, 2005, Kos sought a temporary restraining order and preliminary
injunction preventing Barr from distributing its generic ER niacin products until the resolution of
the pending litigation, however, there can be no assurance that such measures will be granted by
the court. If Kos is not able to obtain such a restraining order and injunction, Barr could
commence marketing and selling a generic alternative to Kos Niaspan product as soon as the FDA
gives final approval, which could occur as early as March 30, 2005. Although Kos could seek from
Barr recovery of any damages that Kos sustains in connection with any distribution activities
conducted by Barr of a product that infringes a valid and enforceable claim in Kos patents,
whether Kos is ultimately entitled to such damages would be determined by the court in connection
with ongoing legal proceedings between Kos and Barr. If Barr were to commence selling a generic
alternative to Kos Niaspan product prior to the resolution of the ongoing legal proceedings
between Kos and Barr, it would have a material adverse effect on Kos and its business, financial
condition and results of operations, and could result in the termination of its marketing
arrangements with Takeda and Oryx. In addition, Kos previously issued guidance regarding its
projected financial results for 2005 would no longer be accurate and Kos would have to revise such
guidance. Future Capital Needs; Uncertainty of Additional Funding As of December 31, 2004, the Company had $19.0 million in outstanding borrowings from Michael
Jaharis, the Companys principal shareholder, director, and Chairman Emeritus. The Company can
borrow from Mr. Jaharis and his transferees up to $61.0 million under agreements
currently in place through June 30, 2005 and, thereafter, up to
 $30 million under an agreement currently in place
through June 30, 2008; 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 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 and his transferees. On January 10, 2005, Mr. Jaharis gifted his rights and
obligations under the Companys outstanding borrowings to his wife. All other terms and conditions
of the borrowings remain unchanged. 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 Niaspan, Advicor and Azmacort products and the
Companys other products under development, if regulatory approvals are obtained for such products
under development. 44




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The Company believes that it has sufficient resources, including funds available to it under
loans from Mrs. Jaharis 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 Niaspan, Advicor, and Azmacort; 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 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 regulatory
approvals; costs in filing, prosecuting, defending, litigating and enforcing patent claims and
other intellectual property rights; the Companys ability to manufacture and supply (or have
manufactured and supplied) sufficient quantities of its Niaspan, Advicor and Azmacort products; 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 Niaspan,
Advicor and Azmacort products, the regulatory and commercial success of the Advicor product, the
outcome of litigation related to the Companys intellectual property, including the litigation with
Barr, 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 Niaspan, Advicor, and Azmacort products do not increase
rapidly; if the Company loses the litigation with Barr Laboratories, Inc.; 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 Niaspan, Advicor and Azmacort
products 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 Niaspan, Advicor or Azmacort
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 23,901,507 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 45




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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 Niaspan, Advicor and Azmacort products are marketed by the Companys own sales
forces or through co-promotion or commercialization 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 Niaspan, Advicor and
Azmacort products, or to the Companys products under development or to be acquired or licensed, or
to achieve increasing market acceptance of such products in the highly competitive marketplace for
cholesterol-management therapies. The Companys failure to expend the resources to adequately
promote the Niaspan, Advicor and Azmacort products or its other products under development would
have a material adverse effect on the Companys business and results of operations. 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 Niaspan, Advicor and Azmacort products. As a result, Kos may be unable to generate
significantly increased sales of the Niaspan, Advicor or Azmacort products. The failure of the
Companys sales representatives to generate increased sales of the Niaspan, Advicor and Azmacort
products would have a material adverse effect on operating results. Control by Existing Shareholder Michael Jaharis, the Companys principal shareholder and a director, beneficially owns,
directly or indirectly, including as a member of a group, 20,501,051 shares of the Companys Common
Stock as of December 31, 2004, or approximately 50.8% of the
Common Stock outstanding, excluding the impact of warrants to
purchase 3.8 million shares of the Companys Common Stock, as more fully described below. 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 previously made available by
Mr. Jaharis to the Company, but gifted to Mr. Jaharis wife on January 10, 2005, gives Mrs. Jaharis
the right to exercise warrants to purchase 3.8 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
24,301,051 shares, or approximately 55.0% of the common stock outstanding, assuming the warrant
exercise had occurred as of December 31, 2004. 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 19,000 persons, compared with the Companys approximately
425-person cardiovascular field sales force and the sales force of its co-promotion partners. The
Companys leading competitors and their respective competitive products include, among others:  
    Abbott (Tricor)
    Bristol-Myers Squibb (Pravachol) 46




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
    Merck (Zocor and Mevacor)
    Novartis (Lescol)
    Pfizer (Lipitor, Caduet and Lopid)
    Sankyo (Welchol)
    Merck/Schering-Plough (Zetia and Vytorin)
    AstraZeneca (Crestor) The Company estimates that the existing Niaspan and Advicor prescriptions account for slightly
more than 3.4% 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. Crestor, a new highly powerful statin
product, was launched during September 2003 by AstraZeneca. Vytorin, a combination product of the
statin Zocor and Zetia, was launched in July 2004 by Merck/Schering-Plough Pharmaceuticals, which
is a joint venture between Merck & Co., Inc. and Schering-Plough Corporation. Both
Merck/Schering-Plough Pharmaceuticals and AstraZeneca are competitors who have substantially
greater resources than those available to Kos. 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 they create may
inhibit the Niaspan and Advicor products from competing successfully or from achieving increased
sales. Further, there is ongoing discussion at the FDA concerning the potential approval of
lovastatin as an over-the-counter drug. The sheer size and rapid growth of the patient population
for which cholesterol therapies are indicated, continue to induce new entry of competing
cardiovascular and cholesterol products. 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 Niaspan product 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 Niaspan product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. The emergence of new cholesterol-management products or generic entry would have a
material adverse effect on the Company. There are also many products that are commercially available for the treatment of the
respiratory condition addressed by Azmacort, and the manufacturers of such products have
significantly greater financial resources and sales and manufacturing capabilities than those
available to Kos, including combined field sales forces exceeding 5,500 persons, compared with the
Companys approximately 50-person field sales force. Further, there are many products that are
commercially available for the treatment of the respiratory condition addressed by Azmacort, and
the manufacturers of such products have significantly greater financial resources and sales and
manufacturing capabilities than those available to Kos. The primary competitors of the Azmacort
product include, among others:  
    Advair and Flovent (GlaxoSmithKline)
    Aerobid (Forest)
    Pulmicort (AstraZeneca)
    Vanceril (Schering-Plough)
    QVAR (Ivax) 47




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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, better promoted, 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 Niaspan and Advicor products outside the United States, Canada and Japan.
Under the terms of the Merck Agreement, Merck will provide Kos up to $61 million in licensing,
milestone and reimbursement payments. Through December 31, 2004, Kos has received $20.0 million
in upfront, reimbursement, and milestone payments from Merck, including $15.0 million of upfront
and reimbursement payments. Kos is responsible for obtaining initial marketing authorization in all
European countries and the supply and manufacturing of the products. Pursuant to certain provisions of the Merck Agreement, if marketing authorization is not
obtained for Niaspan and Advicor in certain countries and within certain timeframes, Kos will be
required to refund to Merck up to $3.8 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 Niaspan in certain countries, the achievement of marketing authorization
of Advicor in certain countries, and achieving certain net sales thresholds of Niaspan and Advicor. In 1999, Kos received marketing approval for Niaspan in the United Kingdom, and in 2002,
submitted Advicor for marketing approval in the United Kingdom. In November 2003, Merck launched
the sale of Niaspan in the United Kingdom. Following this initial launch and the December 2003,
completion of the European Unions Mutual Recognition Procedure (MRP), Niaspan has since been
approved in a total of 13 European markets, including such other markets as France, Germany,
Austria, Ireland, Belgium and the Netherlands. Merck and Kos have also initiated a second wave of
the MRP for the additional 10 European countries that were recently added to the list of European
Union countries. Niaspan has also been approved in other countries outside the European Union,
including Lebanon and certain Latin American countries. There is no certainty that further
marketing authorization for the Niaspan product and final authorization for the Advicor product
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
$3.8 million of the upfront payments and may not receive any further 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 Niaspan,
Advicor and Azmacort products 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, 2004, approximately $845 million, or 73%, of the Companys
cumulative Niaspan, Advicor and Azmacort revenue 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 48




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and reduced demand for Niaspan, Advicorand
Azmacortproducts, 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, Azmacort
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, Advicorand Azmacortproducts from many third-party
payors, such approvals, in the United States and in foreign countries, may be discontinued or
unavailable for its existing products or any of the Companys products under development. The
unavailability or inadequacy of third-party reimbursement for Niaspan, Advicor, Azmacortor 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 Niaspan, Advicorand
Azmacortproducts, 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. 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 49




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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 it 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. 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 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 Niaspan
and Advicorproducts 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 50




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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 addition, the Company is subject to the jurisdiction of various other federal regulatory
and enforcement departments and agencies, such as the U.S. Department of Health and Human Services,
the Federal Trade Commission and the Department of Justice. Individual states, acting through their
attorneys general, have become active as well, seeking to regulate the marketing of prescription
drugs under state consumer protection and false advertising laws. These regulatory authorities have
wide-ranging administrative powers to deal with any failure to comply with their ongoing regulatory
oversight. These powers include withdrawal of a license approval previously granted, product
recalls, seizure of products and other sanctions for non-compliance. Kos has recently learned that
the Office of the Inspector General of the U.S. Department of Health and Human Services, in
conjunction with the U.S. Department of Justice, is conducting an investigation of certain of Kos
sales practices but Kos has not been able to confirm the scope of the investigation. Kos has
engaged outside counsel to assist it in conducting its own internal investigation of its sales
practices but has not been able to reach any conclusions because of the preliminary and uncertain
nature of the information of which it is currently aware. Regulatory sanction following a failure
to comply with such ongoing regulatory oversight could have a material adverse effect on the
Companys business, financial condition and results of operations. While the Company has compliance
measures in place to maintain compliance with regulatory requirements, there can be no assurance
that employees will not deviate from the Companys policies and legal requirements in such a way
that it could have a material adverse effect on the Company. 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 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 manufacturing facility located in Edison, New Jersey. The
letter cited four deficiencies in the Companys quality systems. The Company now has remedied
these deficiencies to the satisfaction of the FDA and has regained its FDA current Good
Manufacturing Practices (cGMP) compliance status. The Companys manufacturing facilities, and those of its third party manufacturers, are and
will continue to be subject to, ongoing, periodic inspection by the FDA and state agencies to
ensure, among other things, compliance with cGMP. The
Companys (and its suppliers) 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 Niaspan, Advicorand Azmacortproducts, for commercial use or
clinical study, may result 51




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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 the FDA and other regulations. Any of the foregoing could result in the Company being unable to manufacture and supply (or
have manufactured and supplied) sufficient quantities of its Niaspan, Advicorand Azmacortproducts
to meet the demands of its customers, or to fulfill orders from its international marketing
partner. The Companys failure for any reason to manufacture and supply (or have manufactured and
supplied) sufficient quantities of the Niaspan, Advicorand Azmacortproducts 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 and duration of the manufacturing issues. Although the Company
is currently in discussions with a contract manufacturer for certain of its products, the Company
does not currently have a qualified backup manufacturing capability with a third party. In the event that the Company is not successful in its litigation with Barr, or if Barr
commences distribution of its generic ER niacin product prior to the resolution of such litigation,
then the Company may choose to enter into an arrangement with an authorized generic distributor
pursuant to which such distributor would distribute a generic version of Kos Niaspanproducts that
are manufactured by the Company. In such event, the Company would need to modify its manufacturing
processes to manufacture the generic version of its products instead of the branded versions. This
may result in the Company having inadequate supply of the generic version or the branded version,
or both. The Companys failure for any reason to manufacture and supply sufficient quantities of
either the branded or generic versions of its Niaspanproducts would have a material adverse impact
on the Company and its financial condition. 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 52




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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 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 cGMP 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. The Company obtains the Azmacortproduct pursuant to the Azmacort Supply Agreement, which will
remain in effect until at least March 31, 2009. As such, the Company relies on Aventis to
manufacture and supply adequate quantities of the finished 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
relies solely on Aventis to supply the Company with the Azmacortproduct, and the Company cannot
provide any assurances that Aventis will be able to produce sufficient quantities of the Azmacort
product 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 Azmacortproducts 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 53




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Azmacortproduct to the Company would have a material adverse effect on the Companys
financial condition and results of operations. On February 15, 2005, the Company was informed by
Aventis that it intends, by March 31, 2005, to close on a transaction to sell the manufacturing
plant where the Azmacortproduct is manufactured to a third party. Risk of Product Liability Claims; No Assurance of Adequate Insurance Manufacturing, marketing, selling, and testing Niaspan, Advicor, Azmacortand 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 17 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 Advicorproduct, 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. 54




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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, 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
    
    
    
    32.42Year Ended December 31, 2004First Quarter
    
    $
    59.41
    
    
    $
    37.06Second Quarter
    
    
    44.40
    
    
    
    29.55Third Quarter
    
    
    39.41
    
    
    
    28.00Fourth Quarter
    
    
    45.74
    
    
    
    33.45
 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,
the outcome of the litigation with Barr, publicity regarding actual or potential medical results
relating to the Niaspan, Advicorand Azmacortproducts 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 Niaspan, Advicorand Azmacort
products 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 55




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acquired in certain takeovers without the approval of the Board of Directors or the approval
by a majority 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. 56




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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, 2004, the Company had $19 million of variable rate
indebtedness bearing interest at the prime rate (5.25% at December 31, 2004). 
 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:Managements Annual Report on Internal Control Over Financial Reporting
    
    
    58Report of Independent Registered Public Accounting Firm on Internal
Control Over Financial Reporting
    
    
    59Report of Independent Registered Public Accounting Firm
    
    
    61Consolidated Balance Sheets at December 31, 2004 and 2003
    
    
    62Consolidated Statements of Operations for the years ended
December 31, 2004, 2003, and 2002
    
    
    63Consolidated Statements of Shareholders Equity (Deficit) for
the years ended December 31, 2004, 2003, and 2002
    
    
    64Consolidated Statements of Cash Flows for the years ended
December 31, 2004, 2003, and 2002
    
    
    65Notes to Consolidated Financial Statements
    
    
    66Financial Statement Schedule:*Report
of Independent Registered Public Accounting Firm on Schedule II
    
    
    93Schedule II Valuation and Qualifying Accounts
    
    
    94
   *
    
    All other schedules for which provision is made
in the applicable accounting regulations of the Securities and Exchange
Commission are not required under the related instructions or are inapplicable,
and therefore not included herein. 57




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MANAGEMENTS ANNUAL REPORT ON INTERNAL CONTROL OVER
FINANCIAL REPORTING Our management is responsible for establishing and maintaining adequate internal control over
financial reporting for the Company. Our internal control over financial reporting is a process
designed by, or under the supervision of, our CEO and CFO, and effected by our Board of Directors,
management, and other personnel to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. Our internal control over financial reporting
includes those policies and procedures that: (1) pertain to the maintenance of records that in reasonable detail accurately and fairly
reflect our transactions and dispositions of our assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally accepted accounting principles,
and that our receipts and expenditures are being made only in accordance with authorizations of our
management and board of directors; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use or disposition of our assets that could have a material effect on the financial
statements. Internal control over financial reporting cannot provide absolute assurance of achieving
financial reporting objectives because of its inherent limitations. Internal control over
financial reporting is a process that involves human diligence and compliance and is subject to
lapses in judgment and breakdowns resulting from human failures. Internal control over financial
reporting also can be circumvented by collusion or improper management override. Because of such
limitations, there is a risk that material misstatements may not be prevented or detected on a
timely basis by internal control over financial reporting. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become inadequate because
of changes in conditions, or that the degree of compliance with the policies or procedures may
deteriorate. However, these inherent limitations are known features of the financial reporting
process. Therefore, it is possible to design into the process safeguards to reduce, though not
eliminate, this risk. Management uses the framework in Internal Control-Integrated Framework issued by the Committee
of Sponsoring Organizations of the Treadway Commission, or COSO, to evaluate the effectiveness of
our internal control over financial reporting. Management assessed our internal control over
financial reporting using the COSO framework as of the end of our fiscal year. Based on our
evaluation under the framework in Internal Control  Integrated Framework, we believe our internal
control over financial reporting as of December 31, 2004 was effective. Ernst & Young LLP, an independent registered public accounting firm that audited our financial
statements included in this Annual Report on Form 10-K, has issued an attestation report on
managements assessment of our internal control over financial reporting. Such attestation, which
expresses unqualified opinions on managements assessment and on the effectiveness of our internal
control over financial reporting as of December 31, 2004, is included in this Item 8 under the
heading Report of Independent Registered Public Accounting Firm On Internal Control Over Financial
Reporting. 58




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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON INTERNAL CONTROL OVER FINANCIAL REPORTING The Board of Directors and Shareholders of Kos Pharmaceuticals, Inc. We have audited managements assessment, included in the accompanying Managements Annual
Report on Internal Control Over Financial Reporting, that Kos Pharmaceuticals, Inc. maintained
effective internal control over financial reporting as of December 31, 2004, based on criteria
established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (the COSO criteria). Kos Pharmaceuticals, Inc.s
management is responsible for maintaining effective internal control over financial reporting and
for its assessment of the effectiveness of internal control over financial reporting. Our
responsibility is to express an opinion on managements assessment and an opinion on the
effectiveness of the companys internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether effective internal control over financial reporting was
maintained in all material respects. Our audit included obtaining an understanding of internal
control over financial reporting, evaluating managements assessment, testing and evaluating the
design and operating effectiveness of internal control, and performing such other procedures as we
considered necessary in the circumstances. We believe that our audit provides a reasonable basis
for our opinion. A companys internal control over financial reporting is a process designed to provide
reasonable assurance regarding the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with generally accepted accounting
principles. A companys internal control over financial reporting includes those policies and
procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately
and fairly reflect the transactions and dispositions of the assets of the company; (2) provide
reasonable assurance that transactions are recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting principles, and that receipts and
expenditures of the company are being made only in accordance with authorizations of management and
directors of the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the companys assets that could have
a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent
or detect misstatements. Also, projections of any evaluation of effectiveness to future periods
are subject to the risk that controls may become inadequate because of changes in conditions, or
that the degree of compliance with the policies or procedures may deteriorate. In our opinion, managements assessment that Kos Pharmaceuticals, Inc. maintained effective
internal control over financial reporting as of December 31, 2004, is fairly stated, in all
material respects, based on the COSO criteria. Also, in our opinion, Kos Pharmaceuticals, Inc.
maintained, in all material respects, effective internal control over financial reporting as of
December 31, 2004, based on the COSO criteria. 59




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We also have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated balance sheets of Kos Pharmaceuticals, Inc. and
subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of income,
shareholders equity, and cash flows for each of the three years in the period ended December 31,
2004 of Kos Pharmaceuticals, Inc. and our report dated March 2, 2005 expressed an unqualified
opinion thereon. /s/ Ernst & Young LLP
Certified Public Accountants Miami, Florida
March 2, 2005 60




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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Board of Directors and Shareholders of Kos Pharmaceuticals, Inc. We have audited the accompanying consolidated balance sheets of Kos Pharmaceuticals, Inc. and
subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of income,
shareholders equity, and cash flows for each of the three years in the period ended December 31,
2004. 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 the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material
respects, the consolidated financial position of Kos Pharmaceuticals, Inc. and subsidiaries at
December 31, 2004 and 2003, and the consolidated results of their operations and their cash flows
for each of the three years in the period ended December 31, 2004, in conformity with U.S.
generally accepted accounting principles. We also have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the effectiveness of Kos Pharmaceuticals Inc.s internal control
over financial reporting as of December 31, 2004, based on criteria established in Internal
Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission and our report dated March 2, 2004 which expressed an unqualified opinion thereon. /s/ Ernst & Young LLP
Certified Public Accountants Miami, Florida,
March 2, 2005 61




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KOS PHARMACEUTICALS, INC. AND SUBSIDIARIES 
 CONSOLIDATED BALANCE SHEETS December 31,2004
    
    
    2003ASSETSCurrent Assets:Cash and cash equivalents
    
    $
    258,702,556
    
    
    $
    259,957,534Trade accounts receivable, net
    
    
    74,567,946
    
    
    
    37,465,695Inventories, net
    
    
    10,649,370
    
    
    
    6,406,125Prepaid expenses and other current assets
    
    
    11,571,944
    
    
    
    10,123,004Current deferred tax asset, net
    
    
    41,185,755
    
    
    
    Total current assets
    
    
    396,677,571
    
    
    
    313,952,358Fixed Assets, net
    
    
    23,340,585
    
    
    
    17,841,356Long Term Deferred Tax Asset, net
    
    
    13,346,245
    
    
    
    Intangible Assets, net
    
    
    150,078,880
    
    
    
    Other Assets
    
    
    3,482,467
    
    
    
    3,727,457Total assets
    
    $
    586,925,748
    
    
    $
    335,521,171LIABILITIES AND SHAREHOLDERS
EQUITYCurrent Liabilities:Accounts payable
    
    $
    9,160,532
    
    
    $
    7,784,968Accrued expenses
    
    
    104,898,205
    
    
    
    43,313,390Advance payment received on license agreement,
net of amortized amount
    
    
    18,384,492
    
    
    
    14,770,794Note payable to shareholder
    
    
    19,000,000
    
    
    
    Current portion of capital lease obligations
    
    
    131,820
    
    
    
    24,614Total current liabilities
    
    
    151,575,049
    
    
    
    65,893,766Notes Payable to Shareholder, net of current portion
    
    
    
    
    
    
    30,000,000Capital Lease Obligations, net of current portion
    
    
    208,518
    
    
    
    Commitments and Contingencies (Notes 1, 12 and 14)Shareholders Equity:Preferred stock, $.01 par value, 10,000,000 shares authorized,
none issued and outstanding
    
    
    
    
    
    
    Common stock, $.01 par value, 50,000,000 shares authorized,
40,211,375 and 36,791,290 shares issued and outstanding as of
December 31, 2004 and 2003, respectively
    
    
    402,114
    
    
    
    367,913Additional paid-in capital
    
    
    526,462,711
    
    
    
    473,601,791Restricted stock grant
    
    
    (94,568
    )
    
    
    (394,895
    )Accumulated deficit
    
    
    (91,628,076
    )
    
    
    (233,947,404
    )Total shareholders equity
    
    
    435,142,181
    
    
    
    239,627,405Total liabilities and shareholders equity
    
    $
    586,925,748
    
    
    $
    335,521,171
 The accompanying notes are an integral part of these financial statements. 62




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KOS PHARMACEUTICALS, INC. AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF OPERATIONS For the Year Ended December 31,2004
    
    
    2003
    
    
    2002Net sales
    
    $
    495,544,530
    
    
    $
    293,907,409
    
    
    $
    172,692,718Licensing revenue
    
    
    1,559,359
    
    
    
    
    
    
    
    Total revenue
    
    
    497,103,889
    
    
    
    293,907,409
    
    
    
    172,692,718Cost of
sales (for 2004, does not include $10.3 million of amortization
charges related to the Azmacortdeveloped and core technology intangible
asset acquired from Aventis; see Note 6)
    
    
    36,925,890
    
    
    
    20,038,529
    
    
    
    15,361,756460,177,999
    
    
    
    273,868,880
    
    
    
    157,330,962Operating expenses:Research and development
    
    
    111,064,304
    
    
    
    52,202,981
    
    
    
    43,980,867Selling, general and administrative
    
    
    235,717,688
    
    
    
    156,469,215
    
    
    
    130,144,643Total operating expenses
    
    
    346,781,992
    
    
    
    208,672,196
    
    
    
    174,125,510Income (loss) from operations
    
    
    113,396,007
    
    
    
    65,196,684
    
    
    
    (16,794,548
    )Other expense (income):Interest income, net
    
    
    (2,387,839
    )
    
    
    (613,984
    )
    
    
    (160,274
    )Interest expense, related parties
    
    
    1,209,465
    
    
    
    3,316,367
    
    
    
    4,038,563Interest expense, other
    
    
    8,415
    
    
    
    3,575
    
    
    
    7,306Other expense (income)
    
    
    (3,577,304
    )
    
    
    198,332
    
    
    
    136,021Total other expense (income)
    
    
    (4,747,263
    )
    
    
    2,904,290
    
    
    
    4,021,616Income (loss) before provision for income taxes
    
    
    118,143,270
    
    
    
    62,292,394
    
    
    
    (20,816,164
    )Provision for / (Benefit from) income taxes
    
    
    (24,176,058
    )
    
    
    2,878,821
    
    
    
    Net income (loss)
    
    $
    142,319,328
    
    
    $
    59,413,573
    
    
    $
    (20,816,164
    )Basic earnings (loss) per share of Common Stock
    
    $
    3.76
    
    
    $
    2.71
    
    
    $
    (1.01
    )Diluted earnings (loss) per share of Common Stock
    
    $
    3.13
    
    
    $
    1.53
    
    
    $
    (1.01
    )Weighted average shares of Common Stock and
Common Stock equivalents outstanding:Basic
    
    
    37,897,597
    
    
    
    21,913,928
    
    
    
    20,582,205Diluted
    
    
    45,835,563
    
    
    
    41,033,325
    
    
    
    20,582,205
 The accompanying notes are an integral part of these financial statements. 63




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KOS PHARMACEUTICALS, INC. AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY (DEFICIT) Common Stock
    
    
    Additional Paid-
    
    
    Restricted
    
    
    AccumulatedShares
    
    
    Amount
    
    
    in Capital
    
    
    Stock Grant
    
    
    Deficit
    
    
    TotalBalance 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
    )
    
    
    239,627,405Conversion of Note Payable to
Shareholder to Common Stock
    
    
    2,200,000
    
    
    
    22,000
    
    
    
    10,978,000
    
    
    
    
    
    
    
    
    
    
    
    11,000,000Common Stock issued to employees
under Kos Savings Plan
    
    
    41,139
    
    
    
    411
    
    
    
    1,569,215
    
    
    
    
    
    
    
    
    
    
    
    1,569,626Issuance of Common Stock to employees
under Stock Purchase Plan
    
    
    110,778
    
    
    
    1,108
    
    
    
    2,632,027
    
    
    
    
    
    
    
    
    
    
    
    2,633,135Exercise of stock options
    
    
    1,068,168
    
    
    
    10,682
    
    
    
    15,433,678
    
    
    
    
    
    
    
    
    
    
    
    15,444,360Compensation expense on restricted
Common Stock grant
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    300,327
    
    
    
    
    
    
    
    300,327Tax benefit of stock option exercises
    
    
    
    
    
    
    
    
    
    
    22,248,000
    
    
    
    
    
    
    
    
    
    
    
    22,248,000Net income
    
    
    
    
    
    
    
    

    
    
    
    
    
    
    
    
    
    
    142,319,328
    
    
    
    142,319,328Balance at December 31, 2004
    
    
    40,211,375
    
    
    $
    402,114
    
    
    $
    526,462,711
    
    
    $
    (94,568
    )
    
    $
    (91,628,076
    )
    
    $
    435,142,181
 The accompanying notes are an integral part of these financial statements. 64




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KOS PHARMACEUTICALS, INC. AND SUBSIDIARIES 
 CONSOLIDATED STATEMENTS OF CASH FLOWS For the Year Ended December 31,2004
    
    
    2003
    
    
    2002Cash Flows from Operating Activities:Net Income (Loss)
    
    $
    142,319,328
    
    
    $
    59,413,573
    
    
    $
    (20,816,164
    )Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities -Provision for doubtful accounts
    
    
    237,577
    
    
    
    217,143
    
    
    
    150,000Depreciation
    
    
    4,311,529
    
    
    
    3,310,964
    
    
    
    2,110,538Amortization
    
    
    10,982,631
    
    
    
    
    
    
    
    Provision for inventory obsolescence
    
    
    959,859
    
    
    
    770,538
    
    
    
    480,000Recognition of deferred revenue under license agreement
    
    
    (1,136,306
    )
    
    
    
    
    
    
    Reimbursement recognized under license agreement
    
    
    (249,996
    )
    
    
    (229,206
    )
    
    
    Loss from disposal of fixed assets
    
    
    364,293
    
    
    
    197,606
    
    
    
    131,806Deferred income tax benefit
    
    
    (24,176,058
    )
    
    
    
    
    
    
    Common Stock issued to employees under Kos Savings Plan
    
    
    1,569,626
    
    
    
    1,079,327
    
    
    
    761,315Compensation expense on restricted stock grant
    
    
    300,327
    
    
    
    299,626
    
    
    
    300,000Compensation cost on Common Stock warrants and options
    
    
    
    
    
    
    2,534,231
    
    
    
    211,500Tax benefit of stock option exercises
    
    
    22,248,000
    
    
    
    1,133,431
    
    
    
    Write-off of acquired in-process research and development
    
    
    38,000,000
    
    
    
    
    
    
    
    Changes in operating assets and liabilities:Trade accounts receivable
    
    
    (37,339,828
    )
    
    
    (15,982,827
    )
    
    
    (10,560,920
    )Inventories
    
    
    1,796,896
    
    
    
    (1,249,649
    )
    
    
    1,325,155Prepaid expenses and other current assets
    
    
    (1,448,940
    )
    
    
    (4,228,711
    )
    
    
    2,072,165Deferred tax assets
    
    
    (30,355,942
    )
    
    
    
    
    
    
    Other assets
    
    
    10,000
    
    
    
    (74,152
    )
    
    
    10,592Accounts payable
    
    
    1,375,564
    
    
    
    597,447
    
    
    
    2,490,167Accrued expenses
    
    
    61,584,815
    
    
    
    11,152,668
    
    
    
    8,456,207Advance payments from customers
    
    
    
    
    
    
    (9,128,668
    )
    
    
    2,437,476Advance payment received on license agreement
    
    
    5,000,000
    
    
    
    5,796,875
    
    
    
    9,203,125Net cash provided by (used in) operating activities
    
    
    196,353,375
    
    
    
    55,610,216
    
    
    
    (1,237,038
    )Cash Flows from Investing Activities:Capital expenditures and deposits on fixed
assets to be acquired
    
    
    (9,535,881
    )
    
    
    (11,043,794
    )
    
    
    (6,729,750
    )Product acquisition
    
    
    (206,061,511
    )
    
    
    
    
    
    
    Purchases of marketable securities
    
    
    
    
    
    
    (13,564,297
    )
    
    
    Sales of marketable securities
    
    
    
    
    
    
    13,564,297
    
    
    
    Net cash used in investing activities
    
    
    (215,597,392
    )
    
    
    (11,043,794
    )
    
    
    (6,729,750
    )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
    
    
    2,633,135
    
    
    
    1,982,818
    
    
    
    1,624,954Net proceeds from exercise of stock options
    
    
    15,444,360
    
    
    
    13,616,948
    
    
    
    1,648,582Borrowings under Notes Payable to Shareholder
    
    
    
    
    
    
    
    
    
    
    18,000,000Payments of Notes Payable to Shareholder
    
    
    
    
    
    
    (4,000,000
    )
    
    
    (39,000,000
    )Payments under capital lease obligations
    
    
    (88,456
    )
    
    
    (57,285
    )
    
    
    (53,253
    )Net cash provided by (used in) financing activities
    
    
    17,989,039
    
    
    
    195,819,066
    
    
    
    (17,779,717
    )Net increase (decrease) in cash and cash equivalents
    
    
    (1,254,978
    )
    
    
    240,385,488
    
    
    
    (25,746,505
    )Cash and Cash Equivalents, beginning of period
    
    
    259,957,534
    
    
    
    19,572,046
    
    
    
    45,318,551Cash and Cash Equivalents, end of period
    
    $
    258,702,556
    
    
    $
    259,957,534
    
    
    $
    19,572,046Supplemental Disclosure of Cash Flow Information:Interest paid
    
    $
    1,444,801
    
    
    $
    3,075,218
    
    
    $
    3,833,472Income taxes paid
    
    
    5,454,000
    
    
    
    2,459,898
    
    
    
    130,702Supplemental Disclosure of Non-cash Information:Conversion of Note Payable to Shareholder to Common Stock
(See Note 8)
    
    $
    11,000,000
    
    
    $
    50,000,000
    
    
    $
    Acquisition of equipment under capital lease obligations
    
    
    404,180
    
    
    
    
    
    
    
    
 The accompanying notes are an integral part of these financial statements. 65




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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s prescribing 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 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. On March 8, 2004, the Company announced that it had entered into a product acquisition
agreement with Aventis Pharmaceuticals Holdings Inc. (the Azmacort Acquisition Agreement) and a
finished product supply agreement (the Azmacort Supply Agreement and together with the Azmacort
Acquisition Agreement, the Aventis Agreements) with Aventis Pharmaceuticals Inc. (collectively
with Aventis Pharmaceuticals Holdings Inc., Aventis) to acquire global rights to the Azmacort®
(triamcinolone acetonide) inhalation aerosol franchise. The transaction was completed on March 31,
2004. Accordingly, Kos began recording revenue for all sales related to the Azmacortproduct
beginning April 1, 2004. 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 and his transferees; 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
and the outcome of litigation related to the Companys intellectual property, including the
litigation with Barr Laboratories, Inc.; uncertainties relating to the timing of any generic entry
into the ER niacin market; uncertainties related to competition and 66




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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. 2. Summary of Significant Accounting Policies Basis of Presentation The consolidated financial statements include the results of the Company and its subsidiaries,
Aeropharm Technology, LLC and Kos Life Sciences, LLC. All intercompany accounts and transactions
have been eliminated in consolidation. Reclassification Balances related to the Companys sales returns and allowances have been reclassified on the
Companys Consolidated Financial Statements and Related Notes to Consolidated Financial Statements
as of December 31, 2003, 2002 and 2001, in order to conform to the current year presentation. 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, managed care rebates, reimbursements relating
to Medicaid and Medicare discounts and other sales allowances; estimation of customer inventory
levels; estimation of the useful lives and realizability of recorded intangible assets; and the
accounting for 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. 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 of its trade accounts
receivable. 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 Advicor
products are available from a limited number of suppliers. The Company obtains the Azmacortproduct
pursuant to a supply agreement with Aventis that will remain in effect until at least March 31,
2009. As such, the 67




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Company relies on Aventis to manufacture and supply adequate quantities of the finished
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 relies solely on Aventis to supply the Company with the
Azmacortproduct. The Company is also dependent on its other 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. 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, 2004 or 2003. Fair Value of Financial Instruments As of December 31, 2004 and 2003, 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, 94% of the trade accounts
receivable before allowances at December 31, 2004, 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. 68




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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 revenue by product for the years ended
December 31, 2004, 2003 and 2002, respectively, are as follows: December 31,2004
    
    
    2003
    
    
    2002Niaspan
    
    $
    319,071,000
    
    
    $
    226,541,000
    
    
    $
    145,646,000Advicor
    
    
    108,197,000
    
    
    
    67,366,000
    
    
    
    27,047,000Azmacort
    
    
    68,277,000
    
    
    
    
    
    
    
    Other
    
    
    1,559,000
    
    
    
    
    
    
    
    Total
    
    $
    497,104,000
    
    
    $
    293,907,000
    
    
    $
    172,693,000
 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 and government units with whom the Company has contracts. These provisions totaled
$180.3 million, $83.0 million, and $44.4 million for the years ended December 31, 2004, 2003 and
2002, respectively. The most significant of
 these amounts is the Companys provision for rebates and chargebacks to managed care
organizations and governmental units.  For the years ended December
31, 2004 and 2003, Kos
 provision for managed care and government rebates and chargebacks increased as a percentage
of gross sales by 22% and 14%, respectively, over the preceding period, mostly as a result
 of increased availability of the Companys Niaspan and Advicor products to patients having
access to medical care through managed care organizations and government units, including the
second quarter 2004 Kos introduction of the Azmacort product. Included in Accrued expenses in the accompanying consolidated balance sheets
are $52.8 million and $20.3 million at December 31, 2004 and 2003, respectively, related to these
provisions. The most pertinent inputs used in the estimation of the Companys sales allowances and
accruals, and product inventory levels in its distribution channel
(as discussed below), include prescription data (derived from a third party publication), consumer price index
(derived from a third party publication), product best price (derived from the Companys
contractual arrangements), and average manufacturer price (AMP) (computational in nature using
historical data). Of these inputs, prescription data and AMP require significant estimation. Accounting for Product Returns  Impact on Revenue Recognition The
Companys return policy allows a customer to return product no
sooner than six months prior to the products expiration date
and no later than one year after the products expiration date. The Company periodically evaluates the volume of its 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 Niaspanand Advicorproducts 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 be required to not recognize the
revenue and related costs associated with the excess inventory until such return risk is mitigated. 69




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Shipping and Handling Costs The Company typically does not charge customers for shipping and handling costs. Shipping and
handling costs are classified as Cost of sales in the accompanying Consolidated Statements of
Operations. International Commercialization Agreement with Merck 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 (the Merck Agreement). Under terms of the Merck Agreement, Merck will
provide Kos up to $61.0 million in licensing, upfront, milestone and reimbursement payments. Kos,
which manufactures the product supplied to Merck, receives licensing revenue amounting to 25% of
net sales of the products in the territory, which includes the cost of goods sold, and upfront and
milestone payments upon the achievement of certain regulatory approvals and sales thresholds.
During the year ended December 31, 2004, Kos received $5.0 million from Merck related to the
attainment of certain milestones and, through December 31, 2004, has received $20.0 million in
upfront, reimbursement, and milestone payments from Merck, including $15.0 million of upfront and
reimbursement payments (of which $3.8 million is currently refundable to Merck if Kos fails to
achieve certain regulatory milestones). Merck is 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. The Companys policy with respect to the Merck Agreement is to (i) record licensing revenue as
the product sales are made by Merck; (ii) record milestone and upfront payments as licensing
revenue following milestone attainment by systematically recognizing such payments as revenue over
the then remaining agreement period, using the straight-line method; and (iii) record reimbursement
payments received from Merck by systematically recognizing such payments as an offset to operating
expenses over the then remaining agreement period, using the straight-line method. For the year ended December 31, 2004, the Company recorded $1.6 million of licensing revenue
and amortization of upfront and milestone payments received pursuant to the Merck Agreement. During
the years ended December 31, 2004 and 2003, the Company also recorded $0.3 million and $0.2
million, respectively, as an offset to research and development expenses pursuant to the Merck
Agreement. The Company expects to continue to recognize as revenue or as an offset to research and
development expenses, over the remaining term of the Merck Agreement, the upfront, reimbursement
and milestones payments received from Merck. Included in Advance payment received on license
agreement, net of amortized amount in the accompanying consolidated balance sheet as of December
31, 2004, are $18.4 million related to upfront, reimbursement and milestone payments received from
Merck that are expected to be recognized as licensing revenue or as an offset to research and
development expenses in future periods. Co-Promotion and Strategic Alliance Arrangements 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 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
significant promotional effort 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 collects and records all sales associated with its products. Takeda receives 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 70




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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 7-10
years or lives of
leases
 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 $7.5 million, $6.8 million, and $7.3 million in advertising
expense for the years ended December 31, 2004, 2003 and 2002, respectively. Income Taxes The
provisions of Statement of Financial Accounting Standards
(SFAS) No. 109, Accounting for Income Taxes
(SFAS 109) require, among other things, recognition of future tax benefits measured at enacted rates attributable
to the deductible temporary differences between the financial
statement and income tax bases of assets and liabilities and to tax net operating loss carryforwards to the
extent that the realization of such benefits is more likely
than not (see Note 9). Under SFAS 109, deferred tax
assets and liabilities are determined based on the difference between the financial statement and tax bases of
assets and liabilities, using enacted tax rates in effect for the year in which the differences are expected to reverse. 71




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Earnings (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: 2004
    
    
    2003
    
    
    2002Numerator:Net income (loss)
    
    $
    142,319,328
    
    
    $
    59,413,573
    
    
    $
    (20,816,164
    )Interest expense from convertible debt
    
    
    1,209,465
    
    
    
    3,316,367
    
    
    
    N/ADiluted net income (loss)
    
    $
    143,528,793
    
    
    $
    62,729,940
    
    
    $
    (20,816,164
    )Denominator:Basic weighted average number of
shares outstanding
    
    
    37,897,597
    
    
    
    21,913,928
    
    
    
    20,582,205Effect of dilutive securities:Stock options
    
    
    2,372,889
    
    
    
    3,078,860
    
    
    
    Non-detachable warrants (See Note 8)
    
    
    5,542,077
    
    
    
    6,000,000
    

    
    
    Convertible debt (See Note 8)
    
    
    
    
    
    
    10,032,113
    
    
    
    Other Common Stock warrants
shares outstanding (See Note 12)
    
    
    23,000
    
    
    
    8,424
    
    
    
    Diluted weighted average number of
shares outstanding
    
    
    45,835,563
    
    
    
    41,033,325
    
    
    
    20,582,205Basic earnings (loss) per share of
Common Stock
    
    $
    3.76
    
    
    $
    2.71
    
    
    $
    (1.01
    )Diluted earnings (loss) per share of
Common Stock
    
    
    3.13
    
    
    
    1.53
    
    
    
    (1.01
    )
 The following Common Stock equivalents have been excluded from the calculation of weighted
average shares outstanding because their impact is antidilutive: 2004
    
    
    2003
    
    
    2002Stock options
    
    
    2,950,125
    
    
    
    167,000
    
    
    
    6,544,822Non-detachable warrants (See Note 8)
    
    
    
    
    
    
    
    
    
    
    6,000,000Convertible debt (See Note 8)
    
    
    
    
    
    
    
    
    
    
    10,183,299Total
    
    
    2,950,125
    
    
    
    167,000
    
    
    
    22,728,121
 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. 72




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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). Consequently,
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: 2004
    
    
    2003
    
    
    2002Net income (loss):As reported
    
    $
    142,319,328
    
    
    $
    59,413,573
    
    
    $
    (20,816,164
    )Option modification expense
under APB 25
    
    
    
    
    
    
    774,368
    
    
    
    Stock-based employee
compensation expense
under fair value method
    
    
    (24,990,213
    )
    
    
    (22,373,131
    )
    
    
    (14,837,272
    )Pro forma
    
    $
    117,329,115
    
    
    $
    37,814,810
    
    
    $
    (35,653,436
    )Net income (loss) per share:As reported:Basic
    
    $
    3.76
    
    
    $
    2.71
    
    
    $
    (1.01
    )Diluted
    
    
    3.13
    
    
    
    1.53
    
    
    
    (1.01
    )Pro forma:Basic
    
    $
    3.10
    
    
    $
    1.73
    
    
    $
    (1.73
    )Diluted
    
    
    2.63
    
    
    
    1.02
    
    
    
    (1.73
    )Number of shares used in
calculation:As reported:Basic
    
    
    37,897,597
    
    
    
    21,913,928
    
    
    
    20,582,205Diluted
    
    
    45,835,563
    
    
    
    41,033,325
    
    
    
    20,582,205Pro forma:Basic
    
    
    37,897,597
    
    
    
    21,913,928
    
    
    
    20,582,205Diluted
    
    
    45,137,279
    
    
    
    40,332,908
    
    
    
    20,582,205
 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 73




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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 a company
is not required to consolidate but in which it has a significant
variable interest. FIN 46(R) was
effective for all variable interest entities no later than March 31, 2004, and in the case of
certain variable interest entities, was applicable as of earlier
dates. The adoption of FIN 46(R)
did not impact the Companys financial position or results of operations because the Company does
not have any variable interest entities or SPEs. In November 2004, the FASB issued SFAS 151, Inventory Costs (SFAS 151). SFAS 151 requires
that the allocation of fixed production overhead costs be based on the normal capacity of the
production facilities and that unallocated overhead costs be recognized as an expense in the period
incurred. In addition, other items such as abnormal freight, handling costs and wasted materials
require treatment as current period charges rather than as a portion of the inventory cost. SFAS
151 is effective for inventory costs incurred during periods beginning after June 15, 2005. The
Company is currently evaluating the impact of the adoption of SFAS 151 on its consolidated
financial statements. In December 2004, the FASB issued SFAS 123R, Share-Based Payment(SFAS 123R). SFAS 123R
requires measurement of all employee stock-based compensation awards using a fair value method and
the recording of such expense in the consolidated financial statements. In addition, the adoption
of SFAS 123R will require additional accounting related to the income tax effects and additional
disclosure regarding the cash flow effects resulting from share-based payment arrangements. SFAS
123R is effective for the Company beginning in the third quarter of 2005. The Company is evaluating
the requirements of SFAS 123R and it expects that the adoption of SFAS 123R will have a material
impact on its results operations and financial condition. The Company has not yet determined
whether the adoption of SFAS 123R will result in stock-based compensation charges that are similar
to the current pro forma disclosures under SFAS 123. 3. Trade Accounts Receivable, net Trade accounts receivable consist of the following: December 31,2004
    
    
    2003Trade accounts receivable
    
    $
    77,910,655
    
    
    $
    40,081,737Less: Sales returns and allowances
    
    
    (2,814,709
    )
    
    
    (2,092,942
    )Allowance for doubtful accounts
    
    
    (528,000
    )
    
    
    (523,100
    )Trade accounts receivable, net
    
    $
    74,567,946
    
    
    $
    37,465,695
 4. Inventories, net Inventories consist of the following: December 31,2004
    
    
    2003Raw materials
    
    $
    2,199,352
    
    
    $
    1,775,488Work in process
    
    
    4,160,583
    
    
    
    3,440,691Finished goods
    
    
    4,289,435
    
    
    
    1,189,946Total inventories
    
    $
    10,649,370
    
    
    $
    6,406,125
 74




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5. Fixed Assets, net Fixed assets consist of the following: December 31,2004
    
    
    2003Furniture and equipment
    
    $
    3,665,108
    
    
    $
    2,386,196Computer software and hardware
    
    
    10,548,445
    
    
    
    8,617,067Laboratory and manufacturing equipment
    
    
    12,662,199
    
    
    
    12,326,359Leasehold improvements
    
    
    15,776,388
    
    
    
    10,675,350Fixed assets, gross
    
    
    42,652,140
    
    
    
    34,004,972Less accumulated depreciation
    
    
    (19,311,555
    )
    
    
    (16,163,616
    )Fixed assets, net
    
    $
    23,340,585
    
    
    $
    17,841,356
 The Company recorded depreciation expense of $4.3 million, $3.3 million, and $2.1 million for
the years ended December 31, 2004, 2003 and 2002, respectively. 6. Product Acquisition and Intangible Assets As previously discussed, on March 8, 2004, the Company announced that it had entered into a
product acquisition agreement and a finished product supply agreement with Aventis to acquire
global rights to the AzmacortÒ (triamcinolone acetonide) inhalation aerosol franchise. Under
the terms of the Aventis Agreements, Kos paid Aventis approximately $206.1 million in cash and has
agreed to pay a royalty on future sales of another version of the product to be developed, a
chlorofluorocarbon (CFC)-free product that was being developed by Aventis. Under the terms of the
finished product supply agreement, Aventis has agreed to supply finished product to Kos for a
period of five years. The purchase price has been allocated based on an estimate of the fair value
of assets acquired and liabilities assumed: Component
    
    Estimated Value
    
    
    Weighted Average Life(in years)Developed and Core
Technology
    
    $
    154,429,211
    
    
    10Supply Contract
    
    
    4,050,300
    
    
    5Trademark
    
    
    2,341,000
    
    
    IndefiniteOther Intangibles
    
    
    241,000
    
    
    5In-process Research and
Development
    
    
    38,000,000
    
    
    N/AInventory
    
    
    7,000,000
    
    
    N/ATotal
    
    $
    206,061,511
 The $38.0 million value assigned to in-process research and development of the CFC-free
product was recorded as a research and development expense in the accompanying condensed
consolidated statement of operations during the quarter ended March 31, 2004 (the In-process R&D
Write-off). The In-process R&D Write-off resulted in the Company also recording an approximately
$14.4 million deferred tax benefit to account for the difference between the book and tax basis of
accounting for this write-off. 75




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The amount assigned to in-process technology was determined by identifying the specific
in-process research and development projects that would be continued and for which (a)
technological feasibility has not been established as of the acquisition date, (b) there was no
alternative future use, and (c) the fair value was estimable with reasonable reliability. The
acquired in-process research and development represents a single
project, the hydrofluoroalkane (HFA)
formulation of Azmacort. The HFA formulation of Azmacortdoes not use a CFC-based propellant and,
consequently, does not deplete the Ozone Layer. The Montreal Protocol on Substances that Deplete
the Ozone Layer (the Protocol) is an international treaty under which the production and
consumption of ozone-depleting substances is being phased out worldwide. Under the Protocol,
codified by the U.S. Congress into law in Title VI of the Clean Air Act, the production of CFCs in
the U.S. was banned as of January 1, 1996, unless a specific exemption is approved annually by the
international parties to the Protocol. In order to comply with the Clean Air Act and the Montreal
Protocol, the U.S. will eventually need to phase out CFC-propelled
Metered Dose Inhalers. The AzmacortHFA formulation had not achieved technological feasibility as of the transaction
date. Among the technological matters to be resolved are: manufacturing controls and evidence of
dose proportionality between the 75 μg and 225 μg formulations. If the technological and regulatory
challenges are overcome, sales of the AzmacortHFA formulation could begin as early as 2009. The fair value of all of the in-process research and development was determined using the
income approach. This method starts with a forecast of all of the expected future net cash flows
associated with the in-process technology. These cash flows are then adjusted to present value by
applying an appropriate discount rate that reflects the risk factors associated with the cash flow
streams, some of which are more certain than others. The risk-adjusted discount rate utilized in
calculating the fair value of the AzmacortHFA formulation was 36%. Intangible assets consist of the following: December 31, 2004NetGross Carrying
    
    
    Accumulated
    
    
    CarryingAmount
    
    
    Amortization
    
    
    AmountDeveloped and Core
Technology
    
    $
    154,429,211
    
    
    $
    (10,337,175
    )
    
    $
    144,092,036Supply Contract
    
    
    4,050,300
    
    
    
    (607,800
    )
    
    
    3,442,500Other Intangibles
    
    
    241,000
    
    
    
    (37,656
    )
    
    
    203,344Trademarks*
    
    
    2,341,000
    
    
    
    
    
    
    
    2,341,000Total
    
    $
    161,061,511
    
    
    $
    (10,982,631
    )
    
    $
    150,078,880
   *
    
    Indefinite-lived intangible assets The Company calculates amortization of intangible assets based on a straight-line method using
estimated lives ranging from 5 to 22 years. The Company recorded $11.0 million of amortization
expense related to its intangible assets during the year ended December 31, 2004. Amortization
expense of intangible assets is estimated to be $14.6 million for each of the fiscal years from
2005 through 2008, and $14.0 million for 2009. The Company does not allocate to cost of sales the amortization charges related to the
developed and core technology intangible asset because such amortization is not clearly related to
the production of the Azmacortproduct as it also pertains to components related to our ability to
conduct further research and 76




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development, and market and sell the Azmacortproduct. Amortization charges related to the
developed and core technology intangible asset were $10.3 million for the year ended December 31,
2004 and are included under Selling, general and administrative expenses in the accompanying
consolidated statements of operations. 7. Accrued Expenses The components of accrued expenses are as follows: December 31,2004
    

    
    2003Managed care rebates and chargebacks
    
    $
    49,998,035
    
    
    $
    18,189,658Employee commissions and bonuses
    
    
    14,780,000
    
    
    
    8,008,725Royalties
    
    
    13,811,276
    
    
    
    2,875,583Employee vacations
    
    
    3,436,987
    
    
    
    2,690,128All other
    
    
    22,871,907
    
    
    
    11,549,296Total accrued expenses
    
    $
    104,898,205
    
    
    $
    43,313,390
 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 another 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, 2004. Borrowings,
when outstanding, will bear interest at the prime rate (5.25% as of December 31, 2004), and will be
subject to the terms and conditions of borrowings made under the Supplemental Credit Facility, as
defined below, 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
facility 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 controlled. 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 the Limited Partnership as part of the
equity offering. The Company did not receive any proceeds from such sale by the Limited Partnership
controlled 77




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by Mrs. Jaharis. On December 31, 2003, all then outstanding borrowings under the Supplemental
Credit Facility, which totaled $43,862,500 and bore interest at the prime rate, were converted into
8,933,299 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 $19 million
as of December 31, 2004, 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.
In lieu of a conversion feature, the Company 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.
Mr. Jaharis exercised 2,000,000 and 200,000 warrants to purchase shares of the Companys
Common Stock at $5.00 per share on October 13, 2004, and November 24, 2004, respectively. As of
December 31, 2004, warrants to purchase 3,800,000 shares of the Companys Common Stock remained
outstanding. 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, 2004, all of the Companys assets were pledged as collateral for the
Additional Standby Facility and the Standby Facility. On January 10, 2005, Mr. Jaharis gifted his
rights and obligations under the Companys outstanding borrowings to his wife. All other terms and
conditions of the Additional Standby Facility and the Standby Facility remain unchanged. The Company recorded $1,209,000, $3,316,000 and $4,039,000 of interest expense for the years
ended December 31, 2004, 2003 and 2002, respectively, related to its credit facilities with Mr.
Jaharis and his transferees. 9. Income Taxes The Company follows SFAS 109, which requires, among other things, recognition of future tax
benefits and liabilities measured at enacted tax 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. Through December 31, 2003, the Company had established a valuation allowance against its net
deferred tax assets because there was not sufficient evidence to conclude that the Company would
more likely than not realize all or a portion of such assets. Management currently believes,
based on the Companys historical profitability and on its expected future profitability, that the
Company will generate sufficient taxable income to realize its deferred tax assets prior to the
expiration of most net operating loss carryforwards (NOLs) and, therefore, that the Company will
more likely than not realize most of its deferred tax assets. As of December 31, 2004, the Company had deferred tax assets of approximately $58.7 million
and a remaining valuation allowance of approximately $4.2 million. Under SFAS 109, the valuation
allowance should be adjusted when a change in circumstances causes a change in judgment about the
realizability of deferred tax assets. The portion of the valuation allowance related to NOLs
expected to be utilized to offset estimated ordinary income in the current year is included in
the computation of the estimated annual effective tax rate. The portion of the valuation allowance
related to other deferred tax assets, including net operating losses expected to be utilized to
offset ordinary income in future years, is reversed 78




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as of the date of the change in circumstances. For the year ended December 31, 2004, the $24.2
million benefit from income taxes in the accompanying condensed consolidated statement of
operations includes the reversal of $71.2 million of valuation allowance, of which $67.3 million
represents the portion reversed through the effective tax rate and $3.9 million relates to the
reversal of valuation allowance on deferred tax assets to be realized through ordinary income in
future years. The composition of the net deferred tax assets is as follows: December 31,2004
    
    
    2003Current:Reserves and accruals
    
    $
    21,193,085
    
    
    $
    9,958,726Tax net operating loss carryforwards and credits
    
    
    11,972,768
    
    
    
    Intangible assets
    
    
    971,280
    
    
    
    Advance payment received on license agreement
    
    
    7,048,622
    
    
    
    5,705,542Total Current
    
    
    41,185,755
    
    
    
    15,664,268Non-current:Tax net operating loss carryforwards
    
    
    4,181,274
    
    
    
    57,891,594Intangible assets
    
    
    15,348,930
    
    
    
    1,353,588Property and equipment, principally
due to depreciation
    
    
    (2,585,414
    )
    
    
    (1,097,220
    )Other
    
    
    582,870
    
    
    
    Total Non-current
    
    
    17,527,660
    
    
    
    58,147,96258,713,415
    
    
    
    73,812,230Valuation allowance
    
    
    (4,181,415
    )
    
    
    (73,812,230
    )$
    54,532,000
    
    
    $
    
 Excluding
the benefit resulting from the $71.2 million reversal of the valuation allowance, the Company
recorded a provision for income taxes of $47.0 million for the
year ended December 31, 2004. The $47.0 million provision
for income taxes was made up of $43.1 million in federal income tax provision and $3.9 million in state income tax
provision. The $43.1 million in federal income tax provision was composed of $68.5 million of
current federal income tax provision, offset by $25.4 million of deferred federal income tax
benefits. The $3.9 million in state income tax provision was composed of $6.0 million of current
state income tax provision, offset by $2.1 million of deferred state income tax benefits. For the
year ended December 31, 2003, prior to the reversal of the valuation allowance, the company
recorded $2.9 million of income tax provision to reflect $1.3 million in federal alternative
minimum tax and $1.6 million in state income tax liabilities that could not be offset by the
Companys net operating loss carryforwards. 79




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A reconciliation between the statutory federal income tax and the income tax expense (benefit)
at the Companys effective rate for the years ended December 31, 2004, 2003 and 2002 is set forth
below: December 31,2004
    
    
    2003
    
    
    2002Computed expected income tax based
on statutory federal income tax rate
    
    $
    41,350,145
    
    
    $
    21,802,338
    
    
    $
    (7,285,657
    )State income taxes, net of federal benefit
    
    
    3,519,594
    
    
    
    2,614,495
    
    
    
    (749,384
    )Non deductible expenses
    
    
    1,787,705
    
    
    
    2,928,564
    
    
    
    1,133,120Change in valuation allowance
    
    
    (69,630,815
    )
    
    
    (25,855,662
    )
    
    
    6,901,921Other
    
    
    (1,202,687
    )
    
    
    1,389,086
    
    
    
    Provision for/(Benefit from) income taxes
    
    $
    (24,176,058
    )
    
    $
    2,878,821
    
    
    $
    
 As of December 31, 2004, the Company had available approximately $12.5 million of federal NOLs
available to offset future federal taxable income and $152.9 million of state NOLs available to
offset future state taxable income. These NOLs will expire between 2005 and 2021. In addition, the
Company had $4.7 million of tax credits to offset future federal income tax. If Kos is unable to
generate sufficient future taxable income through operating results, or if its estimates about
future profitability change significantly, increases or decreases to the valuation allowance will
be required through adjustments to income. 10. Major Customers Sales to customers that were at least 10% of the Companys net sales are as follows: December 31,2004
    
    
    2003
    
    
    2002Customer A
    
    $
    184,788,262
    
    
    $
    94,496,344
    
    
    $
    56,694,295Customer B
    
    
    134,436,596
    
    
    
    75,371,320
    
    
    
    38,504,032Customer C
    
    
    83,482,589
    
    
    
    60,620,703
    
    
    
    32,514,268Total
    
    $
    402,707,447
    
    
    $
    230,488,367
    
    
    $
    127,712,595
 80




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11. Selected Quarterly Financial Information (Unaudited) The following table summarizes selected quarterly financial data of the Company for the years
ended December 31, 2004 and 2003 (in thousands, except per share data): First
    
    
    Second
    
    
    Third
    
    
    Fourth
    
    
    FullQuarter(1)
    
    
    Quarter
    
    
    Quarter
    
    
    Quarter
    
    
    Year(1)2004Revenues, net
    
    $
    94,268
    
    
    $
    120,250
    
    
    $
    131,876
    
    
    $
    150,710
    
    
    $
    497,104Cost of sales
    
    
    6,754
    
    
    
    10,187
    
    
    
    9,561
    
    
    
    10,424
    
    
    
    36,926Operating expenses(2)
    
    
    109,093
    
    
    
    73,387
    
    
    
    77,531
    
    
    
    86,771
    
    
    
    346,782Income/(loss) from operations
    
    
    (21,579
    )
    
    
    36,676
    
    
    
    44,784
    
    
    
    53,515
    
    
    
    113,396Net income(2)(3)
    
    
    8,048
    
    
    
    38,501
    
    
    
    42,746
    
    
    
    53,024
    
    
    
    142,319Basic income per share(4)
    
    $
    0.22
    
    
    $
    1.03
    
    
    $
    1.14
    
    
    $
    1.34
    
    
    $
    3.76Diluted income per share(4)
    
    
    0.17
    
    
    
    0.83
    
    
    
    0.94
    
    
    
    1.15
    
    
    
    3.132003Revenues, 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(4)
    
    $
    0.61
    
    
    $
    0.53
    
    
    $
    0.68
    
    
    $
    0.86
    
    
    $
    2.71Diluted income per share(4)
    
    
    0.35
    
    
    
    0.31
    
    
    
    0.37
    
    
    
    0.49
    
    
    
    1.53
   (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)
    
    Includes the impact of the In-process R&D Write-off. The In-process R&D
Write-off resulted in the Company also recording an approximately $14.4 million deferred
tax benefit to account for the difference between the book and tax basis of accounting for
this write-off.(3)
    
    Includes a benefit from income taxes resulting from the reversal of $71.2
million of valuation allowance, of which $67.3 million represents the portion reversed
through the effective tax rate and $3.9 million relates to the reversal of valuation
allowance on deferred tax assets to be realized through ordinary income in future years.(4)
    
    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. 12. 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 terms of the Letter of Credit Facility as of December 31,
2003, letters of credit outstanding could not exceed 90% of the Companys cash balance kept at such
bank. During 2004, the terms of the Letter of Credit Facility were amended and a balance held in
such bank was no longer required. As of December 31, 2004 and 2003, letters of credit outstanding
totaled $15.4 million and $16.0 million, respectively. As of December 31, 2003, cash and cash
equivalents of $17.8 million were pledged as collateral on such letters of credit. 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, 2004, the Company had open purchase commitments totaling $10.4 million. 81




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Employment and Royalty Agreements As of December 31, 2004, the Company had employment and/or royalty agreements with three of
its current 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, 2004 and 2003, in the accompanying consolidated balance
sheets are $1.5 million and $1.0 million, respectively, related to this deferred compensation
agreement. Salary and benefits expense recorded under the employment agreements totaled $2.8
million, $1.8 million and $1.6 million, during the years ended December 31, 2004, 2003 and 2002,
respectively. Future minimum payments under the employment agreements are as follows: Year Ending December 31,
    
    Amount2005
    
    $
    1,387,0002006
    
    
    1,409,0002007
    
    
    1,106,0002008
    
    
    934,0002009
    
    
    959,000Thereafter
    
    
    1,068,000Total
    
    $
    6,863,000
 A royalty agreement with a former officer entitled the former officer to certain royalties not
to exceed an aggregate of $4.0 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 and 2002, were $0.4 million, and $1.7 million, respectively, and are included in
Selling, general and administrative in the accompanying consolidated statements of operations. A
royalty agreement with a current officer allows for certain royalties not to exceed an aggregate of
$1.5 million on sales of future products. No royalties have been incurred pursuant to the royalty
agreement with the current officer of the Company. The Company is also subject to a royalty consideration on net sales of future products
developed by IEP Pharmaceutical Devices, LLC (a wholly-owned subsidiary of Aeropharm Technology,
LLC) utilizing technology acquired from IEP Group, Inc. (the IEP 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. 82




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Operating 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,
    
    Amount2005
    
    $
    8,049,0002006
    
    
    7,639,0002007
    
    
    5,923,0002008
    
    
    3,946,0002009
    
    
    3,187,000Thereafter
    
    
    14,683,000Total
    
    $
    43,427,000
 As of December 31, 2004 and 2003, standby letters of credit of $2.9 million and $3.5 million,
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 $10.7 million, $7.4 million
and $5.7 million, during the years ended December 31, 2004, 2003 and 2002, respectively. Capital Lease Commitments The Company is the lessee of certain equipment under a capital lease which expires in the year
2007. The assets and liabilities under capital leases are recorded at the lower of the present
value of the minimum lease payments or the fair value of the asset and are included in the
Companys fixed assets. The fixed assets of the Company include the following capital lease
amounts: December 31,2004
    
    
    2003Acquisition value
    
    $
    404,180
    
    
    $
    164,590Accumulated depreciation
    
    
    (67,363
    )
    
    
    (137,144
    )Capital leases, net
    
    $
    336,817
    
    
    $
    27,446
 Assets acquired under capital leases are depreciated over the lesser of their estimated useful
lives or the term of the lease. The Company recorded depreciation expense related to its capital
leases of $95,000, $55,000 and $55,000 for the years ended December 31, 2004, 2003 and 2002,
respectively. 83




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Minimum future lease payments under capital leases as of December 31, 2004 are as follows: Year Ending December 31,
    
    Amount2005
    
    $
    144,0002006
    
    
    144,0002007
    
    
    71,000Total minimum lease payments
    
    
    359,000Less amount representing interest
    
    
    (19,000
    )Present value of net minimum lease payments
    
    $
    340,000
 The interest rate on capitalized leases outstanding as of December 31, 2004 was 4.25% and was
based on the Companys incremental borrowing rate. Interest expense related to capital lease
obligations was $8,400, $3,600 and $7,300 for the years ended December 31, 2004, 2003 and 2002,
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 and other licensing activities, the Company recorded
licensing expense of approximately $0.5 million, $0.6 million and $0.3 million, for the years ended
December 31, 2004, 2003 and 2002, respectively, and such expense 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,
    
    Amount2005
    
    $
    155,0002006
    
    
    30,0002007
    
    
    30,0002008
    
    
    30,0002009
    
    
    30,000Thereafter
    
    
    200,000Total
    
    $
    475,000
 In connection with one of these agreements, the Company is also subject to certain royalties
on net sales of the Niaspanand Advicorproducts. The Company recorded $2.5 million of royalty
expense from this agreement for each of the years ended December 31, 2004, 2003 and 2002. These
royalty expenses are included in Selling, general and administrative in the accompanying
consolidated statements of operations. Sponsored Research The Company has on-going sponsored research agreements with certain organizations. Under the
sponsored research agreement with Triad Pharmaceuticals, Inc. (Triad), a privately-held drug
discovery and design pharmaceutical company focused on developing molecules for a variety of
diseases, including orally active therapies for diabetes, cancer and cholesterol disorders, Triad
has agreed to perform research 84




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on behalf of the Company relating to the design and synthesis of molecules to increase HDL
(the Field). See Notes 15 and 16 to these Notes to Consolidated Financial Statements for more
information regarding Triad. Under the sponsored research agreements with a research center and a
university, 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 various sponsored research agreements are as
follows: Year Ending December 31,
    
    Amount2005
    
    $
    1,028,0002006
    
    
    447,0002007 and thereafter
    
    
    Total
    
    $
    1,475,000
 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 $2.0 million,
$1.0 million and $0.9 million,
during the years ended December 31, 2004, 2003 and 2002, 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 $0.7
million, $0.3 million and $0.8 million, during the years ended December 31, 2004, 2003 and 2002,
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 $16.9 million, $6.9 million and $3.2 million for the years ended December 31, 2004,
2003, and 2002 respectively, and are included in Selling, general and administrative in the
accompanying consolidated statements of operations. Through December 31, 2004, the Company had
incurred approximately $28.6 million in royalties related to the Contract Sales Force Agreement. 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 85




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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 $1.8 million
and $0.2 million 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 25% 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 for any given year. An employee is always 100% vested in the employees
elective deferral contributions to the Kos Savings Plan and vests up to 100% in the Company
matching contribution portion of such plan at 25% vesting per year of employment. The Company
recorded $1.6 million, $1.1 million and $0.8 million, in expenses related to its match of employee
contributions to the Kos Savings Plan for the years ended December 31, 2004, 2003 and 2002,
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, 2004, the Company had issued 620,228 shares of Common Stock
under the Stock Purchase Plan and had 379,772 shares reserved for future issuance. 13. 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 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 86




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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 a third
party 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 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, 2004, a maximum of 17,000,000 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 FASB
Interpretation No. 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-Free
    
    
    
    ExpectedGrant
    
    Volatility
    
    Interest
    
    Expected
    
    TermDate
    
    Rate
    
    Rate
    
    Dividends
    
    (Years)2002
    
    66.0%
    
    4.20%
    
    
    
    52003
    
    61.0%
    
    2.98%
    
    
    
    52004
    
    60.1%
    
    3.15%
    
    
    
    5
 87




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Based on calculations using the Black-Scholes option valuation model, the weighted average
fair value of options granted was $25.45, $12.28 and $13.04 during the years ended December 31,
2004, 2003 and 2002, respectively. As of December 31, 2004, the Company had outstanding options to
purchase 10,107,814 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, 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
    
    
    
    0.60
    
    
    
    
    
    
    
    44.15
    
    
    
    18.38Granted
    
    
    3,334,887
    
    
    
    29.01
    
    
    
    
    
    
    
    50.71
    
    
    
    47.26Exercised
    
    
    (1,068,168
    )
    
    
    5.06
    
    
    
    
    
    
    
    34.10
    
    
    
    14.46Canceled
    
    
    (247,172
    )
    
    
    10.67
    
    
    
    
    
    
    
    50.20
    
    
    
    30.14Outstanding, December 31, 2004
    
    
    10,107,814
 Options Outstanding
    
    
    Options ExercisableWeightedNumber
    
    
    Average
    
    Weighted
    
    
    Number
    
    
    WeightedOutstanding
    
    
    Remaining
    
    Average
    
    
    Exercisable
    
    
    AverageRange of
    
    December 31,
    
    
    Contractual
    
    Exercise
    
    
    December 31,
    
    
    ExerciseExercise Prices
    
    2004
    
    
    Life
    
    Price
    
    
    2004
    
    
    Price$   0.60
    
    
    300,000
    
    
    1.5 years
    
    $
    0.60
    
    
    
    300,000
    
    
    $
    0.604.28 to 6.24
    
    
    298,483
    
    
    3.9 years
    
    
    5.14
    
    
    
    298,483
    
    
    
    5.147.00 to 10.50
    
    
    86,825
    
    
    3.8 years
    
    
    7.45
    
    
    
    86,075
    
    
    
    7.4310.67 to 16.00
    
    
    1,029,140
    
    
    5.5 years
    
    
    13.35
    
    
    
    817,882
    
    
    
    13.1116.09 to 24.05
    
    
    4,402,114
    
    
    7.3 years
    
    
    20.26
    
    
    
    1,933,774
    
    
    
    20.1124.24 to 36.13
    
    
    891,789
    
    
    8.4 years
    
    
    30.23
    
    
    
    290,139
    
    
    
    27.6036.50 to 50.71
    
    
    3,099,463
    
    
    9.1 years
    
    
    48.71
    
    
    
    236,250
    
    
    
    43.4910,107,814
    
    
    7.5 years
    
    $
    28.02
    
    
    
    3,962,603
    
    
    $
    17.73
 At December 31, 2004, 2,918,695 shares remain reserved for issuance under the Plan, and
options to purchase 3,962,603 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 88




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made a restricted grant to the officer of 66,668 shares of Common Stock, valued at $1.2
million, or $17.97 per share (the fair market of the Common Stock on the effective date of the
agreement). The restricted stock grant vests 25% on each anniversary date of the April Employment
Agreement. The Company recorded $0.3 million of compensation expense related to the April
Employment Agreement for each of the years ended December 31, 2004, 2003 and 2002, respectively,
and such expense is included in Selling, general and administrative in the accompanying
consolidated statements of operations. 14. Legal Proceedings 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. 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 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 the
Company, 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 the Companys 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, the Company replied to Barrs declaratory judgment counterclaims by denying that
the Companys patents are invalid or not infringed. The Company also sought a declaratory judgment
that one or more of Barrs products will infringe the 145 and 181 patents. On March 4, 2003, the
Company replied to Barrs declaratory judgment counterclaims by denying that the Companys patents
are invalid or not infringed. The Company also sought a declaratory judgment that one or more of
Barrs products will infringe the 145 and 181 patents. From January 21 through February 23, 2004, the Company received numerous notices from Barr
that if had filed a Supplemental Paragraph IV Certification to each ANDA to provide for the
6,676,967 patent. On March 26, 2004, the Company filed a patent infringement lawsuit against Barr
in the SDNY asserting infringement of this patent. On April 20, 2004 Barr answered the complaint
by denying that the 967 patent is valid and infringed and seeking a declaratory judgment of
invalidity and non-infringment. Barr also sought a declaratory judgment that the 715 patent is
unenforceable; a declaratory judgment that the 145, 181, 428, 715, and 930 patents are
invalid; and a declaratory judgment that the 145, 181,428, and 930 patents are not infringed.
The fourth case was consolidated with the first three on May 10, 2004. From June 8, 2004 through July 19, 2004 the Company received numerous notices from Barr that
Barr had filed a Supplemental Paragraph IV Certification to each ANDA to provide for the 6,746,691 89




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patent. On September 3, 2004 Barr filed a complaint seeking a declaratory judgment of
invalidity of the patent. On September 30, 2004, the Company answered the complaint by denying
invalidity and counterclaiming for infringement and seeking a declaratory judgment of infringement.
Barr replied on October 20, 2004, by denying infringement of any valid and enforceable claim of
the patent. The fifth case was consolidated with the first four on September 21, 2004. From November 22, 2004 through December 21, 2004 the Company received numerous notices from
Barr that Barr had filed a Supplemental Paragraph IV Certification for each ANDA to provide for the
6,818,229 patent. The Company is currently evaluating the notices. The Hatch-Waxman Act provides for an automatic stay of the FDAs authority to grant marketing
approval to Barr that would otherwise give Barr the right to market its generic niacin product.
This stay is currently set at thirty months and is scheduled to expire on March 30, 2005. Upon the
expiration of the thirty month stay, the FDA could grant final approval to Barr and Barr could
commence the distribution of its generic ER niacin products notwithstanding Kos patents unless Kos
were able to obtain an injunction prohibiting such activities by Barr. Kos believes that Barr may
be taking certain actions to prepare for the distribution of its generic ER niacin products prior
to resolution of the legal proceedings and that Barr could begin distributing such generic products
as soon as March 30, 2005, although Kos has no way of knowing whether or when Barr might begin such
distribution. On March 7, 2005, Kos sought a temporary restraining order and preliminary
injunction preventing Barr from distributing its generic ER niacin products until the resolution of
the pending litigation, however, there can be no assurance that such measures will be granted by
the court. If Kos is not able to obtain such a restraining order and injunction, Barr could
commence marketing and selling a generic alternative to Kos Niaspanproduct as soon as the FDA
gives final approval, which could occur as early as March 30, 2005. Although Kos could seek from
Barr recovery of any damages that Kos sustains in connection with any distribution activities
conducted by Barr of a product that infringes a valid and enforceable claim in Kos patents,
whether Kos is ultimately entitled to such damages would be determined by the court in connection
with ongoing legal proceedings between Kos and Barr. If Barr were to commence selling a generic
alternative to Kos Niaspanproduct prior to the resolution of the ongoing legal proceedings
between Kos and Barr, it would have a material adverse effect on Kos and its business, financial
condition and results of operations, and could result in the termination of its marketing
arrangements with Takeda and Oryx. In addition, Kos previously issued guidance regarding its
projected financial results for 2005 would no longer be accurate and Kos would have to revise such
guidance. 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. An
Order denying the Motion for Preliminary Injunction was entered September 23, 2003. On May 24,
2004, the Third Circuit reversed the District Courts denial of the Companys Motion for
Preliminary Injunction and directed the District Court to enter a Preliminary Injunction enjoining
Andrx from using the mark Altocor. On June 10, 2004 the District Court entered a Consent Judgment
permanently enjoining Andrx from using the mark Altocor effective August 15, 2004. The same day
the District Court dismissed the trademark infringement lawsuit. In connection with the
settlement, Andrx made a one-time settlement payment of $6.0 million dollars to the Company of
which $2.0 million, representing a reimbursement of legal costs, was recorded as an offset to
general and administrative expenses and $4.0 million was recorded as other income for the year
ended December 31, 2004. In addition, the Company is subject to the jurisdiction of various other federal regulatory
and enforcement departments and agencies, such as the U.S. Department of Health and Human Services,
the Federal Trade Commission and the Department of Justice. Individual states, acting through their
attorneys general, have become active as well, seeking to regulate the marketing of prescription
drugs under state 90




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consumer protection and false advertising laws. These regulatory authorities have wide-ranging
administrative powers to deal with any failure to comply with their ongoing regulatory oversight.
These powers include withdrawal of a license approval previously granted, product recalls, seizure
of products and other sanctions for non-compliance. Kos has recently learned that the Office of the
Inspector General of the U.S. Department of Health and Human Services, in conjunction with the U.S.
Department of Justice, is conducting an investigation of certain of Kos sales practices but Kos
has not been able to confirm the scope of the investigation. Kos has engaged outside counsel to
assist it in conducting its own internal investigation of its sales practices but has not been able
to reach any conclusions because of the preliminary and uncertain nature of the information of
which it is currently aware. Regulatory sanction following a failure to comply with such ongoing
regulatory oversight could have a material adverse effect on the Companys business, financial
condition and results of operations. While the Company has compliance measures in place to maintain
compliance with regulatory requirements, there can be no assurance that employees will not deviate
from the Companys policies and legal requirements in such a way that it could have a material
adverse effect on the Company. 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. 15. Other Related Party Transaction The Company entered into a sponsored research agreement (the Sponsored Research Agreement)
and a related license agreement (the License Agreement), each dated November 8, 2004, with Triad,
which is now controlled by a limited partnership (the Triad Limited Partnership) formed by the
wife of Michael Jaharis, the Companys founder and Chairman Emeritus of the Companys Board of
Directors. At the time the agreements were executed, Mr. Jaharis directly controlled Triad. Under
the Sponsored Research Agreement, Triad has agreed to perform research on behalf of the Company in
the Field. The Sponsored Research Agreement has a two-year term ending September 30, 2005, subject
to extension, and provides for total payments by the Company during the initial two-year term of
$1.5 million. Triad commenced the sponsored research in 2003 in anticipation of the execution of
the definitive agreements. The Company paid $0.2 million to Triad in 2003 and $0.9 million, in
2004, in connection with the Sponsored Research Agreement. Under the License Agreement, Triad
granted to the Company the right to obtain exclusive, worldwide, royalty-bearing rights to all
intellectual property in the Field developed during the term of the Sponsored Research Agreement
that ultimately is embodied in a patent claim, and non-exclusive rights to all other intellectual
property in the Field developed during the term of the Sponsored Research Agreement (e.g., methods,
processes, trade secrets and technical data) that is not otherwise the subject of, or embodied in,
a patent claim. During the term of the Sponsored Research Agreement, Triad may not use the
non-exclusive intellectual property in the Field for commercial purposes. Following termination of
the Sponsored Research Agreement, Triad will pay to the Company royalties on income earned by Triad
from the commercialization of any such non-exclusive intellectual property within the Field. Triad
conducts the sponsored research on behalf of the Company pursuant to its sponsored research and
license agreements with Tufts University. See Note 16 for more information regarding Triad. Christopher P. Kiritsy, the Executive Vice President, Corporate Development and CFO of the
Company, has served as a member of the Board of Directors of Triad since 1999 as the designee of
Mr. Jaharis and receives $10,000 from Mr. Jaharis annually for serving in such capacity. In 1999,
while serving as Director of Business Planning at the Company, a non-executive officer position,
and before the Company conducted business with Triad, Mr. Kiritsy acted as advisor to Mr. Jaharis
in connection with his initial investment in Triad and received $75,000 from Mr. Jaharis for such
services. 91




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16. Subsequent Events On January 10, 2005, Mr. Jaharis gifted his rights and obligations under the Companys
outstanding borrowings to his wife. All other terms and conditions of the outstanding borrowings
remain unchanged. On February 1, 2005, the Company consummated $4 million of a proposed aggregate $8 million
investment in Triad through the purchase of shares of a new series of convertible preferred stock
of Triad (the Series F Preferred Stock). Subject to the satisfaction of certain conditions,
including Triad achieving certain agreed-upon milestones relating to its research and development
activities by August 1, 2006, the Company will purchase an additional $4 million of Series F
Preferred Stock. The investment is part of a $16.0 million round of financing for Triad, with the
remaining $8.0 million being provided by the Triad Limited Partnership under similar terms and
conditions as the Companys investment. Assuming consummation of the second $4 million investment,
the Company would own approximately 27% and the Triad Limited Partnership would own or have the
right to vote approximately 48% of the outstanding common stock of Triad on a fully diluted basis.
Under the agreements related to the investment, the Company is entitled to designate three persons,
and the Triad Limited Partnership is entitled to designate seven persons, to Triads 13-member
Board of Directors. Adrian Adams, the President and Chief Executive Officer of the Company, has
been appointed by the Company to the Triad Board of Directors and has been elected by the directors
of Triad as Chairman. The Company will appoint two additional persons to the Triad Board at a
later date. Michael Jaharis, Steven Jaharis and Kevin T. Ferro, directors of Kos, have been
appointed by the Triad Limited Partnership to the Triad Board of Directors. In connection with the closing of the investment in Triad, on February 1, 2005, Mr. Kiritsy
accepted the position of President and Chief Executive Officer of Triad and has notified the
Company that he will be resigning as Executive Vice President, Corporate Development and CFO after
his successor as CFO at the Company is found, which is expected to occur during the second quarter
of 2005. Additionally, pursuant to pre-existing contractual arrangements, Mr. Kiritsy acquired
directly from Mrs. Jaharis approximately 1% of the outstanding Triad stock on an as converted
basis, representing all of her remaining ownership interest in Triad. Mr. Kiritsy has also received
options to purchase 243,600 shares of Triad common stock under the Triad option plan. The Triad
stock currently owned by Mr. Kiritsy and the Triad stock issuable upon exercise of options granted
to Mr. Kiritsy are subject to voting agreements in favor of the Triad Limited Partnership and
Triad, respectively. On February 15, 2005, the Company was informed by Aventis that it intends, by March 31, 2005,
to close on a transaction to sell the manufacturing plant where the Azmacortproduct is
manufactured to a third party. Kos has recently learned that the Office of the Inspector General of the U.S. Department of
Health and Human Services, in conjunction with the U.S. Department of Justice, is conducting an
investigation of certain of Kos sales practices but Kos has not been able to confirm the scope of
the investigation. Kos has engaged outside counsel to assist it in conducting its own internal
investigation of its sales practices but has not been able to reach any conclusions because of the
preliminary and uncertain nature of the information of which it is currently aware. Regulatory
sanction following a failure to comply with such ongoing regulatory oversight could have a material
adverse effect on the Companys business, financial condition and results of operations. 92




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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The Board of Directors and Shareholders of Kos Pharmaceuticals, Inc. We have audited the consolidated financial statements of Kos Pharmaceuticals, Inc. and
subsidiaries as of December 31, 2004 and 2003 and for each of the three years in the period ended
December 31, 2004, and have issued our report thereon dated March 2, 2005. Our audits also included
the financial statement schedule listed in Item 15(a) of this Form 10-K for the three years in the
period ended December 31, 2004. 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
Certified Public Accountants Miami, Florida,
March 2, 2005 93




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KOS PHARMACEUTICALS, INC. AND SUBSIDIARIES 
 SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 2004, 2003 AND 2002 (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, 2002
    
    $
    194
    
    
    $
    150
    
    
    $
    38
    
    
    $
    306Fiscal year ended December 31, 2003
    
    
    306
    
    
    
    217
    
    
    
    
    
    
    
    523Fiscal year ended December 31, 2004
    
    
    523
    
    
    
    238
    
    
    
    233
    
    
    
    528
 
 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES. None 
 ITEM 9A. CONTROLS AND PROCEDURES. Disclosure 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. Managements Annual Report on Internal Control Over Financial Reporting Managements Annual Report on Internal Control Over Financial Reporting is contained in Item 8
of this Form 10-K. Report of Independent Registered Public Accounting Firm On Internal Control Over Financial
Reporting The report of Ernst & Young LLP on managements assessment of the Companys internal control
over financial reporting is contained in Item 8 of this Form 10-K. 94




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Changes to the Companys Internal Control Over Financial Reporting There have been no changes to the Companys internal control over financial reporting that
occurred during the Companys fourth fiscal quarter that have materially affected, or are
reasonably likely to materially affect, the Companys internal control over financial reporting. 95




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##### 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 2005 Annual Meeting of Shareholders to be filed
with the Securities and Exchange Commission. 96




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##### Table of Contents



PART IV 
 ITEM 15. EXHIBITS AND FINANCIAL SCHEDULES.  (a)
    1. The Financial Statements filed as part of this report are listed separately
in the index to Financial Statements beginning on page 57 of
this report. 2. The following Financial Statement Schedules are filed herewith: Schedule
    
    DescriptionII
    
    Valuation and Qualifying Accounts for the Year Ended December
31, 20043. The following exhibits are filed herewith:
 ExhibitNumber
    
    Exhibit Description1.1(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.2.1(12)+
    
    Product Acquisition Agreement between the Company and Aventis
Pharmaceuticals Holdings Inc., dated March 5, 2004.2.2(12)+
    
    Supply Agreement between the Company and Aventis Pharmaceuticals
Inc., dated March 5, 2004.3.1(2)
    
    Amended and Restated Articles of
Incorporation of the Company.3.2
    
    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
 97




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##### Table of Contents



Company, Kos Holdings,
Inc., Kos Investments, Inc., and Michael Jaharis.10.17(5)
    
    Promissory Note dated December 21, 1999, in favor of Michael
Jaharis.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.10.23(7)
    
    Stock Purchase Agreement dated May 3, 2000, between the Company
and DuPont Pharmaceuticals Company.10.24(8)*
    
    Employment Agreement dated April 26, 2001, between the Company
and Adrian Adams.10.25(9)*
    
    Management Agreement dated December 13, 2001, between the
Company and Daniel M. Bell.10.26(9)+
    
    Master Services Agreement effective December 17,
2001, between the Company, Innovex LP and PharmaBio Development, Inc.10.27(9)+
    
    Investment and Royalty Agreement effective December
17, 2001, between the Company, Innovex LP and PharmaBio Development, Inc.10.28(9)
    
    Warrant Agreement dated January 1, 2002, between the
Company and PharmaBio Development, Inc.10.29(10)+
    
    Distribution, Patent & Trademark License, Marketing and Supply
Agreement, dated October 23, 2002, between the Company and Merck KGaA.10.30(11)+
    
    Co-Promotion Agreement dated as of October 29, 2003 between
the Company and Takeda Pharmaceuticals North America, Inc.10.31(14)
    
    Form of Consulting Agreement Between the Company and
Christopher P. Kiritsy.10.32(14)
    
    Securities Purchase Agreement dated February 1, 2005, among
Triad Pharmaceuticals, Inc., Kos Pharmaceuticals, Inc. and 2004 Oikos
Investment Partners, LP.
 98




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##### Table of Contents



10.33(14)
    
    Stockholders Agreement dated February 1, 2005, among Triad
Pharmaceuticals, Inc., Kos Pharmaceuticals, Inc., 2004 Oikos Investment
Partners, LP and the other stockholders parties thereto.10.34(14)
    
    Registration Rights Agreement dated February 1, 2005, among
Triad Pharmaceuticals, Inc., Kos Pharmaceuticals, Inc., 2004 Oikos Investment
Partners, LP and the other stockholders parties thereto.10.35*
    
    Employment Agreement dated as of February 2, 2005, between Adrian
Adams and the Company.10.36*
    
    Summary Term Sheet of Board Compensation.14.1(13)
    
    Code of Ethics for Senior Financial Officers.21
    
    Subsidiaries of the Company.23.1
    
    Consent of Independent Registered Public Accounting Firm, Ernst
& Young 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-14.32.1
    
    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 2002.99.1*
    
    Summary Sheet of 2005 Named Executive Officer Compensation.
   (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. 99




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##### Table of Contents



(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/A 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 5, 2003, and incorporated herein
by reference.(12)
    
    Filed with the Companys Current Report on Form 8-K filed with the
Securities and Exchange Commission on March 26, 2004, and incorporated herein
by reference.(13)
    
    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 March 31, 2003, and incorporated herein by reference.(14)
    
    Filed with the Companys Current Report on Form 8-K filed with the
Securities and Exchange Commission on February 7, 2005, and incorporated herein
by reference.+
    
    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. 100




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##### 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 AdamsAdrian AdamsPresident and Chief Executive Officer
 POWER OF ATTORNEY KNOW ALL MEN BY THESE PRESENT, 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 16, 2005/s/ Daniel M. Bell

Daniel M. Bell
    
    Chairman of the Board
of Directors
    
    March 16, 2005/s/ Robert E. Baldini

Robert E. Baldini
    
    Vice Chairman of the Board
    
    March 16, 2005/s/ Adrian Adams

Adrian Adams
    
    President, Chief Executive
Officer, and Director
(Principal Executive Officer)
    
    March 16, 2005/s/ Christopher P. Kiritsy

Christopher P. Kiritsy
    
    Executive Vice President, Chief
Financial Officer
(Principal Financial Officer)
    
    March 16, 2005/s/ Juan F. Rodriguez

Juan F. Rodriguez
    
    Senior Vice President, Controller and
Corporate Administration
(Principal Accounting Officer)
    
    March 16, 2005/s/ John Brademas

John Brademas
    
    Director
    
    March 16, 2005/s/ Kevin T. Ferro

Kevin T. Ferro
    
    Director
    
    March 16, 2005/s/ Steven Jaharis

Steven Jaharis
    
    Director
    
    March 16, 2005/s/ Nicolaos E. Madias

Nicolaos E. Madias
    
    Director
    
    March 16, 2005/s/ Mark Novitch

Mark Novitch
    
    Director
    
    March 16, 2005/s/ William D. Pruitt

William D. Pruitt
    
    Director
    
    March 16, 2005/s/ Frederick B. Whittemore

Frederick B. Whittemore
    
    Director
    
    March 16, 2005
 101




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##### Table of Contents



EXHIBIT INDEX ExhibitNumber
    
    Description3.2
    
    Amended and Restated Bylaws of the Company.10.35
    
    Employment Agreement dated February 2, 2005, between Adrian Adams and the Company.10.36
    
    Summary Term Sheet of Board Compensation.21
    
    Subsidiaries of the Company.23.1
    
    Consent of Independent Registered Public Accounting Firm, Ernst & Young 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 2002.99.1
    
    Summary Sheet of 2005 Named Executive Officer Compensation.
 102