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 June 30, 2005.

or

¨ Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

For the transition period from ___________ to ___________.

Commission File Number:

000-31633

Kosan Biosciences Incorporated

(Exact name of registrant as specified in its charter)

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

3832 Bay Center Place, Hayward, California 94545

(address of principal executive offices)

(510) 732-8400

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to filing requirements for the past 90 days.     Yes  x    No  ¨

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: Common Stock, $.001 par value; 29,252,938 shares outstanding at July 31, 2005.

KOSAN BIOSCIENCES INCORPORATED

Form 10-Q

Quarter Ended June 30, 2005

INDEX

		Page
PART I.	FINANCIAL INFORMATION
Item 1:	Condensed Financial Statements and Notes:
	Condensed Balance Sheets as of June 30, 2005 (unaudited) and December 31, 2004	3
	Condensed Statements of Operations (unaudited) for the three and six months ended June 30, 2005 and 2004	4
	Condensed Statements of Cash Flows (unaudited) for the six months ended June 30, 2005 and 2004	5
	Notes to Condensed Financial Statements	6
Item 2:	Management’s Discussion and Analysis of Financial Condition and Results of Operations	13
Item 3:	Quantitative and Qualitative Disclosures About Market Risk	35
Item 4:	Controls and Procedures	35
PART II.	OTHER INFORMATION
Item 1:	Legal Proceedings	36
Item 2:	Unregistered Sales of Equity Securities and Use of Proceeds	36
Item 3:	Defaults Upon Senior Securities	36
Item 4:	Submission of Matters to a Vote of Security Holders	36
Item 5:	Other Information	36
Item 6:	Exhibits	37
SIGNATURES		38
CERTIFICATIONS

2

PART I. FINANCIAL INFORMATION

Item 1: Condensed Financial Statements and Notes

KOSAN BIOSCIENCES INCORPORATED

CONDENSED BALANCE SHEETS

(in thousands)

	June 30, 2005			December 31, 2004 (1)
	(unaudited)
Assets
Current assets:
Cash and cash equivalents	$	10,444		$	13,777
Short-term investments		44,996			53,783
Accounts and other receivables		2,771			4,447
Prepaid and other current assets		1,223			1,260
Total current assets		59,434			73,267
Property and equipment, net		6,817			7,159
Long-term investments		13,819			15,833
Other assets and notes receivable from related parties		315			354
Total assets	$	80,385		$	96,613
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable	$	1,036		$	1,343
Accrued liabilities		6,829			6,455
Current portion of deferred revenue		3,277			3,277
Current portion of equipment loans		2,039			1,916
Total current liabilities		13,181			12,991
Deferred revenue, less current portion		10,514			12,153
Equipment loans, less current portion		2,202			2,283
Stockholders’ equity:
Common stock		29			29
Additional paid-in capital		171,271			170,735
Accumulated other comprehensive income		(281	)		(378	)
Accumulated deficit		(116,531	)		(101,200	)
Total stockholders’ equity		54,488			69,186
Total liabilities and stockholders’ equity	$	80,385		$	96,613

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

See accompanying notes.

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KOSAN BIOSCIENCES INCORPORATED

CONDENSED STATEMENTS OF OPERATIONS

(unaudited)

(in thousands, except per share data)

	Three Months Ended June 30,						Six Months Ended June 30,
	2005			2004			2005			2004
Revenues:
Contract revenue	$	2,897		$	5,111		$	5,513		$	11,234
Grant revenue		441			829			700			1,067
Total revenues		3,338			5,940			6,213			12,301
Operating expenses:
Research and development		9,471			10,000			19,126			19,341
General and administrative		1,523			1,388			3,064			2,791
Total operating expenses		10,994			11,388			22,190			22,132
Loss from operations		(7,656	)		(5,448	)		(15,977	)		(9,831	)
Other income, net		340			268			646			526
Net loss	$	(7,316	)	$	(5,180	)	$	(15,331	)	$	(9,305	)
Basic and diluted net loss per common share	$	(0.25	)	$	(0.18	)	$	(0.53	)	$	(0.32	)
Shares used in computing basic and diluted net loss per common share		29,194			28,899			29,146			28,827

See accompanying notes.

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KOSAN BIOSCIENCES INCORPORATED

CONDENSED STATEMENTS OF CASH FLOWS

(unaudited)

(in thousands)

	Six Months Ended June 30,
	2005			2004
Operating activities
Net loss	$	(15,331	)	$	(9,305	)
Adjustment to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		1,295			1,232
Amortization of investment premiums and discounts		416			1,055
Amortization of stock-based compensation		—			119
Other stock-based compensation		215			316
Changes in assets and liabilities:
Accounts and other receivables		1,259			4,456
Prepaid and other current assets		37			(11	)
Other assets and notes receivable from related parties		39			120
Accounts payable and accrued liabilities		67			(252	)
Deferred revenue		(1,639	)		(2,812	)
Net cash used in operating activities		(13,642	)		(5,082	)
Investing activities
Acquisition of property and equipment		(953	)		(1,331	)
Purchase of investments		(37,883	)		(67,800	)
Proceeds from maturity of investments		48,365			45,430
Net cash provided by (used in) investing activities		9,529			(23,701	)
Financing activities
Proceeds from issuance of common stock		321			1,089
Proceeds from equipment loans		1,519			930
Principal payments under equipment loans		(1,060	)		(988	)
Net cash provided by financing activities		780			1,031
Net decrease in cash and cash equivalents		(3,333	)		(27,752	)
Cash and cash equivalents at beginning of period		13,777			31,491
Cash and cash equivalents at end of period	$	10,444		$	3,739

See accompanying notes.

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KOSAN BIOSCIENCES INCORPORATED

NOTES TO CONDENSED FINANCIAL STATEMENTS

(unaudited)

1. Organization and Summary of Significant Accounting Policies

Overview

Kosan Biosciences Incorporated (the “Company”) was incorporated under the laws of the State of California on January 6, 1995 and commenced operations in 1996. In July 2000, the Company was reincorporated under the laws of the State of Delaware. The Company has proprietary technologies for the manipulation of polyketides, a rich source of pharmaceutical products. The Company uses its platform technologies to develop product candidates that target large pharmaceutical markets. In collaboration with Hoffmann-La Roche Inc. and F. Hoffmann-La Roche Ltd., collectively Roche, the Company is testing KOS-862 (Epothilone D), a potential anticancer agent, in Phase II and Phase Ib clinical trials and its second-generation epothilone product candidate, KOS-1584, in Phase I clinical trials.

In its Hsp90 inhibitor program, the Company is also developing analogs of geldanamycin, a polyketide, as anticancer agents in collaboration with the National Cancer Institute, or NCI, a component of the National Institutes of Health. Under a Cooperative Research and Development Agreement between the Company and the NCI Cancer Therapy Evaluation Program, the NCI is sponsoring Phase II and Phase Ib combination clinical trials of 17-AAG. The Company intends to use the data from these studies to support the clinical development of KOS-953, a proprietary formulation of 17-AAG, currently in Phase I and Phase Ib clinical trials. In addition, the Company is developing KOS-1022 (DMAG), a highly-potent, water-soluble and orally-available analog of geldanamycin, in Phase I clinical trials. Under a Company-sponsored Investigational New Drug application, or IND, a Phase I clinical trial in hematologic malignancies was initiated in June 2005. The Company also has additional product candidates in the areas of gastrointestinal motility, cancer and infectious disease that are undergoing preclinical evaluation and several early stage product and research technology development programs.

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

Basis of Presentation

The accompanying unaudited condensed financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information. The information as of June 30, 2005, and for the three and six months ended June 30, 2005 and 2004, reflects all adjustments (including normal recurring adjustments) that the management of the Company believes are necessary for a fair presentation of the results for the periods presented. Results for any interim period are not necessarily indicative of results for any future interim period or for the entire year. The accompanying unaudited condensed financial statements should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004.

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KOSAN BIOSCIENCES INCORPORATED

NOTES TO CONDENSED FINANCIAL STATEMENTS (continued)

(unaudited)

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

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the 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. All investment securities are classified as available-for-sale and are recorded at fair value based on quoted market prices, with unrealized gains and losses excluded from earnings and reported in other comprehensive income/(loss). Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Realized gains and losses and declines in the fair value that are deemed to be other-than-temporary are reflected in earnings. The cost of securities sold is based on the specific identification method.

The Company recognizes an impairment charge when the decline in the estimated fair value of a marketable security below the amortized cost is determined to be other-than-temporary. The Company considers various factors in determining whether to recognize an impairment charge, including the duration of time and the severity to which the fair value has been less than its amortized cost, any adverse changes in the investees’ financial condition and associated downgrades to credit ratings and the Company’s intent and ability to hold the marketable security for a period of time sufficient to allow for any anticipated recovery in market value. For the three and six months ended June 30, 2005 and 2004, the Company did not recognize an impairment charge related to its investment securities.

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

Revenue Recognition

The Company generates revenue under collaborative agreements with pharmaceutical companies and under research grants from the National Institutes of Health and the National Institute of Standards and Technology. The arrangements may include upfront non-refundable fees, reimbursement for personnel and supply costs, milestone payments for the achievement of defined collaboration objectives and royalties on potential sales of commercialized products. The Company recognizes revenue under these arrangements when (i) persuasive evidence of an arrangement exists; (ii) delivery of the services, supplies or technology license has occurred; (iii) the price is fixed and determinable; and (iv) collectability is reasonably assured.

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KOSAN BIOSCIENCES INCORPORATED

NOTES TO CONDENSED FINANCIAL STATEMENTS (continued)

(unaudited)

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

Revenue Recognition (Continued)

The Company recognizes license and other upfront and initial fees pursuant to research and development collaboration agreements over the estimated research and development term of the respective agreement. These estimated terms are reviewed on a periodic basis and updated if the underlying assumptions are modified. Payments related to substantive performance milestones that are at risk at the initiation of an agreement are recognized upon successful completion of a performance milestone event.

Contract revenues related to collaborative research and development efforts are recognized as revenue as the related services are performed or delivered in accordance with contract terms. Such payments generally are made based on the number of full-time equivalent researchers assigned to the collaboration project and the related research and development expenses incurred or as other deliverables under the contracts are fulfilled. Revenues related to government grants are recognized at the time a grant is awarded and as related research expenses are incurred. Any amounts received in advance of performance are recorded as deferred revenue until earned.

Research and Development

Research and development consists of costs incurred for Company-sponsored and collaborative research and development activities. These costs consist primarily of salaries and other personnel-related expenses, including associated stock-based compensation, facility-related expenses, licensing-related expenses, depreciation of facilities and equipment, lab consumables, services performed by clinical research organizations and research institutions and other outside service providers.

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

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

Net Loss per Share

Basic and diluted net loss per common share has been computed using the weighted-average number of shares of common stock outstanding during the period, less shares subject to repurchase. Diluted net loss is not presented separately as the Company is in a net loss position and including potentially dilutive securities in the loss per share computation would be antidilutive.

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KOSAN BIOSCIENCES INCORPORATED

NOTES TO CONDENSED FINANCIAL STATEMENTS (continued)

(unaudited)

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

Net Loss per Share (continued)

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

	Three Months Ended June 30,						Six Months Ended June, 30,
	2005			2004			2005			2004
Net loss	$	(7,316	)	$	(5,180	)	$	(15,331	)	$	(9,305	)
Weighted-average shares of common stock outstanding		29,194			28,926			29,146			28,863
Less: weighted-average shares subject to repurchase		—			(27	)		—			(36	)
Weighted-average shares used in computing basic and diluted net loss per common share		29,194			28,899			29,146			28,827
Basic and diluted net loss per common share	$	(0.25	)	$	(0.18	)	$	(0.53	)	$	(0.32	)

Stock-Based Compensation

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

Pro forma net loss and net loss per share information is required by SFAS 123 and has been determined as if the Company had accounted for its employee stock options under the fair value method of that statement. The effects of applying the intrinsic value method for either recognizing compensation expense or providing pro forma disclosures are not likely to be representative of the effects on net income for future years.

9

KOSAN BIOSCIENCES INCORPORATED

NOTES TO CONDENSED FINANCIAL STATEMENTS (continued)

(unaudited)

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

Stock-Based Compensation (continued)

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

	Three Months Ended June 30,						Six Months Ended June 30,
	2005			2004			2005			2004
Net loss attributable to common stockholders, as reported	$	(7,316	)	$	(5,180	)	$	(15,331	)	$	(9,305	)
Add: Stock-based employee compensation expense included in reported net loss		—			21			—			119
Deduct: Stock-based employee compensation expense determined under fair value based method for all awards		(770	)		(969	)		(1,378	)		(2,024	)
Pro forma net loss	$	(8,086	)	$	(6,128	)	$	(16,709	)	$	(11,210	)
Basic and diluted net loss per common share:
As reported	$	(0.25	)	$	(0.18	)	$	(0.53	)	$	(0.32	)
Pro forma	$	(0.28	)	$	(0.21	)	$	(0.57	)	$	(0.39	)

New Accounting Pronouncement

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

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

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KOSAN BIOSCIENCES INCORPORATED

NOTES TO CONDENSED FINANCIAL STATEMENTS (continued)

(unaudited)

2. Research and Development Agreements (continued)

Roche

Effective September 2002, the Company entered into a research and development collaboration agreement (the “Agreement”) with Roche. Under the terms of the Agreement, Roche has worldwide exclusive rights to market and sell KOS-862 (Epothilone D) and other epothilones (including KOS-1584) in the field of oncology, and the Company will co-develop and has the right to co-promote the product in the United States. The Agreement provides for the Company to receive payments for the reimbursement of research and development expenditures, funding of a back-up program, achievement of clinical, regulatory and commercial milestones, development activities and royalties on sales of collaboration products. In addition, the Company has the opportunity to increase its royalties through a buy-in at a later stage of clinical development and by co-promotion of products resulting from the collaboration. Effective July 1, 2004, the Company entered into an amendment to the Agreement that provided for the reimbursement of costs that exceeded the previously stipulated amounts set forth in the Agreement. In December 2004, upon the commencement of a Phase I clinical trial of KOS-1584, the Company determined that the estimated clinical development period extended from the second half of 2007, which was initially estimated when the Company entered into the collaboration with Roche in 2002, to the second half of 2009. The Company’s initial estimate of the clinical development period contemplated development of one product candidate, KOS-862. The change in the estimate has resulted in a further deferral of the unrecognized portion of the initial fee received in connection with its research and development collaboration agreement with Roche. For the six months ended June 30, 2005 and 2004, the Company recognized revenue related to this agreement of approximately $5.5 million and $11.2 million, respectively.

License Agreements

The Company has collaborative and license agreements with several academic, government and medical institutions. Included in research and development expenses were total payments made under these agreements of approximately $183,000 and $6,000 for the three months ended June 30, 2005 and 2004, respectively, and $323,000 and $94,000 for the six months ended June 30, 2005 and 2004, respectively.

3. Comprehensive Loss

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

	Three Months Ended June 30,						Six Months Ended June 30,
	2005			2004			2005			2004
Net loss	$	(7,316	)	$	(5,180	)	$	(15,331	)	$	(9,305	)
Unrealized gain (loss) on available-for-sale securities		171			(610	)		97			(493	)
Comprehensive loss	$	(7,145	)	$	(5,790	)	$	(15,234	)	$	(9,798	)

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KOSAN BIOSCIENCES INCORPORATED

NOTES TO CONDENSED FINANCIAL STATEMENTS (continued)

(unaudited)

4. Equipment Financing

The Company finances certain equipment and facility improvements under debt obligations with terms of 48 months. The interest rates of each of the loans are fixed at the time of the draw down, with the interest rates ranging from 6.31% to 8.90%. Obligations under the loans are secured by the assets financed under the loans.

In April 2004, the Company entered into a new $3.5 million equipment line of credit agreement, of which $1.9 million had been utilized as of June 30, 2005.

5. Accrued Liabilities

Accrued liabilities consisted of the following (in thousands):

	June 30, 2005		December 31, 2004
Research and development-related	$	3,059	$	2,896
Compensation-related		1,345		1,602
Professional services		1,053		718
Facilities-related		1,131		948
Other		241		291
	$	6,829	$	6,455

6. Subsequent Event

In July 2005, the Company entered into a $35 million secured line of credit facility with Silicon Valley Bank (“Bank”), a subsidiary of SVB Financial Group. Under the terms of the agreement, the Company has the option of making up to two draws through May 31, 2006, with a minimum initial draw of $15.0 million. The credit facility contains financial covenants, including covenants requiring the Company to maintain: a ratio of unrestricted cash and cash equivalents, investments and eligible accounts to the aggregate principal amount outstanding under the line of credit of at least 1.3 to 1; at least six months “remaining months liquidity,” which is calculated by dividing (i) cash and cash equivalents, investments and eligible accounts by (ii) the Company’s cash utilization calculated on a rolling three-month basis; and aggregate balances in its investment and operating accounts with Bank or SVB Asset Management equal to the lesser of (a) the amount of the aggregate outstanding principal amount under the line of credit plus $5 million; and (b) 85% of the Company’s aggregate cash and investment account balances. As of July 31, 2005, the Company had not made any draws on the facility.

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

Forward-Looking Statements

The following discussion of our financial condition and results of operations contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, which are subject to the “safe harbor” created by those sections. These forward-looking statements include, but are not limited to, statements about:

• our plans with respect to the timing of announcements of clinical data, decisions on whether to proceed to the next stage of clinical trials and initiations of clinical trials;

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

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

• sufficiency of our cash resources, including our belief that our existing cash and investment securities and anticipated cash flow from our existing collaboration will be sufficient to support our current operating plan into the second half of 2006; and

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

In some cases, forward-looking statements can be identified by words such as “expect,” “anticipate,” “intend,” “believe,” “hope,” “assume,” “estimate,” “plan,” “will” and other similar words and expressions. In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances are forward-looking statements. Discussions containing these forward-looking statements may be found throughout this Form 10-Q, including the sections entitled “Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations.” These forward-looking statements involve risks and uncertainties, including the risks discussed below under the heading “Risks Factors That May Affect Results of Operations and Financial Condition,” that could cause our actual results to differ materially from those in the forward-looking statements. We undertake no obligation to publicly release any revisions to the forward-looking statements or reflect events or circumstances after the date of this document. The risks discussed below under the heading “Risks Factors That May Affect Results of Operations and Financial Condition” and elsewhere in this report should be considered in evaluating our prospects and future financial performance.

Overview

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

• KOS-862 (Epothilone D). In collaboration with Roche, we are testing KOS-862, a potential anticancer agent, in Phase II and Phase Ib clinical trials. The two current Phase II clinical trials, a metastatic breast cancer trial being conducted by Roche and a hormone-refractory prostate cancer trial being conducted by us, are Simon two-stage design trials that have an interim review and decision point following the completion of stage one before advancing to stage two. In

13

April 2005, upon completion of the analysis of the data from the first stage of the metastatic breast cancer trial, we announced that the Phase II clinical trial had achieved the primary objective of the first stage and would proceed into the second stage of the trial. At the time of the analysis of data for an abstract submitted to the 2005 American Society of Clinical Oncology Annual Meeting, preliminary Phase II data from the metastatic breast cancer trial demonstrated that two of the then ten evaluable patients had confirmed partial responses by RECIST criteria. In the first quarter of 2005, we commenced a Phase II clinical trial in prostate cancer. We expect that we and Roche will review the data from the first stage of this prostate cancer trial and decide whether to proceed to the second stage in the second half of 2005. The three Phase Ib trials are traditional dose-escalating trials in combination with other chemotherapeutic agents. Preliminary data from the Phase Ib trials of KOS-862 administered in combination with Gemzar^® and Paraplatin^® suggested anti-tumor activity. Preliminary data from the Phase Ib trial of KOS-862 administered in combination with Herceptin^® is expected in December 2005.

• KOS-1584 (2nd generation Epothilone D). In December 2004, in collaboration with Roche, we initiated a Phase I clinical trial of KOS-1584 in solid tumors. In July 2005, we initiated a second Phase I clinical trial of KOS-1584 in solid tumors that is investigating a different dosing regimen.

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

• KOS-953 (proprietary formulation of 17-AAG). We are also developing our own Hsp90 inhibitor, a proprietary formulation of 17-AAG, which we refer to as KOS-953. During the second quarter of 2005, we presented preliminary data from our Phase I and Phase Ib clinical trials of KOS-953 as monotherapy and in combination with Velcade^® in patients with multiple myeloma. The data demonstrated early signs of anticancer activity and tolerability in an advanced and heavily pre-treated population. We expect to report additional data from these trials in December 2005. We are also conducting Phase Ib clinical trials of KOS-953 in combination with Herceptin^® primarily in patients with metastatic breast cancer and Gleevec^® in patients with chronic myelogenous leukemia and expect to announce preliminary data from at least one of these combination clinical trials in December 2005.

• KOS-1022 (2nd generation proprietary geldanamycin analog, DMAG). In collaboration with the NCI, we are developing our second generation Hsp90 inhibitor, KOS-1022. The NCI initiated Phase I clinical trials of KOS-1022 in solid tumors in July 2004. Under a Kosan-sponsored Investigational New Drug Application, or IND, filed in December 2004, we initiated a Phase I clinical trial of intravenously-delivered KOS-1022 in hematologic malignancies in June 2005. We filed an IND for our oral formulation of KOS-1022 in July 2005.

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

We have incurred significant losses since our inception. As of June 30, 2005, our accumulated deficit was approximately $116.5 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.

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

Critical Accounting Policies

Critical accounting policies are those that require significant judgment and/or estimates by management at the time that the financial statements are prepared such that materially different results might have been reported if other assumptions had been made. We consider certain accounting policies related to revenue recognition, clinical trial accruals and stock-based compensation to be critical policies. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for our making judgments about

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the carrying values of assets and liabilities that are not readily apparent from other sources. The basis of our current estimates or assumptions has not changed since we filed our Annual Report on Form 10-K for the year ended December 31, 2004 with the SEC on March 16, 2005. Since December 31, 2004, we have not made any significant changes to either our policies or any significant estimates or assumptions.

Results of Operations

Revenues

Revenues were approximately $3.3 million and $6.2 million for the three and six months ended June 30, 2005, respectively, compared to approximately $5.9 million and $12.3 million for the same periods in 2004. Revenues in both periods consisted primarily of contract revenues recognized under our development and commercialization agreement with Roche and funded research related to government grant awards.

	Three Months Ended June 30,						Six Months Ended June 30,
(In thousands, except percentages)	2005		2004		% Change		2005		2004		% Change
Contract revenue	$	2,897	$	5,111	-43	%	$	5,513	$	11,234	-51	%
Grant revenue		441		829	-47	%		700		1,067	-34	%
Total revenues	$	3,338	$	5,940	-44	%	$	6,213	$	12,301	-49	%

The decrease in revenues of approximately 44%, or $2.6 million, and 49%, or $6.1 million, for the three and six months ended June 30, 2005 compared to the same periods last year was the result of the following:

• approximately $2.8 million and $6.4 million, respectively, in lower research funding as a result of the selection of KOS-1584 as a second-generation epothilone compound and its advancement into clinical trials in December 2004 and lower reimbursement for KOS-862 production-related activities due to the manufacture of sufficient clinical supply and lower clinical trial reimbursement associated with the conclusion of certain Phase I and Phase II clinical trials;

• approximately $587,000 and $1.2 million, respectively, in lower amortization of the $25.0 million initial fee from Roche, which is now being amortized through the second half of 2009, the current estimated clinical development period;

• approximately $389,000 and $368,000, respectively, in lower grant revenue due to the timing and number of government grant awards in 2005; and

• partially offset by approximately $1.2 million and $1.8 million, respectively, in increased KOS-1584 clinical and production-related reimbursement.

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

Research and Development Expenses

Our research and development expenses decreased to approximately $9.5 million and $19.1 million for the three and six months ended June 30, 2005, respectively, from approximately $10.0 million and $19.3 million for the same periods in 2004. Our research and development activities consist primarily of salaries and other personnel-related expenses, clinical trial-related services performed by clinical research organizations and research institutions and other outside service providers, licensing-related expenses, lab

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consumables and facility-related expenses. We group these activities into two major categories: “research and preclinical” and “clinical development”.

	Three Months Ended June 30,						Six Months Ended June 30,
(In thousands, except percentages)	2005		2004		% Change		2005		2004		% Change
Research and preclinical	$	4,488	$	6,266	-28	%	$	9,535	$	11,985	-20	%
Clinical development		4,983		3,734	33	%		9,591		7,356	30	%
Total research and development	$	9,471	$	10,000	-5	%	$	19,126	$	19,341	-1	%

The decrease of 5%, or approximately $529,000, and 1%, or approximately $215,000, in research and development expenses for the three and six months ended June 30, 2005, respectively, compared to the same periods in 2004 was the result of the following:

• approximately $1.2 million and $2.3 million, respectively, in lower preclinical costs primarily due to advancing KOS-1584 through IND-enabling studies in the first half of 2004; and

• partially offset by approximately $700,000 and $2.1 million, respectively, in higher clinical costs related to the advancement of KOS-1584 in Phase I clinical trials, and the progress made in our Hsp90 inhibitor program, including further advancement of KOS-953 through Phase I and Phase Ib clinical trials, and progression of the KOS-1022 intravenous and oral programs.

We expect that our research and development expenses will increase substantially as KOS-862, KOS-1584, 17-AAG, KOS-953 and KOS-1022 advance further into the clinic and as we advance our research programs, including our motilide program, into later stages of development.

General and Administrative Expenses

	Three Months Ended June 30,						Six Months Ended June 30,
(In thousands, except for percentages)	2005		2004		% Change		2005		2004		% Change
General and administrative	$	1,523	$	1,388	10	%	$	3,064	$	2,791	10	%

For the three and six months ended June 30, 2005, the increase of 10%, or approximately $135,000 and $273,000, respectively, in general and administrative expenses compared to the same periods in 2004 was the result of the following:

• approximately $115,000 and $220,000, respectively, in higher employee-related expenses to support our expanding research and development activities; and

• approximately $20,000 and $50,000, respectively, in higher facility and equipment related allocations.

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

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Other income, net

	Three Months Ended June 30,								Six Months Ended June 30,
(In thousands, except for percentages)	2005			2004			% Change		2005			2004			% Change
Interest income	$	423		$	361		17	%	$	806		$	703		15	%
Interest expense		(83	)		(93	)	-11	%		(160	)		(177	)	-10	%
Other income, net	$	340		$	268		27	%	$	646		$	526		23	%

Interest income increased to approximately $423,000 and $806,000 for the three and six months ended June 30, 2005, respectively, from approximately $361,000 and $703,000 for the same periods in 2004. The increase resulted from higher returns in the current rising interest rate environment, partially offset by lower average investment balances in the first six months of 2005 compared to the same period in 2004.

Interest expense decreased to approximately $83,000 and $160,000 for the three and six months ended June 30, 2005 from approximately $93,000 and $177,000 for the same periods in 2004. The decrease resulted from the lower average debt balances in the first six months of 2005, partially offset by higher average interest rates on more recent debt-financing drawdowns. We expect that our interest expense will increase in the future as a result of additional property and equipment-related debt financing combined with anticipated higher-interest rates and as a result of any draw downs on our credit facility.

Liquidity and Capital Resources

Since inception, we have financed our operations primarily through sales of our convertible preferred stock and common stock, contract payments received under our corporate collaboration agreements and government grant awards, interest income and equipment financing arrangements. As of June 30, 2005, we had received approximately $150.4 million from the sale of convertible preferred stock and common stock, approximately $97.6 million from contract payments received under our corporate collaboration agreements and government grant awards, approximately $14.8 million from interest income and approximately $13.2 million from equipment financing arrangements. As of June 30, 2005, we had approximately $69.3 million in cash and investments, compared to approximately $83.4 million as of December 31, 2004. Our funds are currently invested in U.S. Treasury and government agency obligations and corporate obligations.

Our operating activities used cash of approximately $13.6 million for the six months ended June 30, 2005 compared to approximately $5.1 million for the same period in 2004. Our net loss of approximately $15.3 million for the six months ended June 30, 2005 was partially offset by non-cash charges of approximately $1.9 million related to stock-based compensation, depreciation and amortization of investment premiums and discounts. Cash used for the same period in 2004 was primarily used to fund the net loss of $9.3 million, partially offset by non-cash charges of approximately $2.7 million related to stock-based compensation, depreciation and amortization of investment premiums and discounts.

Our investing activities, excluding changes in our investments, for the six months ended June 30, 2005, used cash of approximately $953,000, compared to approximately $1.3 million for the same period in 2004, reflecting facility and capital expenditures as we continued to enhance and improve upon our laboratory capabilities.

Cash provided by financing activities was approximately $780,000 for the six months ended June 30, 2005, compared to approximately $1.0 million for the same period in 2004. This decrease was primarily attributed to the timing of the sale of our common stock related to stock option exercises and stock purchases made under our 2000 Employee Stock Purchase Plans, partially offset by higher proceeds from

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equipment debt financing in the six months ended June 30, 2005 compared to the same period in 2004. Financing activities for 2005 included approximately $459,000 in proceeds from equipment loans, net of scheduled payments on new and existing debt, and $321,000 in proceeds from the sale of our common stock related to stock option exercises and stock purchases made under our 2000 Employee Stock Purchase Plan. Financing activities for 2004 included approximately $58,000 in scheduled payments on new and existing debt, net of proceeds from equipment loans, and $1.1 million in proceeds from the sale of our common stock related to stock option exercises and stock purchases made under our 2000 Employee Stock Purchase Plan.

In April 2004, we entered into a $3.5 million equipment line of credit agreement for facility improvements and capital purchases, which was scheduled to expire in April 2005, but has been extended through December 2005. As of June 30, 2005, we had utilized approximately $1.9 million of the line of credit, leaving approximately $1.6 million available for future draws. In July 2005, we entered into a loan and security agreement with Silicon Valley Bank for a $35.0 million line of credit. Under the terms of the agreement, we have the option of making up to two draws through May 31, 2006, with a minimum initial draw of $15.0 million. As of July 31, 2005, we had not utilized the line of credit.

We believe that our existing cash and investment securities, credit facility and anticipated cash flow from our existing collaboration with Roche will be sufficient to support our current operating plan into the second half of 2006. We expect to obtain additional financing from time to time, or focus our spending on priority programs to provide for the proper alignment of resources and maintenance of sufficient levels of financial reserves. We have based this estimate on assumptions that may prove to be wrong. Our future capital uses and requirements depend on numerous forward-looking factors, including the following:

• our ability to establish any new collaborations, our rights and obligations under any new collaboration agreements and our ability to generate revenues under any new collaborations;

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

• the progress, success and costs of preclinical testing and clinical trials of our drug candidates;

• any acceleration of our clinical development plans;

• our ability to maintain or extend our existing collaborations with Roche and the NCI;

• the progress, number and costs of our research programs;

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

• any need to obtain licenses to additional patents or other intellectual property in order to use, import, manufacture, market or sell our product candidates;

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

• any need to expand our manufacturing capabilities;

• any need to build commercial infrastructure to market our products; and

• expenses associated with any possible future litigation.

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

We expect that additional financing will be required in the future to fund operations. We expect to finance future cash needs through the public or private sale of equity securities, debt financings, additional collaboration or licensing arrangements, government grant awards or any combination of the foregoing or other arrangements. In September 2003, we filed a registration statement on Form S-3 to offer to sell common stock in one or more offerings up to a dollar amount of $75.0 million. In December 2003, we completed a registered direct offering of 3,115,000 shares of common stock at a price of $9.00 per share.

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We received approximately $26.0 million in net proceeds after placement agent fees and other offering costs. As of June 30, 2005, approximately $47.0 million remained available on the Form S-3. In December 2004, we filed an additional registration statement on Form S-3 to offer to sell common stock and/or warrants in one or more offerings up to a dollar amount of $50.0 million. In aggregate, approximately $97.0 million remain available on both Forms S-3.

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

We have no current commitments to offer and sell any securities that may be offered or sold pursuant to the registration statements described above. Additional financing or collaboration and licensing arrangements may not be available when needed or, if available, may not be on terms favorable to us or our stockholders. Insufficient funds may require us to delay, scale back or eliminate some or all of our research or development programs, to lose rights under existing licenses or to relinquish greater or all rights to product candidates at an earlier stage of development or on less favorable terms than we would otherwise choose. Insufficient funds may preclude us from meeting the conditions required for the extension of credit and may adversely affect our ability to operate as a going concern. If additional funds are obtained by issuing equity securities, substantial dilution to existing stockholders may result. In addition, see “Risk Factors That May Affect Results of Operations and Financial Condition”.

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

	Total		Less than 1 Year		1-3 Years		4-5 Years		After 5 Years
	(in thousands)
Equipment financing obligations	$	4,650	$	2,286	$	2,170	$	194	$	—
Operating leases		10,063		1,609		3,128		2,177		3,149
Total contractual cash obligations	$	14,713	$	3,895	$	5,298	$	2,371	$	3,149

Risk Factors That May Affect Results of Operations and Financial Condition

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

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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 June 30, 2005, we had an accumulated deficit of approximately $116.5 million. To date, our revenues have been primarily from collaborations and government grant awards. Our expenses have consisted principally of costs incurred in research and development and from general and administrative costs associated with our operations. We have incurred net losses since our inception, including a net loss of approximately $15.3 million for the six months ended June 30, 2005. We expect our expenses to increase and to continue to incur operating losses for at least the next several years as we continue our research and development efforts for our drug candidates and research programs. The amount of time necessary to successfully commercialize any of our drug candidates is long and uncertain, and successful commercialization may not occur at all. As a result, we may never become profitable.

We expect that additional financing will be required, and an inability to obtain the capital necessary to fund our operations on acceptable terms or at all would threaten the continued operation of our business.

We expect that additional financing will be required in the future to fund operations. We do not know whether additional financing will be available when needed, or that, if available, we will obtain financing on favorable terms. We have consumed substantial amounts of cash to date and expect capital outlays and operating expenditures to increase over the next several years as we expand our infrastructure and research and development activities.

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

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

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

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

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

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

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

If we are unable to raise sufficient funds when needed, we may be required to delay, scale back or eliminate some or all of our research or development programs; lose rights under existing licenses; or relinquish greater or all rights to product candidates at an earlier stage of development or on less favorable

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terms than we would otherwise choose. Insufficient funds may adversely affect our ability to operate as a going concern. See “Item 2. Management’s Discussion and Analysis of Financial Condition and Result of Operations -Liquidity and Capital Resources.”

We believe that our existing cash and investment securities, credit facility and anticipated cash flow from our existing collaboration with Roche will be sufficient to support our current operating plan into the second half of 2006, although we may choose to obtain additional financing from time to time. We have based this estimate on assumptions that may prove to be wrong. Our future capital uses and requirements depend on numerous forward-looking factors, including the following:

• our ability to establish any new collaborations, our rights and obligations under any new collaboration agreements and our ability to generate revenues under any new collaborations;

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

• the progress, success and costs of preclinical testing and clinical trials of our drug candidates;

• any acceleration of our clinical development plans;

• our ability to maintain or extend our existing collaborations with Roche and the NCI;

• the progress, number and costs of our research programs;

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

• any need to obtain licenses to additional patents or other intellectual property in order to use, import, manufacture, market or sell our product candidates;

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

• any need to expand our manufacturing capabilities;

• any need to build commercial infrastructure to market our products; and

• expenses associated with any possible future litigation.

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

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

We control neither the amount and timing of resources that our collaborators devote to our programs or potential products, nor the scope, content and timing of the efforts that they conduct or permit under the collaborations. As a result, we do not know if our collaborators will dedicate sufficient resources or if the development or commercialization efforts by our corporate partners will be successful. We also do not know if the development or commercialization efforts by our collaborators will be the same as those we

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would choose to devote if we solely controlled the development and commercialization of our programs and product candidates. In particular, in our collaboration with Roche, we do not control the amount and timing of resources that Roche devotes to the epothilone program beyond limited funding for certain Kosan activities specified under the contract, and we do not control the scope, content and timing of the preclinical studies, clinical trials and other development efforts that Roche conducts or permits under the program. In our collaboration with the NCI, we do not control the selection, conduct, timing and resources provided to clinical trials of geldanamycin analogs sponsored by the NCI. For these reasons, we may choose to undertake product development efforts that are within the scope of our collaborations at our own expense. We also do not know whether our current collaborative partners or future collaborative partners, if any, might pursue alternative technologies or develop alternative products either on their own or in collaboration with others, including our competitors, as a means for developing treatments for the diseases targeted by collaborative arrangements with us. In addition, business combinations or significant changes in a collaborator’s business strategy may adversely affect a collaborator’s willingness or ability to continue the collaboration with us.

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

If our collaborators fail to conduct the collaborative activities successfully and in a timely manner or if they or our licensors breach or terminate their agreements with us, the development or commercialization of the affected product candidates, technology or research program could be delayed or terminated. If any of our existing collaboration agreements are terminated, we may be required to seek new collaborators or to undertake product development and commercialization at our own expense. This may limit the number of product candidates we will be able to develop and commercialize, significantly increase our capital requirements and reduce the likelihood of successful product introduction. Disputes might also arise with collaborators or licensors concerning rights to particular compounds or technologies. If we are unable to resolve these disputes in our favor, we could lose our rights to use those compounds or technologies.

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

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

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

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

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

In addition, significant time and investment will be required to try to develop manufacturing processes for our products so that they are economical to manufacture on a commercial scale and satisfactory to the FDA and other governmental authorities.

The progress and results of our animal and human testing are highly uncertain.

We must provide the FDA and foreign regulatory authorities with clinical data that demonstrate the safety and efficacy of our products before they can be approved for commercial sale. As a result, commercialization of our product candidates depends upon successful completion of preclinical and clinical trials. Preclinical testing and clinical development are long, expensive and uncertain processes. It may take us a number of years to complete our testing, and failure can occur at any stage of testing. For example, in November 2004, we discontinued a Phase II clinical study of KOS-862 in non-small cell lung cancer because the study did not meet the primary objective of tumor response in the first stage of a two stage clinical trial, and in June 2004, we discontinued a Phase II clinical study of KOS-862 in colorectal cancer due to unanticipated cumulative drug toxicities in patients who had previously been treated with the cancer treatment oxaliplatin. We could experience similar failures in other current or future clinical testing of our product candidates.

Success in preclinical testing and early clinical trials does not ensure that later clinical trials will be successful, and interim results of trials do not necessarily predict final results. A number of companies in the pharmaceutical and biotechnology industry, including Kosan, have suffered significant setbacks in advanced clinical trials, even after promising results in earlier trials. Also, preclinical and clinical data can be interpreted in different ways, which could delay, limit or prevent further testing or regulatory approval.

We do not know whether clinical trials of our product candidates (including ongoing and anticipated clinical trials of KOS-862, KOS-1584, 17-AAG, KOS-953, KOS-1022 or other product candidates) will begin on time or whether any of our clinical trials will be completed on schedule, or at all. We also do not know whether clinical trials will indicate that an earlier-stage compound will be more appropriate for commercial development than a related compound that is at a later stage of clinical development. Negative or inconclusive results or adverse medical events during a clinical trial could cause a clinical trial to be suspended, repeated or terminated. Certain of the clinical trials of our product candidates are designed to include two stages, with the decision whether to proceed to the second stage dependent on results obtained in the first stage. Failure to achieve predetermined response rates as defined in the protocol may result in the decision not to proceed into the second stage of the related trial.

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We have multiple product candidates in human clinical trials for the treatment of cancer, KOS-862, KOS-1584, 17-AAG, KOS-953 and KOS-1022. Anticancer drugs generally have a narrow therapeutic window between efficacy and toxicity. If unacceptable toxicity is observed in a clinical trial, the trial may be terminated at an early stage. For example, in June 2004, we discontinued a Phase II clinical study of KOS-862 in colorectal cancer due to unanticipated cumulative drug toxicities in patients who had previously been treated with the cancer treatment oxaliplatin.

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, the FDA, or other regulatory authorities believe the patients participating in our studies are exposed to unacceptable health risks. Our ability to commence or timely complete clinical trials may be adversely affected by many factors, including:

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

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

• a failure to obtain approval from the FDA, other regulatory authorities or an investigational site’s investigational institutional review board to conduct a clinical trial;

• inability to reach agreement with a sufficient number of investigational sites to conduct a study;

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

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

• inconclusive or negative results from the clinical trial;

• competing clinical trials in the same or similar indication;

• third-party clinical investigators failing to perform our clinical trials on our anticipated schedule or consistent with a clinical trial protocol, and other third-party organizations not performing data collection and analysis in a timely or accurate manner; and

• a decision by the FDA or other governmental authorities to require suspension of a clinical study.

Our product development costs will increase if we have delays in testing or approvals or if we need to perform more or larger clinical trials than planned. If the delays are significant, our financial results and the commercial prospects for our products will be harmed, and our ability to become profitable will be adversely affected. If any clinical trials of our product candidates are not successful, our business, financial condition and results of operations will be harmed.

If we are not able to obtain required regulatory approvals, we will not be able to commercialize our product candidates, and our ability to generate revenue will be materially impaired.

Our product candidates and the activities associated with their development, manufacture and commercialization are subject to comprehensive regulation by the FDA and other regulatory agencies in the United States, and by comparable authorities in other countries. Our products may not be commercialized unless and until our collaborators or we obtain regulatory approval from the FDA or foreign governmental authorities to do so. The process of obtaining regulatory approvals is expensive, often takes many years, if approval is obtained at all, and can vary substantially based upon the type, complexity and novelty of the product candidates involved. We have not received regulatory approval to market any of our product candidates in any jurisdiction and, although our personnel have experience from working at other companies, we as a company have no experience in preparing and filing the applications necessary to gain regulatory approvals to commercialize our products. This lack of

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experience may impede our ability to obtain FDA or other foreign regulatory approvals to commercialize our products in a timely manner, if at all.

Changes in the regulatory approval policy during the development period, changes in or the enactment of additional regulations or statutes, or changes in regulatory review for each submitted product application, may cause delays in the approval or rejection of an application. Furthermore, the approval procedure and the time required to obtain approval varies among countries and can involve additional testing beyond that required by the FDA. Approval by one regulatory authority does not ensure approval by regulatory authorities in other jurisdictions.

The FDA and other regulatory authorities have substantial discretion in the approval process and may refuse to accept any application or may decide that our data is insufficient for approval and require additional preclinical, clinical or other studies or modifications to the manufacturing processes or facilities or quality control procedures for our products. Any clinical trial may fail to produce results satisfactory to the FDA or other regulatory authorities. Preclinical and clinical data can be interpreted in different ways, which could delay, limit or prevent regulatory approval. Furthermore, even if we file an application with the FDA or other regulatory authorities for marketing approval of a product candidate, it may not result in marketing approval from the FDA or other regulatory authorities.

We do not know whether clinical trials for our product candidates (including ongoing and anticipated clinical trials of KOS-862, KOS-1584, 17-AAG, KOS-953, KOS-1022 or other product candidates) will demonstrate safety and efficacy sufficient to obtain the requisite regulatory approvals or will result in marketable products. Our failure to adequately demonstrate the safety and efficacy of our products under development will prevent receipt of FDA and foreign approvals and, ultimately, commercialization of our products.

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

We do not have the ability to independently conduct clinical trials for our products, and we rely on third parties such as contract research organizations, medical institutions and clinical investigators to perform this function. We also rely on Roche to conduct certain clinical trials for KOS-862 and potentially KOS-1584 and the NCI to conduct certain clinical trials for 17-AAG and KOS-1022. We may rely on future collaborators to conduct clinical trials for our product candidates. If any of these third parties do not successfully carry out their obligations or meet expected deadlines, clinical trials may be extended, delayed, suspended or terminated, and our product candidates may not receive regulatory approval or be successfully commercialized.

Even if any of our product candidates receives regulatory approval, we may still face significant development and regulatory difficulties.

Even if the FDA or other regulatory authorities approves a product candidate, the approval may impose significant restrictions on the indicated uses, conditions for use, labeling, advertising, promotion, marketing and/or production of such product, and may impose ongoing requirements for post-approval studies, including additional research and development and clinical trials. In addition, regulatory agencies subject a product, its manufacturer and the manufacturer’s facilities to continual review and periodic inspections. If a regulatory agency discovers previously unknown problems with a product, including adverse events of unanticipated severity or frequency, or problems with the facility where the product is manufactured, a regulatory agency may impose restrictions on that product, our collaborators or us, including requiring withdrawal of the product from the market.

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If any of our approved products, our collaborators or we fail to comply with applicable regulatory requirements, a regulatory authority may take various actions, including:

• issuing warning letters;

• imposing civil or criminal penalties;

• suspending regulatory approval;

• refusing to approve pending applications or supplements to approved applications filed by us or our collaborators;

• imposing restrictions on operations, including costly new manufacturing requirements; or

• seizing or detaining products or requiring a product recall.

Any inability to protect our proprietary technologies could significantly harm our business and ability to successfully commercialize product candidates.

Our commercial success will depend in part on our ability to obtain patents and maintain adequate protection of other intellectual property for our technologies and products in the United States and other countries and prevent others from infringing our proprietary rights. If we are unable to adequately protect our intellectual property, competitors may be able to use our technologies and erode or negate any competitive advantage we may have. Intellectual property laws vary from country to country, and the laws of a particular country may afford less intellectual property protection than another country.

We will be able to protect our proprietary rights from unauthorized use by third parties only to the extent that our proprietary technologies and products are covered by valid and enforceable patents or are effectively maintained as trade secrets. However, the patent positions of biotechnology companies, including our patent position, involve complex legal and factual questions, and, therefore, we cannot predict with certainty whether our patent applications will be allowed or any resulting patents will be valid or enforceable. Further, our patents or patent applications or those of our licensors could be placed into interference, and we may lose our rights in such patents or applications. In particular, two of our exclusively licensed patents are the subject of an interference proceeding with a patent application concerning epothilones C, D, E and F filed by Gesellschaft für Biotechnologische Forschung (GBF). We believe this application to be licensed to Bristol-Myers Squibb. Patents may be challenged, held unenforceable, invalidated or circumvented. Thus, any patents that we own or license from third parties may not provide protection against competitors.

The degree of future protection for our proprietary rights is uncertain, and we cannot ensure that:

• we or our licensors were the first to make the inventions covered by each of our patents or pending patent applications;

• we or our licensors were the first to file patent applications for these inventions;

• others will not independently develop similar or alternative technologies or duplicate any of our technologies;

• any of our or our licensors’ pending patent applications will result in issued patents;

• any of our or our licensors’ patents will be valid or enforceable;

• any patents issued to us or our licensors and collaborators will provide a basis for commercially viable products, will provide us with any competitive advantages or will not be challenged by third parties;

• we will develop additional proprietary technologies that are patentable; or

• the patents of others will not have an adverse effect on our business.

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We apply for patents covering our technologies, drug candidates, formulations and uses thereof, as we deem appropriate. However, we may fail to apply for patents on important technologies or products in a timely fashion or at all. Our existing patents and any future patents we obtain may not be sufficiently broad to prevent others from practicing our technologies or from developing competing products and technologies. For example, 17-AAG, the active pharmaceutical ingredient in the two most advanced product candidates in our Hsp90 inhibitor program is not covered by a composition of matter patent. These two product candidates are the formulation of 17-AAG being studied by the NCI under our CRADA and KOS-953, our proprietary formulation of 17-AAG. Consequently, others can develop products containing 17-AAG. We are aware of at least two other companies that have been developing product candidates containing or based on 17-AAG, and these companies have filed patent applications relating to may relate to their products in development. Other competitors may be currently developing, or may in the future develop, products containing or based on 17-AAG. In addition, we generally are unable to control the patent prosecution of technology that we license from others to the same degree as we would for our own technology.

In addition to patents, we rely on trade secrets and proprietary know-how. We have taken measures to protect our confidential information and trade secrets. However, these measures may not provide adequate protection. We seek to protect our confidential information and trade secrets by entering into confidentiality agreements with employees, collaborators, consultants and others. Nevertheless, parties may breach these agreements or competitors may otherwise obtain or independently develop our trade secrets.

Patents related to our lead compound, KOS-862, are the subject of adversarial proceedings, namely, an interference involving patent rights licensed to us and oppositions against third-party patents. Interference with patent rights we own or license, or opposition against third-party patent rights, could result in substantial costs to us and, if we are unsuccessful, could prevent us from using the patent rights.

We are aware of a significant number of patents and patent applications relating to aspects of our technologies and compounds filed by, and issued to, other parties. Others have filed patent applications or have been granted patents claiming inventions also claimed or licensed by us, and we may have to participate in an interference or other proceeding before a patent agency or court to determine priority of invention or which party was first to invent and, thus, has the right to a patent for these inventions. For example, two of our exclusively licensed patents are the subject of an interference proceeding with a patent application concerning epothilones C, D, E and F filed by GBF. We believe GBF has licensed this patent application to Bristol-Myers Squibb, one of our competitors. Further, we believe one or more interferences may be declared between patents and applications we own or have exclusively licensed and patents and applications owned by Novartis relating to epothilone biosynthetic genes; and patents and applications owned by Abbott Laboratories or Biotica Technologies Ltd. relating to erythromycin PKS genes, methods for altering PKS genes, and erythromycin analogs. In April 2005, a hearing was held at the European Patent Office to address an opposition filed by Biotica to one of our exclusively licensed patents related to the recombinant production of polyketides. At the hearing, the patent was maintained (upheld) with narrowing amendment; the time for Biotica to appeal the ruling has not yet expired. In addition, the European Patent Office has recently granted patents to GBF, which we believe to be licensed to Bristol-Myers Squibb and which, if valid in individual European countries, would cover Epothilone D in those countries. Formal oppositions to these patents have been filed with the European Patent Office and we expect responses by GBF to those oppositions to continue through the second half of 2005.

A proceeding or a lawsuit involving an interference or opposition could result in substantial cost to us even if the outcome is favorable, and if the outcome is unfavorable, we could be required to license the other party’s rights, on terms that may be unfavorable to us, or cease using the technology and could materially harm our business, financial condition and results of operations. Even if successful on priority grounds, an interference or opposition may result in loss of claims based on patentability grounds raised in the interference or opposition. Although patent and intellectual property disputes in the biotechnology area are often settled through licensing or similar arrangements, costs associated with these arrangements may be substantial and could include ongoing royalties. Furthermore, we cannot be certain that a license would be available to us on satisfactory terms, if at all. Companies and others developing products that could compete with our product candidates, such as Bristol-Myers Squibb and Novartis in the area of potential epothilone products, may be particularly unwilling to grant us a license at any price. If we are not able to obtain necessary licenses, we may not be able to manufacture or commercialize, which could materially harm our business, financial condition and results of operations.

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Claims by third-parties of intellectual property infringement would require us to spend time and money and could deprive us of valuable rights needed to develop or commercialize our products.

Our commercial success depends significantly on not infringing the patents and proprietary rights of other parties and not breaching any licenses that we have entered into with regard to our technologies and products. Other parties may currently or in the future possess intellectual property rights covering drug candidates that we are developing or desire to develop and genes, gene fragments, cell lines, compounds and technologies we use or may wish to use. Any infringement of patent rights or violation of other proprietary rights may require us to obtain a license from another party, forego product development or commercialization or face lawsuits or other claims.

The biotechnology industry is characterized by extensive litigation regarding patents and other intellectual property rights. We are aware of patents and published patent applications that, if valid, and if we are unsuccessful in circumventing or acquiring the rights to these patents, may block our ability to commercialize products based on the drug candidates that we are developing or pursue our polyketide synthase (PKS) gene manipulation and production technologies. We cannot be sure that other parties have not filed for or obtained relevant patents that could affect our ability to obtain patents or operate our business. Others may challenge our patent or other intellectual property rights or sue us for patent infringement, misappropriation of their intellectual property rights or breach of license agreements. We may be required to commence legal proceedings to resolve our patent or other intellectual property rights. An adverse determination in any litigation or in administrative proceeding to which we may become a party could subject us to significant liabilities, result in our patents being deemed invalid, unenforceable or revoked, require us to license disputed rights from others or to cease using the disputed technology. In addition, our involvement in any of these proceedings may cause us to incur substantial costs and result in diversion of management and technical personnel.

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

• pay substantial damages;

• stop producing certain products and using certain methods;

• develop non-infringing products and methods; and

• obtain one or more licenses from other parties.

We may not be able to obtain licenses from other parties at a reasonable cost, or at all. If we are not able to obtain necessary licenses at a reasonable cost or at all, we could encounter substantial delays in product introductions while we attempt to develop alternative methods and products, which we may not be able to accomplish. Litigation or the failure to obtain licenses could prevent us from manufacturing or commercializing products and could materially harm our business, financial condition and results of operation.

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

Currently, we are the sole manufacturer of the active pharmaceutical ingredient for KOS-862, we rely on contract manufacturers for the active pharmaceutical ingredient for KOS-1584 and we use a single outside

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contractor to formulate drug product for KOS-862 and KOS-1584. We currently maintain limited inventories of the active pharmaceutical ingredient for KOS-862 and KOS-1584 at our facilities in Hayward, California. We currently maintain limited inventories of formulated drug product for KOS-862 and KOS-1584 at our facilities in Hayward, California and at the facilities of an outside contractor. Limited inventories of formulated drug product for KOS-862 are also maintained by Roche.

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

If any of our or our contract manufacturers’ manufacturing or inventory facilities encounter delays, are destroyed or otherwise become unavailable to us, then the clinical development of our product candidates or submissions for their regulatory approval, and therefore commercialization, could be delayed or precluded. Adverse effects would be particularly acute if problems arise with our sole sourcing or inventory relationships. Because our manufacturing processes and those of our contractors are complex and subject to a lengthy regulatory approval process, alternative qualified production capacity may not be available on a timely basis or at all.

A number of factors could cause prolonged interruptions in the manufacturing and supply of our products, including:

• the inability of a supplier to provide raw materials or key intermediates used for manufacture of our products;

• equipment malfunctions or failures;

• the inability to manufacture in accordance with current good manufacturing practices;

• the delay of product shipments due to U.S. custom regulations or third-party carriers used to transport our products, and damage to our products while they are in transit;

• changes in FDA or other regulatory authority requirements or standards that require modifications to the manufacturing processes or facilities used in the production of our products;

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

• difficulties in scaling-up production of our products for large clinical trials or commercial supply.

While our manufacturing personnel have extensive experience from working at other companies, we as a company have no experience manufacturing products for commercial sale. We may encounter difficulties in attempting to scale-up our manufacturing processes and facilities. We may not be able to achieve such scale-up in a timely manner or at a commercially reasonable cost, if at all. In addition, our facilities in Hayward, California are located within the San Francisco Bay Area, an area where earthquakes periodically occur. Our access to any key intermediates, active pharmaceutical ingredient or formulated drug product for our product candidates sourced or inventoried solely through our facilities in Hayward may be subject to interruption in the event of an earthquake.

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

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profit margins and our ability to commercialize any products that we may develop on a timely and competitive basis. Dependence on contract manufacturers involves a number of additional risks, many of which are outside of our control, including:

• failure of a contract manufacturer to manufacture products to our specifications or to deliver products in the quantities or timeframe that we require;

• failure of a contract manufacturer to comply with current good manufacturing practices or other regulatory requirements;

• a decision by the FDA or other regulatory authorities not to approve our use of a particular contract manufacturer to supply our products;

• intellectual property rights to any improvements in a manufacturing process or new manufacturing processes being owned by or shared with a contract manufacturer;

• termination of an agreement with a contract manufacturer or increased prices charged by a contract manufacturer; or

• a contract manufacturer declaring bankruptcy or otherwise going out of business.

Any of these factors could cause us to delay or suspend clinical trials, regulatory submissions or commercialization of our products and could result in significantly increased costs.

In addition, our future contract manufacturers may not be in the United States, and we currently utilize a contract manufacturer located outside the United States. Consequently, we may face additional manufacturing difficulties due to a number of potential factors, including importation and customs issues, political uncertainties and a potentially limited ability to enforce our contractual rights against parties not located within the United States.

If we are unable to recruit and retain skilled employees and consultants, we may not be able to successfully operate our business.

Retaining our current employees and recruiting qualified scientific personnel to perform future research and development work, as well as manufacturing and key management personnel, will be critical to our success. We may also need to hire personnel with expertise in clinical testing, government regulation, marketing, law and finance. In the past, we have experienced turnover among our management. In addition, none of our employees have employment commitments for any fixed period of time and could leave our employment at will. Competition is intense among biotechnology, pharmaceutical and healthcare companies, universities and non-profit research institutions for experienced scientists and other personnel, and we may not be able to retain or recruit sufficient skilled personnel on acceptable terms to allow us to pursue collaborations and develop our products and core technologies to the extent otherwise possible.

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

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

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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, that are pursuing competing technologies and products. These organizations may develop or currently possess technologies or products that are superior alternatives to ours. For example, competing epothilones in clinical development include those being developed by Bristol-Myers Squibb (reported to be in Phase III clinical trials), Novartis AG (reported to be in Phase II clinical trials) and Schering AG (reported to be in Phase I clinical trials). In Hsp90 inhibitors, both Conforma Therapeutics and Infinity Pharmaceuticals have initiated Phase I clinical trials with their formulations of 17-AAG. Further, our competitors in the polyketide gene-engineering field may be more effective at implementing their technologies to develop commercial products or may hold or develop patents or other proprietary rights that may prevent us from practicing our technologies and pursuing our programs. Some of these competitors have entered into collaborations with leading companies within our target markets to produce polyketides for commercial purposes.

Any products that we develop through our technologies will compete in multiple, highly competitive markets. Development of pharmaceutical products requires significant investment and resources. Many of the organizations competing with us in the markets for such products have greater capital resources, research and development and marketing staffs, facilities and capabilities, and greater experience in discovery and developing drugs, obtaining regulatory approvals and product manufacturing and marketing. Accordingly, our competitors may succeed in more rapidly developing and marketing technologies and products that are more effective than our technologies and products or that would render our products or technologies obsolete or noncompetitive.

We believe that our ability to successfully compete will depend on, among other things:

• our ability to develop novel compounds with attractive pharmaceutical properties and to secure and protect intellectual property rights based on our innovations;

• the efficacy, safety and reliability of our product candidates;

• the speed at which we develop our product candidates;

• our ability to design and successfully execute appropriate clinical trials;

• the timing and scope of regulatory approvals;

• our ability to manufacture and sell commercial quantities of future products to the market;

• acceptance of future products by physicians and other healthcare providers; and

• the development of effective pricing and reimbursement strategies.

If we face product liability claims, these claims will divert our management’s time and we will incur litigation costs, and if we are held liable, our business, financial condition and results of operation may be materially harmed.

We face an inherent business risk of liability claims in the event that the use of our potential products in clinical trials or otherwise, or any other products manufactured in our facility, results in personal injury or death. Even though we have obtained product liability insurance, it may not be sufficient to cover claims that may be made against us. Product liability insurance is expensive, difficult to obtain and may not be available in the future on acceptable terms, if at all. Any claims against us, regardless of their merit, could materially and adversely affect our business, financial condition and results of operation, because litigation related to these claims would strain our financial resources in addition to consuming the time and attention of our management. If we are sued for any injuries caused by our products or products manufactured at our facility, our liability could exceed our total assets.

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

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

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

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

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

We have adopted a rights agreement under which all stockholders have the right to purchase shares of a new series of preferred stock at an exercise price of $70.00 per one one-hundredth of a share, if a person acquires more than 20% of our common stock. The rights plan could make it more difficult for a person to acquire a majority of our outstanding voting stock. The rights plan could also reduce the price that investors might be willing to pay for shares of our common stock and result in the market price being lower than it would be without the rights plan. In addition, the existence of the rights plan itself may deter a potential acquiror from acquiring us. As a result, either by operation of the rights plan or by its potential deterrent effect, mergers and acquisitions of us that our stockholders may consider in their best interests may not occur.

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

Our officers, directors and their affiliates together controlled approximately 23% of our outstanding common stock as of June 30, 2005. As a result, these stockholders, if they act together, are able to exert a

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significant degree of influence over our management and affairs and over matters requiring stockholder approval, including the election of directors and approval of significant corporate transactions. This concentration of ownership may delay or prevent a change in control of us and might affect the market price of our common stock, even when a change may be in the best interests of all stockholders. In addition, the interests of this concentration of ownership may not always coincide with our interests or the interests of other stockholders, and accordingly, they could cause us to enter into transactions or agreements, which we would not otherwise consider.

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

The trading price of our common stock has been, and is likely to continue to be, highly volatile. During the period from June 30, 2004 through June 30, 2005, our common stock traded between $3.98 and $8.00 on the NASDAQ National Market. The trading price of our common stock could be subject to wide fluctuations in price in response to various factors, many of which are beyond our control, including:

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

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

• developments in clinical trials for potentially competitive product candidates;

• changes in the United States or foreign health care systems or regulations;

• regulatory approvals for competitive product candidates or delays or failures by our collaborators or us in obtaining regulatory approvals for our product candidates;

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

• published reports by securities analysts;

• announcements of expirations, terminations or amendments of collaborations, licenses or government research grants, or announcements that we have entered into new collaboration, licensing or similar arrangements;

• departures of key personnel;

• developments or disputes as to patent or other proprietary rights;

• litigation or an unfavorable outcome in litigation;

• sales of our common stock;

• announcements of, and actual or anticipated fluctuations in, our financial results; and

• economic and other external factors, disasters or crises.

In addition, the stock market in general, and the NASDAQ National Market and the market for biotechnology companies in particular, has experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of those companies. These broad market and industry factors may seriously harm the market price of our common stock, regardless of our 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.

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

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

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

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

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

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

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

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

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

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

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

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

Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, on an annual basis, our management is required to report on, and our independent auditors to attest to, the effectiveness of our internal controls over financial reporting. The rules governing the standards that must be met for management to make its annual assessment are complex and require significant documentation and testing. While our internal controls over financial reporting were deemed effective by both our management and our independent auditors as of December 31, 2004, there may be changes in our systems, processes or operations that will effect the effectiveness of internal controls in the future. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Our future assessments of internal controls may continue to result in increased expenses and the devotion of significant management resources. If we cannot favorably assess the effectiveness of our internal controls over financial reporting in the future, or if our independent auditors are unable to provide an unqualified attestation report on our assessment, investor confidence and our stock price could be adversely affected.

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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 maximize the income we receive from our investments without significantly increasing risk. Some of the securities that we invest in may have market risk. This means that a change in prevailing interest rates may cause the principal amount of the investments to fluctuate. To minimize this risk in the future, we intend to maintain our portfolio of cash equivalents and investments in a variety of securities, including commercial paper, money market funds, government and non-government debt securities and investment-grade corporate obligations. Through our money managers, we maintain risk management control systems to monitor interest rate risk. The risk management control systems use analytical techniques, including sensitivity analysis. If market interest rates were to increase by 100 basis points, or 1%, as of June 30, 2005 rates, the fair value of our portfolio would decline by approximately $365,000 on that date.

The following table represents the fair value balance of our cash, cash equivalents and short-term and long-term investments that are subject to interest rate risk by year of expected maturity and average interest rates as of June 30, 2005 (dollars in thousands):

	2005			2006			2007
Cash and cash equivalents	$	10,444		$	—		$	—
Average interest rates		2.75	%
Short-term investments		24,254			20,742			—
Average interest rates		2.03	%		2.70	%
Long-term investments		949			10,070			2,800
Average interest rates		0.65	%		3.53	%		4.13

We did not hold any derivative instruments as of June 30, 2005, and we have never held such instruments in the past. In addition, we had outstanding debt, consisting of borrowings under equipment financings, of $4.2 million as of June 30, 2005, with a range of interest rates from 6.31% to 8.90%.

Item 4: Controls and Procedures

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

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

Limitations on the Effectiveness of Controls. The Company’s management, including our chief executive officer and chief financial officer, does not expect that our disclosure controls and procedures or our internal controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected.

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PART II. OTHER INFORMATION

Item 1: Legal Proceedings

Not applicable.

Item 2: Unregistered Sales of Equity Securities and Use of Proceeds

Not applicable.

Item 3: Defaults Upon Senior Securities

Not applicable.

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

The Company held its Annual Meeting of Stockholders on May 26, 2005. The results of the voting were as follows:

a) To approve the election of three directors, Bruce A. Chabner, M.D., Peter Davis, Ph.D. and Christopher T. Walsh, Ph.D., Class B directors of the Company, to serve until the 2008 Annual Meeting of Stockholders. Directors whose term of office as a director continued after the meeting are Daniel V. Santi, M.D., Ph.D., Jean Deleage, Ph.D., Charles J. Homcy, M.D., and Chaitan S. Khosla, Ph.D. The number of votes cast as to the election of the Class B directors of the Company at the Annual Meeting of Stockholders is as follows:

Candidate	Shares Voted In Favor	Shares Withheld	Broker Non- Votes
Bruce A. Chabner, M.D.	27,708,654	83,690	—
Peter Davis, Ph.D.	27,583,792	208,552	—
Christopher T. Walsh, Ph.D.	27,465,178	327,166	—

b) To ratify the selection of Ernst & Young LLP as independent auditors of the Company for its fiscal year ending December 31, 2005.

Shares Voted In Favor	Shares Withheld	Abstain	Broker Non- Votes
27,582,338	193,216	16,790	—

Item 5: Other Information

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

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

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

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

36

Item 6: Exhibits

Exhibit No.
3.1	Amended and Restated Certificate of Incorporation. (1)
3.2	Amended and Restated Bylaws of Registrant. (2)
4.1	Form of Specimen Common Stock Certificate. (3)
4.2	Third Amended and Restated Registration Rights Agreement, dated March 30, 2000, between Registrant and certain stockholders. (3)
4.3	Registrant’s Certificate of Designation of Series A Junior Preferred Stock. (4)
10.1	Transition Separation and Consulting Agreement between Registrant and Bruce E. MacMillan dated June 24, 2005.*
10.2	Loan and Security Agreement between Registrant and Silicon Valley Bank, dated July 15, 2005.
31.1	Certification required by Rule 13a-14(a) or Rule 15d-14(a)
31.2	Certification required by Rule 13a-14(a) or Rule 15d-14(a)
32.1	Certification by the Chief Executive Officer and the Chief Financial Officer of Kosan Biosciences Incorporated, as required by Rule 13a-14(b) or Rule 15d-14(b) and Section 1350 of Chapter 63 of Title 18 of the United Stated Code (18 U.S.C. 1350). (5)

(1) Incorporated herein by reference to an exhibit of our quarterly report on Form 10-Q for the period ended June 30, 2001.

(2) Incorporated herein by reference to an exhibit of our Quarterly Report on Form 10-Q for the period ended June 30, 2003.

(3) Incorporated herein by reference to an exhibit of our Registration Statement on Form S-1, Registration No. 333-33732.

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

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

* Represents a management or director compensation plan.

37

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
August 4, 2005	By:	/s/ Daniel V. Santi
		Daniel V. Santi, M.D., Ph.D.
		Chairman and Chief Executive Officer

August 4, 2005	By:	/s/ Susan M. Kanaya
		Susan M. Kanaya
		Senior Vice President, Finance and Chief Financial Officer

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EXHIBIT INDEX

Exhibit No.
3.1	Amended and Restated Certificate of Incorporation. (1)
3.2	Amended and Restated Bylaws of Registrant. (2)
4.1	Form of Specimen Common Stock Certificate. (3)
4.2	Third Amended and Restated Registration Rights Agreement, dated March 30, 2000, between Registrant and certain stockholders. (3)
4.3	Registrant’s Certificate of Designation of Series A Junior Preferred Stock. (4)
10.1	Transition Separation and Consulting Agreement between Registrant and Bruce E. MacMillan dated June 24, 2005.*
10.2	Loan and Security Agreement between Registrant and Silicon Valley Bank, dated July 15, 2005.
31.1	Certification required by Rule 13a-14(a) or Rule 15d-14(a)
31.2	Certification required by Rule 13a-14(a) or Rule 15d-14(a)
32.1	Certification by the Chief Executive Officer and the Chief Financial Officer of Kosan Biosciences Incorporated, as required by Rule 13a-14(b) or Rule 15d-14(b) and Section 1350 of Chapter 63 of Title 18 of the United Stated Code (18 U.S.C. 1350). (5)

(1) Incorporated herein by reference to an exhibit of our quarterly report on Form 10-Q for the period ended June 30, 2001.

(2) Incorporated herein by reference to an exhibit of our Quarterly Report on Form 10-Q for the period ended June 30, 2003.

(3) Incorporated herein by reference to an exhibit of our Registration Statement on Form S-1, Registration No. 333-33732.

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

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

* Represents a management or director compensation plan.

39

EX-10.1

Exhibit 10.1

June 24, 2005

VIA HAND DELIVERY

Bruce E. MacMillan

Kosan Biosciences, Inc.

3832 Bay Center Place

Hayward, CA 94545

Dear Bruce:

As you know, you have tendered the resignation of your employment with Kosan Biosciences Incorporated (the “Company”), to be effective as of July 1, 2005. As we discussed, this letter sets forth the terms of the separation and consulting agreement (the “Agreement”) that the Company is offering to you to aid in your employment transition.

1. Period of Continued Employment. The Company will continue your employment in your current position, through your requested resignation date of July 1, 2005, unless your employment is terminated earlier due to your material breach of Company policies or procedures or a written agreement with the Company. The last date of your employment is referred to herein as the “Resignation Date”. Between now and your Resignation Date, you will continue to be paid your regular base salary.

2. Accrued Salary and Vacation Pay. On the Resignation Date, the Company will pay you all accrued salary, and all accrued and unused vacation, earned through the Resignation Date, less standard payroll deductions and withholdings. You are entitled to these payments by law.

3. Severance Benefits. Although the Company is not otherwise obligated to do so, if you enter into this Agreement and abide by your obligations hereunder (including satisfactorily performing your job duties through July 1, 2005), and you provide transition assistance to the Company after the Resignation Date as reasonably requested by the Company (including but not limited to timely responding to requests for information), the Company will provide you the following severance benefits (the “Severance Benefits”). The Company’s obligation to continue to provide the Severance Benefits set forth below will cease immediately if you breach this Agreement.

(a) Severance Payments. You will receive severance payments in the form of continuation of your final base salary (the “Severance Payments”) through the earlier of: (i) August 1, 2005, or (ii) the date that you commence either full-time employment or a full-time consulting arrangement with another for-profit entity. The Severance Payments will be subject to required payroll deductions and withholdings and paid on the Company’s normal payroll

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schedule, beginning with the first payroll date after the Effective Date of this Agreement (as defined in Paragraph 15). You agree to promptly notify the Company in writing of the date that you commence either full-time employment or a full-time consulting arrangement with another for-profit entity.

(b) COBRA Premium Payments. To the extent provided by the federal COBRA law or, if applicable, state insurance laws, and by the Company’s current group health insurance policies, you will be eligible to continue your group health insurance benefits at your own expense after the Resignation Date. Later, you may be able to convert to an individual policy through the provider of the Company’s health insurance, if you wish. You will be separately provided a written notice of your rights and obligations under COBRA. If you timely elect continued coverage under COBRA and meet the other conditions precedent for Severance Benefits as required by this Paragraph 3, the Company, as an additional severance benefit, will reimburse your COBRA premiums in an amount sufficient to continue your (and your dependents) health insurance coverage at the level in effect as of the Resignation Date, through the earlier of the following: (i) the date that you become eligible for group health insurance benefits through a new employer; or (ii) August 1, 2005. You agree to promptly notify the Company in writing if you become eligible for group health insurance coverage through a new employer prior to August 1, 2005.

4. Consulting Relationship. If you enter into this Agreement and abide by your obligations hereunder (including satisfactorily performing your job duties through July 1, 2005), the Company will retain you to provide services as a consultant under the following terms and conditions:

(a) Consulting Period. The consulting period (the “Consulting Period”) will commence on the Resignation Date, and will continue until the earlier of: (i) December 31, 2005; (ii) the date of termination by either the Company for good cause or you for any reason upon ten (10) business days advance written notice to the other party; or (iii) the date either party terminates for material breach of this Agreement, which may be done immediately upon delivery of written notice.

(b) Consulting Duties. You agree that you will provide consulting services (the “Services”) during the Consulting Period in any area of your expertise as requested by the Company’s Chief Executive Officer (“CEO”), which shall not include requested transition assistance pursuant to Paragraph 3 of this Agreement (if any). The time you spend on the Services shall be mutually agreed. You agree to exercise the highest degree of professionalism and utilize your expertise and creative talents in performing the Services.

(c) Independent Contractor Consulting. You acknowledge and agree that during the Consulting Period you will be an independent contractor of the Company and not an employee. You further acknowledge and agree that, during the Consulting Period, you will not be entitled to any of the benefits that the Company may make available to its employees, except to the extent that you elect continued health care coverage under COBRA as provided by law.

(d) Consulting Fees and Expenses. The Company will pay you consulting fees (the “Consulting Fees”) at the rate of two hundred dollars ($200) per hour for services rendered

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between July 2, 2005 and July 31, 2005; thereafter, Consulting Fees shall be at the rate of three hundred fifty dollars ($350) per hour. In addition, the Company will reimburse you for all reasonable business expenses you incur in providing the Services, provided that the CEO approves such expenses in advance and you provide supporting documentation (including receipts) for such expenses. You must provide the Company with an invoice for any Services rendered during the Consulting Period, and the Company will make payment for approved Services within thirty (30) days after receipt of the invoice. The Company will report all Consulting Fees paid to you by filing a Form 1099-MISC with the Internal Revenue Service as required by law. Because your consulting services will be performed as an independent contractor and not an employee, the Company will not: make any withholdings from the Consulting Fees; make payments for state or federal tax or social security; make unemployment insurance or disability insurance contributions; or obtain workers’ compensation insurance on your behalf. You agree to accept exclusive liability for complying with all applicable local, state and federal laws governing self-employed individuals, including obligations such as payment of taxes, social security, disability and other contributions based on Consulting Fees paid to you under this Agreement. Other than your right to continued group health insurance coverage under COBRA as discussed above, you will not receive any employee benefits under any Company-sponsored benefit plans or participate in Company-sponsored health insurance.

(e) Stock Option Awards. You and the Company agree to the following regarding the two stock option grants provided to you in connection with your employment with the Company:

(i) Grant Number 692. Notwithstanding any provision to the contrary contained in the applicable stock option grant notice, applicable stock option agreement, and governing stock option plan, and notwithstanding your continued service to the Company during the Consulting Period, you and the Company agree that your option grant number 692 dated June 21, 2004 (“Grant Number 692”) will cease to vest as of the Resignation Date, and your option on all unvested shares as of that date will terminate. Notwithstanding the preceding, you and the Company agree that you will be entitled to exercise any vested shares subject to Grant Number 692 on or within thirty (30) days after the termination of the Consulting Period, pursuant to the terms of the applicable stock option grant notice, applicable stock option agreement, and governing stock option plan.

(ii) Grant Number 716. Pursuant to the terms of the applicable stock option grant notice, applicable stock option agreement, and governing stock option plan (collectively, the “Stock Option Documents”), the shares subject to your option grant number 716 dated December 4, 2004 (“Grant Number 716”) will continue to vest during the Consulting Period. The shares subject to Grant Number 716 will cease vesting on the last day of the Consulting Period, and your option on all unvested shares as of that date will terminate. You will be entitled to exercise any vested shares subject to Grant Number 716 on or within thirty (30) days after the termination of the Consulting Period, pursuant to the terms of your Stock Option Documents.

(iii) Change in Grant Status. The above stock option grants will cease to qualify as incentive stock options ninety (90) days after the Resignation Date pursuant to Internal Revenue Service regulations. You acknowledge that you have been advised by the Company to seek advice from your tax or legal advisor concerning your stock option grants.

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(f) Limitations on Authority. During the Consulting Period, you will have no responsibilities or authority as a consultant to the Company other than as provided above or authorized in writing by the CEO. You agree not to represent or purport to represent the Company in any manner whatsoever to any third party or enter into any contract or commitment on behalf of the Company, unless specifically authorized to do so in writing by the CEO.

(g) Other Work Activities. During the Consulting Period, you may engage in employment, consulting, or other work relationships in addition to your work for the Company, so long as such activities: (i) are not competitive with the Company, (ii) are not on behalf of a competitor of the Company, or (iii) do not otherwise conflict with your obligations hereunder. The Company will make reasonable arrangements to enable you to perform your Services for the Company at such times and in such a manner so that it will not interfere with other permissible work activities in which you may engage. For purposes of this paragraph, “competitive with” and “competitor” shall mean employment, consulting or other work relationships with entities primarily engaged in the creation of novel polyketides for anticancer or anti-infective therapeutic applications.

(h) Protection of Company Information. You agree that, during the Consulting Period and thereafter, other than in the course of performing the Services, you will not use or disclose any confidential or proprietary information or materials of the Company which you obtain or develop in the course of performing the Services, except with the advance written authorization of the CEO. Any and all work product you create in connection with the Services will be the sole and exclusive property of the Company. You hereby assign to the Company, to the fullest extent permitted by law, all right, title, and interest in all inventions, techniques, processes, materials, and other intellectual property developed in the course of performing the Services.

5. No Other Compensation or Benefits. You acknowledge that, except as expressly provided in this Agreement, you will not receive any additional compensation, severance, stock option vesting, or benefits after the Resignation Date, with the exception of any vested right you may have under the terms of a written ERISA-qualified benefit plan (e.g., 401(k) account). By way of example, but not limitation, you acknowledge that you are not owed any bonus or incentive compensation.

6. Expense Reimbursements. You agree that, within thirty (30) days after the Resignation Date, you will submit your final documented expense reimbursement statement reflecting all business expenses you incurred through the Resignation Date, if any, for which you seek reimbursement. The Company will reimburse you for these expenses pursuant to its regular business practices.

7. Return of Company Property. You agree that, on the Resignation Date (or earlier if requested by the Company), you will return to the Company all Company documents (and all copies thereof) and other Company property that you have in your possession or control, including, but not limited to, any personnel information, operational information, files, correspondence, memoranda, reports, lists, proposals, notes, drawings, records, plans, forecasts, financial reports or information, purchase orders, customer information and contact lists, sales and marketing information, research and development information, promotional literature,

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product specifications, computer-recorded information, other tangible property, credit cards, entry cards, identification badges and keys; and, any materials of any kind that contain or embody any proprietary or confidential information of the Company or its officers, directors, and employees (and all reproductions thereof in whole or in part). You agree that you will make a diligent search to locate any such documents, property and information on or before the Resignation Date. In addition, if you have used any personally-owned computer, server, or e-mail system to receive, store, review, prepare or transmit any Company confidential or proprietary data, materials or information, you agree to provide the Company with a computer-useable copy of such information and then permanently delete and expunge such Company confidential or proprietary information from those systems. Your timely return of all Company property is a precondition to your receipt of the Severance Benefits. Notwithstanding the above, you will be permitted to retain during the Consulting Period, for your use only in connection with the Services, any Company property or materials for which you have been provided advance written authorization from the CEO; provided that you shall return any or all such Company property to the Company upon any earlier date, immediately upon receiving written notice from the Company to do so.

8. Proprietary Information Obligations. You hereby acknowledge and agree to abide by your continuing obligations under your Proprietary Information and Inventions Agreement, a copy of which is attached hereto as Exhibit A.

9. Confidentiality. The provisions of this Agreement will be held in strictest confidence by you and the Company and will not be publicized or disclosed in any manner whatsoever; provided, however, that: (a) you may disclose this Agreement in confidence to your immediate family; (b) the parties may disclose this Agreement in confidence to their respective attorneys, accountants, auditors, tax preparers, and financial advisors; (c) the Company may disclose this Agreement to investors or potential investors and as necessary to fulfill standard or legally required corporate reporting or disclosure requirements; and (d) the parties may disclose this Agreement insofar as such disclosure may be necessary to enforce its terms or as otherwise required by law. In particular, and without limitation, you agree not to disclose the terms of this Agreement to any current or former employee or independent contractor of the Company; provided, however, that you and the Company may disclose to third parties the fact that you have a consulting relationship with the Company and the nature and scope of the time commitments, if any.

10. Nondisparagement. You agree not to disparage the Company or its officers, directors, employees, shareholders and agents, in any manner likely to be harmful to them or their business, business reputation or personal reputation, and the Company (through its officers and directors) agrees not to disparage you in any manner likely to be harmful to you or your business, business reputation or personal reputation; provided that both you and the Company may respond accurately and fully to any question, inquiry or request for information when required by legal process.

11. No Voluntary Adverse Action. You agree that you will not voluntarily assist any person in bringing or pursuing any claim or action of any kind against the Company, its parents, subsidiaries, affiliates, officers, directors, employees or agents, unless pursuant to subpoena or other compulsion of law.

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12. Cooperation. Before and after the Resignation Date, you agree to reasonably cooperate with the Company in connection with its actual or contemplated defense, prosecution, or investigation of any claims or demands by third parties, or other matters, arising from events, acts, or failures to act that occurred during the time period in which you were an employee of the Company. To the extent the Company seeks your advice and counsel (as opposed to your provision of factual information or transition assistance) with respect to any of the foregoing, you shall be paid the Consulting Fees. Cooperation includes, without limitation, making yourself available upon reasonable notice, without subpoena, for interviews and truthful and accurate deposition and trial testimony. The Company will reimburse you for reasonable out-of-pocket expenses you incur in connection with any such cooperation (excluding forgone wages, salary, or other compensation), and will reasonably accommodate your scheduling needs. In addition, you agree to execute all documents (if any) necessary to carry out the terms of this Agreement.

13. No Admissions. Nothing contained in this Agreement shall be construed as an admission by you or the Company of any liability, obligation, wrongdoing or violation of law.

14. Employee Release of Claims. Except as otherwise set forth in this Agreement, in exchange for the consideration under this Agreement to which you would not otherwise be entitled, you hereby generally and completely release the Company and its parents, subsidiaries, successors, predecessors and affiliates, and its and their directors, officers, employees, agents, attorneys, insurers, affiliates and assigns, from any and all claims, liabilities and obligations, both known and unknown, that arise out of or are in any way related to events, acts, conduct, or omissions occurring at any time prior to and including the date you sign this Agreement. This general release includes, but is not limited to: (a) all claims arising out of or in any way related to your employment with the Company or the termination of that employment; (b) all claims related to your compensation or benefits, including salary, bonuses, commissions, vacation pay, expense reimbursements, severance pay, fringe benefits, stock, stock options, or any other equity interests in the Company; (c) all claims for breach of contract, wrongful termination, and breach of the implied covenant of good faith and fair dealing; (d) all tort claims, including claims for fraud, defamation, emotional distress, and discharge in violation of public policy; and (e) all federal, state, and local statutory claims, including claims for discrimination, harassment, retaliation, attorneys’ fees, or other claims arising under the federal Civil Rights Act of 1964 (as amended), the federal Americans with Disabilities Act of 1990 (as amended), the federal Age Discrimination in Employment Act (as amended) (“ADEA”), the California Labor Code, and the California Fair Employment and Housing Act (as amended). Notwithstanding the foregoing, you are not releasing the Company hereby from any obligation to indemnify you pursuant to the articles and bylaws of the Company, applicable law, and any current indemnification agreements between you and the Company. You represent that you have no lawsuits, claims or actions pending in your name, or on behalf of any other person or entity, against the Company or any other person or entity subject to the release granted in this paragraph.

15. ADEA Waiver. You acknowledge that you are knowingly and voluntarily waiving and releasing any rights you may have under the ADEA, and that the consideration given for the waiver and release in the preceding paragraph hereof is in addition to anything of value to which you are already entitled. You further acknowledge that you have been advised, as required by the ADEA, that: (a) your waiver and release do not apply to any rights or claims that may arise after the date that you sign this Agreement; (b) you should consult with an attorney prior to

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signing this Agreement (although you may choose voluntarily not to do so); (c) you have twenty-one (21) days to consider this Agreement (although you may choose voluntarily to sign it earlier); (d) you have seven (7) days following the date you sign this Agreement to revoke the Agreement (by providing written notice of your revocation to the Company’s CEO); and (e) this Agreement will not be effective until the date upon which the revocation period has expired, which will be the eighth day after the date that this Agreement is signed by you (the “Effective Date”).

16. Company Release of Claims. Except as otherwise set forth in this Agreement, the Company hereby generally and completely releases you and your agents, successors, assigns, attorneys and affiliates from any and all claims, liabilities, and obligations of every kind and nature, in law, equity or otherwise, known and unknown, suspected and unsuspected, arising out of or in any way related to agreements, events, acts or conduct at any time within the authorized course and scope of your employment with the Company. The Company represents that it has no lawsuits, claims or actions pending on its behalf against you subject to the release granted in this paragraph.

17. Section 1542 Waiver. In giving the releases set forth in this Agreement, which include claims which may be unknown to you and the Company at present, both parties acknowledge that each has read and understands Section 1542 of the California Civil Code which reads as follows: “A general release does not extend to claims which the creditor does not know or suspect to exist in his favor at the time of executing the release, which if known by him must have materially affected his settlement with the debtor.” You and the Company hereby expressly waive and relinquish all rights and benefits under that section and any law or legal principle of similar effect in any jurisdiction with respect to their respective release of claims herein, including but not limited to the release of unknown and unsuspected claims.

18. Dispute Resolution. Any and all disputes, claims, and causes of action that may arise from or relate to this Agreement or its enforcement, performance, breach, or interpretation, shall be resolved solely and exclusively to the fullest extent permitted by law, by final, binding and confidential arbitration in San Francisco, California conducted before a single arbitrator by Judicial Arbitration and Mediation Services, Inc. (“JAMS”) or its successor, under the then applicable JAMS rules. By agreeing to this arbitration procedure, both you and the Company waive the right to resolve any such dispute through a trial by jury or judge or by administrative proceeding. The arbitrator shall: (a) have the authority to compel adequate discovery for the resolution of the dispute and to award such relief as would otherwise be permitted by law; and (b) issue a written arbitration decision including the arbitrator’s essential findings and conclusions and a statement of the award. The arbitrator should have the authority to determine whether and to what extent either party is the prevailing party, and to award such prevailing party recovery of reasonable attorney’s fees and costs. The Company shall pay all JAMS’ arbitration fees. Nothing in this Agreement shall prevent either you or the Company from obtaining injunctive relief in court if necessary to prevent irreparable harm pending the conclusion of any arbitration. Any awards or orders in such arbitrations may be entered and enforced as judgments in the federal and the state courts of any competent jurisdiction. The arbitrator, and not a court, shall have the authority to determine any dispute or claim regarding the arbitrability of any issue.

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19. Miscellaneous. This Agreement, including the attached exhibit, constitutes the complete, final and exclusive embodiment of the entire agreement between you and the Company with regard to its subject matter. It is entered into without reliance on any promise or representation, written or oral, other than those expressly contained herein, and it supersedes any other such promises, warranties or representations. This Agreement may not be modified or amended except in a writing signed by both you and a duly authorized officer of the Company. This Agreement will bind the heirs, personal representatives, successors and assigns of both you and the Company, and inure to the benefit of both you and the Company, their heirs, successors and assigns. If any provision of this Agreement is determined to be invalid or unenforceable, in whole or in part, this determination will not affect any other provision of this Agreement and the provision in question shall be modified so as to be rendered enforceable in a manner consistent with the intent of the parties insofar as possible under applicable law. This Agreement will be deemed to have been entered into and will be construed and enforced in accordance with the laws of the State of California without regard to conflicts of laws principles. Any ambiguity in this Agreement shall not be construed against either party as the drafter. Any waiver of a breach of this Agreement shall be in writing and shall not be deemed to be a waiver of any successive breach. This Agreement may be executed in counterparts and facsimile signatures will suffice as original signatures.

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If this Agreement is acceptable to you, please sign below and return the original to me on or before twenty-one (21) days from the date you receive this Agreement. The offer contained in this Agreement will automatically expire if we do not receive the executed Agreement from you by that date.

I wish you the best in your future endeavors.

Sincerely,

KOSAN BIOSCIENCE INCORPORATED
By:	/s/ Daniel V. Santi
	Daniel V. Santi, M.D., Ph.D. Chief Executive Officer

ACCEPTED AND AGREED:

/s/ Bruce E. MacMillan

Bruce E. MacMillan

Date: June 24, 2005

Exhibit A –Proprietary Information and Inventions Agreement

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EXHIBIT A

PROPRIETARY INFORMATION AND INVENTIONS AGREEMENT

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EX-10.2

Exhibit 10.2

LOAN AND SECURITY AGREEMENT

between

SILICON VALLEY BANK

and

KOSAN BIOSCIENCES INCORPORATED

July 15, 2005

$35,000,000

TABLE OF CONTENTS

			Page
1.	ACCOUNTING AND OTHER TERMS		3
2.	LOAN AND TERMS OF PAYMENT		3
	2.1	Promise to Pay	3
	2.2	Intentionally Omitted	4
	2.3	Interest Rate	4
	2.4	Fees	4
3.	CONDITIONS OF LOANS		5
	3.1	Conditions Precedent to Initial Credit Extension	5
	3.2	Conditions Precedent to all Credit Extensions	5
4.	CREATION OF SECURITY INTEREST		5
	4.1	Grant of Security Interest	5
	4.2	Authorization to File	5
5.	REPRESENTATIONS AND WARRANTIES		6
	5.1	Due Organization and Authorization	6
	5.2	Collateral	6
	5.3	Litigation	6
	5.4	No Material Adverse Change in Financial Statements	6
	5.5	Solvency	7
	5.6	Regulatory Compliance	7
	5.7	Subsidiaries	7
	5.8	Full Disclosure	7
6.	AFFIRMATIVE COVENANTS		8
	6.1	Government Compliance	8
	6.2	Financial Statements, Reports, Certificates	8
	6.3	Inventory	9
	6.4	Taxes	9
	6.5	Insurance	9
	6.6	Intentionally Omitted	9
	6.7	Location of Inventory and Equipment	9
	6.8	Primary Accounts; Minimum Balances	9
	6.9	Financial Covenants	10
	6.10	Intellectual Property Rights
	6.11	Control Agreements	10
	6.12	Further Assurances	10
7.	NEGATIVE COVENANTS		10
	7.1	Dispositions	11
	7.2	Changes in Business, Ownership, Management or Locations of Collateral	11
	7.3	Mergers or Acquisitions	11
	7.4	Indebtedness	11
	7.5	Encumbrance	11

1

	7.6	Distributions; Investments	11
	7.7	Transactions with Affiliates	12
	7.8	Subordinated Debt	12
	7.9	Compliance	12
8.	EVENTS OF DEFAULT		12
	8.1	Payment Default	12
	8.2	Covenant Default	12
	8.3	Material Adverse Change
	8.4	Attachment	13
	8.5	Insolvency	13
	8.6	Other Agreements	13
	8.7	Judgments	13
	8.8	Misrepresentations	13
9.	BANK’S RIGHTS AND REMEDIES		14
	9.1	Rights and Remedies	14
	9.2	Power of Attorney	14
	9.3	Accounts Collection	15
	9.4	Bank Expenses	15
	9.5	Bank’s Liability for Collateral	15
	9.6	Remedies Cumulative	15
	9.7	Demand Waiver	15
10.	NOTICES		15
11.	CHOICE OF LAW, VENUE AND JURY TRIAL WAIVER		16
12.	GENERAL PROVISIONS		16
	12.1	Successors and Assigns	16
	12.2	Indemnification	16
	12.3	Time of Essence	16
	12.4	Severability of Provision	16
	12.5	Amendments in Writing, Integration	17
	12.6	Counterparts	17
	12.7	Survival	17
	12.8	Confidentiality	17
	12.9	Attorneys’ Fees, Costs and Expenses	17
13.	DEFINITIONS		18
	13.1	Definitions	18

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This LOAN AND SECURITY AGREEMENT dated as of the 15th day of July, 2005 (the “Effective Date”), between SILICON VALLEY BANK (“Bank”), whose address is 3003 Tasman Drive, Santa Clara, California 95054, and KOSAN BIOSCIENCES INCORPORATED, a Delaware corporation (“Borrower”), whose address is 3832 Bay Center Place, Hayward, CA 94545, provides the terms on which Bank will lend to Borrower and Borrower will repay Bank. The parties agree as follows:

1. ACCOUNTING AND OTHER TERMS.

Accounting terms not defined in this Agreement will be construed following GAAP. Calculations and determinations must be made following GAAP. The term “financial statements” includes the notes and schedules. The terms “including” and “includes” always mean “including (or includes) without limitation,” in this or any Loan Document.

2. LOAN AND TERMS OF PAYMENT.

2.1 Promise to Pay.

Borrower will pay Bank the unpaid principal amount of all Credit Extensions and interest on the unpaid principal amount of the Credit Extensions.

2.1.1 Term Loan.

(a) Bank will make a Term Loan available to Borrower. The Term Loan shall be available to Borrower in a maximum of two advances during the period from the Effective Date through May 31, 2006, and the minimum amount of the initial Term Loan advance shall be $15,000,000. To obtain an advance under the Term Loan, Borrower must notify Bank (the notice is irrevocable) by facsimile no later than 3:00 p.m. Pacific time one (1) Business Day before the day on which the Term Loan advance is to be made. The notice in the form of Exhibit B (Payment/Advance Form) must be signed by a Responsible Officer or designee.

(b) Interest accrued on the principal balance of the Term Loan shall be due and payable on the      day of each month. With respect to each Term Loan advance, equal installments of principal and interest shall be due and payable on the      day of each month commencing with the      day of the 25th month following the date of such Term Loan advance, which installments shall be calculated based upon an 84-month amortization of the principal balance of such Term Loan advance outstanding on the      day of such 25th month. If no Event of Default has occurred and is continuing, Bank may debit only Borrower’s deposit account (Account Number 3300091145) for principal and interest payments owing or any other amounts Borrower owes Bank. If an Event of Default has occurred and is continuing, Bank may debit any of Borrower’s deposit accounts, including Borrower’s deposit account (Account Number 3300091145) for principal and interest payments owing or any other amounts Borrower owes Bank. Bank will promptly notify Borrower when it debits Borrower’s accounts. These debits are not a set-off. Payments received after 12:00 noon Pacific time are considered received at the opening of business on the next Business Day. When a payment is due on a day that is not a Business Day, the payment is due the next Business Day and additional fees or interest accrue.

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(c) On the Maturity Date of each Term Loan advance, Borrower will pay to Bank the unpaid principal and accrued interest on such Term Loan advance and all other amounts due on such date with respect to such Term Loan advance, together with the Final Payment for such Term Loan advance.

(d) Borrower shall have the option to prepay all of either Term Loan advance without penalty or premium, provided Borrower (i) provides written notice to Bank of its election to make such prepayment at least ten (10) days prior to such prepayment, and (ii) pays, on the date of the prepayment (A) all unpaid scheduled payments then due (including principal and interest) with respect to such Term Loan advance; (B) the then principal balance of such Term Loan advance; (C) the Final Payment applicable to that Term Loan advance; and (D) all other amounts, if any, that shall then be due and payable hereunder with respect to this Agreement.

2.2 Intentionally Omitted.

2.3 Interest Rate.

(a) Interest Rate. The Term Loan accrues interest at a per annum fixed rate of interest equal to the greater of (i) four and four-tenths percent (4.4%), and (ii) one-half (0.5) percentage point above the Treasury Note Rate. The rate of interest applicable to the Term Loan shall be fixed on the date of the initial Term Loan advance. After an Event of Default and during the continuance thereof, Obligations accrue interest at three (3) percentage points above the rate effective immediately before the Event of Default. Interest is computed on a 360 day year for the actual number of days elapsed.

2.4 Fees.

Borrower will pay:

(a) Loan Fee. A loan fee equal to three-fourths of one percent (0.75%) of the difference between $35,000,000 and the aggregate amount advanced under the Term Loan as of the earlier of (i) May 31, 2006, or (ii) the date Borrower terminates this Agreement; provided that no such fee shall be payable in the event Bank does not fund the Term Loan after a request for a Term Loan advance by Borrower if no Event of Default then exists and if all conditions applicable hereunder to such advance have been satisfied by Borrower.

(b) Bank Expenses. All Bank Expenses (including reasonable attorneys’ fees and reasonable expenses) incurred through and after the date of this Agreement, are payable when due; provided that Bank Expenses reimbursable by Borrower consisting of reasonable attorneys’ fees and expenses incurred by Bank through the Effective Date shall not exceed $10,000 without Borrower’s prior written consent.

(c) Good Faith Deposit. Bank acknowledges receipt of Borrower’s good faith deposit in the amount of $50,000 (the “Deposit”). Bank will return the Deposit to Borrower on the Effective Date less such Bank Expenses as are then payable therefrom.

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3. CONDITIONS OF LOANS

3.1 Conditions Precedent to Initial Credit Extension.

Bank’s obligation to make the initial Credit Extension is subject to the following conditions precedent:

(i) Borrower’s financial projections, approved by Borrower’s board of directors, in a format reasonably acceptable to Bank (and Bank hereby acknowledges that the format of Borrower’s projections delivered to Bank prior to the Effective Date is acceptable).

3.2 Conditions Precedent to all Credit Extensions.

Bank’s obligations to make each Credit Extension, including the initial Credit Extension, is subject to the following:

(a) timely receipt of any Payment/Advance Form; and

(b) the representations and warranties in Section 5 must be materially true on the date of the Payment/Advance Form and on the effective date of each Credit Extension and no Event of Default may have occurred and be continuing, or result from the Credit Extension. Each Credit Extension is Borrower’s representation and warranty on that date that the representations and warranties of Section 5 remain true in all material respects.

4. CREATION OF SECURITY INTEREST

4.1 Grant of Security Interest.

Borrower grants Bank a continuing security interest in all presently existing and later acquired Collateral to secure all Obligations and performance of each of Borrower’s duties under the Loan Documents. Except for Permitted Liens, any security interest will be a first priority security interest in the Collateral. Upon the occurrence and during the continuance of an Event of Default, Bank may place a “hold” on any deposit account pledged as Collateral. If this Agreement is terminated, Bank’s lien and security interest in the Collateral will continue until Borrower fully satisfies its Obligations. Upon the indefeasible payment in full in cash of all Obligations under this Agreement, Bank shall execute and deliver to Borrower all documents and instruments as shall be reasonably necessary to evidence termination of the security interest in the Collateral created hereunder, including a UCC-3 Termination Statement.

4.2 Authorization to File.

Borrower authorizes Bank to file financing statements without notice to Borrower, with all appropriate jurisdictions, as Bank deems appropriate, in order to perfect or protect Bank’s interest in the Collateral.

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5. REPRESENTATIONS AND WARRANTIES

Borrower represents and warrants as follows:

5.1 Due Organization and Authorization.

Borrower and each Subsidiary is duly existing and in good standing in its state of formation and qualified and licensed to do business in, and in good standing in, any state in which the conduct of its business or its ownership of property requires that it be qualified, except where the failure to do so would not reasonably be expected to cause a Material Adverse Change. Borrower has not changed its state of formation or its organizational structure or type or any organizational number (if any) assigned by its jurisdiction of formation.

The execution, delivery and performance of the Loan Documents have been duly authorized, and do not conflict with Borrower’s formation documents, nor constitute an event of default under any material agreement by which Borrower is bound. Borrower is not in default under any agreement to which or by which it is bound in which the default would reasonably be expected to cause a Material Adverse Change.

5.2 Collateral.

Borrower has good title to the Collateral, free of Liens except Permitted Liens, or Borrower has Rights to each asset that is Collateral. Borrower has no other deposit account, other than the deposit accounts described in the Schedule. The Accounts are bona fide, existing obligations, and the service or property has been performed or delivered to the account debtor or its agent for immediate shipment to and unconditional acceptance by the account debtor. The Collateral is not in the possession of any third party bailee (such as at a warehouse) except as set forth on Schedule 6.7 (as the same may be amended pursuant to Section 6.7) and except for certain drug compounds of Borrower that are located with third party manufacturers. In the event that Borrower, after the date hereof, intends to store or otherwise deliver the Collateral to such a bailee (other than such manufacturers), then Borrower will receive the prior written consent of Bank, which consent shall not be unreasonably withheld, and such bailee must acknowledge in writing that the bailee is holding such Collateral for the benefit of Bank. All Inventory consisting of finished products is in all material respects of good and marketable quality, free from material defects.

5.3 Litigation.

Except as shown in the Schedule, there are no actions or proceedings pending or, to the knowledge of Borrower’s Responsible Officers, threatened by or against Borrower or any Subsidiary in which a likely adverse decision would reasonably be expected to cause a Material Adverse Change.

5.4 No Material Adverse Change in Financial Statements.

All consolidated financial statements for Borrower, and any Subsidiary, delivered to Bank fairly present in all material respects Borrower’s consolidated financial condition and Borrower’s consolidated results of operations. There has not been any material deterioration in Borrower’s consolidated financial condition since the date of the most recent financial statements submitted to Bank.

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5.5 Solvency.

The fair salable value of Borrower’s assets exceeds the fair value of its liabilities; the Borrower is not left with unreasonably small capital after the transactions in this Agreement; and Borrower is able to pay its debts (including trade debts) as they mature.

5.6 Regulatory Compliance.

Borrower is not an “investment company” or a company “controlled” by an “investment company” under the Investment Company Act. Borrower is not engaged as one of its important activities in extending credit for margin stock (under Regulations T and U of the Federal Reserve Board of Governors). Borrower has complied in all material respects with the Federal Fair Labor Standards Act. Borrower has not violated any laws, ordinances or rules, the violation of which would reasonably be expected to cause a Material Adverse Change. None of Borrower’s or any Subsidiary’s properties or assets has been used by Borrower or any Subsidiary or, to the best of Borrower’s knowledge, by previous Persons, in disposing, producing, storing, treating, or transporting any hazardous substance other than legally. Borrower and each Subsidiary has timely filed all required tax returns and paid, or made adequate provision to pay, all material taxes, except those being contested in good faith with adequate reserves under GAAP. Borrower and each Subsidiary has obtained all consents, approvals and authorizations of, made all declarations or filings with, and given all notices to, all government authorities that are necessary to continue its business as currently conducted, except where the failure to do so could not reasonably be expected to cause a Material Adverse Change.

5.7 Subsidiaries.

Borrower does not own any stock, partnership interest or other equity securities except for Permitted Investments.

5.8 Full Disclosure.

No written representation, warranty or other statement of Borrower in any certificate or written statement given to Bank (taken together with all such written certificates and written statements to Bank) contains any untrue statement of a material fact or omits to state a material fact necessary to make the statements contained in the certificates or statements not misleading. It is recognized by Bank that the projections and forecasts provided by Borrower in good faith and based upon reasonable assumptions are not viewed as facts and that actual results during the period or periods covered by such projections and forecasts may differ from the projected and forecasted results.

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6. AFFIRMATIVE COVENANTS

Borrower will do all of the following for so long as Bank has an obligation to lend under this Agreement, or there are outstanding Obligations:

6.1 Government Compliance.

Borrower will maintain its and all Subsidiaries’ legal existence and good standing in its jurisdiction of formation and maintain qualification in each jurisdiction in which the failure to so qualify would reasonably be expected to cause a material adverse effect on Borrower’s business or operations. Borrower will comply, and have each Subsidiary comply, with all laws, ordinances and regulations to which it is subject, noncompliance with which would reasonably be expected to cause a Material Adverse Change.

6.2 Financial Statements, Reports, Certificates.

(a) Borrower will deliver to Bank: (i) as soon as available, but no later than 30 days after the last day of each month (except that the financial statements for the month of January will be delivered together with the February financial statements but the Compliance Certificate for January shall be delivered per subsection (b) below within 30 days of the end of January), a company prepared consolidated balance sheet and income statement covering Borrower’s consolidated operations during the period, certified by a Responsible Officer and in a form acceptable to Bank; (ii) as soon as available, but no later than 120 days after the last day of Borrower’s fiscal year, audited consolidated financial statements prepared under GAAP, consistently applied, together with an unqualified opinion on the financial statements from an independent certified public accounting firm reasonably acceptable to Bank; provided that Borrower shall be deemed to have satisfied such requirement if such financial statements are available from public sources (e.g., online through the Securities and Exchange Commission’s Edgar website service); (iii) as soon as available, but no later than 45 days after the last day of each of Borrower’s fiscal quarters, company prepared consolidated balance sheet and income statement and statement of cash flows covering Borrower’s consolidated operations during the period; provided that Borrower shall be deemed to have satisfied such requirement if such financial statements are available from public sources (e.g., online through the Securities and Exchange Commission’s Edgar website service); (iv) within 5 days of filing, copies of all statements, reports and notices made available to Borrower’s security holders or to any holders of Subordinated Debt and all reports on Form 8-K filed with the Securities and Exchange Commission; provided that Borrower shall be deemed to have satisfied such requirement if such reports are available from public sources (e.g., online through the Securities and Exchange Commission’s Edgar website service); (v) a prompt report of any legal actions pending or, to the knowledge of a Responsible Officer, threatened against Borrower or any Subsidiary that would reasonably be expected to result in damages or costs to Borrower or any Subsidiary of $250,000 or more; and (vi) budgets, sales projections, operating plans or other financial information Bank reasonably requests, including without limitation annual projections approved by Borrower’s board of directors, in a format reasonably acceptable to Bank (and Bank hereby acknowledges that the format of Borrower’s projections delivered to Bank prior to the Effective Date is acceptable), within 45 days after the end of Borrower’s fiscal year.

(b) Within 30 days after the last day of each month, Borrower will deliver to Bank with the monthly financial statements a Compliance Certificate signed by a Responsible Officer in the form of Exhibit C.

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(c) Bank has the right to audit Borrower’s Collateral at Borrower’s expense (not to exceed $5,000 unless an Event of Default has occurred and is continuing), but the audits will be conducted no more often than every year unless an Event of Default has occurred and is continuing. Each audit will be conducted during reasonable business hours and upon reasonable (and in no event less than 5 Business Days) prior notice, unless an Event of Default has occurred and is continuing.

6.3 Inventory.

Borrower will keep all Inventory consisting of finished products in good and marketable condition, free from material defects.

6.4 Taxes.

Borrower will make, and cause each Subsidiary to make, timely payment of all material federal, state, and local taxes or assessments (other than taxes and assessments which Borrower is contesting in good faith, with adequate reserves maintained in accordance with GAAP) and will deliver to Bank, on demand, appropriate certificates attesting to the payment.

6.5 Insurance.

Borrower will keep its business and the Collateral insured for risks and in amounts that are standard for Borrower’s industry. Insurance policies will be in a form, with companies, and in amounts that are standard for Borrower’s industry. All property policies will have a lender’s loss payable endorsement showing Bank as an additional loss payee and all general liability policies will show the Bank as an additional insured. At Bank’s request, Borrower will deliver certified copies of policies and evidence of all premium payments. If an Event of Default has occurred and is continuing, proceeds payable under any policy will, at Bank’s option, be payable to Bank on account of the Obligations. Bank hereby acknowledges that Borrower’s existing insurance policies (as disclosed to Bank prior to the Effective Date) satisfy the requirements of this Section 6.5.

6.6 Intentionally Omitted.

6.7 Location of Inventory and Equipment.

Keep Borrower’s and its Subsidiaries’ Inventory and Equipment only at the locations identified on Schedule 6.7 (except for compounds of Borrower that are located with third party manufacturers) and their chief executive offices only at the locations identified on Schedule 6.7 (b); provided, however, that Borrower may amend Schedule 6.7 and Schedule 6.7 (b) so long as such amendment occurs by written notice to Bank not less than 30 days prior to the date on which such Inventory or Equipment is moved to such new location or such chief executive office is relocated, so long as such new location is within the continental United States.

6.8 Primary Accounts; Minimum Balances.

Borrower will maintain its primary depository and operating accounts with Bank.

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Commencing on the date of the initial advance of the Term Loan and so long as this Agreement remains in effect, Borrower shall maintain aggregate balances at all times in its investment and operating accounts with Bank or SVB Asset Management equal to the lesser of: (i) the amount of the aggregate unpaid principal amount of the Term Loan advances plus $5,000,000; and (ii) 85% of its aggregate cash and investment account balances.

6.9 Financial Covenants.

Borrower will maintain as of the last day of each month the greater of:

(i) Liquidity Coverage. A ratio of unrestricted cash and cash equivalents, plus marketable securities, plus Eligible Accounts, divided by the then outstanding principal balance of the Term Loan, of not less than 1.30 to 1.00. Eligible Accounts shall be included in foregoing calculation only after Bank shall have performed a collateral audit reasonably satisfactory to Bank.

(ii) Remaining Months Liquidity. At least six (6) months Remaining Months Liquidity. “Remaining Months Liquidity” is cash and cash equivalents, plus marketable securities, plus Eligible Accounts, divided by Cash Burn. “Cash Burn” is net loss, plus depreciation, plus amortization, minus any decrease in deferred revenue, plus any increase in deferred revenue, plus stock based compensation, in each case for the reporting period. Cash Burn shall be calculated on a rolling three-month basis. Eligible Accounts shall be included in foregoing calculation only after Bank shall have performed a collateral audit reasonably satisfactory to Bank.

6.10 Control Agreements.

With respect to deposit accounts or investment accounts maintained at SVB Asset Management, within 30 days of the opening of any such deposit account or investment account, Borrower will use commercially reasonable efforts to execute and deliver to Bank, a control agreement in form satisfactory to Bank in order for Bank to perfect its security interest in such deposit accounts or investment accounts.

6.11 Further Assurances.

Borrower will execute any further instruments and take further action as Bank reasonably requests to perfect or continue Bank’s security interest in the Collateral or to effect the purposes of this Agreement.

7. NEGATIVE COVENANTS

For so long as Bank has an obligation to lend under this Agreement, or there are outstanding Obligations, Borrower will not do any of the following without Bank’s prior written consent, which consent will not be unreasonably withheld:

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7.1 Dispositions.

Convey, sell, lease, transfer or otherwise dispose of (collectively “Transfer”), or permit any of its Subsidiaries to Transfer, all or any part of its business or property, other than Transfers (i) of Inventory in the ordinary course of business; (ii) consisting of non-exclusive or exclusive licenses and similar arrangements for the use of the property of Borrower or its Subsidiaries in the ordinary course of business; (iii) of worn-out or obsolete Equipment; or (iv) of other assets of Borrower or its Subsidiaries that do not in the aggregate exceed $250,000 during any fiscal year.

7.2 Change in Business; Change of Control; Relocation of Chief Executive Office, etc.

Engage in any business other than the businesses currently engaged in by Borrower or reasonably related thereto or have a Change in Control. Borrower will not, without at least 30 days prior written notice, relocate its chief executive office, change its state of formation (including reincorporation), change its organizational number or name.

7.3 Mergers or Acquisitions.

Merge or consolidate, or permit any of its Subsidiaries to merge or consolidate, with any other Person, or acquire, or permit any of its Subsidiaries to acquire, all or substantially all of the capital stock or property of another Person, except for Permitted Investments and except where (i) no Event of Default has occurred and is continuing or would result from such action during the term of this Agreement and (ii) Borrower is the surviving entity after any such transaction has been consummated. Notwithstanding the foregoing, a Subsidiary may merge or consolidate into another Subsidiary or into Borrower.

7.4 Indebtedness.

Create, incur, assume, or be liable for any Indebtedness, or permit any Subsidiary to do so, other than Permitted Indebtedness.

7.5 Encumbrance.

Create, incur, or allow any Lien on any of its property, or assign or convey any right to receive income, including the sale of any Accounts, or permit any of its Subsidiaries to do so, except for Permitted Liens, or permit any Collateral not to be subject to the first priority security interest granted here, subject to Permitted Liens.

7.6 Distributions; Investments.

Directly or indirectly acquire or own any Person, or make any Investment in any Person, other than Permitted Investments, or permit any of its Subsidiaries to do so. Pay any dividends or make any distribution or payment or redeem, retire or purchase any capital stock, except for (a) dividends and distributions payable solely in capital stock of Borrower and (b) repurchases of stock from former employees or directors of Borrower under the terms of applicable repurchase agreements in an aggregate amount not to exceed $250,000 in the aggregate in any fiscal year, provided that no Event of Default has occurred, is continuing or would exist after giving effect to the repurchases.

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7.7 Transactions with Affiliates.

Directly or indirectly enter into or permit to exist any material transaction with any Affiliate of Borrower except for transactions otherwise permitted by another Section of this Agreement and except for transactions that are in the ordinary course of Borrower’s business, upon fair and reasonable terms that are no less favorable to Borrower than would be obtained in an arm’s length transaction with a nonaffiliated Person.

7.8 Subordinated Debt.

Make or permit any payment on any Subordinated Debt, except under the terms of the Subordinated Debt, or amend any provision in any document relating to the Subordinated Debt without Bank’s prior written consent.

7.9 Compliance.

Become an “investment company” or a company controlled by an “investment company,” under the Investment Company Act of 1940 or undertake as one of its important activities extending credit to purchase or carry margin stock, or use the proceeds of any Credit Extension for that purpose; fail to meet the minimum funding requirements of ERISA, permit a Reportable Event or Prohibited Transaction, as defined in ERISA, to occur; fail to comply with the Federal Fair Labor Standards Act or violate any other law or regulation, if the violation would reasonably be expected to cause a Material Adverse Change, or permit any of its Subsidiaries to do so.

8. EVENTS OF DEFAULT

Any one of the following is an Event of Default:

8.1 Payment Default.

If Borrower fails to pay any of the Obligations within 3 days after their due date. During the additional period the failure to cure the default is not an Event of Default (but no Credit Extension will be made during the cure period);

8.2 Covenant Default.

(a) If Borrower fails to perform any obligation under Sections 6.2 or 6.7 or violates any of the covenants contained in Section 7 of this Agreement, or

(b) If Borrower fails or neglects to perform, keep, or observe any other material term, provision, condition, covenant, or agreement contained in this Agreement, in any of the Loan Documents, or in any other present or future agreement between Borrower and Bank and as to any default under such other term, provision, condition, covenant or agreement that can be cured, has failed to cure such default within ten (10) days after the occurrence thereof; provided, however, that if the default cannot by its nature be cured within the ten (10) day period or cannot after diligent attempts by Borrower be cured within such ten (10) day period, and such default is

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likely to be cured within a reasonable time, then Borrower shall have an additional reasonable period (which shall not in any case exceed thirty (30) days) to attempt to cure such default, and within such reasonable time period the failure to have cured such default shall not be deemed an Event of Default (provided that no Credit Extensions will be made during such cure period).

8.3 Intentionally Omitted.

8.4 Attachment.

If any material portion of Borrower’s assets is attached, seized, levied on, or comes into possession of a trustee or receiver and the attachment, seizure or levy is not removed in 10 days, or if Borrower is enjoined, restrained, or prevented by court order from conducting a material part of its business or if a judgment or other claim becomes a Lien on a material portion of Borrower’s assets, or if a notice of lien, levy, or assessment is filed against any of Borrower’s assets by any government agency and not paid within 10 days after Borrower receives notice. These are not Events of Default if stayed or if a bond is posted pending contest by Borrower (but no Credit Extensions will be made during the cure period);

8.5 Insolvency.

If Borrower becomes insolvent or if Borrower begins an Insolvency Proceeding or an Insolvency Proceeding is begun against Borrower and not dismissed or stayed within 60 days (but no Credit Extensions will be made before any Insolvency Proceeding is dismissed);

8.6 Other Agreements.

If there is a default in any agreement between Borrower and a third party that gives the third party the right to accelerate any Indebtedness exceeding $250,000 or that could cause a Material Adverse Change;

8.7 Judgments.

If a money judgment(s) in the aggregate of at least $250,000 is rendered against Borrower and is unsatisfied and unstayed for 10 days (but no Credit Extensions will be made before the judgment is stayed or satisfied); or

8.8 Misrepresentations.

Any representation or warranty made or deemed made by or on behalf of Borrower in or in connection with any Loan Document or in any report, certificate, financial statement or other document furnished pursuant to or in connection with any Loan Document shall prove to have been incorrect in any material respect when made or deemed made.

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9. BANK’S RIGHTS AND REMEDIES

9.1 Rights and Remedies.

When an Event of Default occurs and continues Bank may, without notice or demand, do any or all of the following:

(a) Declare all Obligations immediately due and payable (but if an Event of Default described in Section 8.5 occurs all Obligations are immediately due and payable without any action by Bank);

(b) Stop advancing money or extending credit for Borrower’s benefit under this Agreement or under any other agreement between Borrower and Bank;

(c) Settle or adjust disputes and claims directly with account debtors for amounts, on terms and in any order that Bank considers advisable; notify any Person owing Borrower money of Bank’s security interest in the funds and verify the amount of the Account. Borrower must collect all payments in trust for Bank and, if requested by Bank, immediately deliver the payments to Bank in the form received from the account debtor, with proper endorsements for deposit;

(d) Make any payments and do any acts it considers necessary or reasonable to protect its security interest in the Collateral. Borrower will assemble the Collateral if Bank requires and make it available as Bank designates. Bank may enter premises where the Collateral is located, take and maintain possession of any part of the Collateral, and pay, purchase, contest, or compromise any Lien which appears to be prior or superior to its security interest and pay all expenses incurred. Borrower grants Bank a license to enter and occupy any of its premises, without charge, to exercise any of Bank’s rights or remedies;

(e) Apply to the Obligations any (i) balances and deposits of Borrower it holds, or (ii) any amount held by Bank owing to or for the credit or the account of Borrower;

(f) Ship, reclaim, recover, store, finish, maintain, repair, prepare for sale, advertise for sale, and sell the Collateral; and

(g) Dispose of the Collateral according to the Code.

9.2 Power of Attorney.

Effective only when an Event of Default occurs and continues, Borrower irrevocably appoints Bank as its lawful attorney to: (i) endorse Borrower’s name on any checks or other forms of payment or security; (ii) sign Borrower’s name on any invoice or bill of lading for any Account or drafts against account debtors, (iii) make, settle, and adjust all claims under Borrower’s insurance policies; (iv) settle and adjust disputes and claims about the Accounts directly with account debtors, for amounts and on terms Bank determines reasonable; and (v) transfer the Collateral into the name of Bank or a third party as the Code permits. Bank may exercise the power of attorney to sign Borrower’s name on any documents necessary to perfect or continue the perfection of any security interest regardless of whether an Event of Default has occurred. Bank’s appointment as Borrower’s attorney in fact, and all of Bank’s rights and powers, coupled with an interest, are irrevocable until all Obligations have been fully repaid and performed and Bank’s obligation to provide Credit Extensions terminates.

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9.3 Accounts Collection.

When an Event of Default occurs and continues, Bank may notify any Person owing Borrower money of Bank’s security interest in the funds and verify the amount of the Account. Borrower must collect all payments in trust for Bank and, if requested by Bank, immediately deliver the payments to Bank in the form received from the account debtor, with proper endorsements for deposit.

9.4 Bank Expenses.

If Borrower fails to pay any amount or furnish any required proof of payment to third persons, Bank may make all or part of the payment or obtain insurance policies required in Section 6.5, and take any action under the policies Bank deems prudent. Any amounts paid by Bank are Bank Expenses and immediately due and payable, bearing interest at the then applicable rate and secured by the Collateral. No payments by Bank are deemed an agreement to make similar payments in the future or Bank’s waiver of any Event of Default.

9.5 Bank’s Liability for Collateral.

If Bank complies with reasonable banking practices and Section 9-207 of the Code, it is not liable for: (a) the safekeeping of the Collateral; (b) any loss or damage to the Collateral; (c) any diminution in the value of the Collateral; or (d) any act or default of any carrier, warehouseman, bailee, or other person. Borrower bears all risk of loss, damage or destruction of the Collateral.

9.6 Remedies Cumulative.

Bank’s rights and remedies under this Agreement, the Loan Documents, and all other agreements are cumulative. Bank has all rights and remedies provided under the Code, by law, or in equity. Bank’s exercise of one right or remedy is not an election, and Bank’s waiver of any Event of Default is not a continuing waiver. Bank’s delay is not a waiver, election, or acquiescence. No waiver is effective unless signed by Bank and then is only effective for the specific instance and purpose for which it was given.

9.7 Demand Waiver.

Borrower waives demand, notice of default or dishonor, notice of payment and nonpayment, notice of any default, nonpayment at maturity, release, compromise, settlement, extension, or renewal of accounts, documents, instruments, chattel paper, and guarantees held by Bank on which Borrower is liable.

10. NOTICES

All notices or demands by any party about this Agreement or any other related agreement must be in writing and be personally delivered or sent by an overnight delivery service, by certified mail, postage prepaid, return receipt requested, or by telefacsimile to the addresses set forth at the beginning of this Agreement. A party may change its notice address by giving the other party written notice.

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11. CHOICE OF LAW, VENUE AND JURY TRIAL WAIVER

California law governs the Loan Documents without regard to principles of conflicts of law. Borrower and Bank each submit to the exclusive jurisdiction of the State and Federal courts in Santa Clara County, California.

BORROWER AND BANK EACH WAIVE THEIR RIGHT TO A JURY TRIAL OF ANY CLAIM OR CAUSE OF ACTION ARISING OUT OF ANY OF THE LOAN DOCUMENTS OR ANY CONTEMPLATED TRANSACTION, INCLUDING CONTRACT, TORT, BREACH OF DUTY AND ALL OTHER CLAIMS. THIS WAIVER IS A MATERIAL INDUCEMENT FOR BOTH PARTIES TO ENTER INTO THIS AGREEMENT. EACH PARTY HAS REVIEWED THIS WAIVER WITH ITS COUNSEL.

12. GENERAL PROVISIONS

12.1 Successors and Assigns.

This Agreement binds and is for the benefit of the successors and permitted assigns of each party. Borrower may not assign this Agreement or any rights under it without Bank’s prior written consent which may be granted or withheld in Bank’s discretion. Bank has the right, without the consent of or notice to Borrower, to sell, transfer, negotiate, or grant participation in all or any part of, or any interest in, Bank’s obligations, rights and benefits under this Agreement.

12.2 Indemnification.

Borrower will indemnify, defend and hold harmless Bank and its officers, employees, and agents against: (a) all obligations, demands, claims, and liabilities asserted by any other party in connection with the transactions contemplated by the Loan Documents; and (b) all losses or Bank Expenses (subject to the limitation contained in Section 2.4(b)) incurred, or paid by Bank from, following, or consequential to transactions between Bank and Borrower (including reasonable attorneys fees and expenses), except as to (a) and (b) for losses caused by Bank’s gross negligence or willful misconduct.

12.3 Time of Essence.

Time is of the essence for the performance of all obligations in this Agreement.

12.4 Severability of Provision.

Each provision of this Agreement is severable from every other provision in determining the enforceability of any provision.

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12.5 Amendments in Writing, Integration.

All amendments to this Agreement must be in writing and signed by Borrower and Bank. Except for that certain Mutual Non-Disclosure Agreement between Borrower and Bank dated as of May 4, 2005 (the “Non-Disclosure Agreement”), this Agreement represents the entire agreement about this subject matter, and supersedes prior negotiations or agreements. Except for the Non-Disclosure Agreement, all prior agreements, understandings, representations, warranties, and negotiations between the parties about the subject matter of this Agreement merge into this Agreement and the other Loan Documents.

12.6 Counterparts.

This Agreement may be executed in any number of counterparts and by different parties on separate counterparts, each of which, when executed and delivered, are an original, and all taken together, constitute one Agreement.

12.7 Survival.

All covenants, representations and warranties made in this Agreement continue in full force while any Obligations remain outstanding. The obligations of Borrower in Section 12.2 to indemnify Bank will survive until all statutes of limitations for actions that may be brought against Bank have run.

12.8 Confidentiality.

The terms of the Non-Disclosure Agreement shall apply with respect to information received by Bank in connection with this Agreement, except that the term of Bank’s obligations with respect to confidentiality and disclosure of such information shall continue until five years after the expiration or earlier termination of this Agreement and except that disclosure of information may be made (i) to Bank’s subsidiaries or affiliates in connection with their business with Borrower, (ii) to prospective transferees or purchasers of any interest in the loans (provided, however, Bank shall require that such prospective transferee or purchasers agree to abide by the terms of the Non-Disclosure Agreement), (iii) as required by law, regulation, subpoena, or other order, (iv) as required in connection with Bank’s examination or audit, and (v) as may be required in Bank’s exercise of remedies under this Agreement.

12.9 Attorneys’ Fees, Costs and Expenses.

In any action or proceeding between Borrower and Bank arising out of the Loan Documents, the prevailing party will be entitled to recover its reasonable attorneys’ fees and other reasonable costs and expenses incurred, in addition to any other relief to which it may be entitled.

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13. DEFINITIONS

13.1 Definitions.

In this Agreement:

“Accounts” are all existing and later arising accounts, contract rights, and other obligations owed Borrower in connection with its sale or lease of goods (including licensing software and other technology) or provision of services, all credit insurance, guaranties, other security and all merchandise returned or reclaimed by Borrower and Borrower’s Books relating to any of the foregoing.

“Affiliate” of a Person is a Person that owns or controls directly or indirectly the Person, any Person that controls or is controlled by or is under common control with the Person, and each of that Person’s senior executive officers, directors, partners and, for any Person that is a limited liability company, that Person’s managers and members.

“Bank Expenses” are all audit fees and expenses and reasonable costs and expenses (including reasonable attorneys’ fees and expenses) for preparing, negotiating, administering, defending and enforcing the Loan Documents (including appeals or Insolvency Proceedings).

“Borrower’s Books” are all Borrower’s books and records including ledgers, records regarding Borrower’s assets or liabilities, the Collateral, business operations or financial condition and all computer programs or discs or any equipment containing the information.

“Business Day” is any day that is not a Saturday, Sunday or a day on which the Bank is closed.

“Cash Burn” is defined in Section 6.9.

“Change in Control” means “a transaction in which any “person” or “group” (within the meaning of Section 13(d) and 14(d)(2) of the Securities Exchange Act of 1934) becomes the “beneficial owner” (as defined in Rule 13d-3 under the Securities Exchange Act of 1934), directly or indirectly, of a sufficient number of shares of all classes of stock then outstanding of Borrower ordinarily entitled to vote in the election of directors, empowering such “person” or “group” to elect a majority of the Board of Directors of Borrower, who did not have such power before such transaction.

“Code” is the California Uniform Commercial Code.

“Collateral” is the property described on Exhibit A.

“Contingent Obligation” is, for any Person, any direct or indirect liability, contingent or not, of that Person for (i) any indebtedness, lease, dividend, letter of credit or other obligation of another such as an obligation directly or indirectly guaranteed, endorsed, co-made, discounted or sold with recourse by that Person, or for which that Person is directly or indirectly liable; (ii) any obligations for undrawn letters of credit for the account of that Person; and (iii) all obligations from any interest rate, currency or commodity swap agreement, interest rate cap or collar agreement, or other agreement or arrangement designated to protect a Person against fluctuation in interest rates, currency exchange rates or commodity prices; but “Contingent Obligation” does not include endorsements in the ordinary course of business. The amount of a Contingent Obligation is the stated or determined amount of the primary obligation for which the Contingent Obligation is made or, if not determinable, the maximum reasonably anticipated liability for it determined by the Person in good faith; but the amount may not exceed the maximum of the obligations under the guarantee or other support arrangement.

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“Copyrights” are all copyright rights, applications or registrations and like protections in each work or authorship or derivative work, whether published or not (whether or not it is a trade secret) now or later existing, created, acquired or held.

“Credit Extension” is the Term Loan or any other extension of credit by Bank for Borrower’s benefit, excluding any extension of credit by Bank made in connection with that certain standby letter of credit issued by Bank to Borrower (No. SVBSF002904) (the “SVB Letter of Credit”).

“Effective Date” is the date on which the Bank executes this Agreement.

“Eligible Accounts” are Accounts in the ordinary course of Borrower’s business that meet all Borrower’s representations and warranties in Section 5; but Bank may reasonably change eligibility standards by giving Borrower thirty days prior written notice (provided that Bank may not delete the exceptions set forth in clauses (d), (e) and (f) below). Unless Bank agrees otherwise in writing, Eligible Accounts will not include:

(a) Accounts that the account debtor has not paid within 90 days of invoice date;

(b) Accounts for an account debtor, 50% or more of whose Accounts have not been paid within 90 days of invoice date;

(c) Credit balances over 90 days from invoice date;

(d) Accounts for an account debtor, including Affiliates, whose total obligations to Borrower exceed 25% of all Accounts, for the amounts that exceed that percentage, unless the Bank approves in writing; except that this clause (d) shall not apply to (i) Accounts arising under that certain Collaborative Research, Development and Commercialization Agreement among Borrower and Hoffmann-La Roche, Inc. and F. Hoffmann-La Roche Ltd. dated September 19, 2002 (the “Roche Agreement”) or (ii) any other account debtor that enters into a similar collaboration agreement with Borrower after the Effective Date;

(e) Accounts for which the account debtor: (i) does not have its principal place of business in the United States or (ii) is not organized under the laws of the United States or any state thereof, unless such Accounts under (i) and (ii) above are Eligible Foreign Accounts;

(f) Accounts for which the account debtor is a federal, state or local government entity or any federal, state or local government department, agency, or instrumentality, except that this clause shall not apply to any Accounts under government research grants;

(g) Accounts for which Borrower owes the account debtor, but only up to the amount owed (sometimes called “contra” accounts, accounts payable, customer deposits or credit accounts);

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(h) Accounts for demonstration or promotional equipment, or in which goods are consigned, sales guaranteed, sale or return, sale on approval, bill and hold, or other terms if account debtor’s payment may be conditional;

(i) Accounts for which the account debtor is Borrower’s Affiliate, officer, employee, or agent;

(j) Accounts with respect to which the account debtor is located in a state or jurisdiction (e.g., New Jersey, Minnesota, and West Virginia) that requires, as a condition to access to the courts of such jurisdiction, that a creditor qualify to transact business, file a business activities report or other report or form, or take one or more other actions, unless Borrower has so qualified, filed such reports or forms, or taken such actions (and, in each case, paid any required fees or other charges), except to the extent that Borrower may qualify subsequently as a foreign entity authorized to transact business in such state or jurisdiction and gain access to such courts, without incurring any cost or penalty viewed by Bank to be significant in amount, and such later qualification cures any access to such courts to enforce payment of such Account;

(k) Accounts that are not subject to a valid and perfected first priority lien in favor of Bank;

(l) Accounts with respect to which (i) the goods giving rise to such Account have not been shipped and billed to the account debtor, or (ii) the services giving rise to such Account have not been performed and billed to the account debtor,

(m) Accounts that represent the right to receive progress payments or other advance billings that are due prior to the completion of performance by Borrower of the subject contract for goods or services;

(n) Accounts in which the account debtor disputes liability or makes any claim and Bank believes there may be a basis for dispute (but only up to the disputed or claimed amount), or if the account debtor is subject to an Insolvency Proceeding, or becomes insolvent, or goes out of business or as to which Borrower has received notice of an imminent Insolvency Proceeding or a material impairment of the financial condition of such account debtor; or

(o) Accounts for which Bank reasonably determines collection to be doubtful.

“Eligible Foreign Accounts” are Accounts for which the account debtor does not have its principal place of business in the United States but are: (1) covered by credit insurance satisfactory to Bank, less any deductible; or (2) supported by letter(s) of credit advised and negotiated by Bank; or (3) that Bank approves in writing. Bank hereby approves as Eligible Foreign Accounts: (i) Accounts arising under the Roche Agreement and (ii) any other account debtor that does not have its principal place of business in the United States and that is a party to a license (or sublicense) or collaboration agreement for the development or commercialization of Borrower’s products or other products or services covered by Borrower’s intellectual property rights after the Effective Date.

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“Equipment” is all present and future machinery, equipment, tenant improvements, furniture, fixtures, vehicles, tools, parts and attachments in which Borrower has any interest.

“ERISA” is the Employment Retirement Income Security Act of 1974, and its regulations.

“Final Payment” shall be determined separately for each Term Loan advance and shall mean a payment (in addition to and not a substitution for the regular monthly payments of principal plus accrued interest) equal to the original principal amount of such Term Loan advance multiplied by the Final Payment Percentage. The Final Payment shall be due and payable in accordance with Sections 2.1.1(c) and 2.1.1(d).

“Final Payment Percentage” is 9.6%.

“GAAP” is generally accepted accounting principles.

“Indebtedness” is (a) indebtedness for borrowed money or the deferred price of property or services, such as reimbursement and other obligations for surety bonds and letters of credit, (b) obligations evidenced by notes, bonds, debentures or similar instruments, (c) capital lease obligations and (d) Contingent Obligations.

“Insolvency Proceeding” are proceedings by or against any Person under the United States Bankruptcy Code, or any other bankruptcy or insolvency law, including assignments for the benefit of creditors, compositions, extensions generally with its creditors, or proceedings seeking reorganization, arrangement, or other relief.

“Intellectual Property” is:

(a) Copyrights, Trademarks, Patents, and Mask Works including amendments, renewals, extensions, and all licenses or other rights to use Copyrights, Trademarks, Patents, or Mask Works, and all license fees and royalties from such use;

(b) Any trade secrets, including any rights to unpatented inventions, know-how, operating manuals, license rights and agreements and confidential information, and any intellectual property rights in computer software and computer software products now or later existing, created, acquired or held;

(c) All design rights which may be available to Borrower now or later existing, created, acquired or held;

(d) Any claims for damages (past, present or future) for infringement of any of the rights above, with the right, but not the obligation, to sue and collect damages for use or infringement of the intellectual property rights above;

All proceeds and products of the foregoing, including all insurance, indemnity or warranty payments.

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“Inventory” is present and future inventory in which Borrower has any interest, including merchandise, raw materials, parts, supplies, packing and shipping materials, work in process and finished products intended for sale or lease or to be furnished under a contract of service, of every kind and description now or later owned by or in the custody or possession, actual or constructive, of Borrower, including inventory temporarily out of its custody or possession or in transit and including returns on any accounts or other proceeds (including insurance proceeds) from the sale or disposition of any of the foregoing and any documents of title.

“Investment” is any beneficial ownership of (including stock, partnership interest or other securities) any Person, or any loan, advance or capital contribution to any Person.

“Lien” is a mortgage, lien, deed of trust, charge, pledge, security interest or other encumbrance.

“Loan Documents” are, collectively, this Agreement, any note or notes executed by Borrower, and any other present or future agreement between Borrower and/or for the benefit of Bank in connection with this Agreement, all as amended, extended or restated.

“Mask Works” are all mask works or similar rights available for the protection of semiconductor chips, now owned or later acquired.

“Material Adverse Change” means (i) a material adverse change in the business, operations or condition (financial or otherwise) of Borrower, (ii) a material impairment of the prospect of repayment of any portion of the Obligations, or (iii) a material impairment of the value or priority of Bank’s security interests in the Collateral.

“Maturity Date” shall be determined separately for each Term Loan advance and shall mean the      day of the 60^th month following the date of such Term Loan advance, or the earlier acceleration of the Obligations pursuant to the terms of this Agreement.

“Obligations” are debts, principal, interest, Bank Expenses and other amounts Borrower owes Bank now or later, including cash management services, letters of credit and foreign exchange contracts, if any and including interest accruing after Insolvency Proceedings begin and debts, liabilities, or obligations of Borrower assigned to Bank. Notwithstanding the foregoing, “Obligations” shall not include any reimbursement or other obligation that Borrower owes Bank now or hereafter in connection with the SVB Letter of Credit.

“Patents” are patents, patent applications and like protections, including improvements, divisions, continuations, renewals, reissues, extensions and continuations-in-part of the same.

“Permitted Indebtedness” is:

Borrower’s indebtedness to Bank under this Agreement or any other Loan Document;

(a) Indebtedness existing on the Effective Date and shown on the Schedule;

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(b) Subordinated Debt;

(c) Indebtedness to trade creditors (including service providers and licensors) incurred in the ordinary course of business;

(d) Indebtedness secured by Permitted Liens;

(e) Indebtedness incurred now or after the Effective Date to General Electric Capital Corporation (or any successor or assign) pursuant to that certain Master Security Agreement dated as of April 24, 2002 between General Electric Capital Corporation and Borrower not to exceed $3,500,000 in the aggregate;

(f) Indebtedness of Borrower to any Subsidiary and Contingent Obligations of any Subsidiary with respect to obligations of Borrower (provided that the primary obligations are not prohibited hereby), and Indebtedness of any Subsidiary to any other Subsidiary and Contingent Obligations of any Subsidiary with respect to obligations of any other Subsidiary (provided that the primary obligations are not prohibited hereby);

(g) Indebtedness incurred pursuant to or arising under currency agreements or interest rate agreements entered into in the ordinary course of business;

(h) Other Indebtedness not otherwise permitted by Section 7.4 not exceeding $250,000 in the aggregate outstanding at any time, provided that no such Indebtedness shall be permitted to be incurred if an Event of Default is then occurring or would otherwise upon the incurring thereof; and

(i) Extensions, refinancings, modifications, amendments and restatements of any items of Permitted Indebtedness as set forth above, provided that the principal amount thereof is not increased or the terms thereof are not modified to impose more burdensome terms upon Borrower or its Subsidiaries, as the case may be.

“Permitted Investments” are:

(a) Investments shown on the Schedule and existing on the Effective Date;

(b) (i) marketable direct obligations issued or unconditionally guaranteed by the United States or its agency or any State maturing within 1 year from its acquisition, (ii) commercial paper maturing no more than 1 year after its creation and having the highest rating from either Standard & Poor’s Corporation or Moody’s Investors Service, Inc., (iii) Bank’s certificates of deposit issued maturing no more than 1 year after issue, and (iv) any Investments permitted by Borrower’s investment policy, as amended from time to time, provided that such investment policy (and any such amendment thereto) has been approved by Bank (which investment policy, as of the Effective Date, is attached hereto as Exhibit D);

(c) Equity securities issued to Borrower pursuant to license (or sublicense) collaborative agreements entered into in the ordinary course of business;

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(d) Mergers and acquisitions permitted by Section 7.3;

(e) Investments consisting of (i) travel advances and employee relocation loans and other employee loans and advances in the ordinary course of business and (ii) loans to employees, officers or directors relating to the purchase of equity securities of Borrower or its Subsidiaries pursuant to employee stock purchase plans or agreements approved by Borrower’s Board of Directors; which do not exceed $250,000 in the aggregate in any year, provided that no cash loans under this clause (ii) may be made if an Event of Default is then occurring or would otherwise upon the making thereof;

(f) Investments (including debt obligations) received in connection with bankruptcy or reorganization of customers or suppliers and in settlement of delinquent obligations of, and other disputes with, customers or suppliers arising in the ordinary course of business;

(g) Investments consisting of notes receivable of, or prepaid royalties and other credit extensions, to customers and suppliers who are not Affiliates of Borrower, in the ordinary course of business;

(h) Joint ventures or strategic alliances (in the ordinary course of Borrower’s business) consisting of the licensing of technology, the development of technology or the providing of technical support;

(i) Investments pursuant to or arising under currency agreements or interest rate agreements entered into in the ordinary course of business;

(j) Investments consisting of deposit accounts and securities accounts of Borrower, subject to compliance by Borrower with the covenant set forth in Section 6.11 hereof;

(k) Investments of Subsidiaries in or to other Subsidiaries of Borrower and Investments by Borrower in Subsidiaries (including Subsidiaries formed or acquired after the Effective Date) not to exceed $250,000 in the aggregate in any fiscal year, provided that no Investments by Borrower in Subsidiaries may be made if an Event of Default is then occurring or would otherwise upon the making thereof; and

(l) Other Investments not otherwise permitted by Section 7.6 not exceeding $250,000 in the aggregate outstanding at any time; provided that no such Investment may be made if an Event of Default is then occurring or would otherwise occur upon the making thereof.

“Permitted Liens” are:

(a) Liens existing on the Effective Date and shown on the Schedule or arising under this Agreement or other Loan Documents;

(b) Liens for taxes, fees, assessments or other government charges or levies, either not delinquent or being contested in good faith and for which Borrower maintains adequate reserves on its Books, if they have no priority over any of Bank’s security interests;

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(c) Liens (and including for purposes of this clause Liens incurred in connection with capital leases) (i) on Equipment and soft costs (and the proceeds thereof) acquired or held by Borrower or its Subsidiaries incurred in connection with the acquisition or financing of such Equipment or soft costs, or (ii) existing on Equipment or soft costs (and the proceeds thereof) when acquired, if the Lien is confined to the Equipment and soft costs and the proceeds thereof;

(d) Licenses or sublicenses granted by Borrower as licensor or sublicensor in the ordinary course of Borrower’s business;

(e) Any interest or title of a licensor or sublicensor under any license or sublicense to Borrower;

(f) Leases or subleases granted in the ordinary course of Borrower’s business, including in connection with Borrower’s leased premises or leased property;

(g) materialmen’s, mechanic’s, repairmen’s, employee’s or other like Liens arising in the ordinary course of business and which are not delinquent;

(h) banker’s liens, rights of setoff and similar Liens incurred on deposits made in the ordinary course of business;

(i) Liens arising from judgments, decrees or attachments in circumstances not constituting an Event of Default under Section 8.4 or 8.6;

(j) Liens in favor of other financial institutions arising in connection with Borrower’s deposit accounts or securities accounts held at such institutions to secure payment of fees and similar costs and expenses;

(k) Liens to secure payment of worker’s compensation, employment insurance, old age pensions or other social security obligations of Borrower in each case arising in the ordinary course of business of Borrower;

(l) easements, reservations, rights-of-way, restrictions, minor defects or irregularities in title and similar charges or encumbrances affecting real property not constituting a material adverse effect on the business or condition (financial or otherwise) of Borrower or otherwise materially impairing the conduct of Borrower’s business;

(m) Liens incurred in the extension, renewal or refinancing of the indebtedness secured by Liens described in (a) through (l), but any extension, renewal or replacement Lien must be limited to the property encumbered by the existing Lien and the principal amount of the indebtedness may not increase.

“Person” is any individual, sole proprietorship, partnership, limited liability company, joint venture, company association, trust, unincorporated organization, association, corporation, institution, public benefit corporation, firm, joint stock company, estate, entity or government agency.

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“Remaining Months Liquidity” is defined in Section 6.9.

“Responsible Officer” is each of the Chief Executive Officer, the President, the Chief Financial Officer and the Controller of Borrower.

“Rights”, as applied to the Collateral, means the Borrower’s rights and interests in, and powers with respect to, that Collateral, whatever the nature of those rights, interests and powers and, in any event, including Borrower’s power to transfer rights in such Collateral to Bank.

“Schedule” is any attached schedule of exceptions.

“Subordinated Debt” is debt now or hereafter incurred by Borrower subordinated to Borrower’s indebtedness owed to Bank and which is reflected in a written agreement in a manner and form acceptable to Bank and approved by Bank in writing.

“Subsidiary” is for any Person, any other business entity of which more than 50% of the voting stock or other equity interests is owned or controlled, directly or indirectly, by the Person or one or more Subsidiaries of the Person.

“Tangible Net Worth” is, on any date, the consolidated total assets of Borrower and its Subsidiaries minus, (i) any amounts attributable to (a) goodwill, (b) intangible items such as unamortized debt discount and expense, Patents, trade and service marks and names, Copyrights and research and development expenses except prepaid expenses, and (c) reserves not already deducted from assets, and (ii) Total Liabilities.

“Term Loan” is a loan of up to $35,000,000.

“Total Liabilities” is on any day, obligations that should, under GAAP, be classified as liabilities on Borrower’s consolidated balance sheet, including all Indebtedness, and current portion Subordinated Debt allowed to be paid, but excluding all other Subordinated Debt.

“Trademarks” are trademark and service mark rights, registered or not, applications to register and registrations and like protections, and the entire goodwill of the business of Borrower connected with the trademarks.

“Treasury Note Maturity” is 60 months.

“Treasury Note Rate” is, as of the date of funding of the initial Term Loan advance, the per annum rate of interest (based on a year of 360 days) equal to the U.S. Treasury note yield to maturity for a term equal to the Treasury Note Maturity as quoted in The Wall Street Journal on the day of such advance.

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BORROWER:
KOSAN BIOSCIENCES INCORPORATED
By:	/s/ Susan Kanaya
Title:	SVP, Finance and C.F.O
BANK:
SILICON VALLEY BANK
By:	/s/ Pete Scott
Title:	SVP
Effective Date: 7/15/05

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EXHIBIT A

The Collateral consists of all of Borrower’s right, title and interest in and to the following whether owned now or hereafter arising and whether the Borrower has rights now or hereafter has rights therein and wherever located:

All goods and equipment now owned or hereafter acquired, including, without limitation, all machinery, fixtures, vehicles (including motor vehicles and trailers), and any interest in any of the foregoing, and all attachments, accessories, accessions, replacements, substitutions, additions, and improvements to any of the foregoing, wherever located;

All inventory, now owned or hereafter acquired, including, without limitation, all merchandise, raw materials, parts, supplies, packing and shipping materials, work in process and finished products including such inventory as is held for sale or lease, or to be furnished under a contract of service or is temporarily out of Borrower’s custody or possession or in transit and including any returns or repossession upon any accounts or other proceeds, including insurance proceeds, resulting from the sale or disposition of any of the foregoing and any documents of title representing any of the above;

All contract rights and general intangibles now owned or hereafter acquired, including, without limitation, leases, franchise agreements, blueprints, drawings, purchase orders, customer lists, route lists, claims, literature, reports, catalogs, income tax refunds, payments of insurance, payment intangibles, and rights to payment of any kind;

All now existing and hereafter arising accounts (including health-care insurance receivables), contract rights, royalties, and all other forms of obligations owing to Borrower arising out of the sale or lease of goods, the licensing of technology from Borrower or the rendering of services by Borrower, whether or not earned by performance, and any and all credit insurance, insurance (including refunds) claims and proceeds, guaranties, and other security therefor, as well as all merchandise returned to or reclaimed by Borrower;

All documents (including negotiable documents), cash, deposit accounts, securities, securities entitlements, securities accounts, investment property, financial assets, letters of credit, letter of credit rights, money, certificates of deposit, instruments (including promissory notes) and chattel paper (including tangible and electronic chattel paper) now owned or hereafter acquired; and

All Borrower’s Books relating to the foregoing, and the computers and equipment containing said books and records, and any and all claims, rights and interests in any of the above and all substitutions for, additions and accessions to and proceeds thereof.

Notwithstanding the foregoing, the Collateral shall not be deemed to include any (i) Intellectual Property, except that the Collateral shall include the proceeds of all the Intellectual Property that are accounts (i.e. accounts receivable) of Borrower, or general intangibles consisting of rights to payment, (ii) any accounts, contracts, licenses or other general intangibles of Borrower, or any instruments or chattel paper of Borrower, if and to the extent such account,

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contract, license, general intangible, instrument or chattel paper contains restrictions on assignments and the creation of Liens, or such an assignment or Lien would cause a default to occur under such account, contract, license, general intangible, instrument or chattel paper (other than to the extent that any such term would be rendered ineffective pursuant to Section 9-406(d), 9-407(a) or 9-408(a) of the Code); provided that immediately upon the ineffectiveness, lapse or termination of any such provision, the Collateral shall include, and Borrower shall be deemed to have granted a security interest in, all such right, title and interests as if such provision had never been in effect; (iii) more than 65% of the outstanding voting stock of any Subsidiary not incorporated or organized under the laws of one of the States or jurisdictions of the United States; (iv) any governmental permit or franchise that prohibits Liens on or collateral assignments of such permit or franchise (other than to the extent that any such prohibition would be rendered ineffective pursuant to Section 9-406(f) or 9-408(c) of the Code); provided that immediately upon the ineffectiveness, lapse or termination of any such prohibition, the Collateral shall include, and Borrower shall be deemed to have granted a security interest in, all such right, title and interests as if such prohibition had never been in effect; or (v) any right, title or interest of Borrower in and to (A) the collateral indicated on the financing statements set forth on Attachment A hereto (provided that the grant of a security interest as provided herein shall extend to, and the term “Collateral” shall, subject to clause (B) below, include, such collateral from and after such time as the applicable financing statement is terminated) or (B) Equipment and soft costs (and the proceeds thereof) on which a security interest is granted after the Effective Date if such security interest is permitted under clause (c) of the definition of “Permitted Liens.”

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EXHIBIT B

LOAN PAYMENT/ADVANCE TELEPHONE REQUEST FORM

DEADLINE FOR SAME DAY PROCESSING IS 12:00 NOON., P.S.T.

TO:	CENTRAL CLIENT SERVICE DIVISION	DATE:
FAX#:	(408) 496-2426	TIME:

FROM: KOSAN BIOSCIENCES INCORPORATED
CLIENT NAME (BORROWER)
REQUESTED BY:
AUTHORIZED SIGNER’S NAME
AUTHORIZED SIGNATURE:
PHONE NUMBER:
FROM ACCOUNT #	TO ACCOUNT #
REQUESTED TRANSACTION TYPE		REQUESTED DOLLAR AMOUNT
PRINCIPAL INCREASE (ADVANCE)		$
PRINCIPAL PAYMENT (ONLY)		$
INTEREST PAYMENT (ONLY)		$
PRINCIPAL AND INTEREST (PAYMENT)		$
OTHER INSTRUCTIONS:
_________________________________________________________________________________________________

All Borrower’s representations and warranties in the Loan and Security Agreement are true, correct and complete in all material respects on the date of the telephone request for an advance confirmed by this Borrowing Certificate; but those representations and warranties expressly referring to another date shall be true, correct and complete in all material respects as of that date.

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BANK USE ONLY

TELEPHONE REQUEST:

The following person is authorized to request the loan payment transfer/loan advance on the advance designated account and is known to me.

__________________________________________ Authorized Requester	__________________________________________ Phone #
__________________________________________ Received By (Bank)	__________________________________________ Phone #
_______________________________________________________________ Authorized Signature (Bank)

2

30

EXHIBIT C

COMPLIANCE CERTIFICATE

TO:	SILICON VALLEY BANK
FROM:	KOSAN BIOSCIENCES INCORPORATED

The undersigned authorized officer of Kosan Biosciences Incorporated (“Borrower”) certifies that under the terms and conditions of the Loan and Security Agreement between Borrower and Bank (the “Agreement”), (i) Borrower is in complete compliance for the period ending                              with all required covenants except as noted below and (ii) all representations and warranties in the Agreement are true and correct in all material respects on this date (except that representations and warranties expressly referring to another date shall be true and correct in all material respects as of that date). In addition, the undersigned authorized officer of Borrower certifies that Borrower and each Subsidiary (i) has timely filed all required tax returns and paid, or made adequate provision to pay, all material taxes, except those being contested in good faith with adequate reserves under GAAP and (ii) does not have any legal actions pending or, to the knowledge of Borrower’s Responsible Officers threatened, against Borrower or any Subsidiary which Borrower has not previously notified in writing to Bank. Attached are the required documents supporting the certification. The Officer certifies that these are prepared in accordance with Generally Accepted Accounting Principles (GAAP) consistently applied from one period to the next except as explained in an accompanying letter or footnotes. The Officer acknowledges that no borrowings may be requested at any time or date of determination that Borrower is not in compliance with any of the terms of the Agreement, and that compliance is determined not just at the date this certificate is delivered.

Please indicate compliance status by circling Yes/No under “Complies” column.

Reporting Covenant	Required	Complies
Monthly financial statements + CC	Monthly within 30 days	Yes	No
Quarterly*	FQE within 45 days	Yes	No
Annual (Audited)*	FYE within 120 days	Yes	No
A/R Audit**	Initial and Annual	Yes	No

* May be satisfied by public records (e.g., Edgar)

** Required only if accounts receivable included in RML covenant compliance calculation

Financial Covenant	Required	Actual	Complies
Maintain on a Monthly Basis:
Minimum Liquidity Coverage	1.30:1.00	:1.00	Yes	No
Minimum Remaining Months Liquidity	6 Months	Months	Yes	No

Borrower only has deposit accounts located at the following institutions:                                                      .

31

BANK USE ONLY
Received by:
	AUTHORIZED SIGNER
Date:	__________________________________
Verified:	__________________________________
	AUTHORIZED SIGNER
Date:	__________________________________
Compliance Status:		Yes    No

Comments Regarding Exceptions: See Attached.

Sincerely,

KOSAN BIOSCIENCES INCORPORATED

__________________________________

SIGNATURE

__________________________________

TITLE

__________________________________

DATE

32

Exhibit D

Kosan Biosciences Incorporated

Investment Guidelines

Investment objectives

• Preservation of capital

• Fulfillment of liquidity needs

• Maximize total return

• Fiduciary control of cash and investments

Eligible investments

All investments must be held in U.S. dollars. Borrowing for investment purposes is prohibited.

Government / Agency Bonds

• U.S. Treasury Bills, Notes and Bonds

• Federal Agency Securities

• Includes putable, callable and floating-rate obligations for both US Treasury and US Agency obligations.

Corporate Instruments

• Corporate Bonds, Commercial paper

• Rating: A or better by Moody’s and Standard & Poor’s

P1 by Moody’s and A1 by Standard & Poor’s

• Includes variable-rate demand notes; putable, callable and floating-rate obligations; Eurodollar and Yankee debt obligations.

Bank Debt Obligations

• Rating: A or better by Moody’s and Standard & Poor’s

P1 by Moody’s and A1 by Standard & Poor’s

• Includes variable-rate demand notes; putable, callable and floating-rate obligations; Eurodollar and Yankee debt obligations.

Taxable Municipal Debt Obligations

• Rating: A or better by Moody’s and Standard & Poor’s

P1 by Moody’s and A1 by Standard & Poor’s

• Includes variable-rate demand notes; putable, callable and floating-rate obligations; Eurodollar and Yankee debt obligations.

Repurchase Agreements

• Collateralized at a minimum of 102% with one of the following:

• US Treasury bills, notes or bonds

• US agency debt obligations

• Collateral may not have maturities in excess of 24 months

Taxable Auction-Rate Preferred Securities

• Rating: AAA by Moody’s or Standard & Poor’s

33

Other

• Collateralized mortgage obligations, mortgage and asset-backed securities are no longer eligible investments and will be eliminated in an orderly phase out.

Kosan Biosciences Incorporated

Investment Guidelines, Continued

Maturity Parameters:

• The maximum allowable maturity of individual securities in the portfolio may not exceed twenty-four (24) months

• The weighted average maturity of the portfolio may not exceed twelve (12) months

• For securities that have put, reset or auction dates, the put, reset or auction dates will be use, instead of the final maturity dates, for maturity limit purposes.

• The liquidity requirements set for by the Company will always take priority over the maturity limits

Concentration Limits

• No limit to the percentage of the portfolio that may be maintained in US Treasury debt obligations and US agency debt obligations.

• With the exception of US Treasury and agency debt obligations, no one issuer or group of issuers from the same holding company is to exceed ten (10) percent of the book value of the portfolio at the time of purchase.

34

CORPORATE BORROWING RESOLUTION

RESOLUTION

OF THE BOARD OF DIRECTORS OF

KOSAN BIOSCIENCES INCORPORATED

Susan M. Kanaya, Assistant Secretary of Kosan Biosciences Incorporated, organized under the laws of Delaware, does hereby certify that a meeting of the Board of Directors duly held on June 10, 2005 at which a quorum was present and acting throughout, the following resolution was duly adopted:

RESOLVED, that the executive officers (Dr. Santi, Dr. Johnson, Ms. Kanaya), and each of them in their respective capacity as an executive officer of the Company, be, and hereby are, authorized to execute the letter term sheet in a form as is attached to these Minutes as Exhibit A, and, further, to proceed to enter into negotiations, and consummate by execution of appropriate loan documentation, a credit facility with Silicon Valley Bank materially consistent with those terms with such changes therefrom, as each in his or her sole discretion, determines is in the Company’s best interests; provided, however, that the aggregate principal indebtedness of the Company for money borrowed pursuant to this authority shall not exceed $35,000,000; and

FURTHER RESOLVED, that each of the aforementioned executive officers be, and hereby are, authorized to act on behalf of the Company with respect to such credit facility and to execute and deliver all such documents, agreements and instruments as they, in their sole discretion, acting individually or collectively, deem necessary or advisable in connection therewith and to take all actions deemed necessary or advisable to cause the Company’s obligations thereunder to be performed, including, without limitation, with respect to borrowings of the Company thereunder, payments to be made, and the creation of security interests, if any, as security for repayment of the Company’s indebtedness.

/s/ Susan Kanaya

Susan M. Kanaya

Assistant Secretary

35

EX-31.1

EXHIBIT 31.1

I, Daniel V. Santi, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Kosan Biosciences Incorporated;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrants other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: August 4, 2005

/s/ Daniel V. Santi

Daniel V. Santi, M.D., Ph.D.

Chairman and Chief Executive Officer

EX-31.2

EXHIBIT 31.2

I, Susan M. Kanaya, certify that:

1. I have reviewed this quarterly report on Form 10-Q of Kosan Biosciences Incorporated;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrants other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: August 4, 2005

/s/ Susan M. Kanaya

Susan M. Kanaya

Senior Vice President, Finance and Chief

Financial Officer

EX-32.1

EXHIBIT 32.1

CERTIFICATION¹

Pursuant to the requirement set forth in Rule 13a-14(b) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. § 1350), Daniel V. Santi, M.D., Ph.D., Chairman and Chief Executive Officer of Kosan Biosciences Incorporated (the “Company”), and Susan M. Kanaya, Senior Vice President, Finance and Chief Financial Officer of the Company, each hereby certifies that, to the best of his or her knowledge:

1. The Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2005, to which this Certification is attached as Exhibit 32.1 (the “Periodic Report”), fully complies with the requirements of Section 13(a) or Section 15(d) of the Exchange Act, and

2. The information contained in the Periodic Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

In Witness Whereof, the undersigned have set their hands hereto as of August 4, 2005.

/s/ Daniel V. Santi

Daniel V. Santi, M.D., Ph.D.

Chairman and Chief Executive Officer

/s/ Susan M. Kanaya

Susan M. Kanaya

Senior Vice President, Finance and Chief Financial Officer

¹ This certification accompanies the Form 10-Q to which it relates, is not deemed filed with the Securities and Exchange Commission and is not to be incorporated by reference into any filing of Kosan Biosciences Incorporated under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended (whether made before or after the date of the Form 10-Q), irrespective of any general incorporation language contained in such filing.

A signed original of this written statement required by Section 906 has been provided to Kosan Biosciences Incorporated and will be retained by Kosan Biosciences Incorporated and furnished to the Securities and Exchange Commission or its staff upon request.