10-Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark one)

[X]	Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. For the quarterly period ended September 30, 2001.
	or
[   ]	Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. For the transition period from            to

Commission File Number:

000-31633

Kosan Biosciences Incorporated

(Exact name of registrant as specified in its charter)

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

3832 Bay Center Place, Hayward, California 94545

(address of principal executive offices)

(510) 732-8400

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to filing requirements for the past 90 days.

Yes [X]    No [   ]

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. Common Stock, $.001 par value; 25,262,403 shares outstanding at October 31, 2001.

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION
	Item 1: Condensed Financial Statements and Notes
		CONDENSED BALANCE SHEETS
		CONDENSED STATEMENTS OF OPERATIONS
		CONDENSED STATEMENTS OF CASH FLOWS
		NOTES TO CONDENSED FINANCIAL STATEMENTS
	Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations
	Item 3: Quantitative and Qualitative Disclosures About Market Risk
PART II.OTHER INFORMATION
	Item 1. Legal Proceedings
	Item 2. Changes in Securities and Use of Proceeds
	Item 3. Defaults Upon Senior Securities
	Item 4. Submission of Matters to a Vote of Security Holders
	Item 5. Other Information
	Item 6. Exhibits and Reports on Form 8-K
SIGNATURES
Amendmend No. 3 to Research and License Agreement
Master Loan and Security Agreement no. 84325

KOSAN BIOSCIENCES INCORPORATED

Form 10-Q

Quarter Ended September 30, 2001

INDEX

		Page
PART I	FINANCIAL INFORMATION	3
Item 1:	Condensed Financial Statements and Notes:	3
	Condensed Balance Sheets as of September 30, 2001 and December 31, 2000	3
	Condensed Statements of Operations for the three months and nine months ended September 30, 2001 and 2000	4
	Condensed Statements of Cash Flows for the nine months ended September 30, 2001 and 2000	5
	Notes to Condensed Financial Statements	6
Item 2:	Management’s Discussion and Analysis of Financial Condition and Results of Operations	11
Item 3:	Quantitative and Qualitative Disclosures About Market Risk	21
PART II	OTHER INFORMATION	23
Item 1:	Legal Proceedings	23
Item 2:	Changes in Securities and Use of Proceeds	23
Item 3:	Defaults Upon Senior Securities	23
Item 4:	Submission of Matters to a Vote of Security Holders	23
Item 5:	Other Information	23
Item 6:	Exhibits and Reports on Form 8-K	23
SIGNATURES		25

2

PART I. FINANCIAL INFORMATION

Item 1: Condensed Financial Statements and Notes

KOSAN BIOSCIENCES INCORPORATED

CONDENSED BALANCE SHEETS
(in thousands)

					September 30,			December 31,
					2001			2000
					(unaudited)			(1)
Assets
Current assets:
	Cash and cash equivalents				$	23,504		$	36,425
	Short-term investments					56,096			49,313
	Other receivables					789			21
	Prepaid expenses and other current assets					337			515
			Total current assets			80,726			86,274
Property and equipment, net						3,593			3,133
Long-term investments						13,858			17,003
Notes receivable from related parties						1,066			917
Other assets						244			244
			Total assets		$	99,487		$	107,571
Liabilities and Stockholders’ Equity
Current liabilities:
		Accounts payable			$	1,673		$	980
		Accrued liabilities				1,271			1,597
		Deferred revenue				717			619
		Current portion of capital lease obligation and equipment loans				1,339			1,035
				Total current liabilities		5,000			4,231
Capital lease obligation and equipment loans, less current portion						1,930			1,975
Stockholders’ equity:
		Common stock				25			25
		Additional paid-in capital				141,909			141,590
		Notes receivable from stockholders				(1,705	)		(2,079	)
		Deferred stock-based compensation				(5,998	)		(11,122	)
		Accumulated other comprehensive income/(loss)				1,059			(380	)
		Accumulated deficit				(42,733	)		(26,669	)
				Total stockholders’ equity		92,557			101,365
				Total liabilities and stockholders’ equity	$	99,487		$	107,571

See accompanying notes.

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

3

KOSAN BIOSCIENCES INCORPORATED

CONDENSED STATEMENTS OF OPERATIONS

(unaudited)
(in thousands, except per share data)

			Three Months Ended						Nine Months Ended
			September 30,						September 30,
			2001			2000			2001			2000
Revenues:
	Contract revenue		$	717		$	1,025		$	2,443		$	3,109
	Grant revenue			783			170			1,264			310
		Total revenues		1,500			1,195			3,707			3,419
Operating expenses:
	Research and development (including charges for stock- based compensation of $1,279 and $1,925 in the three months ended September 30, 2001 and 2000, respectively, and $4,110 and $4,522 in the nine months ended September 30, 2001 and 2000, respectively)			6,478			4,860			18,784			12,481
	General and administrative (including charges for stock- based compensation of $316 and $428 in the three months ended September 30, 2001 and 2000, respectively, and $967 and $1,136 in the nine months ended September 30, 2001 and 2000, respectively)			1,286			1,022			3,848			2,815
		Total operating expenses		7,764			5,882			22,632			15,296
Loss from operations				(6,264	)		(4,687	)		(18,925	)		(11,877	)
Other income, net				1,118			436			2,861			947
Net loss				(5,146	)		(4,251	)		(16,064	)		(10,930	)
Deemed dividend upon issuance of Series C convertible preferred stock				—			—			—			(11,267	)
Net loss attributable to common stockholders			$	(5,146	)	$	(4,251	)	$	(16,064	)	$	(22,197	)
Basic and diluted net loss per common share			$	(0.21	)	$	(0.79	)	$	(0.67	)	$	(4.31	)
Shares used in computing basic and diluted net loss per common share				24,243			5,384			24,051			5,147

See accompanying notes.

4

KOSAN BIOSCIENCES INCORPORATED

CONDENSED STATEMENTS OF CASH FLOWS

(unaudited)
(in thousands)

					Nine Months Ended
					September 30,
					2001			2000
Operating activities
	Net loss				$	(16,064	)	$	(10,930	)
		Adjustment to reconcile net loss to net cash used in operating activities:
				Depreciation		912			666
				Amortization of investment premiums and discounts, net		(867	)		—
				Amortization of stock-based compensation		4,642			4,544
				Other stock-based compensation		435			1,114
				Issuance of convertible preferred stock for license fees		—			30
				Loss on write-down of investment		990			—
		Changes in assets and liabilities:
				Other receivables		(768	)		329
				Prepaid expenses and other current assets		178			230
				Other assets and notes receivable from related parties		187			(1,913	)
				Accounts payable		693			714
				Accrued liabilities		(326	)		551
				Deferred revenue		98			(409	)
				Net cash used in operating activities		(9,890	)		(5,074	)
Investing activities
	Acquisition of property and equipment, net					(1,372	)		(1,210	)
	Purchase of investments					(77,525	)		(15,682	)
	Proceeds from maturity of investments					75,203			—
				Net cash used in investing activities		(3,694	)		(16,892	)
Financing activities
	Proceeds from issuance of common stock, net					404			60
	Proceeds from issuance of convertible preferred stock, net of issuance costs					—			24,600
	Proceeds from equipment loans					1,092			1,754
	Principal payments under capital lease obligation and equipment loans					(833	)		(557	)
			Net cash provided by financing activities			663			25,857
Net (decrease) increase in cash and cash equivalents						(12,921	)		3,891
Cash and cash equivalents at beginning of period						36,425			1,032
Cash and cash equivalents at end of period					$	23,504		$	4,923

See accompanying notes.

5

KOSAN BIOSCIENCES INCORPORATED

NOTES TO CONDENSED FINANCIAL STATEMENTS

(unaudited)

1. Organization and Summary of Significant Accounting Policies

     Overview

     Kosan Biosciences Incorporated (“Kosan” or the “Company”) was incorporated under the laws of the State of California on January 6, 1995 and commenced operations in 1996. In July 2000, the Company was reincorporated under the laws of the state of Delaware. Kosan has proprietary gene-engineering technologies for the manipulation and production of polyketides, a rich source of pharmaceutical products.

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

     Basis of Presentation

     The accompanying unaudited condensed financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information. The information as of September 30, 2001, and for the three months and nine months ended September 30, 2001 and 2000, reflects all adjustments (including normal recurring adjustments) that the management of the Company believes are necessary for a fair presentation of the results for the periods presented. Results for any interim period are not necessarily indicative of results for any future interim period or for the entire year. The accompanying condensed financial statements should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2000.

     Use of Estimates

     The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the accompanying notes. Actual results could differ from those estimates.

     Cash Equivalents and Investments

     The Company considers all highly liquid investments with a maturity from date of purchase of three months or less to be cash equivalents. The Company limits its concentration of risk by diversifying its investments among a variety of issuers. The Company classifies all investment securities as available-for-sale in accordance with Statement of Financial Accounting Standards No. 115, “Accounting for Certain Investments in Debt and Equity Securities” (“SFAS 115”). Available-for-sale investments are recorded at fair value based on quoted market prices, with unrealized gains and losses excluded from earnings and reported in other comprehensive income (loss). Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Declines in the fair value of available-for-sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.

6

KOSAN BIOSCIENCES INCORPORATED

NOTES TO CONDENSED FINANCIAL STATEMENTS
(unaudited)

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

     Revenue Recognition

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

     Research and Development

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

     Net Loss per Share

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

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

7

KOSAN BIOSCIENCES INCORPORATED

NOTES TO CONDENSED FINANCIAL STATEMENTS (Continued)
(unaudited)

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

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

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2001			2000			2001			2000
Net loss attributable to common stockholders	$	(5,146	)	$	(4,251	)	$	(16,064	)	$	(22,197	)
Weighted-average shares of common stock outstanding		25,192			6,706			25,180			6,400
Less: weighted-average shares subject to repurchase		(949	)		(1,322	)		(1,129	)		(1,253	)
Weighted-average shares used in computing basic and diluted net loss per common share		24,243			5,384			24,051			5,147
Basic and diluted net loss per common share	$	(0.21	)	$	(0.79	)	$	(0.67	)	$	(4.31	)
Pro forma:
Shares used above		24,243			5,384			24,051			5,147
Pro forma adjustment to reflect weighted effect of conversion of convertible preferred stock		—			12,221			—			11,426
Shares used in computing pro forma basic and diluted net loss per common share		24,243			17,605			24,051			16,573
Pro forma basic and diluted net loss per share	$	(0.21	)	$	(0.24	)	$	(0.67	)	$	(1.34	)

     Stock-Based Compensation

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

     Stock-based compensation expense for options granted to non-employees has been determined in accordance with Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”) and Emerging Issues Task Force (“EITF”) Consensus No. 96-18 as the fair value of the consideration received or the fair value of the equity instruments issued, whichever is more reliably measured. The measurement of stock-based compensation to non-employees is subject to periodic adjustment as the underlying securities vest.

8

KOSAN BIOSCIENCES INCORPORATED

NOTES TO CONDENSED FINANCIAL STATEMENTS (Continued)
(unaudited)

2. Collaborative Research and Development and License Agreements

     The R.W. Johnson Pharmaceutical Research Institute

     In September 1998, the Company signed a collaborative agreement with The R.W. Johnson Pharmaceutical Research Institute and Ortho-McNeil Pharmaceutical, Inc., both Johnson & Johnson companies. In September 2001, the Company amended its collaborative research and development agreement. Under the terms of the amended agreement, subject to termination provisions, the research program and funding have been extended until December 28, 2002. In February 2001, the Company received, and recognized in full, a $250,000 milestone in connection with this agreement.

     License Agreements

     The Company has collaborative and license agreements with several academic and medical institutions. For the nine months ended September 30, 2001 and 2000, the Company made payments under these agreements of approximately $371,000 and $316,000, respectively. At September 30, 2001, the Company estimated its non-cancelable commitments under these agreements to be approximately $375,000.

3. Comprehensive Income/(Loss)

     For the three and nine months ended September 30, 2001 and 2000, comprehensive loss is as follows (in thousands):

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2001			2000			2001			2000
Net loss	$	(5,146	)	$	(4,251	)	$	(16,064	)	$	(22,197	)
Unrealized gain on available-for-sale securities		671			53			449			59
Reclassification of write-down on available-for-sale securities		—			—			990			—
Comprehensive loss	$	(4,475	)	$	(4,198	)	$	(14,625	)	$	(22,138	)

4. Loss on Write-Down of Investment

     In accordance with SFAS 115, the Company determined that an other-than-temporary decline in fair value of its investment in short-term commercial paper of Southern California Edison (“So Cal Ed”), a utility company, had occurred at June 30, 2001. At the time of purchase, the security was a high investment-grade security, but was subsequently downgraded due to the financial uncertainty that resulted from the California energy crisis. The security matured on April 18, 2001, and So Cal Ed defaulted on payment. The initial cost of the security was $3.0 million, and the security was valued at approximately 67% of cost at June 30, 2001. Accordingly, the Company recorded a $990,000 loss on the related write-down in the carrying value of the investment. Subsequent to the maturity date, So Cal Ed has made interest payments on a monthly basis at the stated interest rate of 6.64%. At September 30, 2001, the security remained outstanding and was valued at approximately 83% of cost. The unrealized gain of $480,000 is included in accumulated other comprehensive income (loss).

9

KOSAN BIOSCIENCES INCORPORATED

NOTES TO CONDENSED FINANCIAL STATEMENTS (Continued)
(unaudited)

5. Capital Leases and Equipment Financing

     The Company leases certain equipment and facility improvements under non-cancelable capital leases and debt obligations. Some of the equipment loans have a balloon payment at the end of the term. The interest rates of each of the leases and loans are fixed at the time of the draw down, with the interest rates ranging from 9.02% to 16.96%. In July 2001, the Company entered into a $2.5 million equipment line of credit agreement (the “Line of Credit”). Each draw down has a repayment period of 42 months and an interest rate that is fixed at the time of draw down. As of September 30, 2001, the Company utilized approximately $1.1 million of the Line of Credit, which carries with it an interest rate of 9.02%. Obligations under the Line of Credit are payable in monthly installments of principal and interest and are secured by the assets financed under the Line of Credit.

6. Accrued Liabilities

     Accrued liabilities consisted of the following (in thousands):

	September 30,		December 31,
	2001		2000
Facilities-related	$	325	$	415
Compensation-related		306		451
Professional services		373		250
Other		267		481
	$	1,271	$	1,597

7. Subsequent Event

     On October 5, 2001, the Board of Directors of the Company adopted a Stockholder Rights Plan under which all stockholders of record as of October 29, 2001 will receive rights (the “Rights”) to purchase shares of a new series of Preferred Stock. The Rights will be distributed as a non-taxable dividend and will expire on October 29, 2011. As set forth in the Stockholder Rights Plan, each Right entitles the holder to purchase one one-hundredth of a share of newly created Series A Junior Participating Preferred Stock of the Company at an exercise price of $70.00 per one-one hundredth of a share, if a person acquires more than 20% of the Company’s Common Stock. The Rights holder will generally be entitled to redeem the Rights for $0.001 per share prior to the time a person acquires more than 20% of the Company’s Common Stock.

10

Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

     The following discussion of our financial condition and results of operations contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These statements relate to future events or our future financial performance. In some cases, you can identify forward-looking statements by terminology such as may, will, should, expect, plan, anticipate, believe, estimate, predict, potential or continue, the negative of terms like these or other comparable terminology. Actual events or results may differ materially from those anticipated in these forward-looking statements. All forward-looking statements included in this document are based on information available to us on the date hereof, and we assume no obligation to update any such forward-looking statements. In evaluating these statements, you should specifically consider various factors, including the risks outlined under the caption “Factors that May Affect Results of Operations and Financial Condition” set forth at the end of this Item 2, the Risk Factors set forth in our Annual Report on Form 10-K filed with the SEC and those contained from time to time in our other filings with the SEC. We caution investors that our business and financial performance are subject to substantial risks and uncertainties.

Overview

     We have proprietary gene-engineering technologies for the manipulation and production of polyketides, a rich source of pharmaceutical products. We use our platform technologies to develop product candidates that target large pharmaceutical markets. We are testing Epothilone D, a potential anti-cancer agent in Phase I human clinical trials. In infectious disease, we have a collaboration with The R.W. Johnson Pharmaceutical Research Institute, a Johnson & Johnson company, focusing on the development of a next generation antibiotic.

     We have incurred significant losses since our inception. As of September 30, 2001, our accumulated deficit was $42.7 million. We expect to incur additional operating losses over the next several years as we continue to develop our technologies and fund internal product research and development.

Stock-Based Compensation

     Stock-based compensation represents the difference between the exercise price of an option and the deemed fair value of our common stock on the date of the option grant calculated in accordance with Accounting Principles Board Opinion No. 25 and its related interpretations. Such amounts are included as a reduction of stockholders’ equity and are being amortized to expense using the graded vesting method over the vesting periods of the underlying options, which generally are four years. Amortization of stock-based compensation has been allocated to research and development expense and general and administrative expense, as appropriate. We recognized stock-based compensation expense of $4.6 million and $4.5 million for the nine months ended September 30, 2001 and 2000, respectively. Based on deferred stock-based compensation recorded as of September 30, 2001, we expect to record amortization for deferred stock-based compensation approximately as follows: $1.4 million for the three months remaining in 2001, $3.0 million in 2002, $1.3 million in 2003 and $298,000 in 2004.

     In connection with the grants of stock options and restricted stock to non-employees, we recognize compensation on a ratable basis over the related service period. We recognized other stock-based compensation for non-employees of $435,000 and $1.1 million in the nine months ended September 30, 2001 and 2000, respectively. In addition, we expect to recognize other stock-based compensation in connection with stock options and restricted stock granted to non-employees of $568,000 for the three months remaining in 2001, $431,000 in 2002, $197,000 in 2003, $121,000 in 2004 and $34,000 in 2005. The measurement of stock-based compensation to our non-employees is subject to periodic adjustment as

11

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

Results of Operations

     Revenues. Our revenues were $1.5 million and $3.7 million for the three and nine months ended September 30, 2001, compared to $1.2 million and $3.4 million for the same periods in 2000. Grant revenue was $1.3 million for the nine months ended September 30, 2001, compared to $310,000 for the same period last year. In addition, during the nine months ended September 30, 2001, we recognized a non-recurring $250,000 milestone received in connection with the anti-infective collaboration with The R.W. Johnson Pharmaceutical Research Institute. Included in the year-to-date 2000 revenues was $375,000 in amortization of the up-front fee received in connection with this collaboration. The initial term of the collaboration with The R.W. Johnson Pharmaceutical Research Institute has been extended to December 28, 2002, subject to early termination. If we do not maintain or further extend this agreement, or if it is terminated early, our revenues will significantly decrease thereafter, unless we enter into additional collaborations.

     Research and Development Expenses. Our research and development expenses consist primarily of stock-based compensation, salaries and other personnel-related expenses, facility-related expenses and fees paid to outside service providers. Research and development expenses increased to $6.5 million and $18.8 million for the three and nine months ended September 30, 2001 from $4.9 million and $12.5 million for the same periods in 2000. These increases were primarily attributable to our expanded research and development efforts, including advancing Epothilone D toward the clinic and continued investment in our internally funded programs and technologies. Stock-based compensation decreased in the three months ended September 30, 2001 to $1.3 million from $1.9 million for the same period in 2000 and decreased for the nine months ended September 30, 2001 to $4.1 million from $4.5 million for the same period in 2000. We expect our research and development expenses will increase substantially to advance our Epothilone D program through clinical trials, fund the expansion of our technology platform, support our collaborative research programs and advance other in-house research programs into later stages of development.

     General and Administrative Expenses. General and administrative expenses increased to $1.3 million and $3.8 million for the three and nine months ended September 30, 2001 from $1.0 million and $2.8 million for the same periods in 2000. This increase was primarily due to higher employee-related costs to support our expanding research and development activities and added public company-related expenses. We expect our general and administrative expenses will increase in the future to support the continued growth of our research and development efforts and to fulfill our obligations associated with being a publicly held company.

     Interest Income. Interest income increased to $1.2 million and $3.1 million for the three and nine months ended September 30, 2001 from $530,000 and $1.2 million for the same periods in 2000. This increase was due to higher average investment balances due to aggregate net proceeds of $98.0 million received in connection with our October 2000 initial public offering of common stock and the issuance of Series C convertible preferred stock in March 2000.

     Interest Expense. Interest expense decreased to $88,000 for the three months ended September 30, 2001 from $94,000 for the same period in 2000 and increased to $262,000 for the nine months ended September 30, 2001 from $261,000 for the same period in 2000. The decrease for the quarter ended September 30, 2001 from the quarter ended September 30, 2000 resulted from normal amortization of our existing debt.

     Write-down of Investment. At September 30, 2001, we had approximately $3.0 million invested in short-term commercial paper of Southern California Edison (“So Cal Ed”), a utility company. The security matured on April 18, 2001 and So Cal Ed defaulted on payment. At June 30, 2001, the security

12

was valued at approximately 67% of cost, and we recorded a write-down on the carrying value of the investment of $990,000. Due to the continuing uncertainty associated with the California energy crisis, additional write-downs in the carrying value of the security may be required in the event So Cal Ed experiences further adverse material changes in its financial condition. As of September 30, 2001, the security remained outstanding and was valued at approximately 83% of cost. The $480,000 increase in the carrying value is included in accumulated other comprehensive gain (loss).

     Beneficial Conversion Feature. In March 2000, we sold 804,196 shares of Series C convertible preferred stock (which converted into 2,412,588 shares of common stock at the closing of our initial public offering) for net proceeds of approximately $24.6 million. After evaluating the fair value of our common stock in contemplation of our initial public offering, we determined that the issuance of the Series C convertible preferred stock resulted in a beneficial conversion feature calculated in accordance with EITF Consensus No. 98-5, “Accounting for Convertible Securities with Beneficial Conversion Features.” The beneficial conversion feature was reflected as a deemed dividend of $11.3 million in our financial statements for the six months ended June 30, 2000.

Liquidity and Capital Resources

     We have financed our operations from inception primarily through sales of convertible preferred stock and common stock, totaling $119.5 million in net proceeds, contract payments under our collaboration agreement, equipment financing arrangements and government grants. As of September 30, 2001, we had $93.5 million in cash, cash equivalents and investments, compared to $102.7 million as of December 31, 2000. Our funds are invested in U.S. Treasury and government agency obligations, investment-grade asset-backed securities and corporate obligations.

     Our operating activities used cash of $9.9 million for the nine months ended September 30, 2001, compared to $5.1 million for the same period in 2000. Our net loss of $16.1 million for the nine months ended September 30, 2001 was partially offset by non-cash expenses of $6.1 million related to stock-based compensation, depreciation and amortization and the write-down of our investment in So Cal Ed. Cash used for the same period in 2000 was used primarily to fund our net operating losses of $10.9 million, partially offset by non-cash expenses of $6.4 million related to stock-based compensation and depreciation.

     Our investing activities, excluding changes in our investments, for the nine months ended September 30, 2001 used cash of $1.4 million, compared to $1.2 million for the same period in 2000, reflecting capital expenditures and facility improvements.

     Cash provided by financing activities was $663,000 for the nine months ended September 30, 2001, compared to cash provided by financing activities of $25.9 million for the same period in 2000. Financing activities included $1.1 million in net proceeds from our equipment loan financing in July 2001 and $24.6 million in net proceeds from the issuance of our Series C convertible preferred stock in March 2000. In July 2001, we secured a $2.5 million equipment line of credit. As of September 30, 2001, $1.1 million had been utilized leaving approximately $1.4 million available to be drawn upon.

     For periods subsequent to September 30, 2001, we have estimated our non-cancelable commitments under our collaborative and license agreements to be approximately $375,000.

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

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

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

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

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

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

• the costs and timing of regulatory approvals; and

• expenses associated with unforeseen litigation.

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

Factors That May Affect Results of Operations and Financial Condition.

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

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

     We commenced operations in 1996 and are still in an early stage of development. We have not commercialized any products, and we have incurred significant losses to date. As of September 30, 2001, we had an accumulated deficit of approximately $42.7 million. To date, our revenues have been solely from collaborations and government grants. Our expenses have consisted principally of costs incurred in research and development and from general and administrative costs associated with our operations. We have incurred net losses since our inception, including a net loss of approximately $16.1 million for the nine months ended September 30, 2001. We expect our expenses to increase and to continue to incur operating losses for at least the next several years as we continue our research and development efforts for our drug candidates. The amount of time necessary to commercialize any of our drug candidates is long and uncertain, and successful commercialization may not occur at all. As a result, we may never become profitable.

If we do not establish and maintain collaborations with other parties, the development of our products may be delayed or stopped.

     Because we do not currently possess the financial and other resources necessary to develop potential products that may result from our technologies, or the financial and other resources to complete any approval processes that may be required for these products, we must enter into collaborative arrangements to develop many of our drug candidates. If we do not maintain or further extend our current collaboration with The R.W. Johnson Pharmaceutical Research Institute and Ortho-McNeil Pharmaceutical, Inc., both Johnson & Johnson companies, which expires on December 28, 2002, subject to termination provisions,

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or if we do not enter into new collaborative agreements, then our revenues will be significantly reduced, and our drug candidates may not be developed, manufactured or marketed.

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

     Our technologies are new, and our drug candidates are in early stages of research and development. We may not develop products that prove to be safe and effective, meet applicable regulatory standards, are capable of being manufactured at reasonable costs or can be marketed successfully. All of the potential proprietary products that we are currently developing will require significant development and investment, including extensive pre-clinical and clinical testing, before we can submit any application for regulatory approval. Before obtaining regulatory approvals for the commercial sale of any of our products, we must demonstrate through pre-clinical testing and clinical trials that our drug candidates are safe and effective in humans. In October 2001, we initiated clinical trials of Epothilone D. Conducting clinical trials is a lengthy, expensive and uncertain process. Completion of clinical trials may take several years or more. The length of time generally varies substantially according to the type, complexity, novelty and intended use of the drug candidate. Our clinical trials may be suspended at any time, if we or the U.S. Food and Drug Administration, or the FDA, believe the patients participating in our studies are exposed to unacceptable health risks. We may encounter problems in our studies that will cause us or the FDA to delay or suspend the studies.

     Our commencement and rate of completion of clinical trials may be delayed by many factors, including:

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

• inability to manufacture sufficient quantities of compound for use in clinical trials;

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

• slower than expected rate of patient recruitment;

• unforeseen safety issues; or

• government or regulatory delays.

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

Any inability to protect our proprietary technologies adequately could harm our competitive position.

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

     The patent positions of biotechnology companies, including our patent position, involve complex legal and factual questions and, therefore, validity and enforceability cannot be predicted with certainty. Patents may be challenged, deemed unenforceable, invalidated or circumvented. We will be able to protect our proprietary rights from unauthorized use by third parties only to the extent that our proprietary technologies are covered by valid and enforceable patents or are effectively maintained as trade secrets.

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     We apply for patents covering both our technologies and drug candidates as we deem appropriate. However, we may fail to apply for patents on important technologies or products in a timely fashion or at all, and in any event, the applications we do file may not result in issued patents or, if issued, may be challenged. Our existing patents and any future patents we obtain may not be sufficiently broad to prevent others from practicing our technologies or from developing competing products. Furthermore, others may independently develop similar or alternative technologies or design around our patented technologies. In addition, others may challenge or invalidate our patents, or our patents may fail to provide us with any competitive advantages. If the use or validity of any of our patents is ever challenged, resulting in litigation or administrative proceedings, we would incur substantial costs and the diversion of management in defending the patent. In addition, we generally do not control the patent prosecution of technology that we license from others. Accordingly, we are unable to exercise the same degree of control over this intellectual property as we would over technology we own.

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

Litigation or other proceedings or third-party claims of intellectual property infringement would require us to spend time and money and could prevent us from developing or commercializing products.

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

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

     We are aware of a significant number of patents and patent applications relating to aspects of our technologies and families of compounds filed by, and issued to, other parties. Others have filed patent applications or have been granted patents claiming inventions also claimed by us, and we may have to participate in an interference proceeding declared by the relevant patent regulatory agency to determine priority of invention and, thus, the right to a patent for these inventions in the United States. For example, we believe one or more interferences or other legal proceedings to determine priority of invention may be declared between patents and patent applications we own or have exclusively licensed and patents owned by Novartis relating to epothilone biosynthetic genes and Epothilone D and related compounds and patents owned by Abbott Laboratories relating to erythromycin polyketide synthase genes and methods

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for altering polyketide synthase genes. Such a proceeding or a lawsuit in which we are alleged to have infringed an issued patent could result in substantial cost to us even if the outcome is favorable, and if the outcome is unfavorable, we could be required to license the other party’s rights, on terms that may be unfavorable to us, or cease using the technology. Even if successful on priority grounds, an interference may result in loss of claims based on patentability grounds raised in the interference. Although patent and intellectual property disputes in the biotechnology area are often settled through licensing or similar arrangements, costs associated with these arrangements may be substantial and could include ongoing royalties. Furthermore, we cannot be certain that the necessary license would be available to us on satisfactory terms, if at all.

     Other parties have obtained or may obtain patents and then claim that the use of our technologies infringes these patents or that we are employing their proprietary technology without authorization. We could incur substantial costs and diversion of management and technical personnel in defending ourselves against any of these claims or enforcing our patents against others. Furthermore, parties making claims against us may be able to obtain injunctive or other equitable relief, which could effectively block our ability to further develop, commercialize and sell products, and could result in the award of substantial damages against us. In the event of a successful claim of infringement against us, we may be required to:

• pay damages;

• stop using our products or methods;

• develop non-infringing products or methods; and

• obtain one or more licenses from other parties.

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

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

If we are unable to manage our growth effectively through recruiting and retaining skilled employees and expand our management and improve our controls and systems, we may not be able to manage our day-to-day operations.

     We have experienced a period of rapid and substantial growth that has placed, and if this growth continues will further place, a strain on our human and capital resources. If we are unable to manage this growth effectively, then our losses could increase. The number of our employees increased from 65 on September 30, 2000 to 94 on September 30, 2001. Retaining our current employees and recruiting qualified scientific personnel to perform future research and development work will be critical to our success. Competition is intense for experienced scientists, and we may not be able to retain or recruit sufficient skilled personnel to allow us to pursue collaborations and develop our products and core technologies to the extent otherwise possible. Additionally, we are highly dependent on the principal members of our management and scientific staff, such as our two co-founders, the loss of whose services would adversely impact the achievement of our objectives. Although we maintain and are the beneficiary of $1.0 million key-man life insurance policies for the lives of each of our two co-founders, Dr. Daniel Santi, our chief executive officer, and Dr. Chaitan Khosla, a director and consultant, we do not believe the proceeds would be adequate to compensate us for their loss.

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

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

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

     Any products that we develop through our technologies will compete in multiple, highly competitive markets. Development of pharmaceutical products requires significant investment and resources. Many of the organizations competing with us in the markets for such products have greater capital resources, research and development and marketing staffs, facilities and capabilities, and greater experience in modifying DNA, obtaining regulatory approvals and product manufacturing and marketing. Accordingly, our competitors may be able to develop technologies and products more easily, which would render our technologies and products and those of our collaborators obsolete and noncompetitive.

If we face claims in clinical trials of a drug candidate, these claims will divert our management’s time and we will incur litigation costs.

     We face an inherent business risk of clinical trial liability claims in the event that the use or misuse of our potential products results in personal injury or death. We may experience clinical trial liability claims if our drug candidates are misused or cause harm before regulatory authorities approve them for marketing. Even though we have obtained clinical trial liability insurance, it may not be sufficient to cover claims that may be made against us. Clinical trial liability insurance is expensive, difficult to obtain and may not be available in the future on acceptable terms, if at all. Any claims against us, regardless of their merit, could materially and adversely affect our financial condition, because litigation related to these claims would strain our financial resources in addition to consuming the time and attention of our management. If we are sued for any injuries caused by our products, our liability could exceed our total assets.

We use hazardous chemicals and radioactive and biological materials in our business. Any claims relating to improper handling, storage or disposal of these materials could be time consuming and costly.

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

We rely on a continuous power supply to conduct our operations, and California’s recent energy problems could disrupt our operations and increase our expenses.

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

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

We have anti-takeover provisions in our corporate charter documents that may result in outcomes with which you do not agree.

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

     Our certificate of incorporation provides for staggered terms for the members of the board of directors and prevents our stockholders from acting by written consent. These provisions and other provisions of our bylaws and of Delaware law applicable to us could delay or make more difficult a merger, tender offer or proxy contest involving us. This could reduce the price that investors might be willing to pay for shares of our common stock and result in the market price being lower than it would be without these provisions.

     We have adopted a Stockholder Rights Plan under which all stockholders of record as of October 29, 2001 will receive rights to purchase shares of a new series of preferred stock at an exercise price of $70.00 per one one-hundredth of a share, if a person acquires more than 20% of the Company’s common stock. The rights plan could make it more difficult for a person to acquire a majority of our outstanding voting stock. The rights plan could also reduce the price that investors might be willing to pay for shares of our common stock and result in the market price being lower than it would be without the rights plan.

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

     Our officers, directors and affiliates together control approximately 44% of our outstanding common stock. As a result, these stockholders, if they act together, are able to exert a significant degree of influence over our management and affairs and over matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions. This concentration of ownership may delay or prevent a change in control of us and might affect the market price of our common stock, even when a change may be in the best interests of all stockholders. In addition, the interests of this concentration of ownership may not always coincide with our interests or the interests of other stockholders and accordingly, these stockholders, could cause us to enter into transactions or agreements that we would not otherwise consider.

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

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

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

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

• achievement of regulatory approvals;

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

• changes in financial estimates by securities analysts;

• announcements of departures or departures of key personnel;

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

• sales of our common stock.

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

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

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

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

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

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

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

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

     Due to the possibility of fluctuations in our revenues and expenses, we believe that quarter-to-quarter comparisons of our operating results are not a good indication of our future performance. Our operating

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results in some quarters may not meet the expectations of stock market analysts and investors. In that case, our stock price would probably decline.

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Item 3: Quantitative and Qualitative Disclosures About Market Risk

Interest Rate Risk

     The primary objective of our investment activities is to preserve principal while at the same time maximizing yields without significantly increasing risk. To achieve this objective, we maintain our portfolio of cash equivalents, and short-term and long-term investments in a variety of securities, including corporate obligations and money market funds. As of September 30, 2001, approximately 85% of our total portfolio will mature in one year or less, with the remainder maturing in less than two years.

     At September 30, 2001, we had approximately $3.0 million invested in short-term commercial paper of Southern California Edison, a utility company. At the time of purchase, the security was a high investment-grade security, but subsequently was downgraded due to the financial uncertainty that has resulted from the California energy crisis. The security matured on April 18, 2001, and Southern California Edison defaulted on payment. At June 30, 2001, the security was valued at approximately 67% of cost. We determined that there had been an other-than-temporary decline in fair value of the security and recorded a write-down of $990,000. As of September 30, 2001, the security remained outstanding and was valued at approximately 83% of cost.

     The following table represents the fair value balance of our cash, cash equivalents and short-term and long-term investments that are subject to interest rate risk by year of expected maturity and average interest rates as of September 30, 2001 (dollars in thousands):

	2001			2002			2003
Cash & equivalents	$	23,504			—			—
Average interest rates		3.44	%
Short-term investments		20,421		$	35,675			—
Average interest rates		4.98	%		4.86	%
Long-term investments		—			4,520		$	9,338
Average interest rates					3.97	%		4.58	%

     We did not hold derivative instruments as of September 30, 2001, and we have never held such instruments in the past. In addition, we had outstanding debt, consisting of borrowings under an equipment financing line of credit and capital lease obligations, of $3.3 million as of September 30, 2001, with a range of interest rates from 9.02% to 16.96%.

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PART II.OTHER INFORMATION

Item 1. Legal Proceedings

Not applicable.

Item 2. Changes in Securities and Use of Proceeds

d) Use of Proceeds

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

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

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

Item 3. Defaults Upon Senior Securities

Not applicable.

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

None.

Item 5. Other Information

In September 2001, Bruce A. Chabner, M.D. was appointed to the Company’s Board of Directors. Dr. Chabner currently serves as the Clinical Director of the Massachusetts General Hospital Cancer Center and Professor of Medicine, Harvard Medical School. He is the Associate Director of Clinical Services of the Dana-Farber Harvard Cancer Center.

Item 6. Exhibits and Reports on Form 8-K

(a)  Exhibits:

Exhibit
No.
10.36†	Amendment No.3 to Research and License Agreement between Registrant and The R.W. Johnson Pharmaceutical Research Institute and Ortho-McNeil Pharmaceutical, Inc., dated September 28, 2001.
10.37	Master Loan and Security Agreement No. 84325 and associated Prepayment Agreement, by and between the Registrant and Wells Fargo Equipment Finance, Inc., dated July 9, 2001.

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Exhibit
No.
10.38	Rights Agreement, dated as of October 5, 2001, between the Registrant and Mellon Investor Services LLC.
(b)	Reports on Form 8-K No Current Reports on Form 8-K were filed during the quarter ended September 30, 2001.

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

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SIGNATURES

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

	Kosan Biosciences Incorporated
November 13, 2001	By:	/s/ Daniel V. Santi, M.D., Ph.D.
		Daniel V. Santi, M.D., Ph.D. Chairman and Chief Executive Officer
November 13, 2001	By:	/s/ Susan M. Kanaya
		Susan M. Kanaya Vice President, Finance and Chief Financial Officer (Principal Financial and Accounting Officer)

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EXHIBIT INDEX

Exhibit
Number	Description of Document
3.1	Amended and Restated Certificate of Incorporation, as amended to date (1)
3.2	Bylaws (2)
4.1	Form of Specimen Common Stock Certificate (2)
10.36†	Amendment No. 3 to Research and License Agreement between Registrant and The R.W. Johnson Pharmaceutical Research Institute and Ortho-McNeil Pharmaceutical, Inc., dated September 28, 2001.
10.37	Master Loan and Security Agreement No. 84325 and associated Prepayment Agreement, by and between the Registrant and Wells Fargo Equipment Finance, Inc., dated July 9, 2001.
10.38	Rights Agreement, dated as of October 5, 2001, between the Registrant and Mellon Investor Services LLC. (1)

(1)	Filed with Kosan’s 10-Q for the period ending June 30, 2001 and Current Report on Form 8-K filed on                      October 15, 2001, and incorporated herein by reference.
(2)	Filed with Kosan’s Registration Statement on Form S-1, as amended (No. 333-33732), and incorporated herein by reference
†	Confidential treatment has been requested with respect to certain portions of this exhibit. Omitted portions have been separately filed with the Securities and Exchange Commission.

26 EX-10.36 3 f76890ex10-36.txt AMENDMEND NO. 3 TO RESEARCH AND LICENSE AGREEMENT CERTAIN CONFIDENTIAL INFORMATION CONTAINED IN THIS DOCUMENT, MARKED BY BRACKETS, HAS BEEN OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO RULE 24B-2 OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. EXHIBIT 10.36 AMENDMENT NUMBER 3 TO RESEARCH AND LICENSE AGREEMENT BY AND BETWEEN KOSAN BIOSCIENCES, INC., AND THE R.W. JOHNSON PHARMACEUTICAL RESEARCH INSTITUTE AND ORTHO-MCNEIL PHARMACEUTICAL, INC. This Amendment dated as of September 28, 2001, is made to the RESEARCH AND LICENSE AGREEMENT, made as of September 28, 1998, and amended pursuant to those certain Amendment Nos. 1 and 2 dated March 17, 2000 and August 31, 2000 (the RESEARCH AND LICENSE AGREEMENT as amended March 17, 2000 and August 31, 2000, is hereinafter called the "AGREEMENT"), by and between KOSAN BIOSCIENCES, INC., a corporation organized under Delaware law having its principal office at 3832 Bay Center Place, Hayward, California, 94545 (hereinafter called "KOSAN"); ON THE ONE HAND, AND: ORTHO MCNEIL PHARMACEUTICAL, INCORPORATED (hereinafter called "ORTHO"), a company organized under Delaware law, having its principal office at U.S. Route 202, Raritan, New Jersey, 08869; and The R.W. JOHNSON PHARMACEUTICAL RESEARCH INSTITUTE (hereinafter called "RWJPRI"), a division of Ortho McNeil Pharmaceutical, Incorporated, having its principal office at U.S. Route 202, Raritan, New Jersey 08869 (ORTHO and RWJPRI hereinafter collectively called "LICENSEE") ON THE OTHER HAND, WITNESSETH: A. WHEREAS, KOSAN and LICENSEE have entered into the AGREEMENT providing for a collaborative research drug discovery program as generally described in the RESEARCH PLAN attached thereto as Appendix A; B. WHEREAS, the AGREEMENT contemplated the termination of the RESEARCH PROGRAM on December 28, 2001, in the event that LICENSEE was not actively engaged in activities to progress a MACROLIDE into full clinical development as of that date; [ * ] = CERTAIN CONFIDENTIAL INFORMATION CONTAINED IN THIS DOCUMENT, MARKED BY BRACKETS, HAS BEEN OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO RULE 24B-2 OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. 1 C. WHEREAS, KOSAN and LICENSEE desire to extend the RESEARCH PROGRAM at least until December 28, 2002; NOW, THEREFORE, in consideration of the premises and the performance of the covenants herein contained, the parties agree to amend the AGREEMENT as follows: 1. Defined Terms. Unless otherwise defined herein, all capitalized terms used herein shall have the same meaning as set forth in the AGREEMENT. 2. Extension of RESEARCH PROGRAM. The RESEARCH PROGRAM shall be continued until at least December 28, 2002, unless terminated in accordance with Section 5, below. 3. Current FTE RESEARCH FUNDING. In accordance with the AGREEMENT, LICENSEE is currently providing RESEARCH FUNDING, paid quarterly in advance, for KOSAN FTEs as follows: [ * ] on an annual basis for the period of December 28, 2000, to December 28, 2001, for a total of [ * ]. 4. Additional KOSAN FTE RESEARCH FUNDING. In accordance with this Amendment, LICENSEE shall provide, in addition to the current RESEARCH FUNDING, RESEARCH FUNDING for additional KOSAN FTEs (the "Additional KOSAN FTEs") as follows: [ * ] on an annual basis for the period of December 28, 2001 to December 28, 2002, for a total of [ * ]. LICENSEE shall provide RESEARCH FUNDING for the Additional KOSAN FTEs on a quarterly basis, in advance, beginning December 28, 2001. After December 28, 2001, KOSAN may elect to devote, at KOSAN's expense, up to [ * ] (the "Optional FTEs") to work on [ * ]. KOSAN shall report the activities of any Optional FTEs to the JRC, but LICENSEE shall have no obligation to provide RESEARCH FUNDING for such Optional FTEs unless [ * ] is accepted [ * ], as provided in Section 8, below, or LICENSEE extends the RESEARCH PROGRAM to March 28, 2002, as provided in Section 7, below. 5. Termination of Additional FTE RESEARCH FUNDING. In the event that, in LICENSEE's judgment to be exercised at its sole discretion, the MACROLIDES developed in the RESEARCH PROGRAM [ * ], LICENSEE shall have the right to terminate the RESEARCH PROGRAM on September 28, 2002, and its obligations to continue to provide RESEARCH FUNDING for the Additional KOSAN FTEs shall terminate concurrently therewith, provided LICENSEE provides KOSAN written notification of LICENSEE's decision to terminate on or before June 28, 2002. 6. Reversion of Rights to KOSAN. LICENSEE's notification of a termination of, under Section 5, above, the RESEARCH PROGRAM and the RESEARCH FUNDING for the Additional KOSAN FTEs shall be deemed to be a termination of the AGREEMENT pursuant to Section 19.2.1(i) of the AGREEMENT and shall constitute a release and reversion to KOSAN in accordance with Section 19.3.4 of the AGREEMENT of any and all of LICENSEE's rights to all MACROLIDES, [ * ] = CERTAIN CONFIDENTIAL INFORMATION CONTAINED IN THIS DOCUMENT, MARKED BY BRACKETS, HAS BEEN OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO RULE 24B-2 OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. 2 AROMATIC POLYKETIDES, NCEs, LICENSED COMPOUNDS, CLOSE STRUCTURAL ANALOGS, and RESERVED COMPOUNDS. 7. Non-Acceptance of [ * ] by November 28, 2002. In the event that LICENSEE has not accepted [ * ] as of November 28, 2002, then LICENSEE may give KOSAN a written notice prior to November 28, 2002, that it wishes to continue the RESEARCH PROGRAM for a further three (3) months to March 28, 2003, in which event LICENSEE shall provide KOSAN RESEARCH FUNDING for the Optional FTEs by reimbursing KOSAN [ * ] and shall make a RESEARCH FUNDING payment in advance for such Optional FTEs for the remainder of calendar 2002 and the three (3) month extension [ * ]. If LICENSEE does not give KOSAN the written notice as described above or if, after having given such written notice, LICENSEE has not accepted [ * ] as of March 28, 2003, the AGREEMENT shall, unless otherwise agreed, terminate pursuant to Section 19.2.1(i) of the AGREEMENT, and such termination shall constitute a release and reversion to KOSAN in accordance with Section 19.3.4 of the AGREEMENT of any and all of LICENSEE's rights to all MACROLIDES, AROMATIC POLYKETIDES, NCEs, LICENSED COMPOUNDS, CLOSE STRUCTURAL ANALOGS, and RESERVED COMPOUNDS. Termination pursuant to this Section 7 shall not obligate LICENSEE to any wind-down or other payment to KOSAN, whether pursuant to Section 19.1.2(c) of the AGREEMENT or otherwise 8. Acceptance of [ * ]. In the event that LICENSEE has accepted [ * ] on or before December 28, 2002, then LICENSEE shall provide KOSAN RESEARCH FUNDING for the Optional FTEs by reimbursing KOSAN [ * ] and by making RESEARCH FUNDING payments in advance for such Optional FTEs until December 28, 2002, [ * ]. 9. AGREEMENT. Except as amended herein, all of the terms and conditions of the AGREEMENT shall remain in full force and effect. [ * ] = CERTAIN CONFIDENTIAL INFORMATION CONTAINED IN THIS DOCUMENT, MARKED BY BRACKETS, HAS BEEN OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO RULE 24B-2 OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. {THE REMAINDER OF THE PAGE DELIBERATELY LEFT BLANK} 3 IN WITNESS WHEREOF, the parties hereto have hereunto set their hands and duly executed this Amendment to the AGREEMENT on the date(s) indicated below, to be effective the day and year first above written. For and on Behalf of KOSAN BIOSCIENCES, INC. By: /s/ Daniel V. Santi ------------------------------------------------- Name: Daniel Santi ------------------------------------------------- Title: Chief Executive ------------------------------------------------- Date: 10/4/2001 ------------------------------------------------- For and on Behalf of LICENSEE By: /s/ Per Peterson ------------------------------------------------- Name: Per A. Peterson, MD, PhD ------------------------------------------------- Title: Chairman, Research & Development, Pharmaceuticals ------------------------------------------------- Date: 10/3/01 ------------------------------------------------- [ * ] = CERTAIN CONFIDENTIAL INFORMATION CONTAINED IN THIS DOCUMENT, MARKED BY BRACKETS, HAS BEEN OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE COMMISSION PURSUANT TO RULE 24B-2 OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. 4 EX-10.37 4 f76890ex10-37.txt MASTER LOAN AND SECURITY AGREEMENT NO. 84325 EXHIBIT 10.37 MASTER LOAN AND SECURITY AGREEMENT NO. 84325 DEBTOR: SECURED PARTY: Kosan Biosciences Incorporated Wells Fargo Equipment Finance, Inc. 3832 Bay Center Place 530 Fifth Avenue Hayward, CA 94545 New York, NY 10036 In consideration of the mutual covenants set forth herein, the above named Debtor and the above named Secured Party hereby enter into this Master Loan and Security Agreement and agree to the terms and conditions set forth herein. Each Loan Schedule which may be executed by Debtor and Secured Party from time to time pursuant to this Master Loan and Security Agreement shall be deemed to be a separate loan transaction incorporating all of the terms and conditions of this Master Loan and Security Agreement. References in this Master Loan and Security Agreement to "Agreement", "hereunder" and "herein" shall mean a Loan Schedule which incorporates this Master Loan and Security Agreement. 1. LOAN SCHEDULES. Debtor shall evidence its agreement to enter into each Agreement incorporating the terms hereof by executing and delivering to Secured Party a Loan Schedule in the form annexed hereto as Exhibit 1. Debtor's execution of a Loan Schedule shall obligate Debtor to make all of the payments set forth in the Schedule of Obligations as set forth in the Loan Schedule. The Loan Schedule shall set forth the amount of the Loan, the Term of the Loan, the number of payments to be made and the amount and dates upon which such payments are due. The Loan Schedule shall also set forth the Time Balance which means the aggregate amount of all payments which are payable under the Agreement evidenced by such Loan Schedule. Subject to the terms and conditions hereof, Secured Party will enter into one or more Loan Schedules hereunder covering Equipment having an aggregate original Equipment cost ("Acquisition Cost") not in excess of Two Million Five Hundred Thousand Dollars ($2,500,000) provided, that: (a) notwithstanding anything to the contrary, Secured Party shall have no obligation to enter into any Loan Schedule if (i) the Equipment to be covered thereunder is not acceptable to Secured Party; or (ii) such Loan Schedule has not been signed by Debtor and delivered to Secured Party on or before September 30, 2001; or (iii) such Equipment has not been delivered to or accepted by Debtor by September 30, 2001 or Secured Party has determined that the scheduled dates for delivery and installation of such Equipment makes acceptance of the Equipment by such date impossible; or (iv) an Event of Default (or any other event which, after a lapse of time, or notice, or both, would become an Event of Default) has occurred and is continuing hereunder or under any Loan Schedule; or (v) the Acquisition Cost of the Equipment to be covered under such Loan Schedule is less than $250,000; Provided further that any Loan Schedule to be executed after September 30, 2001, shall be subject to Secured Party performing its standard update credit review of Debtor to confirm the creditworthiness of the Debtor .No Loan Schedule shall be binding upon Secured Party until accepted by Secured Party which acceptance shall be evidenced only by the execution of such Loan Schedule by Secured Party. 2. GRANT OF SECURITY INTEREST. Debtor hereby grants to Secured Party a security interest in the personal property referred to and/or described in each Loan Schedule (hereinafter with all renewals, substitutions and replacements and all parts, repairs, 1 improvements, additions and accessories incorporated therein or affixed thereto referred to as the "Equipment"), together with any and all proceeds thereof and any and all insurance policies and proceeds with respect thereto. Notwithstanding the foregoing, Equipment shall not include Alterations permitted under Section 9 hereunder which may be removed without any material damage to the personal property referred to and/or described in each Loan Schedule. 3. OBLIGATIONS SECURED. The aforesaid security interest is granted by Debtor as security for (a) the payment of the Time Balance (as set forth in the Loan Schedule) and the payment and performance of all other indebtedness and obligations now or hereafter owing by Debtor to Secured Party, of any and every kind and description under the Agreement evidenced by such Loan Schedule, and any and all renewals and extensions of the foregoing, and all interest, fees, charges, expenses and reasonable attorneys' fees accruing or incurred in connection with any of the foregoing (all of which Time Balance, indebtedness and obligations are hereinafter referred to as the "Liabilities") and (b) the payment and performance of all other indebtedness and obligations now or hereafter owing by Debtor to Secured Party under the Agreement and all Loan Schedules hereunder, of any and every kind and description, howsoever arising or evidenced including without limitation those arising under other Loan Schedules, (all of which indebtedness and obligations are hereinafter referred to as the "Other Liabilities"). Subject to Paragraph 16, any nonpayment of any installment or other amounts due hereunder shall result in the obligation on the part of Debtor promptly to pay also an amount equal to five percent (5%), (or the maximum rate permitted by law, whichever is less) of the installment or other amounts overdue. 4. DISCLAIMER OF WARRANTIES. DEBTOR ACKNOWLEDGES THAT SECURED PARTY MAKES NO WARRANTIES, EXPRESS OR IMPLIED, IN RESPECT OF THE EQUIPMENT, INCLUDING, WITHOUT LIMITATION, ANY WARRANTY OF MERCHANTABILITY OR OF FITNESS FOR ANY PARTICULAR PURPOSE. Secured Party shall not be liable to Debtor for any loss, damage or expense of any kind or nature caused, directly or indirectly, by any Equipment secured hereunder or the use or maintenance thereof or the failure of operation thereof, or the repair, service or adjustment thereof, or by any delay or failure to provide any such maintenance, repairs, service or adjustment, or by any interruption of service or loss of use thereof or for any loss of business howsoever caused. The Equipment shall be shipped directly to Debtor by the supplier thereof and Debtor agrees to accept such delivery. No defect or unfitness of the Equipment, nor any failure or delay on the part of the manufacturer or the shipper of the Equipment to deliver the Equipment or any part thereof to Debtor, shall relieve Debtor of the obligation to pay the Time Balance or any other obligation under this Agreement. Secured Party shall have no obligation under this Agreement in respect of the Equipment and shall have no obligation to install, erect, test, adjust or service the Equipment. Secured Party agrees, so long an Event of Default does not exist hereunder or event which with lapse of time or notice, or both, might become an Event of Default hereunder does not exist, that Secured Party will permit Debtor to enforce in Debtor's own name at Debtor's sole expense any supplier's or manufacturer's warranty or agreement in respect of the Equipment.. Notwithstanding the foregoing, nothing herein shall be deemed to be a disclaimer or waiver of the implied covenant of quiet enjoyment. 5. ASSIGNMENT. Any transaction evidenced by a Loan Schedule shall be assignable by Secured Party, and by its assigns, without the consent of Debtor, but Debtor shall not 2 be obligated to any assignee except upon written notice of such assignment from Secured Party or such assignee. The obligation of Debtor to pay and perform the Liabilities to such assignee shall be absolute and unconditional and shall not be affected by any circumstance whatsoever, and such payments shall be made without interruption or abatement notwithstanding any event or circumstance whatsoever, including, without limitation, the late delivery, non-delivery, destruction or damage of or to the Equipment, the deprivation or limitation of the use of the Equipment, the bankruptcy or insolvency of Secured Party or Debtor or any disaffirmance of this Agreement by or on behalf of Debtor and notwithstanding any defense, set-off, recoupment or counterclaim or any other right whatsoever, whether by reason of breach of this Agreement or of any warranty in respect of the Equipment or otherwise which Debtor may now or hereafter have against Secured Party, and whether any such event shall be by reason of any act or omission of Secured Party (including, without limitation, any negligence of Secured Party) or otherwise; provided, however, that nothing herein contained shall affect any right of Debtor to enforce against Secured Party any claim which Debtor may have against Secured Party in any manner other than by abatement, attachment or recoupment of, interference with, or set-off, counterclaim or defense against, the aforementioned payments to be made to such assignee. Debtor's undertaking herein to pay and perform the Liabilities to an assignee of Secured Party shall constitute a direct, independent and unconditional obligation of Debtor to said assignee. Said assignee shall have no obligations under this Agreement or in respect of the Equipment and shall have no obligation to install, erect, test, adjust or service the Equipment. Debtor also acknowledges and agrees that any assignee of Secured Party's interest in this Agreement shall have the right to exercise all rights, privileges and remedies (either in its own name or in the name of Secured Party) which by the terms of this Agreement are permitted to be exercised by Secured Party. 6. DAMAGE TO OR LOSS OF THE EQUIPMENT; REQUISITION. Debtor assumes and shall bear the entire risk of loss or damage to the Equipment from any and every cause, whatsoever. No loss or damage to the Equipment or any part thereof shall affect any obligation of Debtor with respect to the Liabilities and this Agreement, which shall continue in full force and effect. Debtor shall advise Secured Party in writing promptly of any item of Equipment lost or damaged and of the circumstances and extent of such damage. If the Equipment is totally destroyed, irreparably damaged, lost, stolen or title thereto shall be requisitioned or taken by any governmental authority under the power of eminent domain or otherwise, Debtor shall, at the option of Debtor, so long as no Event of Default exists under this Agreement, otherwise at the option of Secured Party, replace the same with like equipment in good repair, condition and working order and value, or pay to Secured Party all Liabilities due and to become due with respect to the Equipment, less the net amount of the recovery, if any, actually received by Secured Party from insurance or otherwise for such destruction, damage, loss, theft, requisition or taking. Whenever the Equipment is destroyed or damaged and, in the reasonable discretion of Debtor so long as no Event of default exists under this Agreement, otherwise in the sole discretion of Secured Party, such destruction or damage can be repaired, Debtor shall, at its expense, promptly effect such repairs as Secured Party shall deem necessary for compliance with clause (a) of paragraph 8 below. Any proceeds of insurance with respect to such reparable damage to the Equipment shall, at the election of Debtor if no Event of Default is continuing, (and otherwise, at the election of Secured Party), be applied either to the repair of the Equipment by payment directly to the party completing the repairs, or to the reimbursement of Debtor for the cost of such repairs; 3 provided, however, that Secured Party shall have no obligation to make such payment or any part thereof until receipt of such evidence as Secured Party shall deem satisfactory that such repairs have been completed and further provided that Secured Party may apply such proceeds to the payment of any of the Liabilities or the Other Liabilities due if at the time such proceeds are received by Secured Party there shall have occurred and be continuing any Event of Secured Party shall not be obligated to undertake, by litigation or otherwise, the collection of any claim against any person for such destruction, damage, loss, theft, requisition or taking. 7. REPRESENTATIONS AND WARRANTIES OF DEBTOR. Debtor represents and warrants that: it has the right, power and authority to enter into and carry out the terms and provisions of this Agreement; this Agreement constitutes a valid obligation of the Debtor and is enforceable in accordance with its terms; and entering into this Agreement and carrying out its terms and provisions will not violate the terms or constitute a breach of (a) any other material agreement to which Debtor is a party or (b) any other agreement, material or otherwise, affecting or relating to the Equipment. 8. AFFIRMATIVE COVENANTS OF DEBTOR. Debtor shall (a) cause the Equipment to be kept in good condition and use the Equipment only in the manner for which it was designed and intended so as to subject it only to ordinary wear and tear and cause to be made all needed and proper repairs, renewals and replacements thereto; (b) maintain at all times property damage, fire, theft and comprehensive insurance for the full replacement value of the Equipment, with loss payable provisions in favor of Secured Party and any assignee of Secured Party as their interests may appear, and maintain public liability insurance in amounts reasonably satisfactory to Secured Party, naming Secured Party and any assignee of Secured Party as insureds for said insurance related specifically to any Equipment and loss payable provisions to be in form, substance and amount and written by companies approved by Secured Party in its reasonable discretion, and deliver the policies therefor, or duplicates thereof, to Secured Party; (c) pay or reimburse Secured Party for any and all taxes, assessments and other governmental charges of whatever kind or character, however designated (together with any penalties, fines or interest thereon) levied or based upon or with respect to the Equipment, the Liabilities or this Agreement or upon the manufacture, purchase, ownership, delivery, possession, use, storage, operation, maintenance, repair, return or other disposition of the Equipment, or upon any receipts or earnings arising therefrom, or for titling or registering the Equipment, or upon the income or other proceeds received with respect to the Equipment or this Agreement provided, however, that Debtor shall pay taxes on or measured by the net income of Secured Party and franchise taxes of Secured Party only to the extent that such net income taxes or franchise taxes are levied or assessed in lieu of any other taxes, assessments or other governmental charges hereinabove described; (d) pay all shipping and delivery charges and other expenses incurred in connection with the Equipment and pay all lawful claims, whether for labor, materials, supplies, rents or services, which might or could if unpaid become a lien on the Equipment; (e) comply with all governmental laws, regulations, requirements and rules, all instructions and warranty requirements of the manufacturer of the Equipment, and with the conditions and requirements of all policies of insurance with respect to the Equipment and this Agreement; (f) mark and identify the Equipment with all information and in such manner as Secured Party may reasonably request from time to time and replace promptly any such marking or identification which are removed, defaced or destroyed; (g) at any and all times during business hours and upon two business days 4 prior written notice (which may be given by telefax transmission), grant to Secured Party free access to enter upon the premises wherein the Equipment shall be located and permit Secured Party to inspect the Equipment, provided that inspections will not be conducted more frequently than twice during any 12 consecutive month period and that Secured Party will comply with reasonable health and safety procedures while conducting such inspections, provided further that such limitations shall not apply to inspections conducted during the continuance of an Event of Default; (h) reimburse Secured Party for all charges, costs and expenses (including reasonable attorneys' fees) incurred by Secured Party in defending or protecting its interests in the Equipment, in the attempted enforcement or enforcement of the provisions of this Agreement or in the attempted collection or collection of any of the Liabilities; (i) indemnify and hold any assignee of Secured Party, and Secured Party, harmless from and against all claims, losses, liabilities, damages, judgments, suits, and all legal proceedings, and any and all costs and expenses in connection therewith (including reasonable attorneys' fees) arising out of or in any manner connected with the manufacture, purchase, ownership, delivery, possession, use, storage, operation, maintenance, repair, return or other disposition of the Equipment or with this Agreement, including, without limitation, claims for injury to or death of persons and for damage to property, but excluding any of the foregoing caused by the gross negligence or willful misconduct of Secured Party or any assignee, and give Secured Party prompt notice of any such claim or liability; and (j) maintain a system of accounts established and administered in accordance with generally accepted accounting principles and practices consistently applied, and, within forty-five (45) days after the end of each fiscal quarter, deliver to Secured Party a balance sheet as at the end of such quarter and statement of operations for such quarter, and, within one hundred and twenty (120) days after the end of each fiscal year, deliver to Secured Party a balance sheet as at the end of such year and statement of operations for such year, in each case prepared in accordance with generally accepted accounting principles and practices consistently applied and certified by Debtor's chief financial officer as fairly presenting the financial position and results of operation of Debtor, and, in the case of year end financial statements, certified by an independent accounting firm acceptable to Secured Party. 9. NEGATIVE COVENANTS OF DEBTOR. Debtor shall not (a) create, incur, assume or suffer to exist any mortgage, lien, pledge or other encumbrance or attachment of any kind whatsoever upon, affecting or with respect to the Equipment or this Agreement or any of Debtor's interests hereunder; (b) make any changes or alterations in or to the Equipment (collectively, the "Alterations") except (i) as necessary for compliance with clause (a) of paragraph 8 above, and (ii) such Alterations which may be removed without any material damage to the Equipment or do not materially reduce the value of the Equipment; (c) permit the name of any person, association or corporation other than Secured Party to be placed on the Equipment as a designation that might be interpreted as a claim of interest in the Equipment; (d) part with possession or control of or suffer or allow to pass out of its possession or control any of the Equipment or, except with seven (7) business days prior written notice to Secured Party, change the location of the Equipment or any part thereof from the location shown above; (e) assign or in any way dispose of all or any part of its rights or obligations under this Agreement or enter into any lease of all or any part of the Equipment; (f) change its name or address from that set forth above unless it shall have given Secured Party no less than thirty (30) days prior written notice thereof; (g) without Secured Party's prior written consent which will not unreasonably be withheld, sell any shares of its capital stock or transfer any 5 ownership interest in the Debtor to any person, persons, entity or entities (whether in one single transaction or in multiple transactions) which results in a transfer of a majority interest in the ownership and/or the control of the Debtor from the person, persons, entity or entities who hold a majority ownership and/or control of the Debtor as of the date of this Agreement; or (h) without Secured Party's prior written consent which will not unreasonably be withheld, consolidate with or merge into or with any other entity, or purchase or otherwise acquire all or substantially all of the assets or stock or other ownership interest of any person or entity; or (i) without Secured Party's prior written consent which will not unreasonably be withheld sell, transfer, lease or otherwise dispose of all or substantially all of Debtor's assets to any person or entity ( a "Buyer"). With respect to the consent provisions under Sections 9 (g) 9 (h) and 9 (i) of this Agreement, Secured Party shall, in its reasonable discretion, review and determine whether (x) Secured Party is satisfied as to the creditworthiness of the successor entity or Buyer and as to such successor's, Buyer's and/or the new major shareholder's conformance to the other standard criteria then used by Secured Party for such purposes; (y) if requested by Secured Party, such successor entity or Buyer is willing to execute and deliver to Secured Party an agreement satisfactory in form and substance to Secured Party, in its reasonable discretion, containing the successor entity's and/or Buyer's effective assumption of all obligations of the Debtor under the Agreement and all Loan Schedules thereunder; and/or (z) if requested by Secured Party, Debtor, the new major shareholder, Buyer and/or such successor entity are willing to execute such additional documentation or modifications to the Agreement (including without limitation, the Financial Covenant Rider) as are reasonably required by Secured Party to maintain Secured Party's interests in the Equipment or as otherwise required by Secured Party to accomplish Section 9 (x) above. 10. EQUIPMENT PERSONALTY. The Equipment is, and shall at all times be and remain, personal property notwithstanding that the Equipment or any part thereof may now be, or hereafter become, in any manner affixed or attached to, or imbedded in, or permanently resting upon, real property or attached in any manner to real property by cement, plaster, nails, bolts, screws or otherwise. If requested by Secured Party with respect to any item of Equipment, Debtor will obtain and deliver to Secured Party waivers of interest or liens in recordable form, satisfactory to Secured Party, from all persons claiming any interest in the real property on which such item of Equipment is installed or located. 11. EVENTS OF DEFAULT AND REMEDIES. If any one or more of the following events ("Events of Default") shall occur: (a) Debtor shall fail to make any payment in respect of the Liabilities within five (5) business days of when due; or (b) any written certification, statement, representation, warranty or financial report or statement heretofore or hereafter furnished by or on behalf of Debtor or any guarantor of any or all of the Liabilities proves to have been false in any material respect at the time as of which the facts therein set forth were stated or certified or has omitted any material contingent or unliquidated liability or claim against Debtor or any such guarantor; or (c) Debtor or any guarantor of any or all of the Liabilities shall fail to perform or observe any covenant, condition or agreement to be performed or observed by it hereunder or under any 6 guaranty agreement, which has not been cured within twenty (20) days of written notice thereof (except for any Financial Covenant(s) contained in any Rider of even date herewith), provided that Secured Party shall have no obligation to enter into any additional Loan Schedules during such cure period; or (d) Debtor or any guarantor of any or all of the Liabilities shall be in breach of or in default in the payment and performance of any obligation relating to any of the Other Liabilities; or (e) Debtor or any guarantor of any of Debtor's obligations hereunder shall be in breach of or in default in the payment or performance of any obligation owing to any bank, lender, lessor or financial institution in connection with a transaction in excess of $500,000.00, howsoever arising, present or future, contracted for or acquired, and whether joint, several, absolute, contingent, secured, unsecured, matured or unmatured; or (f) Debtor or any guarantor of any or all of the Liabilities shall cease doing business as a going concern, make an assignment for the benefit of creditors, admit in writing its inability to pay its debts as they become due, file a petition commencing a voluntary case under any chapter of Title 11 of the United States Code entitled "Bankruptcy" (the "Bankruptcy Code"), be adjudicated an insolvent, file a petition seeking for itself any reorganization, arrangement, composition, readjustment, liquidation, dissolution or similar arrangement under any present or future statute, law, rule or regulation or file an answer admitting the material allegations of a petition filed against it in any such proceeding, consent to the filing of such a petition or acquiescence in the appointment of a trustee, receiver or liquidator of it or of all or any part of its assets or properties, or take any action looking to its dissolution or liquidation; or (g) an order for relief against Debtor or any guarantor of any or all of the Liabilities shall have been entered under any chapter of the Bankruptcy Code or a decree or order by a court having jurisdiction in the premises shall have been entered approving as properly filed a petition seeking reorganization, arrangement, readjustment, liquidation, dissolution or similar relief against Debtor or any guarantor of any or all of the Liabilities under any present or future statute, law, rule or regulation which shall not, in each case, have been stayed or dismissed within forty-five (45) days, or (ii) within thirty (30) days after the appointment without Debtor's or such guarantor's consent or acquiescence of any trustee, receiver or liquidator of it or (iii) such guarantor or of all or any part of its or such guarantor's assets and properties, such appointment shall not be vacated, or an order, judgment or decree which would reasonably be expected to have a material adverse effect on the business or financial condition of Debtor shall be entered against Debtor or such guarantor by a court of competent jurisdiction and shall continue in effect for any period of twenty (20) consecutive days without a stay of execution, or any execution or writ or process shall be issued under any action or proceeding against Debtor whereby the Equipment or its use may be taken or restrained; or (h) Debtor or any guarantor of any or all of the Liabilities shall suffer an adverse material change in its financial condition as compared to such condition as at the date hereof, and as a result of such change in condition Secured Party deems itself or any of the Equipment to be insecure; "adverse material change" means any set of one or more circumstances which, individually or collectively, will result in, with respect to Debtor, (i) any change or effect that is or is reasonably likely to be materially adverse to the business, operations, properties, assets or conditions (financial or otherwise) of the Debtor; (ii) the material impairment of the ability of the Debtor to perform, or of the Secured Party to enforce, its obligations under the Agreement or 7 Loan Schedules; or (iii) a material adverse effect on the value of the Equipment (other than normal depreciation, ordinary wear and tear and change in market conditions) or the amount which the Secured Party would be likely to receive (after giving consideration to delays in payment and costs of enforcement) in the liquidation of the Equipment; then and in any such event, Secured Party may, at the sole discretion of Secured Party, without notice or demand and without limitation of any rights and remedies of Secured Party under the Uniform Commercial Code, take any one or more of the following steps: (1) Declare all of the Time Balance to be due and payable, whereupon the same shall forthwith mature and become due and payable as provided for in paragraph 16 below, provided, however, upon the occurrence of any of the events specified in subparagraphs (f) and (g) above, all sums as specified in this clause (1) shall immediately be due and payable without notice to Debtor (the date on which Secured Party declares all of the Time Balance to be due and payable is hereinafter referred to as the "Declaration Date"); (2) proceed to protect and enforce its rights by suit in equity, action at law or other appropriate proceedings, whether for the specific performance of any agreement contained herein, or for an injunction against a violation of any of the terms hereof, or in aid of the exercise of any other right, power or remedy granted hereby or by law, equity or otherwise; and (3) at any time and from time to time, with or without judicial process and the aid or assistance of others, enter upon any premises wherein any of the Equipment may be located and, without resistance or interference by Debtor, take possession of the Equipment on any such premises, and require Debtor to assemble and make available to Secured Party at the expense of Debtor any part or all of the Equipment at any place or time designated by Secured Party; and remove any part or all of the Equipment from any premises wherein the same may be located for the purpose of effecting the sale or other disposition thereof; and sell, resell, lease, assign and deliver, grant options for or otherwise dispose of any or all of the Equipment in its then condition or following any commercially reasonable preparation or processing, at public or private sale or proceedings, by one or more contracts, in one or more parcels, at the same or different times, with or without having the Equipment at the place of sale or other disposition, for cash and/or credit, and upon any terms, at such place(s) and time(s) and to such persons, firms or corporations as Secured Party shall deem commercially reasonable, all without demand for performance or any notice or advertisement whatsoever, except that Debtor shall be given ten (10) business days' written notice of the place and time of any public sale or of the time after which any private sale or other intended disposition is to be made, which notice Debtor hereby agrees shall be deemed reasonable notice thereof. If any of the Equipment is sold by Secured Party upon credit or for future delivery, Secured Party shall not be liable for the failure of the purchaser to pay for same and in such event Secured Party may resell such Equipment. Secured Party may buy any part or all of the Equipment at any public sale and if any part or all of the Equipment is of a type customarily sold in a recognized market or which is the subject of widely distributed standard price quotations Secured Party may buy at private sale and may make payment therefor by application of all or a part of the Liabilities and of all or a part of any Other Liabilities. Any personalty in or attached to the Equipment when repossessed may be held by Secured Party without any liability arising with respect thereto, and any and all claims in connection with such personalty shall be deemed to have been waived unless notice of such claim is made by certified or registered mail upon Secured Party within ten business days after repossession. 8 Secured Party shall apply the cash proceeds from any sale or other disposition of the Equipment first, to the reasonable expenses of re-taking, holding, preparing for sale, selling, leasing and the like, and to reasonable attorneys' fees and other expenses which are to be paid or reimbursed to Secured Party pursuant hereto, and second, to all outstanding portions of the Liabilities and to any Other Liabilities in such order as Secured Party may elect, and third, any surplus to Debtor, subject to any duty of Secured Party imposed by law to the holder of any subordinate security interest in the Equipment known to Secured Party; provided however, that Debtor shall remain liable with respect to unpaid portions of the Liabilities owing by it and will pay Secured Party on demand any deficiency remaining with interest as provided for in paragraph 16 below. 12. SECURED PARTY'S RIGHT TO PERFORM FOR DEBTOR. If Debtor fails to perform or comply with any of its agreements contained herein Secured Party may perform or comply with such agreement and the amount of any payments and expenses incurred by Secured Party in connection with such performance or compliance, together with interest thereon at the rate provided for in paragraph 16 below, shall be deemed a part of the Liabilities and shall be payable by Debtor upon demand. 13. FURTHER ASSURANCES. Debtor will cooperate with Secured Party for the purpose of protecting the interests of Secured Party in the Equipment, including, without limitation, the execution of all Uniform Commercial Code financing statements requested by Secured Party. Secured Party and any assignee of Secured Party are each authorized to the extent permitted by applicable law to file one or more Uniform Commercial Code financing statements disclosing any security interest in the Equipment without the signature of Debtor or signed by Secured Party or any assignee of Secured Party as attorney-in-fact for Debtor. Debtor will pay all costs of filing any financing, continuation or termination statements with respect to this Agreement, including, without limitation, any documentary stamp taxes relating thereto. Debtor will do whatever may be necessary to have a statement of the interest of Secured Party and of any assignee of Secured Party in the Equipment noted on any certificate of title relating to the Equipment and will deposit said certificate with Secured Party or such assignee. Debtor shall execute and deliver to Secured Party, upon request, such other instruments and assurances as Secured Party deems reasonably necessary or advisable for the implementation, effectuation, confirmation or perfection of this Agreement and any rights of Secured Party hereunder. 14. NON-WAIVER; ETC. No course of dealing by Secured Party or Debtor or any delay or omission on the part of Secured Party in exercising any rights hereunder shall operate as a waiver of any rights of Secured Party. No waiver or consent shall be binding upon Secured Party unless it is in writing and signed by Secured Party. A waiver on any one occasion shall not be construed as a bar to or a waiver of any right and/or remedy on any future occasion. To the extent permitted by applicable law, Debtor hereby waives the benefit and advantage of, and covenants not to assert against Secured Party, any valuation, inquisition, stay, appraisement, extension or redemption laws now existing or which may hereafter exist which, but for this provision, might be applicable to any sale or other disposition made under the judgment, order or decree of any court or under the powers of sale and other disposition conferred by this Agreement or otherwise. Debtor hereby waives any right to a jury trial with respect to any matter arising under or in connection with this Agreement. 15. ENTIRE AGREEMENT; SEVERABILITY; ETC. This Agreement constitutes the entire agreement between Secured Party and Debtor and all conversations, agreements and representations relating to this Agreement or to the Equipment are integrated herein. If any provision hereof or any remedy herein provided for shall be invalid under any applicable law, such provision or 9 remedy shall be inapplicable and deemed omitted, but the remaining provisions and remedies hereunder shall be given effect in accordance with the intent hereof. Neither this Agreement nor any term hereof may be changed, discharged, terminated or waived except in an instrument in writing signed by the party against which enforcement of the change, discharge, termination or waiver is sought. This Agreement shall in all respects be governed by and construed in accordance with the internal laws of the State of New York, including all matters of construction, validity and performance, and shall be deemed a purchase money security agreement within the meaning of the Uniform Commercial Code. The captions in this Agreement are for convenience of reference only and shall not define or limit any of the terms or provisions hereof. This Agreement shall inure to the benefit of and be binding upon Secured Party and Debtor and their respective successors and assigns, subject, however, to the limitations set forth in this Agreement with respect to Debtor's assignment hereof. No right or remedy referred to in this Agreement is intended to be exclusive but each shall be cumulative and in addition to any other right or remedy referred to in this Agreement or otherwise available to Secured Party at law or in equity, and shall be in addition to the provisions contained in any instrument referred to herein and any instrument supplemental hereto. Debtor shall be liable for all costs and expenses, including reasonable attorneys' fees and disbursements, incurred by reason of the occurrence of any Event of Default or the exercise of Secured Party's remedies with respect thereto. Time is of the essence with respect to this Agreement and all of its provision. 16. PREPAYMENT; REBATE; INTEREST. Except as provided in the prepayment agreement of even date herewith or except for the installment payments of the Time Balance as set forth in the Schedule of Obligations, the Debtor may not prepay the Time Balance, in whole or in part, at any time. In the event Secured Party declares all of the Time Balance to be due and payable pursuant to clause (1) of paragraph 11 above, Debtor shall pay to Secured Party an amount equal to the sum of (a) all accrued and unpaid amounts as of the Declaration Date plus interest thereon, and (b) the present value of all future installments set forth in this Agreement over the remaining unexpired term of this Agreement discounted to present value using a discount rate of five percent (5%), provided that the amount of interest earned by Secured Party computed as aforesaid shall not exceed the highest amount permitted by applicable law. The Time Balance as reduced to present value in accordance with the preceding sentence shall bear interest from and after the Declaration Date, and all other Liabilities due and payable under this Agreement (including past due installments) shall bear interest from and after their respective due dates until paid in full, at the lesser of 1.5% per month or the highest rate permitted by applicable law, provided, however, that Debtor shall have no obligation to pay any interest on interest except to the extent permitted by applicable law. 17. CONSENT TO JURISDICTION. Debtor hereby irrevocably consents to the jurisdiction of the courts of the State of New York and of any federal court located in such state in connection with any action or proceeding arising out of or relating to this Agreement or the transactions contemplated hereby. Any such action or proceeding will be maintained in the United States District Court for the Southern District of New York or in any court of the State of New York located in the County of New York and Debtor waives any objections based upon venue or forum non conveniens in connection with any such action or proceeding. Debtor consents that process in any such action or proceeding may be served upon it by registered mail directed to Debtor at its address set forth at the head of this Agreement or in any other manner permitted by applicable law or rules of court. Debtor hereby irrevocably appoints CT Corporation with offices at Corporation Trust Center, 1209 Orange Street, Wilmington, DE 19801 as its agent to receive service of process in any such action or proceeding. 10 18. NOTICES. Notice hereunder shall be deemed given if served personally or by certified or registered mail, return receipt requested, to Secured Party and Debtor at their respective addresses set forth at the head of this Agreement. Any party hereto may from to time by written notice to the other change the address to which notices are to be sent to such party. A copy of any notice sent by Debtor to Secured Party shall be concurrently sent by Debtor to any assignee of Secured Party of which Debtor has notice. The Debtor agrees to all the provisions set forth above. This Agreement is executed pursuant to due authorization. DEBTOR ACKNOWLEDGES RECEIPT OF A SIGNED TRUE COPY OF THIS AGREEMENT. Date: July 9, 2001 Accepted on July 27, 2001 KOSAN BIOSCIENCES INCORPORATED (Debtor) WELLS FARGO EQUIPMENT FINANCE, INC. (Secured Party) (Signature of Proprietor or name of Corporation or Partnership) By /s/ Susan M. Kanaya By /s/ Sally Doheny ------------------------------------ --------------------------------- Its Vice President, Finance & Its Assistant Vice President ----------------------------------- ------------------------------- Chief Financial Officer ----------------------------------- (if Corporation, President or Vice President should sign and give official title; if Partnership, state partner; if L.L.C., state member or manger) 11 PREPAYMENT AGREEMENT WHEREAS, Wells Fargo Equipment Finance, Inc. ("WFEFI"), as Secured Party and Kosan Biosciences, Inc. as Debtor ("Debtor") are parties to certain Loan Schedule No. 700 which incorporates the terms and conditions of Master Loan and Security Agreement No. 84325 (said Loan Schedule is referred to herein as the "Agreement"), dated July 9, 2001 affecting the equipment (the "Equipment") described therein; and WHEREAS, the parties hereto desire to confirm their understanding pursuant to which the Debtor may prepay the Agreement as set forth below. NOW, THEREFORE, the parties hereto agree as follows: 1. Provided that the Debtor shall so request WFEFI in writing not less than thirty (30) days prior to a Prepayment Date, and further provided that the Debtor shall have paid all monthly installment payments due through and including the applicable Prepayment Date in accordance with the terms and provisions of the Agreement and shall then be in compliance with all the terms and provisions of the Agreement and shall continue to comply with all the terms and provisions of the Agreement thereafter until such Prepayment Date, WFEFI agrees to allow Debtor to prepay the Agreement (in whole, but not in part) by payment of the appropriate prepayment amount as set forth below ("Prepayment Amount") in good funds plus applicable per diem interest as set forth below, on the applicable Prepayment Date. Prepayment Date shall mean the day that the Prepayment Amount together with per diem interest is received in good funds by WFEFI in accordance with the terms hereof. 2. The Prepayment Amount which Debtor shall pay in the event of a prepayment of the Agreement hereunder shall be computed as follows: (a) For a Prepayment Date which is on or after the day that the first (1st) monthly installment is due but prior to the date that the thirteenth (13th) payment is due, the Prepayment Amount shall be 104% of the remaining principal balance due under the Agreement computed in accordance with the books and records of Secured Party or its assigns; (b) For a Prepayment Date which is on or after the day that the thirteenth (13th) monthly installment is due but prior to the date that the twenty-fifth (25th) payment is due, the Prepayment Amount shall be 103% of the remaining principal balance due under the Agreement computed in accordance with the books and records of Secured Party or its assigns; (c) For a Prepayment Date which is on or after the day that the twenty- fifth (25th) monthly installment is due but prior to the date that the thirty-seventh (37th) payment is due, the Prepayment Amount shall be 102% of the remaining principal balance due under the Agreement computed in accordance with the books and records of Secured Party or its assigns; (e) For a Prepayment Date which is on or after the day that the thirty-seventh (37th) monthly installment is due but prior to the date that the forty-second (42nd) payment is due, the Prepayment Amount shall be 101% of the remaining principal balance due under the Agreement computed in accordance with the books and records of Secured Party or its assigns. 3. All taxes attributable to the transaction herein contemplated including any taxes on the Prepayment Amount, shall be borne exclusively by the Debtor (except for taxes based on Secured party's net income.) 4. In addition to the Prepayment Amount and taxes, Debtor shall also pay to Secured Party on the Prepayment Date, per diem interest which means interest on the Prepayment Amount calculated on the basis of a 365 day year using the implicit rate of interest that was used to calculate the installment payments under the Agreement, for each day from the day that the most recent installment was due through and including the Prepayment Date. 5. Time is of the essence for the Debtor's making written request for prepayment and for remitting the Prepayment Amount in the event Debtor timely exercises its option to prepay hereunder. 12 6. Except as specifically permitted by this Prepayment Agreement, Debtor shall have no right to prepay the Agreement. 7. This Prepayment Agreement shall constitute an indivisible part of the Agreement and shall be binding upon and inure to the benefit of the parties hereto and their respective successors and assigns. KOSAN BIOSCIENCES, INC. WELLS FARGO EQUIPMENT FINANCE, INC. By /s/ Susan M. Kanaya By /s/ Sally Doheny ------------------------------------ --------------------------------- Its Vice President, Finance & Its Assistant Vice President ----------------------------------- ------------------------------- Chief Financial Officer ----------------------------------- Dated: July 9, 2001 Dated: July 27, 2001 13 -----END PRIVACY-ENHANCED MESSAGE-----

EX-10.36

CERTAIN CONFIDENTIAL INFORMATION CONTAINED IN THIS DOCUMENT, MARKED BY BRACKETS,
HAS BEEN OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE
COMMISSION PURSUANT TO RULE 24B-2 OF THE SECURITIES EXCHANGE ACT OF 1934, AS
AMENDED.


                                                                   EXHIBIT 10.36


AMENDMENT NUMBER 3 TO RESEARCH AND LICENSE AGREEMENT BY AND BETWEEN KOSAN
BIOSCIENCES, INC., AND THE R.W. JOHNSON PHARMACEUTICAL RESEARCH INSTITUTE AND
ORTHO-MCNEIL PHARMACEUTICAL, INC.


        This Amendment dated as of September 28, 2001, is made to the RESEARCH
AND LICENSE AGREEMENT, made as of September 28, 1998, and amended pursuant to
those certain Amendment Nos. 1 and 2 dated March 17, 2000 and August 31, 2000
(the RESEARCH AND LICENSE AGREEMENT as amended March 17, 2000 and August 31,
2000, is hereinafter called the "AGREEMENT"), by and between

        KOSAN BIOSCIENCES, INC., a corporation organized under Delaware law
having its principal office at 3832 Bay Center Place, Hayward, California, 94545
(hereinafter called "KOSAN");

        ON THE ONE HAND, AND:

        ORTHO MCNEIL PHARMACEUTICAL, INCORPORATED (hereinafter called "ORTHO"),
a company organized under Delaware law, having its principal office at U.S.
Route 202, Raritan, New Jersey, 08869; and

        The R.W. JOHNSON PHARMACEUTICAL RESEARCH INSTITUTE (hereinafter called
"RWJPRI"), a division of Ortho McNeil Pharmaceutical, Incorporated, having its
principal office at U.S. Route 202, Raritan, New Jersey 08869 (ORTHO and RWJPRI
hereinafter collectively called "LICENSEE")

        ON THE OTHER HAND,

WITNESSETH:

        A. WHEREAS, KOSAN and LICENSEE have entered into the AGREEMENT providing
for a collaborative research drug discovery program as generally described in
the RESEARCH PLAN attached thereto as Appendix A;

        B. WHEREAS, the AGREEMENT contemplated the termination of the RESEARCH
PROGRAM on December 28, 2001, in the event that LICENSEE was not actively
engaged in activities to progress a MACROLIDE into full clinical development as
of that date;


[ * ] = CERTAIN CONFIDENTIAL INFORMATION CONTAINED IN THIS DOCUMENT, MARKED BY
BRACKETS, HAS BEEN OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE
COMMISSION PURSUANT TO RULE 24B-2 OF THE SECURITIES EXCHANGE ACT OF 1934, AS
AMENDED.



                                       1


        C. WHEREAS, KOSAN and LICENSEE desire to extend the RESEARCH PROGRAM at
least until December 28, 2002;

        NOW, THEREFORE, in consideration of the premises and the performance of
the covenants herein contained, the parties agree to amend the AGREEMENT as
follows:

        1. Defined Terms. Unless otherwise defined herein, all capitalized terms
used herein shall have the same meaning as set forth in the AGREEMENT.

        2. Extension of RESEARCH PROGRAM. The RESEARCH PROGRAM shall be
continued until at least December 28, 2002, unless terminated in accordance with
Section 5, below.

        3. Current FTE RESEARCH FUNDING. In accordance with the AGREEMENT,
LICENSEE is currently providing RESEARCH FUNDING, paid quarterly in advance, for
KOSAN FTEs as follows: [ * ] on an annual basis for the period of December 28,
2000, to December 28, 2001, for a total of [ * ].

        4. Additional KOSAN FTE RESEARCH FUNDING. In accordance with this
Amendment, LICENSEE shall provide, in addition to the current RESEARCH FUNDING,
RESEARCH FUNDING for additional KOSAN FTEs (the "Additional KOSAN FTEs") as
follows: [ * ] on an annual basis for the period of December 28, 2001 to
December 28, 2002, for a total of [ * ]. LICENSEE shall provide RESEARCH FUNDING
for the Additional KOSAN FTEs on a quarterly basis, in advance, beginning
December 28, 2001. After December 28, 2001, KOSAN may elect to devote, at
KOSAN's expense, up to [ * ] (the "Optional FTEs") to work on [ * ]. KOSAN shall
report the activities of any Optional FTEs to the JRC, but LICENSEE shall have
no obligation to provide RESEARCH FUNDING for such Optional FTEs unless [ * ] is
accepted [ * ], as provided in Section 8, below, or LICENSEE extends the
RESEARCH PROGRAM to March 28, 2002, as provided in Section 7, below.

        5. Termination of Additional FTE RESEARCH FUNDING. In the event that, in
LICENSEE's judgment to be exercised at its sole discretion, the MACROLIDES
developed in the RESEARCH PROGRAM [ * ], LICENSEE shall have the right to
terminate the RESEARCH PROGRAM on September 28, 2002, and its obligations to
continue to provide RESEARCH FUNDING for the Additional KOSAN FTEs shall
terminate concurrently therewith, provided LICENSEE provides KOSAN written
notification of LICENSEE's decision to terminate on or before June 28, 2002.

        6. Reversion of Rights to KOSAN. LICENSEE's notification of a
termination of, under Section 5, above, the RESEARCH PROGRAM and the RESEARCH
FUNDING for the Additional KOSAN FTEs shall be deemed to be a termination of the
AGREEMENT pursuant to Section 19.2.1(i) of the AGREEMENT and shall constitute a
release and reversion to KOSAN in accordance with Section 19.3.4 of the
AGREEMENT of any and all of LICENSEE's rights to all MACROLIDES,


[ * ] = CERTAIN CONFIDENTIAL INFORMATION CONTAINED IN THIS DOCUMENT, MARKED BY
BRACKETS, HAS BEEN OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE
COMMISSION PURSUANT TO RULE 24B-2 OF THE SECURITIES EXCHANGE ACT OF 1934, AS
AMENDED.



                                       2


AROMATIC POLYKETIDES, NCEs, LICENSED COMPOUNDS, CLOSE STRUCTURAL ANALOGS, and
RESERVED COMPOUNDS.

        7. Non-Acceptance of [ * ] by November 28, 2002. In the event that
LICENSEE has not accepted [ * ] as of November 28, 2002, then LICENSEE may give
KOSAN a written notice prior to November 28, 2002, that it wishes to continue
the RESEARCH PROGRAM for a further three (3) months to March 28, 2003, in which
event LICENSEE shall provide KOSAN RESEARCH FUNDING for the Optional FTEs by
reimbursing KOSAN [ * ] and shall make a RESEARCH FUNDING payment in advance for
such Optional FTEs for the remainder of calendar 2002 and the three (3) month
extension [ * ]. If LICENSEE does not give KOSAN the written notice as described
above or if, after having given such written notice, LICENSEE has not accepted [
* ] as of March 28, 2003, the AGREEMENT shall, unless otherwise agreed,
terminate pursuant to Section 19.2.1(i) of the AGREEMENT, and such termination
shall constitute a release and reversion to KOSAN in accordance with Section
19.3.4 of the AGREEMENT of any and all of LICENSEE's rights to all MACROLIDES,
AROMATIC POLYKETIDES, NCEs, LICENSED COMPOUNDS, CLOSE STRUCTURAL ANALOGS, and
RESERVED COMPOUNDS. Termination pursuant to this Section 7 shall not obligate
LICENSEE to any wind-down or other payment to KOSAN, whether pursuant to Section
19.1.2(c) of the AGREEMENT or otherwise

        8. Acceptance of [ * ]. In the event that LICENSEE has accepted [ * ] on
or before December 28, 2002, then LICENSEE shall provide KOSAN RESEARCH FUNDING
for the Optional FTEs by reimbursing KOSAN [ * ] and by making RESEARCH FUNDING
payments in advance for such Optional FTEs until December 28, 2002, [ * ].

        9. AGREEMENT. Except as amended herein, all of the terms and conditions
of the AGREEMENT shall remain in full force and effect.



[ * ] = CERTAIN CONFIDENTIAL INFORMATION CONTAINED IN THIS DOCUMENT, MARKED BY
BRACKETS, HAS BEEN OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE
COMMISSION PURSUANT TO RULE 24B-2 OF THE SECURITIES EXCHANGE ACT OF 1934, AS
AMENDED.


               {THE REMAINDER OF THE PAGE DELIBERATELY LEFT BLANK}


                                       3

        IN WITNESS WHEREOF, the parties hereto have hereunto set their hands and
duly executed this Amendment to the AGREEMENT on the date(s) indicated below, to
be effective the day and year first above written.


For and on Behalf of KOSAN BIOSCIENCES, INC.

By:     /s/ Daniel V. Santi
        -------------------------------------------------

Name:   Daniel Santi
        -------------------------------------------------

Title:  Chief Executive
        -------------------------------------------------

Date:   10/4/2001
        -------------------------------------------------

For and on Behalf of LICENSEE

By:     /s/ Per Peterson
        -------------------------------------------------

Name:   Per A. Peterson, MD, PhD
        -------------------------------------------------

Title:  Chairman, Research & Development, Pharmaceuticals
        -------------------------------------------------

Date:   10/3/01
        -------------------------------------------------



[ * ] = CERTAIN CONFIDENTIAL INFORMATION CONTAINED IN THIS DOCUMENT, MARKED BY
BRACKETS, HAS BEEN OMITTED AND FILED SEPARATELY WITH THE SECURITIES AND EXCHANGE
COMMISSION PURSUANT TO RULE 24B-2 OF THE SECURITIES EXCHANGE ACT OF 1934, AS
AMENDED.



                                       4

EX-10.37

                                                                   EXHIBIT 10.37



                  MASTER LOAN AND SECURITY AGREEMENT NO. 84325


DEBTOR:                              SECURED PARTY:
   Kosan Biosciences Incorporated            Wells Fargo Equipment Finance, Inc.
   3832 Bay Center Place                     530 Fifth Avenue
   Hayward, CA 94545                         New York, NY 10036

In consideration of the mutual covenants set forth herein, the above named
Debtor and the above named Secured Party hereby enter into this Master Loan and
Security Agreement and agree to the terms and conditions set forth herein. Each
Loan Schedule which may be executed by Debtor and Secured Party from time to
time pursuant to this Master Loan and Security Agreement shall be deemed to be a
separate loan transaction incorporating all of the terms and conditions of this
Master Loan and Security Agreement. References in this Master Loan and Security
Agreement to "Agreement", "hereunder" and "herein" shall mean a Loan Schedule
which incorporates this Master Loan and Security Agreement.

             1. LOAN SCHEDULES. Debtor shall evidence its agreement to enter
         into each Agreement incorporating the terms hereof by executing and
         delivering to Secured Party a Loan Schedule in the form annexed hereto
         as Exhibit 1. Debtor's execution of a Loan Schedule shall obligate
         Debtor to make all of the payments set forth in the Schedule of
         Obligations as set forth in the Loan Schedule. The Loan Schedule shall
         set forth the amount of the Loan, the Term of the Loan, the number of
         payments to be made and the amount and dates upon which such payments
         are due. The Loan Schedule shall also set forth the Time Balance which
         means the aggregate amount of all payments which are payable under the
         Agreement evidenced by such Loan Schedule. Subject to the terms and
         conditions hereof, Secured Party will enter into one or more Loan
         Schedules hereunder covering Equipment having an aggregate original
         Equipment cost ("Acquisition Cost") not in excess of Two Million Five
         Hundred Thousand Dollars ($2,500,000) provided, that: (a)
         notwithstanding anything to the contrary, Secured Party shall have no
         obligation to enter into any Loan Schedule if (i) the Equipment to be
         covered thereunder is not acceptable to Secured Party; or (ii) such
         Loan Schedule has not been signed by Debtor and delivered to Secured
         Party on or before September 30, 2001; or (iii) such Equipment has not
         been delivered to or accepted by Debtor by September 30, 2001 or
         Secured Party has determined that the scheduled dates for delivery and
         installation of such Equipment makes acceptance of the Equipment by
         such date impossible; or (iv) an Event of Default (or any other event
         which, after a lapse of time, or notice, or both, would become an Event
         of Default) has occurred and is continuing hereunder or under any Loan
         Schedule; or (v) the Acquisition Cost of the Equipment to be covered
         under such Loan Schedule is less than $250,000; Provided further that
         any Loan Schedule to be executed after September 30, 2001, shall be
         subject to Secured Party performing its standard update credit review
         of Debtor to confirm the creditworthiness of the Debtor .No Loan
         Schedule shall be binding upon Secured Party until accepted by Secured
         Party which acceptance shall be evidenced only by the execution of such
         Loan Schedule by Secured Party.

             2. GRANT OF SECURITY INTEREST. Debtor hereby grants to Secured
         Party a security interest in the personal property referred to and/or
         described in each Loan Schedule (hereinafter with all renewals,
         substitutions and replacements and all parts, repairs,



                                       1


         improvements, additions and accessories incorporated therein or affixed
         thereto referred to as the "Equipment"), together with any and all
         proceeds thereof and any and all insurance policies and proceeds with
         respect thereto. Notwithstanding the foregoing, Equipment shall not
         include Alterations permitted under Section 9 hereunder which may be
         removed without any material damage to the personal property referred
         to and/or described in each Loan Schedule.

             3. OBLIGATIONS SECURED. The aforesaid security interest is granted
         by Debtor as security for (a) the payment of the Time Balance (as set
         forth in the Loan Schedule) and the payment and performance of all
         other indebtedness and obligations now or hereafter owing by Debtor to
         Secured Party, of any and every kind and description under the
         Agreement evidenced by such Loan Schedule, and any and all renewals and
         extensions of the foregoing, and all interest, fees, charges, expenses
         and reasonable attorneys' fees accruing or incurred in connection with
         any of the foregoing (all of which Time Balance, indebtedness and
         obligations are hereinafter referred to as the "Liabilities") and (b)
         the payment and performance of all other indebtedness and obligations
         now or hereafter owing by Debtor to Secured Party under the Agreement
         and all Loan Schedules hereunder, of any and every kind and
         description, howsoever arising or evidenced including without
         limitation those arising under other Loan Schedules, (all of which
         indebtedness and obligations are hereinafter referred to as the "Other
         Liabilities"). Subject to Paragraph 16, any nonpayment of any
         installment or other amounts due hereunder shall result in the
         obligation on the part of Debtor promptly to pay also an amount equal
         to five percent (5%), (or the maximum rate permitted by law, whichever
         is less) of the installment or other amounts overdue.

             4. DISCLAIMER OF WARRANTIES. DEBTOR ACKNOWLEDGES THAT SECURED PARTY
         MAKES NO WARRANTIES, EXPRESS OR IMPLIED, IN RESPECT OF THE EQUIPMENT,
         INCLUDING, WITHOUT LIMITATION, ANY WARRANTY OF MERCHANTABILITY OR OF
         FITNESS FOR ANY PARTICULAR PURPOSE. Secured Party shall not be liable
         to Debtor for any loss, damage or expense of any kind or nature caused,
         directly or indirectly, by any Equipment secured hereunder or the use
         or maintenance thereof or the failure of operation thereof, or the
         repair, service or adjustment thereof, or by any delay or failure to
         provide any such maintenance, repairs, service or adjustment, or by any
         interruption of service or loss of use thereof or for any loss of
         business howsoever caused. The Equipment shall be shipped directly to
         Debtor by the supplier thereof and Debtor agrees to accept such
         delivery. No defect or unfitness of the Equipment, nor any failure or
         delay on the part of the manufacturer or the shipper of the Equipment
         to deliver the Equipment or any part thereof to Debtor, shall relieve
         Debtor of the obligation to pay the Time Balance or any other
         obligation under this Agreement. Secured Party shall have no obligation
         under this Agreement in respect of the Equipment and shall have no
         obligation to install, erect, test, adjust or service the Equipment.
         Secured Party agrees, so long an Event of Default does not exist
         hereunder or event which with lapse of time or notice, or both, might
         become an Event of Default hereunder does not exist, that Secured Party
         will permit Debtor to enforce in Debtor's own name at Debtor's sole
         expense any supplier's or manufacturer's warranty or agreement in
         respect of the Equipment.. Notwithstanding the foregoing, nothing
         herein shall be deemed to be a disclaimer or waiver of the implied
         covenant of quiet enjoyment.

             5. ASSIGNMENT. Any transaction evidenced by a Loan Schedule shall
         be assignable by Secured Party, and by its assigns, without the consent
         of Debtor, but Debtor shall not



                                       2


         be obligated to any assignee except upon written notice of such
         assignment from Secured Party or such assignee. The obligation of
         Debtor to pay and perform the Liabilities to such assignee shall be
         absolute and unconditional and shall not be affected by any
         circumstance whatsoever, and such payments shall be made without
         interruption or abatement notwithstanding any event or circumstance
         whatsoever, including, without limitation, the late delivery,
         non-delivery, destruction or damage of or to the Equipment, the
         deprivation or limitation of the use of the Equipment, the bankruptcy
         or insolvency of Secured Party or Debtor or any disaffirmance of this
         Agreement by or on behalf of Debtor and notwithstanding any defense,
         set-off, recoupment or counterclaim or any other right whatsoever,
         whether by reason of breach of this Agreement or of any warranty in
         respect of the Equipment or otherwise which Debtor may now or hereafter
         have against Secured Party, and whether any such event shall be by
         reason of any act or omission of Secured Party (including, without
         limitation, any negligence of Secured Party) or otherwise; provided,
         however, that nothing herein contained shall affect any right of Debtor
         to enforce against Secured Party any claim which Debtor may have
         against Secured Party in any manner other than by abatement, attachment
         or recoupment of, interference with, or set-off, counterclaim or
         defense against, the aforementioned payments to be made to such
         assignee. Debtor's undertaking herein to pay and perform the
         Liabilities to an assignee of Secured Party shall constitute a direct,
         independent and unconditional obligation of Debtor to said assignee.
         Said assignee shall have no obligations under this Agreement or in
         respect of the Equipment and shall have no obligation to install,
         erect, test, adjust or service the Equipment. Debtor also acknowledges
         and agrees that any assignee of Secured Party's interest in this
         Agreement shall have the right to exercise all rights, privileges and
         remedies (either in its own name or in the name of Secured Party) which
         by the terms of this Agreement are permitted to be exercised by Secured
         Party.

             6. DAMAGE TO OR LOSS OF THE EQUIPMENT; REQUISITION. Debtor assumes
         and shall bear the entire risk of loss or damage to the Equipment from
         any and every cause, whatsoever. No loss or damage to the Equipment or
         any part thereof shall affect any obligation of Debtor with respect to
         the Liabilities and this Agreement, which shall continue in full force
         and effect. Debtor shall advise Secured Party in writing promptly of
         any item of Equipment lost or damaged and of the circumstances and
         extent of such damage. If the Equipment is totally destroyed,
         irreparably damaged, lost, stolen or title thereto shall be
         requisitioned or taken by any governmental authority under the power of
         eminent domain or otherwise, Debtor shall, at the option of Debtor, so
         long as no Event of Default exists under this Agreement, otherwise at
         the option of Secured Party, replace the same with like equipment in
         good repair, condition and working order and value, or pay to Secured
         Party all Liabilities due and to become due with respect to the
         Equipment, less the net amount of the recovery, if any, actually
         received by Secured Party from insurance or otherwise for such
         destruction, damage, loss, theft, requisition or taking. Whenever the
         Equipment is destroyed or damaged and, in the reasonable discretion of
         Debtor so long as no Event of default exists under this Agreement,
         otherwise in the sole discretion of Secured Party, such destruction or
         damage can be repaired, Debtor shall, at its expense, promptly effect
         such repairs as Secured Party shall deem necessary for compliance with
         clause (a) of paragraph 8 below. Any proceeds of insurance with respect
         to such reparable damage to the Equipment shall, at the election of
         Debtor if no Event of Default is continuing, (and otherwise, at the
         election of Secured Party), be applied either to the repair of the
         Equipment by payment directly to the party completing the repairs, or
         to the reimbursement of Debtor for the cost of such repairs;



                                       3


         provided, however, that Secured Party shall have no obligation to make
         such payment or any part thereof until receipt of such evidence as
         Secured Party shall deem satisfactory that such repairs have been
         completed and further provided that Secured Party may apply such
         proceeds to the payment of any of the Liabilities or the Other
         Liabilities due if at the time such proceeds are received by Secured
         Party there shall have occurred and be continuing any Event of Secured
         Party shall not be obligated to undertake, by litigation or otherwise,
         the collection of any claim against any person for such destruction,
         damage, loss, theft, requisition or taking.

             7. REPRESENTATIONS AND WARRANTIES OF DEBTOR. Debtor represents and
         warrants that: it has the right, power and authority to enter into and
         carry out the terms and provisions of this Agreement; this Agreement
         constitutes a valid obligation of the Debtor and is enforceable in
         accordance with its terms; and entering into this Agreement and
         carrying out its terms and provisions will not violate the terms or
         constitute a breach of (a) any other material agreement to which Debtor
         is a party or (b) any other agreement, material or otherwise, affecting
         or relating to the Equipment.

             8. AFFIRMATIVE COVENANTS OF DEBTOR. Debtor shall (a) cause the
         Equipment to be kept in good condition and use the Equipment only in
         the manner for which it was designed and intended so as to subject it
         only to ordinary wear and tear and cause to be made all needed and
         proper repairs, renewals and replacements thereto; (b) maintain at all
         times property damage, fire, theft and comprehensive insurance for the
         full replacement value of the Equipment, with loss payable provisions
         in favor of Secured Party and any assignee of Secured Party as their
         interests may appear, and maintain public liability insurance in
         amounts reasonably satisfactory to Secured Party, naming Secured Party
         and any assignee of Secured Party as insureds for said insurance
         related specifically to any Equipment and loss payable provisions to be
         in form, substance and amount and written by companies approved by
         Secured Party in its reasonable discretion, and deliver the policies
         therefor, or duplicates thereof, to Secured Party; (c) pay or reimburse
         Secured Party for any and all taxes, assessments and other governmental
         charges of whatever kind or character, however designated (together
         with any penalties, fines or interest thereon) levied or based upon or
         with respect to the Equipment, the Liabilities or this Agreement or
         upon the manufacture, purchase, ownership, delivery, possession, use,
         storage, operation, maintenance, repair, return or other disposition of
         the Equipment, or upon any receipts or earnings arising therefrom, or
         for titling or registering the Equipment, or upon the income or other
         proceeds received with respect to the Equipment or this Agreement
         provided, however, that Debtor shall pay taxes on or measured by the
         net income of Secured Party and franchise taxes of Secured Party only
         to the extent that such net income taxes or franchise taxes are levied
         or assessed in lieu of any other taxes, assessments or other
         governmental charges hereinabove described; (d) pay all shipping and
         delivery charges and other expenses incurred in connection with the
         Equipment and pay all lawful claims, whether for labor, materials,
         supplies, rents or services, which might or could if unpaid become a
         lien on the Equipment; (e) comply with all governmental laws,
         regulations, requirements and rules, all instructions and warranty
         requirements of the manufacturer of the Equipment, and with the
         conditions and requirements of all policies of insurance with respect
         to the Equipment and this Agreement; (f) mark and identify the
         Equipment with all information and in such manner as Secured Party may
         reasonably request from time to time and replace promptly any such
         marking or identification which are removed, defaced or destroyed; (g)
         at any and all times during business hours and upon two business days



                                       4


         prior written notice (which may be given by telefax transmission),
         grant to Secured Party free access to enter upon the premises wherein
         the Equipment shall be located and permit Secured Party to inspect the
         Equipment, provided that inspections will not be conducted more
         frequently than twice during any 12 consecutive month period and that
         Secured Party will comply with reasonable health and safety procedures
         while conducting such inspections, provided further that such
         limitations shall not apply to inspections conducted during the
         continuance of an Event of Default; (h) reimburse Secured Party for all
         charges, costs and expenses (including reasonable attorneys' fees)
         incurred by Secured Party in defending or protecting its interests in
         the Equipment, in the attempted enforcement or enforcement of the
         provisions of this Agreement or in the attempted collection or
         collection of any of the Liabilities; (i) indemnify and hold any
         assignee of Secured Party, and Secured Party, harmless from and against
         all claims, losses, liabilities, damages, judgments, suits, and all
         legal proceedings, and any and all costs and expenses in connection
         therewith (including reasonable attorneys' fees) arising out of or in
         any manner connected with the manufacture, purchase, ownership,
         delivery, possession, use, storage, operation, maintenance, repair,
         return or other disposition of the Equipment or with this Agreement,
         including, without limitation, claims for injury to or death of persons
         and for damage to property, but excluding any of the foregoing caused
         by the gross negligence or willful misconduct of Secured Party or any
         assignee, and give Secured Party prompt notice of any such claim or
         liability; and (j) maintain a system of accounts established and
         administered in accordance with generally accepted accounting
         principles and practices consistently applied, and, within forty-five
         (45) days after the end of each fiscal quarter, deliver to Secured
         Party a balance sheet as at the end of such quarter and statement of
         operations for such quarter, and, within one hundred and twenty (120)
         days after the end of each fiscal year, deliver to Secured Party a
         balance sheet as at the end of such year and statement of operations
         for such year, in each case prepared in accordance with generally
         accepted accounting principles and practices consistently applied and
         certified by Debtor's chief financial officer as fairly presenting the
         financial position and results of operation of Debtor, and, in the case
         of year end financial statements, certified by an independent
         accounting firm acceptable to Secured Party.

             9. NEGATIVE COVENANTS OF DEBTOR. Debtor shall not (a) create,
         incur, assume or suffer to exist any mortgage, lien, pledge or other
         encumbrance or attachment of any kind whatsoever upon, affecting or
         with respect to the Equipment or this Agreement or any of Debtor's
         interests hereunder; (b) make any changes or alterations in or to the
         Equipment (collectively, the "Alterations") except (i) as necessary for
         compliance with clause (a) of paragraph 8 above, and (ii) such
         Alterations which may be removed without any material damage to the
         Equipment or do not materially reduce the value of the Equipment; (c)
         permit the name of any person, association or corporation other than
         Secured Party to be placed on the Equipment as a designation that might
         be interpreted as a claim of interest in the Equipment; (d) part with
         possession or control of or suffer or allow to pass out of its
         possession or control any of the Equipment or, except with seven (7)
         business days prior written notice to Secured Party, change the
         location of the Equipment or any part thereof from the location shown
         above; (e) assign or in any way dispose of all or any part of its
         rights or obligations under this Agreement or enter into any lease of
         all or any part of the Equipment; (f) change its name or address from
         that set forth above unless it shall have given Secured Party no less
         than thirty (30) days prior written notice thereof; (g) without Secured
         Party's prior written consent which will not unreasonably be withheld,
         sell any shares of its capital stock or transfer any



                                       5


         ownership interest in the Debtor to any person, persons, entity or
         entities (whether in one single transaction or in multiple
         transactions) which results in a transfer of a majority interest in the
         ownership and/or the control of the Debtor from the person, persons,
         entity or entities who hold a majority ownership and/or control of the
         Debtor as of the date of this Agreement; or (h) without Secured Party's
         prior written consent which will not unreasonably be withheld,
         consolidate with or merge into or with any other entity, or purchase or
         otherwise acquire all or substantially all of the assets or stock or
         other ownership interest of any person or entity; or (i) without
         Secured Party's prior written consent which will not unreasonably be
         withheld sell, transfer, lease or otherwise dispose of all or
         substantially all of Debtor's assets to any person or entity ( a
         "Buyer"). With respect to the consent provisions under Sections 9 (g) 9
         (h) and 9 (i) of this Agreement, Secured Party shall, in its reasonable
         discretion, review and determine whether (x) Secured Party is satisfied
         as to the creditworthiness of the successor entity or Buyer and as to
         such successor's, Buyer's and/or the new major shareholder's
         conformance to the other standard criteria then used by Secured Party
         for such purposes; (y) if requested by Secured Party, such successor
         entity or Buyer is willing to execute and deliver to Secured Party an
         agreement satisfactory in form and substance to Secured Party, in its
         reasonable discretion, containing the successor entity's and/or Buyer's
         effective assumption of all obligations of the Debtor under the
         Agreement and all Loan Schedules thereunder; and/or (z) if requested by
         Secured Party, Debtor, the new major shareholder, Buyer and/or such
         successor entity are willing to execute such additional documentation
         or modifications to the Agreement (including without limitation, the
         Financial Covenant Rider) as are reasonably required by Secured Party
         to maintain Secured Party's interests in the Equipment or as otherwise
         required by Secured Party to accomplish Section 9 (x) above.

             10. EQUIPMENT PERSONALTY. The Equipment is, and shall at all times
         be and remain, personal property notwithstanding that the Equipment or
         any part thereof may now be, or hereafter become, in any manner affixed
         or attached to, or imbedded in, or permanently resting upon, real
         property or attached in any manner to real property by cement, plaster,
         nails, bolts, screws or otherwise. If requested by Secured Party with
         respect to any item of Equipment, Debtor will obtain and deliver to
         Secured Party waivers of interest or liens in recordable form,
         satisfactory to Secured Party, from all persons claiming any interest
         in the real property on which such item of Equipment is installed or
         located.

             11. EVENTS OF DEFAULT AND REMEDIES. If any one or more of the
         following events ("Events of Default") shall occur:

        (a) Debtor shall fail to make any payment in respect of the Liabilities
within five (5) business days of when due; or

        (b) any written certification, statement, representation, warranty or
financial report or statement heretofore or hereafter furnished by or on behalf
of Debtor or any guarantor of any or all of the Liabilities proves to have been
false in any material respect at the time as of which the facts therein set
forth were stated or certified or has omitted any material contingent or
unliquidated liability or claim against Debtor or any such guarantor; or

        (c) Debtor or any guarantor of any or all of the Liabilities shall fail
to perform or observe any covenant, condition or agreement to be performed or
observed by it hereunder or under any



                                       6

guaranty agreement, which has not been cured within twenty (20) days of written
notice thereof (except for any Financial Covenant(s) contained in any Rider of
even date herewith), provided that Secured Party shall have no obligation to
enter into any additional Loan Schedules during such cure period; or

        (d) Debtor or any guarantor of any or all of the Liabilities shall be in
breach of or in default in the payment and performance of any obligation
relating to any of the Other Liabilities; or

        (e) Debtor or any guarantor of any of Debtor's obligations hereunder
shall be in breach of or in default in the payment or performance of any
obligation owing to any bank, lender, lessor or financial institution in
connection with a transaction in excess of $500,000.00, howsoever arising,
present or future, contracted for or acquired, and whether joint, several,
absolute, contingent, secured, unsecured, matured or unmatured; or

        (f) Debtor or any guarantor of any or all of the Liabilities shall cease
doing business as a going concern, make an assignment for the benefit of
creditors, admit in writing its inability to pay its debts as they become due,
file a petition commencing a voluntary case under any chapter of Title 11 of the
United States Code entitled "Bankruptcy" (the "Bankruptcy Code"), be adjudicated
an insolvent, file a petition seeking for itself any reorganization,
arrangement, composition, readjustment, liquidation, dissolution or similar
arrangement under any present or future statute, law, rule or regulation or file
an answer admitting the material allegations of a petition filed against it in
any such proceeding, consent to the filing of such a petition or acquiescence in
the appointment of a trustee, receiver or liquidator of it or of all or any part
of its assets or properties, or take any action looking to its dissolution or
liquidation; or

        (g) an order for relief against Debtor or any guarantor of any or all of
the Liabilities shall have been entered under any chapter of the Bankruptcy Code
or a decree or order by a court having jurisdiction in the premises shall have
been entered approving as properly filed a petition seeking reorganization,
arrangement, readjustment, liquidation, dissolution or similar relief against
Debtor or any guarantor of any or all of the Liabilities under any present or
future statute, law, rule or regulation which shall not, in each case, have been
stayed or dismissed within forty-five (45) days, or (ii) within thirty (30) days
after the appointment without Debtor's or such guarantor's consent or
acquiescence of any trustee, receiver or liquidator of it or (iii) such
guarantor or of all or any part of its or such guarantor's assets and
properties, such appointment shall not be vacated, or an order, judgment or
decree which would reasonably be expected to have a material adverse effect on
the business or financial condition of Debtor shall be entered against Debtor or
such guarantor by a court of competent jurisdiction and shall continue in effect
for any period of twenty (20) consecutive days without a stay of execution, or
any execution or writ or process shall be issued under any action or proceeding
against Debtor whereby the Equipment or its use may be taken or restrained; or

        (h) Debtor or any guarantor of any or all of the Liabilities shall
suffer an adverse material change in its financial condition as compared to such
condition as at the date hereof, and as a result of such change in condition
Secured Party deems itself or any of the Equipment to be insecure; "adverse
material change" means any set of one or more circumstances which, individually
or collectively, will result in, with respect to Debtor, (i) any change or
effect that is or is reasonably likely to be materially adverse to the business,
operations, properties, assets or conditions (financial or otherwise) of the
Debtor; (ii) the material impairment of the ability of the Debtor to perform, or
of the Secured Party to enforce, its obligations under the Agreement or



                                       7


Loan Schedules; or (iii) a material adverse effect on the value of the Equipment
(other than normal depreciation, ordinary wear and tear and change in market
conditions) or the amount which the Secured Party would be likely to receive
(after giving consideration to delays in payment and costs of enforcement) in
the liquidation of the Equipment;

then and in any such event, Secured Party may, at the sole discretion of Secured
Party, without notice or demand and without limitation of any rights and
remedies of Secured Party under the Uniform Commercial Code, take any one or
more of the following steps:

        (1) Declare all of the Time Balance to be due and payable, whereupon the
same shall forthwith mature and become due and payable as provided for in
paragraph 16 below, provided, however, upon the occurrence of any of the events
specified in subparagraphs (f) and (g) above, all sums as specified in this
clause (1) shall immediately be due and payable without notice to Debtor (the
date on which Secured Party declares all of the Time Balance to be due and
payable is hereinafter referred to as the "Declaration Date");

        (2) proceed to protect and enforce its rights by suit in equity, action
at law or other appropriate proceedings, whether for the specific performance of
any agreement contained herein, or for an injunction against a violation of any
of the terms hereof, or in aid of the exercise of any other right, power or
remedy granted hereby or by law, equity or otherwise; and

        (3) at any time and from time to time, with or without judicial process
and the aid or assistance of others, enter upon any premises wherein any of the
Equipment may be located and, without resistance or interference by Debtor, take
possession of the Equipment on any such premises, and require Debtor to assemble
and make available to Secured Party at the expense of Debtor any part or all of
the Equipment at any place or time designated by Secured Party; and remove any
part or all of the Equipment from any premises wherein the same may be located
for the purpose of effecting the sale or other disposition thereof; and sell,
resell, lease, assign and deliver, grant options for or otherwise dispose of any
or all of the Equipment in its then condition or following any commercially
reasonable preparation or processing, at public or private sale or proceedings,
by one or more contracts, in one or more parcels, at the same or different
times, with or without having the Equipment at the place of sale or other
disposition, for cash and/or credit, and upon any terms, at such place(s) and
time(s) and to such persons, firms or corporations as Secured Party shall deem
commercially reasonable, all without demand for performance or any notice or
advertisement whatsoever, except that Debtor shall be given ten (10) business
days' written notice of the place and time of any public sale or of the time
after which any private sale or other intended disposition is to be made, which
notice Debtor hereby agrees shall be deemed reasonable notice thereof. If any of
the Equipment is sold by Secured Party upon credit or for future delivery,
Secured Party shall not be liable for the failure of the purchaser to pay for
same and in such event Secured Party may resell such Equipment. Secured Party
may buy any part or all of the Equipment at any public sale and if any part or
all of the Equipment is of a type customarily sold in a recognized market or
which is the subject of widely distributed standard price quotations Secured
Party may buy at private sale and may make payment therefor by application of
all or a part of the Liabilities and of all or a part of any Other Liabilities.
Any personalty in or attached to the Equipment when repossessed may be held by
Secured Party without any liability arising with respect thereto, and any and
all claims in connection with such personalty shall be deemed to have been
waived unless notice of such claim is made by certified or registered mail upon
Secured Party within ten business days after repossession.



                                       8


Secured Party shall apply the cash proceeds from any sale or other disposition
of the Equipment first, to the reasonable expenses of re-taking, holding,
preparing for sale, selling, leasing and the like, and to reasonable attorneys'
fees and other expenses which are to be paid or reimbursed to Secured Party
pursuant hereto, and second, to all outstanding portions of the Liabilities and
to any Other Liabilities in such order as Secured Party may elect, and third,
any surplus to Debtor, subject to any duty of Secured Party imposed by law to
the holder of any subordinate security interest in the Equipment known to
Secured Party; provided however, that Debtor shall remain liable with respect to
unpaid portions of the Liabilities owing by it and will pay Secured Party on
demand any deficiency remaining with interest as provided for in paragraph 16
below.

        12. SECURED PARTY'S RIGHT TO PERFORM FOR DEBTOR. If Debtor fails to
perform or comply with any of its agreements contained herein Secured Party may
perform or comply with such agreement and the amount of any payments and
expenses incurred by Secured Party in connection with such performance or
compliance, together with interest thereon at the rate provided for in paragraph
16 below, shall be deemed a part of the Liabilities and shall be payable by
Debtor upon demand.

        13. FURTHER ASSURANCES. Debtor will cooperate with Secured Party for the
purpose of protecting the interests of Secured Party in the Equipment,
including, without limitation, the execution of all Uniform Commercial Code
financing statements requested by Secured Party. Secured Party and any assignee
of Secured Party are each authorized to the extent permitted by applicable law
to file one or more Uniform Commercial Code financing statements disclosing any
security interest in the Equipment without the signature of Debtor or signed by
Secured Party or any assignee of Secured Party as attorney-in-fact for Debtor.
Debtor will pay all costs of filing any financing, continuation or termination
statements with respect to this Agreement, including, without limitation, any
documentary stamp taxes relating thereto. Debtor will do whatever may be
necessary to have a statement of the interest of Secured Party and of any
assignee of Secured Party in the Equipment noted on any certificate of title
relating to the Equipment and will deposit said certificate with Secured Party
or such assignee. Debtor shall execute and deliver to Secured Party, upon
request, such other instruments and assurances as Secured Party deems reasonably
necessary or advisable for the implementation, effectuation, confirmation or
perfection of this Agreement and any rights of Secured Party hereunder.

        14. NON-WAIVER; ETC. No course of dealing by Secured Party or Debtor or
any delay or omission on the part of Secured Party in exercising any rights
hereunder shall operate as a waiver of any rights of Secured Party. No waiver or
consent shall be binding upon Secured Party unless it is in writing and signed
by Secured Party. A waiver on any one occasion shall not be construed as a bar
to or a waiver of any right and/or remedy on any future occasion. To the extent
permitted by applicable law, Debtor hereby waives the benefit and advantage of,
and covenants not to assert against Secured Party, any valuation, inquisition,
stay, appraisement, extension or redemption laws now existing or which may
hereafter exist which, but for this provision, might be applicable to any sale
or other disposition made under the judgment, order or decree of any court or
under the powers of sale and other disposition conferred by this Agreement or
otherwise. Debtor hereby waives any right to a jury trial with respect to any
matter arising under or in connection with this Agreement.

        15. ENTIRE AGREEMENT; SEVERABILITY; ETC. This Agreement constitutes the
entire agreement between Secured Party and Debtor and all conversations,
agreements and representations relating to this Agreement or to the Equipment
are integrated herein. If any provision hereof or any remedy herein provided for
shall be invalid under any applicable law, such provision or



                                       9


remedy shall be inapplicable and deemed omitted, but the remaining provisions
and remedies hereunder shall be given effect in accordance with the intent
hereof. Neither this Agreement nor any term hereof may be changed, discharged,
terminated or waived except in an instrument in writing signed by the party
against which enforcement of the change, discharge, termination or waiver is
sought. This Agreement shall in all respects be governed by and construed in
accordance with the internal laws of the State of New York, including all
matters of construction, validity and performance, and shall be deemed a
purchase money security agreement within the meaning of the Uniform Commercial
Code. The captions in this Agreement are for convenience of reference only and
shall not define or limit any of the terms or provisions hereof. This Agreement
shall inure to the benefit of and be binding upon Secured Party and Debtor and
their respective successors and assigns, subject, however, to the limitations
set forth in this Agreement with respect to Debtor's assignment hereof. No right
or remedy referred to in this Agreement is intended to be exclusive but each
shall be cumulative and in addition to any other right or remedy referred to in
this Agreement or otherwise available to Secured Party at law or in equity, and
shall be in addition to the provisions contained in any instrument referred to
herein and any instrument supplemental hereto. Debtor shall be liable for all
costs and expenses, including reasonable attorneys' fees and disbursements,
incurred by reason of the occurrence of any Event of Default or the exercise of
Secured Party's remedies with respect thereto. Time is of the essence with
respect to this Agreement and all of its provision.

        16. PREPAYMENT; REBATE; INTEREST. Except as provided in the prepayment
agreement of even date herewith or except for the installment payments of the
Time Balance as set forth in the Schedule of Obligations, the Debtor may not
prepay the Time Balance, in whole or in part, at any time. In the event Secured
Party declares all of the Time Balance to be due and payable pursuant to clause
(1) of paragraph 11 above, Debtor shall pay to Secured Party an amount equal to
the sum of (a) all accrued and unpaid amounts as of the Declaration Date plus
interest thereon, and (b) the present value of all future installments set forth
in this Agreement over the remaining unexpired term of this Agreement discounted
to present value using a discount rate of five percent (5%), provided that the
amount of interest earned by Secured Party computed as aforesaid shall not
exceed the highest amount permitted by applicable law. The Time Balance as
reduced to present value in accordance with the preceding sentence shall bear
interest from and after the Declaration Date, and all other Liabilities due and
payable under this Agreement (including past due installments) shall bear
interest from and after their respective due dates until paid in full, at the
lesser of 1.5% per month or the highest rate permitted by applicable law,
provided, however, that Debtor shall have no obligation to pay any interest on
interest except to the extent permitted by applicable law.

        17. CONSENT TO JURISDICTION. Debtor hereby irrevocably consents to the
jurisdiction of the courts of the State of New York and of any federal court
located in such state in connection with any action or proceeding arising out of
or relating to this Agreement or the transactions contemplated hereby. Any such
action or proceeding will be maintained in the United States District Court for
the Southern District of New York or in any court of the State of New York
located in the County of New York and Debtor waives any objections based upon
venue or forum non conveniens in connection with any such action or proceeding.
Debtor consents that process in any such action or proceeding may be served upon
it by registered mail directed to Debtor at its address set forth at the head of
this Agreement or in any other manner permitted by applicable law or rules of
court. Debtor hereby irrevocably appoints CT Corporation with offices at
Corporation Trust Center, 1209 Orange Street, Wilmington, DE 19801 as its agent
to receive service of process in any such action or proceeding.



                                       10


        18. NOTICES. Notice hereunder shall be deemed given if served personally
or by certified or registered mail, return receipt requested, to Secured Party
and Debtor at their respective addresses set forth at the head of this
Agreement. Any party hereto may from to time by written notice to the other
change the address to which notices are to be sent to such party. A copy of any
notice sent by Debtor to Secured Party shall be concurrently sent by Debtor to
any assignee of Secured Party of which Debtor has notice.

        The Debtor agrees to all the provisions set forth above. This Agreement
is executed pursuant to due authorization. DEBTOR ACKNOWLEDGES RECEIPT OF A
SIGNED TRUE COPY OF THIS AGREEMENT.


Date: July 9, 2001                           Accepted on July 27, 2001

KOSAN BIOSCIENCES INCORPORATED (Debtor)      WELLS FARGO EQUIPMENT FINANCE, INC.
(Secured Party)
(Signature of Proprietor or name of
Corporation or Partnership)

By /s/ Susan M. Kanaya                       By /s/ Sally Doheny
   ------------------------------------        ---------------------------------
Its Vice President, Finance &                Its Assistant Vice President
    -----------------------------------          -------------------------------
    Chief Financial Officer
    -----------------------------------
(if Corporation, President or Vice President should
sign and give official title; if Partnership,
state partner; if L.L.C., state member or manger)






                                       11


                              PREPAYMENT AGREEMENT

        WHEREAS, Wells Fargo Equipment Finance, Inc. ("WFEFI"), as Secured Party
and Kosan Biosciences, Inc. as Debtor ("Debtor") are parties to certain Loan
Schedule No. 700 which incorporates the terms and conditions of Master Loan and
Security Agreement No. 84325 (said Loan Schedule is referred to herein as the
"Agreement"), dated July 9, 2001 affecting the equipment (the "Equipment")
described therein; and

        WHEREAS, the parties hereto desire to confirm their understanding
pursuant to which the Debtor may prepay the Agreement as set forth below.

        NOW, THEREFORE, the parties hereto agree as follows:

        1. Provided that the Debtor shall so request WFEFI in writing not less
than thirty (30) days prior to a Prepayment Date, and further provided that the
Debtor shall have paid all monthly installment payments due through and
including the applicable Prepayment Date in accordance with the terms and
provisions of the Agreement and shall then be in compliance with all the terms
and provisions of the Agreement and shall continue to comply with all the terms
and provisions of the Agreement thereafter until such Prepayment Date, WFEFI
agrees to allow Debtor to prepay the Agreement (in whole, but not in part) by
payment of the appropriate prepayment amount as set forth below ("Prepayment
Amount") in good funds plus applicable per diem interest as set forth below, on
the applicable Prepayment Date. Prepayment Date shall mean the day that the
Prepayment Amount together with per diem interest is received in good funds by
WFEFI in accordance with the terms hereof.

        2. The Prepayment Amount which Debtor shall pay in the event of a
prepayment of the Agreement hereunder shall be computed as follows:

        (a) For a Prepayment Date which is on or after the day that the first
(1st) monthly installment is due but prior to the date that the thirteenth
(13th) payment is due, the Prepayment Amount shall be 104% of the remaining
principal balance due under the Agreement computed in accordance with the books
and records of Secured Party or its assigns;

        (b) For a Prepayment Date which is on or after the day that the
thirteenth (13th) monthly installment is due but prior to the date that the
twenty-fifth (25th) payment is due, the Prepayment Amount shall be 103% of the
remaining principal balance due under the Agreement computed in accordance with
the books and records of Secured Party or its assigns;

        (c) For a Prepayment Date which is on or after the day that the
twenty- fifth (25th) monthly installment is due but prior to the date that the
thirty-seventh (37th) payment is due, the Prepayment Amount shall be 102% of the
remaining principal balance due under the Agreement computed in accordance with
the books and records of Secured Party or its assigns;

        (e) For a Prepayment Date which is on or after the day that the
thirty-seventh (37th) monthly installment is due but prior to the date that the
forty-second (42nd) payment is due, the Prepayment Amount shall be 101% of the
remaining principal balance due under the Agreement computed in accordance with
the books and records of Secured Party or its assigns.

        3. All taxes attributable to the transaction herein contemplated
including any taxes on the Prepayment Amount, shall be borne exclusively by the
Debtor (except for taxes based on Secured party's net income.)

        4. In addition to the Prepayment Amount and taxes, Debtor shall also pay
to Secured Party on the Prepayment Date, per diem interest which means interest
on the Prepayment Amount calculated on the basis of a 365 day year using the
implicit rate of interest that was used to calculate the installment payments
under the Agreement, for each day from the day that the most recent installment
was due through and including the Prepayment Date.

        5. Time is of the essence for the Debtor's making written request for
prepayment and for remitting the Prepayment Amount in the event Debtor timely
exercises its option to prepay hereunder.



                                       12


        6. Except as specifically permitted by this Prepayment Agreement, Debtor
shall have no right to prepay the Agreement.

        7. This Prepayment Agreement shall constitute an indivisible part of the
Agreement and shall be binding upon and inure to the benefit of the parties
hereto and their respective successors and assigns.


KOSAN BIOSCIENCES, INC.                      WELLS FARGO EQUIPMENT FINANCE, INC.
By /s/ Susan M. Kanaya                       By /s/ Sally Doheny
   ------------------------------------        ---------------------------------
Its Vice President, Finance &                Its Assistant Vice President
    -----------------------------------          -------------------------------
    Chief Financial Officer
    -----------------------------------


Dated: July 9, 2001                          Dated: July 27, 2001







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