KOS PHARMACEUTICALS INC, 10-K405, 1998-03-27

KOS PHARMACEUTICALS INC
10-K405, 1998-03-27
PHARMACEUTICAL PREPARATIONS

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549

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FORM 10-K

[ ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the fiscal year ended

[X] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the transition period from July 1, 1997, to December 31, 1997

Commission file number 000-22171

KOS PHARMACEUTICALS, INC.
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(Exact Name of Company as Specified in Its Charter)

FLORIDA 65-0670898
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(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)

1001 BRICKELL BAY DRIVE, 25TH FLOOR, MIAMI, FLORIDA 33131
---------------------------------------------------------
(Address of Principal Executive Offices, Zip Code)

Company's Telephone Number, Including Area Code: (305) 577-3464

Indicate by check mark whether the Company (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 Company was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]

Indicate by check mark if disclosures of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this form 10-K or any amendment to this
Form 10-K. [X]

The aggregate market value of Kos Pharmaceuticals, Inc. Common Stock, $.01
par value, held by non-affiliates, computed by reference to the price at which
the stock was sold as of February 27, 1998: $86,982,729.

Number of shares of Common Stock of Kos Pharmaceuticals, Inc. issued and
outstanding as of February 27, 1998: 17,165,695

DOCUMENTS INCORPORATED BY REFERENCE

Definitive Proxy Statement for the Company's 1998 Annual Meeting of Shareholders

(incorporated in Part III to the extent provided in Items 10, 11, 12 and 13
hereof).

<PAGE>

TABLE OF CONTENTS

PART I PAGE
-----
Item 1. Business....................................................... 1

Item 2. Properties..................................................... 10

Item 3. Legal Proceedings.............................................. 10

Item 4. Submission of Matters to a Vote of Securities Holders.......... 10

PART II

Item 5. Market for the Company's Common Stock and Related Shareholder
Matters........................................................ 11

Item 6. Selected Consolidated Financial Data........................... 12

Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations.......................................... 13

Forward-Looking Information: Certain Cautionary Statements..... 17

Item 7A. Quantitative and Qualitative Disclosures about Market Risk..... 27

Item 8. Consolidated Financial Statements and Supplementary Data....... 27

Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosures..................................... 46

PART III .............................................................. 47

PART IV

Item 14. Exhibits, Financial Schedules and Reports on Form 8-K....... 48

Signatures ............................................................ 50

Exhibit Index........................................................... 51

NIASPAN(R) is a registered trademark of Kos Pharmaceuticals, Inc.

<PAGE>

PART I

ITEM 1. BUSINESS

Kos Pharmaceuticals, Inc. ("Kos" or the "Company") is a fully-integrated
specialty pharmaceutical company engaged in the development of proprietary
prescription products for the treatment of certain chronic cardiovascular and
respiratory diseases. The Company manufactures its lead product, NIASPAN, and
markets such product directly through its own specialty sales force. The
Company's cardiovascular products under development consist of
controlled-release, once-a-day, oral dosage formulations. The Company's
respiratory products under development consist of aerosolized inhalation
formulations to be used primarily with the Company's proprietary inhalation
devices.

The Company believes that substantial market opportunities exist for
developing drugs that are reformulations of existing approved prescription
pharmaceutical products, but which offer certain safety advantages (such as
reduced harmful side effects) or patient compliance advantages (such as
once-a-day rather than multiple daily dosing regimens) over such currently
existing products. Kos believes that developing proprietary products based on
currently approved drugs, rather than new chemical entities ("NCEs"), may reduce
regulatory and development risks and, in addition, may facilitate the marketing
of such products because physicians are generally familiar with the safety and
efficacy of such products. In addition to NIASPAN, five of the Company's six
products under development require new drug application ("NDA") filings with the
U.S. Food and Drug Administration ("FDA"). Although such NDA filings are more
expensive and time consuming, developing products that require NDA approval
offers several advantages compared with generic products, including the
potential for higher gross margins, limited competition resulting from
significant clinical and formulation development challenges, and a three-year
statutory barrier to generic competition.

The principal elements of the Company's business strategy are as follows:
(i) select products with unrealized commercial potential where safety or patient
compliance may be improved; (ii) focus initially on the large, rapidly growing
cardiovascular and respiratory markets, which include many chronic diseases
requiring long-term therapy; (iii) develop proprietary formulations of currently
approved pharmaceutical compounds, which can reduce regulatory and development
risks typically associated with the development of new chemical entities; (iv)
manage internally the clinical development of its products; (v) manufacture its
products internally; (vi) market its products directly through the Company's
specialty sales force; and (vii) leverage its core competencies through
corporate and academic alliances.

The Company's predecessor, Kos Holdings, Inc. ("Holdings"), which was
previously named Kos Pharmaceuticals, Inc., was incorporated in Florida on July
1, 1988. On June 25, 1996, Kos (named for the Greek island where Hippocrates
founded the science of medicine) was incorporated in Florida as the successor to
the business of Holdings. On June 30, 1996, all of the assets (except for
certain net operating loss carryforwards) and all of the liabilities of Holdings
were transferred to the Company in exchange for shares of Common Stock of the
Company (the "Reorganization"). The Reorganization was accomplished in order to
transfer the assets and operations of Holdings to the Company while preserving
Holdings' net operating loss carryforwards and related tax benefits for
Holdings. As a result, the Company had no tax assets or liabilities as of June
30, 1996. Kos Investments, Inc. ("Investments") is the sole shareholder of
Holdings. Investments is controlled by, and serves as an investment vehicle for,
Michael Jaharis, one of the Company's founders and its Chairman. All references
in this 10-K to the Company include its wholly-owned subsidiary, Aeropharm
Technology, Inc. ("Aeropharm"), and the business and operations of Holdings
until June 30, 1996. The Company's principal executive offices are located at
1001 Brickell Bay Drive, 25th Floor, Miami, Florida 33131, and its telephone
number is (305) 577-3464.

<PAGE>

NIASPAN

On July 28, 1997, the Company received clearance from the FDA to market
NIASPAN for the treatment of mixed lipid disorders. NIASPAN is the first
once-a-day, extended-release niacin product ever approved by the FDA for the
treatment of mixed lipid disorders. The Company began shipping NIASPAN to
wholesalers in mid-August 1997 and began detailing the product to physicians
during September 1997.

Niacin, the active ingredient in NIASPAN, is a water soluble vitamin long
recognized by the National Institutes of Health ("NIH") and the American Heart
Association ("AHA") as an effective pharmacological agent for the treatment of
multiple lipid disorders, including elevated low-density lipoprotein ("LDL")
cholesterol, total cholesterol, and triglycerides and depressed high-density
lipoprotein ("HDL") cholesterol. The Company submitted its NDA for NIASPAN based
principally on data from an aggregate of 633 NIASPAN-treated subjects involved
in three double-blinded, placebo-controlled clinical trials and one long-term,
open-label safety study at 17 sites throughout the United States. The results of
these trials produced statistically significant changes in all major lipid
components without serious treatment-related adverse events. Treatment with
NIASPAN demonstrated a 14% to 19% reduction in LDL cholesterol, a 25% to 35%
reduction in triglycerides, an increase of 22% to 29% in HDL cholesterol, and a
reduction of 24% to 29% in lipoprotein (a) ("Lp(a)"). Moreover, NIASPAN's
controlled-release formulation and dosing regimen reduced the liver toxicity and
intolerable side effects generally associated with currently available
formulations of niacin.

Based principally on the results of the clinical studies evaluating Niaspan,
as well as other long-term interventional studies evaluating niacin for the
reduction of coronary events, NIASPAN is indicated for the following: (i) reduce
elevated total cholesterol, LDL cholesterol, and apolipoprotein B; (ii) reduce
very high serum triglycerides; (iii) reduce elevated total and LDL cholesterol
when used in combination with a bile-acid binding resin; (iv) reduce recurrent
nonfatal myocardial infarction; and (v) promote the regression or slow the
progression of atherosclerosis when combined with bile-binding resins.

The Company markets NIASPAN directly to specialist physicians within the
cardiovascular market who are among the leading prescribers of lipid-altering
medications. Specifically, the Company believes that there are approximately
18,000 such "lipid-management specialists," consisting of cardiologists,
endocrinologists, internists, and general and family practitioners, who
accounted for approximately 40% of the total prescriptions for lipid-altering
medications in the United States in 1996. From launch through December 31, the
Company estimates that it had detailed 18,000 physicians, including more than
50% of the lipid-management specialists.

As part of the Company's detailing effort, three-week NIASPAN titration
starter packs are given to physicians as a promotional item to start their
patients on NIASPAN. These titration packs are generally dispensed without a
prescription. Further, physicians being detailed by the Company may have had
unsatisfactory experiences with currently available generic formulations of
niacin, the active ingredient in NIASPAN. The Company believes, therefore, that
since the launch of NIASPAN, many physicians have started only a limited number
of selected patients on NIASPAN in order to confirm its efficacy, safety, and
tolerability (i.e., employing a "trial use" strategy). Consequently, the Company
believes that such a "trial use" strategy resulted in the modest growth of
NIASPAN prescriptions. The Company anticipates that physicians will continue to
employ a "trial use" strategy for at least the first half of 1998 and that
physicians will broaden their usage of NIASPAN as they confirm its efficiacy,
safety and tolerability.

<PAGE>

The marketing of NIASPAN focuses on the NIH recommendation that niacin be
used as first-line drug therapy for the treatment of hyperlipidemia.
Additionally, the Company informs physicians as to the manner in which NIASPAN
achieves its safety and efficacy profile. This marketing program is implemented
through direct office visits with selected physicians, medical journal reprints,
medical seminars, and clinical discussion groups. The Company also educates
patients on the benefits and proper use of NIASPAN through brochures and product
sample "starter packs" to encourage proper dose titration. Information delivered
by the Company to physicians and patients includes a discussion about the
flushing side effects of NIASPAN, including the importance of proper dose
titration and adherence to the prescribed dosing regimen to reduce this side
effect. Although most patients taking NIASPAN will flush occasionally, the
Company believes that the combination of Niaspan's formulation, its dosing
regimen, and proper dose titration should result in an incidence of flushing
episodes that are tolerable for most patients. NIASPAN'S dosing regimen provides
for the drug to be taken once-a-day at night; therefore, any flushing episodes
will normally occur while the patient is sleeping. The Company believes that
flushing during the night will not cause the discomfort or embarrassment that
often accompanies the multiple daytime flushing episodes that occur with
immediate-release ("IR") niacin. Since the launch of NIASPAN, the Company
believes that the experience of patients taking NIASPAN has been comparable to
that experienced by patients during the Company's well-controlled clinical
trials evaluating NIASPAN prior to marketing.

PRODUCTS UNDER DEVELOPMENT

Although the Company has obtained clearance from the FDA to market NIASPAN,
each of its other products under development is at an earlier stage of
development. The drug development and approval process takes many years and
requires the expenditure of substantial resources. There can be no assurance
that the Company will be able to successfully formulate any of its products
under development as planned, or that the Company will be successful in
demonstrating the safety and efficacy of such products under development in
human clinical trials. These trials may be costly and time-consuming. The
Company may not be able to obtain the regulatory approvals necessary to continue
testing or to market any or all of the Company's products under development.
Thus, there can be no assurances that any of the Company's products under
development will be developed and commercialized in a timely manner, or in
accordance with the Company's plans or projections, or at all. The Company may
determine to discontinue the development of any or all of its products under
development at any time.

NICOSTATIN(TM)

In addition to NIASPAN, Kos is developing internally Nicostatin(TM), which is
a product that consists of a combination of NIASPAN and a currently marketed HMG
CoA reductase inhibitor, or "statin," and is used to treat mixed lipid
disorders. The Nicostatin(TM) product will require an NDA. The Company believes
that a Once-A-Night(TM) tablet with the combined complementary properties of its
Nicostatin(TM) product represents an effective modality for treating patients
with mixed lipid disorders. The Company also believes that such a
Once-A-Night(TM) product should offer significant improvement in patient
compliance compared with taking each product independently under its recommended
dosing regimen. The target market for the Nicostatin(TM) product consists of
patients with mixed lipid disorders, including high total and LDL cholesterol
with high triglycerides or low HDL cholesterol or both. The Company has
completed formulation development of the product and plans to commence clinical
pharmacology studies during 1998.

ISOSORBIDE-5-MONONITRATE

Kos, in collaboration with Fuisz Technologies, Ltd. ("Fuisz"), is developing
a once-a-day, controlled-release, oral, generic version of
isosorbide-5-mononitrate ("IS-5-MN") for the prophylactic

<PAGE>

treatment of angina pectoris. This product will be a branded generic requiring
an abbreviated new drug application ("ANDA") filing. A formulation of IS-5-MN
has been developed and the Company completed an initial clinical pharmacology
study during April 1997. The Company expects to complete pivotal clinical
pharmacology studies and file an ANDA for IS-5-MN during 1998.

CAPTOPRIL

The Company, also in collaboration with Fuisz, is developing a once-a-day,
controlled-release version of captopril, an angiotensin converting enzyme
("ACE") inhibitor for the treatment of hypertension, for which a NDA is
required. At present, captopril is dosed as an immediate-release tablet to be
taken two or three times daily. There exist many generic forms of this IR
product. The Company's investigational new drug ("IND") application for
captopril was accepted by the FDA during the first half of 1997, and the Company
subsequently completed an initial clinical pharmacology study. Results from the
study indicated that the initial formulation of capotopril required
modification. The Company, in collaboration with Fuisz, is modifying the
formulation of captopril. There can be no assurances that the Company will elect
to continue the development of captopril, or if it elects to do so, that the
Company, in collaboration with Fuisz, would be able to successfully complete the
development of a once-a-day captopril.

TRIAMCINOLONE AND FLUNISOLIDE WITH BREATH COORDINATED INHALER

Kos is developing a proprietary non-CFC formulation of triamcinolone to be
used with the Company's proprietary breath coordinated inhaler ("BCI").
Triamcinolone is a corticosteroid that is used to treat the underlying
inflammation of asthma. This product will require the submission of a NDA. The
Company believes that its BCI may improve the coordination of inhalation with
actuation of medication, thereby offering possible benefits in patient
compliance and uniform dose administration. During 1997, the Company completed
the formulation development of triamcinolone and commenced an initial clinical
pharmacology study.

Kos is also developing a non-CFC formulation of flunisolide to be used with
its BCI. Flunisolide is a long-acting inhaled steroid for the treatment of
asthma. The Kos formulation of flunisolide, for which an NDA is required, is
currently in development.

ALBUTEROL

The Company is developing a non-CFC formulation of albuterol to be dispensed
in a generic metered-dose inhaler ("MDI"). Albuterol is a beta-agonist that is
most commonly used to treat acute asthma attacks. This product is presently in
the formulation development stage, and the Company expects that a clinical
pharmacology study will commence during 1998.

BREATH ACTUATED INHALER WITH EITHER ALBUTEROL OR TRIAMCINOLONE AND OTHER DEVICE
PRODUCTS

Kos is developing a second proprietary MDI device, a breath actuated inhaler
("BAI"). The Company's BAI operates automatically and is being developed
principally to address the difficulties often faced by children and the elderly
in taking inhaled medication. The Company intends to develop the BAI with either
its albuterol or triamcinolone non-CFC formulation. Clinical pharmacology trials
with the BAI are expected to commence in 1999.

The Company also is developing a proprietary inhalation dose counter designed
to indicate when sufficient doses no longer remain in the aerosol canister,
thereby alerting the patient to obtain a refill prescription. At present, the
Company intends to use the inhalation dose counter on all of its proprietary
inhalation devices.

<PAGE>

COLLABORATIONS

The Company collaborates with Fuisz, a company engaged in the development and
commercialization of drug delivery and food applications, on the development of
two products, captopril and IS-5-MN. In connection with this collaboration,
Fuisz is responsible for formulating each product, Kos is responsible for the
remainder of each development program and, Kos obtains exclusive rights to
manufacture the formulated products and retains exclusive worldwide marketing
rights upon exercising certain option rights. Kos is obligated to pay the
development costs and pay license and development fees based on milestone
achievements. In addition, Kos will pay royalties to Fuisz based on product
sales by Kos.

The Company is collaborating with certain other firms in the development of
its proprietary inhalation devices.

LICENSING AND OTHER ACTIVITIES

The Company intends to pursue collaborative opportunities, including
licensing the use of selected products and technologies from third parties
("in-licensing"); acquisition of complementary technologies, products or
companies; product co-marketing arrangements; joint ventures; and strategic
alliances. Many existing pharmaceutical products, or products currently under
development, may be suitable candidates for specialty promotional or
co-marketing campaigns. Accordingly, Kos intends to attempt to identify
licensing, co-marketing and product acquisition opportunities that can
complement the Company's future product portfolio. In situations where
third-party drug delivery technologies are complementary to the Company's drug
development formulation capabilities, the Company may pursue licensing rights
for such technology. The Company may also consider licensing certain of its
products and technologies to third parties ("out-licensing").

PATENTS AND PROPRIETARY RIGHTS

The Company actively seeks, when appropriate and available, protection for
its products and proprietary information by means of United States and foreign
patents, trademarks, trade secrets and contractual arrangements. Patent
protection in the pharmaceutical field, however, can involve complex legal and
factual issues. Moreover, broad patent protection for new formulations or new
methods of use of existing chemical entities is sometimes difficult to obtain
and often of limited usefulness, primarily because the active ingredient and
many of the formulation techniques have been known for some time. Consequently,
some patents claiming new formulations or new methods of use for old drugs may
not provide meaningful protection against competition. Nevertheless, the Company
intends to seek patent protection when appropriate and available and otherwise
to rely on regulatory-related exclusivity and trade secrets to protect certain
of its products, technologies and other scientific information. There can be no
assurance, however, that any steps taken to protect such proprietary information
will be effective.

<PAGE>

On February 7, 1997, the Company and such generic manufacturer entered into
an agreement pursuant to which the parties agreed to resolve, as between
themselves, the effects of such potential interference by granting each other
licenses under their respective patent application and patent, regardless of
whether such licenses would be required. Accordingly, under the agreement, the
generic manufacturer granted the Company a license to sell products under the
generic manufacturer's above referenced patent, under a formulation patent owned
by such generic manufacturer, and under corresponding foreign patents owned by
such generic manufacturer, and the Company granted the generic manufacturer the
right to sell such generic manufacturer's products that are covered by the
claims in the Company's patent application and corresponding foreign
applications owned by the Company. As consideration for entering into the
agreement, the Company agreed to pay the generic manufacturer certain license
fees and royalties on the net sales of NIASPAN subject to a cap on such royalty
payments in the United States and a separate cap on such payments outside the
United States. Neither the license fees nor the royalty payments are material to
the financial condition of the Company. The Company may sublicense its rights
under the agreement to third parties to make, use, or sell products developed by
or for the Company. The generic manufacturer may not sublicense or transfer the
license granted to it by the Company, although the generic manufacturer may
sublicense to third parties the right to supply to the generic manufacturer or
market with or on behalf of the generic manufacturer, products that are covered
by the generic manufacturer's patents but which are not covered by the Company's
patent application. The Company may terminate the agreement after February 7,
2001.

Various inhalation devices, technologies, and methods of use licensed from,
or assigned to Kos by, researchers and engineers engaged in development projects
or sponsored research on behalf of Kos are the subject of issued or allowed U.S.
patents, as well as various foreign patents or patent applications. In addition,
patent applications on certain of the Company's products under development or
relating to certain sponsored research activities are pending at the PTO.

There can be no assurance that the patents owned and licensed by the Company,
or any future patents, will prevent other companies from developing similar or
therapeutically equivalent products or that others will not be issued patents
that may prevent the sale of Company products or require licensing and the
payment of significant fees or royalties by the Company. Furthermore, there can
be no assurance that any of the Company's future products or methods will be
patentable, that such products or methods will not infringe upon the patents of
third parties, or that the Company's patents or future patents will give the
Company an exclusive position in the subject matter claimed by those patents.

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

NIASPAN and "Kos" are the Company's principal registered trademarks, although
other applications for registration of trademarks and service marks are
currently pending in the PTO and additional applications are in the process of
being filed.

<PAGE>

MARKETING

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

As of March 23, 1998, the Company had a 191-person sales and marketing
organization, including 161 field sales representatives. The majority of the
sales and marketing personnel have considerable previous experience from major
pharmaceutical companies detailing products to cardiovascular physicians. Kos
began actively detailing NIASPAN during September 1997. The Company intends to
increase the size of its sales force to at least 200 representatives during
1998. The Company intends to leverage its initial NIASPAN sales force by
marketing its future cardiovascular products, if and as they are approved,
simultaneously with NIASPAN.

The Company continues to be interested in co-promoting NIASPAN with a major
pharmaceutical company, to augment the Company's own detailing efforts. Since
the launch of NIASPAN, the Company has had discussions with several
pharmaceutical companies about the possibility of co-promoting NIASPAN. There
can be no assurance, however, that such discussions will continue or that, if
continued, they will lead to an agreement that will be consummated on terms
acceptable to the Company.

The Company plans to license marketing rights for NIASPAN to an established
marketing partner in major international markets. The Company has had initial
discussions concerning such possible arrangements with other companies. There
can be no assurance, however, that such an arrangement can be achieved on terms
acceptable to the Company. Ultimately, the Company will consider establishing
its own sales organization in selected foreign markets.

MANUFACTURING

In order to maximize the quality of developed products, assure compliance
with regulatory requirements, and minimize costs, the Company intends to
manufacture all of its products internally. The Company currently produces
NIASPAN at its Hollywood, Florida facility and intends to produce NIASPAN at its
Edison, New Jersey facility beginning in 1999. The Company's Edison facility is
currently configured, and largely equipped, to manufacture both solid-dose and
aerosol inhalation products. Although the Company believes that its Edison
facility currently operates using current good manufacturing practices as
required by the FDA for the manufacture of product to be used in clinical
trials, the facility requires inspection and approval by the FDA before the
commercial sale of product manufactured at Edison can commence. The Company
believes that it has sufficient capacity, with limited additional capital
outlays, to accommodate sales volume for both solid-dose and aerosol products
through the year 2000.

The Company intends to continue to contract the packaging of its solid-dose
and aerosol products to third parties. The Company intends to begin in-house
packaging operations once product sales volumes justify the capital expenditures
required to establish such capabilities. Certain of the Company's raw materials,
including the active ingredient in NIASPAN, are currently obtained from single
sources of supply. The Company does not have a contractual supply arrangement
with the sole supplier of the

<PAGE>

active ingredient in NIASPAN. The Company intends, to the extent possible, to
identify multiple sources for all of its key raw materials, including the active
ingredient in NIASPAN, although an alternate source for at least one such
material will not be available because of the supplier's patent rights.

COMPETITION

The Company's products will be competing with currently existing or future
prescription pharmaceuticals and vitamins in the United States, Europe and
elsewhere. Competition among these products will be based on, among other
things, efficacy, safety, reliability, availability, price and patent position.
In addition, academic institutions, government agencies and other public and
private organizations conducting research may seek patent protection, discover
new drugs or establish collaborative arrangements for drug research. Most of the
Company's existing or potential competitors have substantially greater
financial, technical and human resources than the Company and may be better
equipped to develop, manufacture and market products.

The Company's cardiovascular and respiratory products, when developed and
marketed, will compete in most cases with well established products containing
the same active ingredient already being marketed by medium-sized and large
pharmaceutical companies in the United States. For example, the Company's
captopril formulation, if successfully commercialized, will compete with several
other ACE inhibitors that are currently available, all of which have approval
for treatment of certain indications using once-a-day administration. Kos is
aware of one other company that is developing a once-a-day formulation of
captopril. Further, the Company's triamcinolone and flunisolide formulations, if
successfully commercialized, each will compete with another triamcinolone and
flunisolide product, respectively, already being marketed in the United States.
Although such competing products are sold only in a CFC version, the Company
believes that the originators are developing non-CFC versions.

Moreover, there are numerous manufacturers of niacin preparations indicated
for use as vitamin supplements or, in IR form, for treatment of hyperlipidemia.
The Company believes that a generic manufacturer has performed at least one
early-stage clinical study using niacin as a once-a-day treatment for
lipid-altering, and such manufacturer may be pursuing an NDA for such product.
Further, the Company's NIASPAN product will compete with many existing
lipid-altering medications, which currently account for more than 80% of the
lipid-altering market.

GOVERNMENT REGULATION

The development, manufacture and potential sales of prescription
pharmaceutical products is subject to extensive regulation by U.S. and foreign
governmental authorities. In particular, pharmaceutical products are subject to
rigorous preclinical and clinical testing and to other approval and
post-approval requirements by the FDA in the United States under the Federal
Food, Drug and Cosmetic Act ("FFDCA") and the Public Health Service Act and by
comparable agencies in most foreign countries. The FDA regulates all aspects of
a product's testing, labeling, promotion, and manufacture, and can impose
substantial restrictions on these activities before or after approval of such
product.

Whether or not FDA approval has been obtained, approval of a product by
regulatory authorities in foreign countries must be obtained prior to the
commencement of commercial sales of the product in such countries. The
requirements governing the conduct of clinical trials and product approvals vary
widely from country to country, and the time required for approval may be longer
or shorter than that required for FDA approval. Although there are some
procedures for unified filings for certain

<PAGE>

European countries, in general, each country at this time has its own procedures
and requirements. Further, the FDA regulates the export of products produced in
the United States and may prohibit their export even if such products are
approved for sale in other countries.

The Company's research and development involves the controlled use of
hazardous materials, chemicals, and various radioactive compounds. Although the
Company believes that its procedures for handling and disposing of those
materials comply with state and federal regulations, the risk of contamination
or injury from these materials cannot be eliminated. In the event of such
contamination or injury, the Company could be held liable for resulting damages,
which could be material to the Company's business, financial condition and
results of operations. The Company is also subject to numerous environmental,
health and workplace safety laws and regulations, including those governing
laboratory procedures, exposure to blood-borne pathogens, and the handling of
biohazardous materials. Additional federal, state and local laws and regulations
affecting the Company may be adopted in the future. Any violation of, and the
cost of compliance with, these laws and regulations could materially and
adversely affect the Company.

Completing the multitude of steps necessary prior to the commencement of
marketing requires the expenditure of considerable resources and a lengthy
period of time. There can be no assurance of approval within any particular
period, or ever, or if approval is granted, of continued approval thereafter.
Delay or failure in obtaining, or the withdrawal of, the required approvals,
clearances, permits or inclusions by the Company or its future corporate
partners or licensees, if any, would have a material adverse effect on the
ability of the Company to generate sales or royalty revenue. Further, the
passage and implementation of new or changed laws or regulations or the
potential impact on the Company of such actions cannot be anticipated.

EMPLOYEES

As of March 23, 1998, the Company had approximately 361 full-time employees.
No employee is represented by a union. The Company regularly employs the
services of outside consultants with respect to regulatory, scientific, and
certain administrative and commercial matters. The Company expects to continue
to require the services of such outside consultants. The Company believes its
employee relations are good.

<PAGE>

ITEM 2. PROPERTIES

The Company leased the following properties as of December 31, 1997:
<TABLE>
<CAPTION>
LEASE EXPIRATION MINIMUM
(INCLUDING RENEWAL ANNUAL
LOCATION USE SQUARE FEET OPTIONS) RENT
- --------------- --------------------------- ----------- ----------------- --------
<S> <C> <C> <C> <C>
Miami, FL Corporate offices 13,000 December 2000 $217,000
Miami Lakes, FL Research and admin. offices 13,000 December 2000 218,000
Hollywood, FL Manufacturing, research and
admin. offices 23,500 November 2000 271,000

Edison, NJ Manufacturing, research,
and admin. offices 32,500 October 2003 183,000
</TABLE>

The Company believes that its existing facilities are adequate to meet its
current needs and that there is sufficient additional space at or in close
proximity to its present facilities to accommodate its near-term requirements.

ITEM 3. LEGAL PROCEEDINGS

There are no material legal proceedings pending against the Company or its
properties or to which the Company is a party.

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

No matters were submitted to a vote of the Company's security holders during
the transition period commencing July 1, 1997, and ending December 31, 1997.

<PAGE>

PART II

ITEM 5. MARKET FOR THE COMPANY'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS.

The Company's common stock, par value $.01 per share (the "Common Stock"),
commenced trading on March 7, 1997, on the Nasdaq National Market under the
symbol "KOSP". As of March 12, 1998, there were 305 shareholders of record of
the Company's Common Stock.

The following table sets forth, for the fiscal periods indicated, the range
of high and low prices for trades of the Company's Common Stock on the Nasdaq
National Market System.

FISCAL YEAR ENDED DECEMBER 31, 1997 HIGH LOW
- ----------------------------------- ------- -------

First Quarter (commencing March 7, 1997).............. $ 25.00 $ 19.25
Second Quarter........................................ 30.50 19.75
Third Quarter......................................... 42.00 27.00
Fourth Quarter........................................ 44.88 13.50

The Company has not declared or paid any cash dividends on its Common Stock.
The Company currently anticipates that it will retain future earnings, if any,
to fund the development and growth of its business and does not intend to pay
dividends on its Common Stock in the foreseeable future.

<PAGE>

ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

The following consolidated selected financial data of the Company for the
five years ended December 31, 1997, should be read in conjunction with
"Management's Discussions and Analysis of Financial Condition and Results of
Operations" and the consolidated financial statements and related notes thereto.
See "Item 8. Consolidated Financial Statements and Supplementary Data."
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------------------------------------------
1993 1994 1995 1996 1997
------------ ------------ ------------ ------------ ------------
(IN THOUSANDS, EXCEPT SHARE DATA)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS:
Net sales ............................ $ -- $ 34 $ 3 $ -- $ 2,892
Cost of sales ........................ -- -- -- -- 792
------------ ------------ ------------ ------------ ------------
Gross profit .................. -- 34 3 -- 2,100
------------ ------------ ------------ ------------ ------------
Operating expenses:
Research and development .......... 6,294 6,248 11,681 13,679 24,130
General, selling and administrative 1,271 1,778 1,655 2,881 20,509
Expense recognized on modification
of stock option grants(1) ...... -- -- -- 5,436 --
------------ ------------ ------------ ------------ ------------
Total operating expenses ...... 7,565 8,026 13,336 21,996 44,639
------------ ------------ ------------ ------------ ------------
Loss from operations ................. (7,565) (7,992) (13,333) (21,996) (42,539)
Other income (expense):
Other income (expense) ............. -- 2 -- -- (10)
Interest income (expense), net ..... (802) (1,647) 6 11 2,787
Interest expense-related parties ... -- (55) -- (136) (868)
------------ ------------ ------------ ------------ ------------
Loss before minority interest (8,367) (9,692) (13,327) (22,121) (40,630)

Minority interest(2) ................. (164) (3) 4 15 --
------------ ------------ ------------ ------------ ------------
Net loss .......................... $ (8,531) $ (9,695) $ (13,323) $ (22,106) $ (40,630)
============ ============ ============ ============ ============
Net loss per share, basic and
diluted(3) ........................ $ (0.75) $ (0.85) $ (1.17) $ (1.95) $ (2.79)
Weighted average common shares in
computing net loss per share(3) .. 11,340,000 11,340,000 11,340,000 11,340,000 14,569,474

DECEMBER 31,
----------------------------------------------------------------------------
1993 1994 1995 1996 1997
------------ ------------ ------------ ------------ ------------
(IN THOUSANDS)
BALANCE SHEET:
Cash and marketable securities ....... $ 16 $ 78 $ 229 $ 358 $ 70,396
Working capital (deficit)(4) ......... (20,464) (30,763) (445) (9,355) 70,939
Total assets ......................... 1,008 1,698 2,380 3,197 84,403
Total debt ........................... 20,405 30,372 -- 8,355 --
Accumulated deficit(5) ............... (20,199) (29,894) (43,217) (65,322) (105,952)
Shareholders' equity (deficit)(4) .... (19,709) (29,404) 1,390 (6,750) 77,870

<FN>
- -------------
(1)Reflects a non-cash charge associated with an extension of the exercise
period for stock options granted during 1988 to 1990 to the Company's Chief
Executive Officer and two independent consultants; no other material economic
terms of these options were changed.
(2)Represents the minority shareholder's interest in Aeropharm Technology,
Inc., which interest was acquired by the Company in June 1996.
(3)See Note 2. of Notes to Consolidated Financial Statements for information
concerning the computation of net loss per share.
(4)In March 1995, Kos Investments, Inc. assumed repayment of a note payable to
a bank in the principal amount of $30,372,000. This assumption was accounted
for as a transfer to Kos Investments, Inc. and as an increase in additional
paid-in capital for the Company. See Note 8. of Notes to Consolidated
Financial Statements.
(5)In connection with the transfer on June 30, 1996, of assets and liabilities
from Kos Holdings, Inc. to the Company, net operating loss carryforwards
amounting to approximately $51.0 million and related tax benefits, were not
transferred to the Company. The Company can only utilize net operating loss
carryforwards sustained subsequent to June 30, 1996 (amounting to
approximately $47.0 million as of December 31, 1997), to offset future
taxable net income, if any. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations".
</FN>
</TABLE>
12
<PAGE>

ITEM 7. MANAGEMENT'S DISCUSSIONS AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

GENERAL

A predecessor corporation to the Company was formed in July 1988 under the
name of Kos Pharmaceuticals, Inc. principally to conduct research and
development on new formulations of existing prescription pharmaceutical
products. In June 1993, Aeropharm Technology, Inc. ("Aeropharm"), a then
majority-owned subsidiary of the Company, was formed to conduct research and
development activities on aerosolized products for the treatment of respiratory
diseases. During June 1996, this predecessor corporation acquired the
outstanding minority interest in Aeropharm; changed its name to Kos Holdings,
Inc. ("Holdings"); established the Company as a wholly-owned subsidiary under
the name of Kos Pharmaceuticals, Inc.; and, effective as of June 30, 1996,
transferred all of its existing assets, liabilities and intellectual property,
other than certain net operating loss carryforwards, to the Company.
Accordingly, all references in this 10-K filing to the Company's business
include the business and operations of Holdings until June 30, 1996.

On March 12, 1997, the Company completed an initial public offering of its
Common Stock ("IPO"). From inception through the IPO, the Company had not
recorded any significant sales and had funded its operations exclusively through
equity contributions and a loan from its majority shareholder. Through December
31, 1997, the Company had accumulated a deficit from operations of approximately
$106 million. In connection with the transfer of operations from Holdings to the
Company on June 30, 1996, net operating loss carryforwards amounting to
approximately $51.0 million and related tax benefits were retained by Holdings
and not transferred to the Company. Consequently, the Company may utilize net
operating losses sustained subsequent to June 30, 1996, amounting to
approximately $47.0 million as of December 31, 1997, to offset future taxable
net income, if any.

From inception through its June 30, 1997, reporting period, the Company was a
development stage company engaged primarily in the development of cardiovascular
and respiratory pharmaceutical products. On July 28, 1997, the Company was
granted clearance by the FDA to market its lead product, NIASPAN. The Company
began shipping NIASPAN to wholesalers in mid-August 1997 and began detailing
NIASPAN to physicians in September 1997. The Company's Board of Directors
changed the end of the Company's fiscal year from June 30 to December 31
effective with its December 31, 1997, reporting period. Fiscal years presented
and referred to in these consolidated financial statements, along with all other
financial data, have been restated to conform with a December 31 fiscal year
basis.

RESULTS OF OPERATIONS

YEARS ENDED DECEMBER 31, 1997 AND 1996

The Company began sales of its NIASPAN product during August 1997. For the
period from August through December 31, 1997, the Company recorded net sales of
the NIASPAN product of $2.9 million. Cost of sales for the same period totaled
$0.8 million.

The Company's research and development expenses increased to $24.1 million
for the year ended December 31, 1997, from $13.7 million for the year ended
December 31, 1996. Of the total increase in research and development expenses,
$3.0 million was attributable to the cost of entering into an agreement, during
February 1997, with an unaffiliated generic drug manufacturer to resolve the
effects

<PAGE>

of a potential patent interference proceeding. Clinical trial costs associated
with the completion of a long-term safety study evaluating the NIASPAN product
and other products under development, licensing and development costs, and
personnel costs also contributed to the higher research and development expenses
for the year ended December 31, 1997. The Company expects research and
development expenditures to increase as personnel are added and research
activities are expanded to support the continued development of products in the
Company's research pipeline as well as for additional development of products
that may be identified.

General, selling and administrative expenses increased to $20.5 million for
the year ended December 31, 1997, from $8.3 million for the year ended December
31, 1996. The increase reflected primarily the commencement of the Company's
sales and marketing activities, including the recruitment of the Company's field
sales organization and the launching of a variety of promotional programs in
connection with the introduction of the NIASPAN product. Administrative costs
also increased during 1997 as a result of higher personnel costs and other
expenses associated with the expanded activities of the Company. The increase in
administrative expenses was offset in part by the absence during the year ended
December 31, 1997, of a $5.4 million non-cash charge in 1996 for compensation
expense associated with an adjustment of the exercise period on certain stock
options granted during 1988 to 1990 to an officer and two independent
consultants of the Company.

From July 1, 1996, to the completion of its IPO on March 12, 1997, the
Company funded its operations from the proceeds of a loan from Kos Investments,
Inc. (the "Convertible Note"), the sole shareholder of Holdings. The Convertible
Note and its accrued interest were convertible into shares of the Company's
Common Stock at a conversion price per share equal to the IPO price per share
($15.00). The Company recorded approximately $868,000 and $136,000 of interest
expense for the years ended December 31, 1997, and 1996, respectively, as a
result of the Convertible Note. On October 25, 1997, the outstanding principal
and interest of the Convertible Note was converted into 960,069 shares of Common
Stock. At the time of conversion, the Convertible Note accrued interest at a
rate of 8.50% per year and had outstanding principal and interest of $13.4
million and $1.0 million, respectively.

The Company received $65.9 million in net proceeds from its IPO, completed in
March 1997, and $43.3 million in net proceeds from a follow-on offering of its
Common Stock, completed in October 1997, after deducting expenses of both
offerings. As of December 31, 1997, $46.4 million of net proceeds from the IPO
have been used to fund the Company's research and development, general, selling
and administrative expenses, capital expenditures, and other working capital
needs. The remaining $19.5 million of net proceeds from the IPO and the net
proceeds from the follow-on offering, along with other cash balances, totaling
$70.4 million as of December 31, 1997, were invested primarily in U.S. Treasury
securities. The Company recorded $2.8 million of interest income for the year
ended December 31, 1997, compared with $11,000 for the year ended December 31,
1996.

The Company incurred a net loss of $40.6 million for the year ended December
31, 1997, compared with a net loss of $22.1 million for the year ended December
31, 1996. The Company expects greater losses in 1998 as a result of
substantially increased general, selling and administrative expenses, and higher
research and development costs, not offset entirely by the net proceeds from
sales of the NIASPAN product.

<PAGE>

YEARS ENDED DECEMBER 31, 1996 AND 1995

The Company's research and development expenses increased to $13.7 million
for the fiscal year ended December 31, 1996, from $11.7 million for the year
ended December 31, 1995. The increase was attributable primarily to licensing
and development programs and the hiring of additional personnel to support the
Company's research and development functions. Hiring of additional personnel,
principally related to manufacturing scale-up of certain of the Company's
products under development and to support the filing of a NDA for NIASPAN, also
contributed to the increase in research and development expenses. These
increases were partially offset by reduced costs for clinical trials for NIASPAN
following the substantial completion of such trials in the year ended December
31, 1995, in support of the filing during May 1996 of the NIASPAN NDA.

General, selling and administrative expenses increased to $8.3 million for
the fiscal year ended December 31, 1996, from $1.7 million for the fiscal year
ended December 31, 1995. This increase was attributable principally to the
hiring of additional personnel to support the Company's administrative
functions, and to the acquisition of market research data. During the year ended
December 31, 1996, a $5.4 million non-cash charge was recorded for compensation
expense associated with an adjustment of the exercise period on certain stock
options granted during 1988 to 1990 to an officer and two independent
consultants of the Company.

The Company recorded $136,000 as interest expense resulting from the
Convertible Note during the year ended December 31, 1996, as compared with no
such expense during the year ended December 31, 1995.

The Company incurred a net loss of $22.1 million for the year ended December
31, 1996, compared with $13.3 million for the year ended December 31, 1995.

LIQUIDITY AND CAPITAL RESOURCES

At December 31, 1997, the Company's working capital totaled approximately
$70.9 million, including cash and cash equivalents, and marketable securities
totaling $70.4 million. The Company's primary uses of cash to date have been in
operating activities to fund research and development, including clinical
trials, and general, selling and administrative expenses. As of December 31,
1997, the Company's investment in equipment and leasehold improvements, net of
depreciation and amortization, was approximately $6.9 million. During the year
ended December 31, 1997, the Company spent $5.2 million in capital expenditures.
The Company expects to nearly double capital expenditures in 1998, primarily for
additional equipment and facilities related to its research and development, and
manufacturing requirements.

Although the Company currently anticipates that it has an amount of working
capital that will be sufficient to fund the Company's operations through
December 31, 1998, the Company's cash requirements during and after its fiscal
year ending December 31, 1998, will be substantial and may exceed the amount of
the Company's working capital. The Company must generate significant sales of
its NIASPAN product during 1998 in order to fund its operating requirements and
maintain an adequate level of working capital through the end of the year;
however, there can be no assurance that such sales can be achieved. The
Company's failure to achieve such sales and other events, including the progress
of the Company's research, development and clinical trial programs; the costs
and timing of seeking regulatory approvals of the Company's products under
development; the Company's ability to obtain regulatory approvals; the Company's
ability to manufacture products at an economically feasible cost; costs in
filing, prosecuting, defending, and enforcing patent claims and other
intellectual property

<PAGE>

rights; the extent and terms of any collaborative research, manufacturing,
marketing, joint venture, or other arrangements; and changes in economic,
regulatory, or competitive conditions or the Company's planned business could
cause the Company to require additional capital prior to the end of such year.
In the event that the Company must raise additional capital to fund its working
capital needs, it may seek to raise such capital in 1998 through loans, which
may include a bank line of credit, or through the issuance of debt or equity
securities. To the extent the Company raises additional capital by issuing
equity securities, ownership dilution to existing shareholders will result, and
future investors may be granted rights superior to those of existing
shareholders. There can be no assurance, however, that any additional capital
will be available to the Company on acceptable terms, or at all.

CONTINGENCIES

The Company has performed an initial assessment of the impact of the "Year
2000 Issue" on its reporting systems and operations. The "Year 2000 Issue"
exists because many computer systems and applications currently use two-digit
fields to designate a year. As the century date occurs, date sensitive systems
will recognize the year 2000 as 1900, or not at all. Based on the Company's
initial assessment, it believes that its accounting systems substantially avoid
the "Year 2000 Issue," thereby enabling it to properly process critical
financial and operational information.

<PAGE>

FORWARD-LOOKING INFORMATION: CERTAIN CAUTIONARY STATEMENTS

Certain statements contained in "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and elsewhere in this report that
are not related to historical results are forward looking statements. Actual
results may differ materially from those projected or implied in the forward
looking statements. Further, certain forward looking statements are based upon
assumptions of future events, which may not prove to be accurate. Subsequent
written and oral forward looking statements attributable to the Company or to
persons acting on its behalf are expressly qualified in their entirety by the
cautionary statements set forth below and elsewhere in this report and in other
reports filed by the Company with the Securities and Exchange Commission.

MARKET ACCEPTANCE OF NIASPAN

The Company's success currently depends primarily upon its ability to
successfully market and sell its NIASPAN product. The Company's ability to
successfully market and sell its NIASPAN product will depend significantly on
the acceptance of the NIASPAN product by physicians and their patients. The
Company believes that intolerable flushing and potential liver toxicity are the
principal reasons why physicians generally have been reluctant to prescribe or
recommend currently available formulations of niacin. Flushing episodes are
often characterized by facial redness, tingling or rash. Although most patients
taking NIASPAN will sometimes flush, the formulation and dosing regimen for
NIASPAN have been designed to maximize patient acceptance and minimize the
occurrence of flushing. There can be no assurance, however, that patients using
NIASPAN will not suffer episodes of flushing that they consider intolerable. The
failure of physicians to prescribe NIASPAN or the failure of patients to
continue taking NIASPAN due to intolerable flushing or to other side effects
would have a material adverse effect on the Company.

Physicians have also been reluctant to prescribe or recommend certain
currently available formulations of niacin because of potential liver toxicity
associated with these formulations. Although clinical trials conducted using
NIASPAN demonstrated that fewer than 1% of patients experienced clinically
significant elevations in liver enzyme levels, there can be no assurance that
patients using NIASPAN in actual practice will not experience clinically
significant elevations of liver enzymes or other side effects at a rate higher
than those experienced in the Company's clinical trials. The Company believes
that since the launch of its NIASPAN product, many physicians have started only
a limited number of selected patients on the NIASPAN product in order to confirm
the product's efficacy, safety, and tolerability. Consequently, the Company
believes that such "trial use" strategy has resulted in the modest growth of
NIASPAN prescriptions. The Company anticipates that physicians will continue to
employ a "trial use" strategy until they have confirmed the efficacy, safety,
and tolerability of the NIASPAN product. Until such time, the Company
anticipates that it will continue to experience modest growth in the sales of
its NIASPAN product. There can be no assurance, however, that physicians
employing such "trial use" will at any time adopt the NIASPAN product for broad
use in their prescribing pattern for treating lipid disorders. Their failure to
do so would have a material adverse effect on the NIASPAN product's sales
potential and on the Company's financial condition.

Unanticipated side effects or unfavorable publicity concerning the NIASPAN
product or any other product incorporating technology similar to that used in
the NIASPAN product also could have an adverse effect on the Company's ability
to obtain regulatory approvals, to achieve acceptance by prescribing physicians,
managed care providers, or patients; any of which would have a material adverse
effect on the Company.

<PAGE>

HISTORY OF OPERATING LOSSES; UNCERTAINTY OF FUTURE PROFITABILITY

To date, the Company has dedicated most of its financial resources to the
development and commercialization of its NIASPAN product, the development of
other products, and general and administrative expenses. The Company expects to
incur significant operating losses for at least the next twelve months, due
primarily to continued manufacturing and marketing, sales and administrative
expenses associated with the commercial launch of the NIASPAN product and for
investments in its research and development programs. No assurance can be given
that additional significant losses will not continue thereafter. The Company's
ability to achieve and maintain profitability will depend, among other things,
on the commercial success of the NIASPAN product; on the Company's ability to
successfully exploit its manufacturing and sales and marketing capabilities; to
complete the development of, and obtain regulatory approvals for, and achieve
market acceptance for its products under development; and on its ability to
maintain sufficient funds to finance its activities. As of December 31, 1997,
the Company's accumulated deficit was $106.0 million. In connection with the
transfer of operations from Holdings to the Company on June 30, 1996, net
operating loss carryforwards amounting to approximately $51.0 million and
related tax benefits remained with Holdings and were not transferred to the
Company. Consequently, the Company may utilize net operating loss carryforwards
sustained subsequent to June 30, 1996 (amounting to approximately $47.0 million
as of December 31, 1997), to offset future taxable net income, if any. There can
be no assurance, however, that the Company will be able to achieve profitability
to utilize such carryforwards or that profitability, if any, can be sustained.

LIMITED SALES AND MARKETING EXPERIENCE AND RESOURCES

Although the Company markets its NIASPAN product and intends to market its
other products under development through its own specialty sales force, its
marketing experience to date is limited. Substantial resources will continue to
be required for the Company to promote the sale of the NIASPAN product and its
products under development. There can be no assurance that the Company will be
able to devote resources to NIASPAN or its other products under development
sufficient to achieve market acceptance. The Company's failure to expend the
resources to adequately promote the NIASPAN product or its products under
development would have a material adverse effect on the Company.

Moreover, the Company has fewer sales persons than many of its competitors
and there can be no assurance that the Company's sales force will be able to
detail successfully physicians who prescribe lipid-altering medications.
Although the Company has stated that it intends to increase the size of its
sales force to at least 200 representatives during 1998, there can be no
assurance that the Company will be able to attract and hire additional sales
representatives or retain its current sales representatives, that any additional
representatives hired by the Company will be immediately effective in promoting
the sale of the NIASPAN product, or that such number of sales representatives
will be able to generate significant sales of the NIASPAN product. The failure
of the Company to hire additional sales representatives or the failure of such
representatives to quickly generate sales of the Niaspan product could have a
material adverse effect on the Company.

PRODUCTS UNDER DEVELOPMENT

Although the Company obtained clearance from the FDA to market NIASPAN, there
can be no assurance that the Company will be able to successfully formulate any
of its other products as planned, or that the Company will be successful in
demonstrating the safety and efficacy of such products in human clinical trials.
These trials may be costly and time-consuming. The administration of any product
the Company develops may produce undesirable side effects that could result in
the

<PAGE>

interruption, delay or suspension of clinical trials, or the failure to
obtain FDA or other regulatory approval for any or all targeted indications.
Even if regulatory approval is secured, the Company's products under development
may later produce adverse effects that limit or prevent their widespread use or
that necessitate their withdrawal from the market. The Company may discontinue
the development of any of its products under development at any time.

FUTURE CAPITAL NEEDS; UNCERTAINTY OF ADDITIONAL FUNDING

The Company has experienced negative cash flows from operations since its
inception. The Company has spent and will continue to be required to spend
substantial funds to continue research and development, including clinical
trials of its products under development, and to commercialize NIASPAN and its
products under development if regulatory approvals are obtained for such
products under development. The Company believes that it has sufficient
resources to fund the operations of the Company until December 31, 1998. The
Company, however, may need or elect to raise additional capital prior to such
date. The Company's capital requirements will depend on many factors, primarily
relating to the near-term commercial success of NIASPAN; the problems, delays,
expenses and complications frequently encountered by companies at this stage of
development; the progress of the Company's research, development, and clinical
trial programs; the costs and timing of seeking regulatory approvals of the
Company's products under development; the Company's ability to obtain such
regulatory approvals; costs in filing, prosecuting, defending, and enforcing
patent claims and other intellectual property rights; the extent and terms of
any collaborative research, manufacturing, marketing, or other arrangements; and
changes in economic, regulatory, or competitive conditions or the Company's
planned business. Estimates about the adequacy of funding for the Company's
activities are based on certain assumptions, including assumptions regarding the
marketing and sales success of the Company's NIASPAN product, and that testing
and regulatory procedures relating to the Company's products under development
can be conducted at projected costs and within projected time frames. There can
be no assurances that any of these assumptions will prove to be accurate.

To satisfy its capital requirements, the Company may seek to raise funds in
the public or private capital markets. The Company's ability to raise additional
funds in the public markets may be adversely affected if the Company's sales of
its NIASPAN product do not increase, if the results of the Company's clinical
trials for its products under development are not favorable, or if regulatory
approval for any of the Company's products under development is not obtained.
The Company may seek additional funding through corporate collaborations and
other financing vehicles. There can be no assurance that any such funding will
be available to the Company, or if available, that it will be available on
acceptable terms. If adequate funds are not available, the Company may be
required to curtail significantly one or more of its research or development
programs or it may be required to obtain funds through arrangements with future
collaborative partners or others that may require the Company to relinquish
rights to NIASPAN or to some or all of its technologies or products under
development. If the Company is successful in obtaining additional financing, the
terms of the financing may have the effect of diluting or adversely affecting
the holdings or the rights of the holders of Common Stock.

PATENTS AND TRADEMARKS; INTERFERENCE

The Company's ability to commercialize any of its products under development
will depend, in part, on its or its licensors' ability to obtain patents,
enforce those patents, preserve trade secrets, and operate without infringing on
the proprietary rights of third parties. In addition, the patents for which the
Company has applied relating to NIASPAN and certain other of the Company's
products under development are based on, among other things, the timed
administration of NIASPAN. If the indications treated by NIASPAN and such other
products under development could be treated using drugs without

<PAGE>

such timed administration, the Company's patents, if issued, would not prevent
the use of such drugs for the treatment of such indications, which would have a
material adverse effect on the Company. There can be no assurance that the
patent applications licensed to or owned by the Company will result in issued
patents, that patent protection will be secured for any particular technology,
that any patents that have been or may be issued to the Company or its licensors
will be valid or enforceable or that any patents will provide meaningful
protection to the Company.

In general, the U.S. patents and patent applications owned by or licensed to
the Company are method-of-use patents that cover the timed use of certain
compounds to treat specified conditions. Composition-of-matter protection is not
available for the active ingredient in NIASPAN. The active ingredient in
NIASPAN, niacin, is currently sold in the United States and other markets for
lipid altering and for other uses. Even in jurisdictions where the use of the
active ingredient in NIASPAN for lipid altering and other indications may be
covered by the claims of a use patent licensed to the Company, off-label sales
might occur, especially if another company markets the active ingredient at a
price that is less than the price of NIASPAN, thereby potentially reducing the
sales of NIASPAN.

The Company has a patent application pending in the U.S. Patent and Trademark
Office ("PTO") with claims covering NIASPAN's method-of-use consistent with its
recommended once-a-day dosing regimen. The Company has been advised by the
patent examiner that certain of these claims are allowable, but none of the
claims have yet been issued as a patent. The patent examiner has, however,
indicated that it may submit Kos' patent application to the PTO's Board of
Interference to determine whether it should declare an interference between
such Kos application and a method-of-use patent issued to a privately owned
generic manufacturer allegedly claiming the same dosing regimen invention. On
February 7, 1997, the Company and such generic manufacturer entered into a
cross-licensing agreement (the "License Agreement") pursuant to which the
parties agreed to resolve, as between themselves, the effects of such potential
interference by granting licenses under their respective patent application and
patent.

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

The patent positions of pharmaceutical and biotechnology companies are highly
uncertain and involve complex legal and factual questions. There can be no
assurance that the patents owned and licensed by the Company, or any future
patents, will prevent other companies from developing similar or therapeutically
equivalent products or that others will not be issued patents that may prevent
the sale of Company products or require licensing and the payment of significant
fees or royalties by the Company. Furthermore, there can be no assurance that
any of the Company's future products or methods will be patentable, that such
products or methods will not infringe upon the patents of third parties, or that
the Company's patents or future patents will give the Company an exclusive
position in the subject matter claimed by those patents. The Company may be
unable to avoid infringement of third party patents and may have to obtain a
license, defend an infringement action, or challenge the validity of the patents
in court. There can be no assurance that a license will be available to the
Company, if at

<PAGE>

all, on terms and conditions acceptable to the Company, or that the Company will
prevail in any patent litigation. Patent litigation is costly and time
consuming, and there can be no assurance that the Company will have or will
devote sufficient resources to pursue such litigation. If the Company does not
obtain a license under such patents, is found liable for infringement or is not
able to have such patents declared invalid, the Company may be liable for
significant money damages, may encounter significant delays in bringing products
to market, or may be precluded from participating in the manufacture, use, or
sale of products or methods of treatment requiring such licenses.

The Company also relies on trade secrets and other unpatented proprietary
information in its product development activities. To the extent that the
Company relies on trade secrets and unpatented know-how to maintain its
competitive technological position, there can be no assurance that others may
not independently develop the same or similar technologies. The Company seeks to
protect trade secrets and proprietary knowledge in part through confidentiality
agreements with its employees, consultants, advisors and collaborators.
Nevertheless, these agreements may not effectively prevent disclosure of the
Company's confidential information and may not provide the Company with an
adequate remedy in the event of unauthorized disclosure of such information. If
the Company's employees, scientific consultants or collaborators develop
inventions or processes independently that may be applicable to the Company's
products under development, disputes may arise about ownership of proprietary
rights to those inventions and processes. Such inventions and processes will not
necessarily become the Company's property, but may remain the property of those
persons or their employers. Protracted and costly litigation could be necessary
to enforce and determine the scope of the Company's proprietary rights. Failure
to obtain or maintain patent and trade secret protection, for any reason, would
have a material adverse effect on the Company.

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

COMPETITION AND TECHNOLOGICAL CHANGE

The active ingredient in NIASPAN, niacin, is available in several other
formulations, most of which do not require a prescription. Although the Company
believes that there are no other currently available niacin formulations that
have been approved by the FDA specifically for once-a-day dosing, there can be
no assurance that physicians will not prescribe or recommend some of these
unapproved niacin formulations, using the NIASPAN dosing regimen, to try to
achieve the same results as NIASPAN. Substitution of other niacin formulations
for NIASPAN could have a material adverse effect on the Company. Moreover,
manufacturers of other niacin formulations could promote their products using
the NIASPAN dosing regimen and could promote the sale of their products to treat
the indications for which the Company has received clearance to market NIASPAN.
Although such promotion would be a violation of FDA regulations, the occurrence
of such practices would have a material adverse effect on the Company. Moreover,
many products are commercially available for the treatment of elevated LDL
cholesterol, and the manufacturers of such products have significantly greater
financial resources and

<PAGE>

sales and manufacturing capabilities than the Company. There can be no
assurance that NIASPAN or any other product developed by the Company will be
able to compete successfully with any of those products.

Many established pharmaceutical and biotechnology companies, universities,
and other research institutions with resources significantly greater than the
Company's may develop products that directly compete with the Company's
products. Even if the Company's products under development prove to be more
effective than those developed by other entities, such other entities may be
more successful in marketing their products than the Company because of greater
financial resources, stronger sales and marketing efforts, and other factors.
These entities may succeed in developing products that are safer, more effective
or less costly than the products developed by the Company. There can be no
assurance that any products developed by the Company will be able to compete
successfully with any of those products.

GOVERNMENT REGULATION; NO ASSURANCES OF REGULATORY APPROVAL

The Company's research and development activities, preclinical studies,
clinical trials, and the manufacturing and marketing of its products are
currently subject to extensive regulation by the FDA and may in the future be
subject to foreign regulations. The drug approval process takes many years and
requires the expenditure of substantial resources. Data obtained from
preclinical and clinical activities are susceptible to varying interpretations
that could delay, limit, or prevent regulatory approval. Although the Company
may consult the FDA for guidance in developing protocols for clinical trials,
that consultation provides no assurance that the FDA will accept the clinical
trials as adequate or well-controlled or accept the results of those trials. In
addition, delays or rejections of applications for regulatory approval may
result from changes in or additions to FDA regulations concerning the drug
approval process. Similar delays may also be encountered in foreign countries.
There can be no assurance that any regulatory review will be conducted in a
timely manner or that regulatory approvals will be obtained for any products
developed by the Company. Even if regulatory approval of a product is obtained,
the approval may be limited as to the indicated uses for which it may be
promoted or marketed. In addition, a marketed drug, its bulk chemical supplier,
its manufacturer and its manufacturing facilities are subject to continual
regulatory review and periodic inspections, and later discovery of previously
unknown problems with a product, supplier, manufacturer or facility may result
in restrictions on such products or manufacturers, which may require a
withdrawal of the product from the market. Failure to comply with the applicable
regulatory requirements can, among other things, result in fines, suspensions of
regulatory approvals, product recalls, operating restrictions and criminal
prosecution, any of which could have a material adverse effect on the Company.

The Company's business is also subject to regulation under state, federal and
local laws, rules, regulations and policies relating to the protection of the
environment and health and safety, including those governing the use,
generation, manufacture, storage, air emission, effluent discharge, handling and
disposal of certain materials. The Company believes that it is in compliance in
all material respects with all such laws, rules, regulations and policies
applicable to the Company. There can be no assurance that the Company will not
be required to incur significant costs to comply with such environmental and
health and safety laws and regulations in the future. The Company's research and
development involves the controlled use of hazardous materials. Although the
Company believes that its safety procedures for handling and disposing of such
materials comply with the standards prescribed by applicable state, federal and
local regulations, the risk of contamination or injury from these materials
cannot be completely eliminated. In the event of such contamination or injury,
the Company

<PAGE>

could be held liable for any damages that result and any such liability could
exceed the resources of the Company and materially adversely affect the
Company's business, financial condition and results of operations.

DEPENDENCE ON CERTAIN COLLABORATORS

The Company relies on third parties for certain aspects of the development of
certain of its products under development. The Company is collaborating with
Fuisz on the development of two products. Pursuant to this collaboration, Kos is
responsible for conducting pharmacokinetic studies and clinical trials and Fuisz
is responsible for the formulation of such products. The Company is not aware of
any FDA approved products that have successfully incorporated Fuisz' microsphere
technology, which is intended to be used in one of the products being developed
under such collaborations. The Company's ability to commercialize these products
may depend to a significant extent on the efforts of Fuisz, over which the
Company has no control. There can be no assurance that Fuisz will be successful
in developing any of the Company's products under development. The Company also
relies on other third parties for certain aspects of the development of the
Company's presently planned or future products. There can be no assurance that
the Company will be able to enter into future collaborative arrangements on
favorable terms, or at all. Even if the Company is successful in entering into
such collaborative agreements, there can be no assurance that any such
arrangement will be successful. The success of any such arrangement is dependent
on, among other things, the skills, experience and efforts of the third party's
employees responsible for the project, the third party's commitment to the
arrangement, and the financial condition of the third party, all of which are
beyond the control of the Company.

LIMITED MANUFACTURING EXPERIENCE; RISK OF SCALE-UP

The Company currently manufactures NIASPAN in one manufacturing plant that
has been inspected and approved by the FDA, and it manufactures clinical
materials for its products under development in another manufacturing plant. The
Company believes both plants operate in substantial compliance with current Good
Manufacturing Practices ("cGMP") regulations for the manufacture of
pharmaceutical products. The Company may need to further scale-up certain of its
current manufacturing processes to achieve production levels consistent with the
commercial sale of its products. Further, modifications to the facilities,
systems and procedures may be necessary to maintain capacity at a level
sufficient to meet market demand or to maintain compliance with cGMP regulations
and other regulations prescribed by various regulatory agencies including the
Occupational Safety and Health Administration and the Environmental Protection
Agency. Failure by the Company to successfully further scale-up, expand in
connection with manufacture for commercial sale, or modify its manufacturing
process or to comply with cGMP regulations and other regulations could delay the
approval of the Company's products under development or limit the Company's
ability to meet the demand for its products, either of which would have a
material adverse effect on the Company. Such occurrences may require the Company
to acquire alternative means of manufacturing its products, which may not be
available to the Company on a timely basis, on commercially practicable terms,
or at all.

NO ASSURANCE OF ADEQUATE THIRD-PARTY REIMBURSEMENT

The Company's ability to commercialize successfully its products under
development is dependent in part on the extent to which appropriate levels of
reimbursement for NIASPAN or the Company's products under development are
obtained from government authorities, private health insurers, and managed care
organizations such as health maintenance organizations ("HMOs"). Managed care
organizations and other third-party payors are increasingly challenging the
pricing of pharmaceutical

<PAGE>

products. The trend toward managed healthcare in the United States, the growth
of organizations such as HMOs, and legislative proposals to reform healthcare
and government insurance programs could significantly influence the purchase of
pharmaceutical products, resulting in lower prices and reduced demand for
NIASPAN or the Company's products under development. Such cost containment
measures and potential legislative reform could affect the Company's ability to
sell NIASPAN or its products under development and may have a material adverse
effect on the Company. Significant uncertainty exists about the reimbursement
status of newly approved pharmaceutical products. There can be no assurance that
reimbursement in the United States or foreign countries will be available for
NIASPAN or any of the Company's products under development, that any
reimbursement granted will be maintained, or that limits on reimbursement
available from third-party payors will not reduce the demand for, or negatively
affect the price of, NIASPAN or the Company's products under development. The
unavailability or inadequacy of third-party reimbursement for NIASPAN or the
Company's products under development would have a material adverse effect on the
Company.

DEPENDENCE ON SINGLE SOURCES OF SUPPLY

Some materials used in the Company's products, including niacin, the active
ingredient in NIASPAN, are currently sourced from a single qualified supplier.
The Company does not have a contractual arrangement with its sole supplier of
niacin. Although the Company has not experienced difficulty to date in acquiring
niacin, or other materials for product development, no assurance can be given
that supply interruptions will not occur in the future or that the Company will
not have to obtain substitute materials, which would require additional product
validations and regulatory submissions. Any such interruption of supply could
have a material adverse effect on the Company's ability to manufacture its
products or to obtain or maintain regulatory approval of such products.

RISK OF PRODUCT LIABILITY CLAIMS; NO ASSURANCE OF ADEQUATE INSURANCE

Manufacturing, marketing, selling, and testing NIASPAN and the Company's
products under development entails a risk of product liability. The Company
could be subject to product liability claims in the event the Company's products
or products under development fail to perform as intended. Even unsuccessful
claims could result in the expenditure of funds in litigation and the diversion
of management time and resources and could damage the Company's reputation and
impair the marketability of the Company's products. While the Company maintains
liability insurance, there can be no assurance that a successful claim could not
be made against the Company, that the amount of indemnification payments or
insurance would be adequate to cover the costs of defending against or paying
such a claim, or that damages payable by the Company would not have a material
adverse effect on the Company's business, financial condition, and results of
operations and on the price of the Company's Common Stock.

DEPENDENCE ON KEY PERSONNEL

The success of the Company is dependent on its ability to attract and retain
highly qualified scientific, management and sales personnel. The Company faces
intense competition for personnel from other companies, academic institutions,
government entities, and other organizations. There can be no assurance that the
Company will be successful in attracting and retaining key personnel. The loss
of key personnel, or the inability to attract and retain the additional,
highly-skilled employees required for the expansion of the Company's activities,
could adversely affect the Company's results of operations and its business.

<PAGE>

SHARES ELIGIBLE FOR FUTURE SALE; REGISTRATION RIGHTS

The Company has granted certain registration rights to the Company's
controlling shareholder and to Kos Investments, which entitle such entities to
cause the Company to effect three registrations under the Securities Act of
sales of shares of the Company's Common Stock owned by such entities. These
registration rights generally would also permit the holders of such rights to
include shares in any registration statement otherwise filed by the Company. By
exercising these registration rights, these entities could cause a large number
of shares to be registered and become freely tradeable without restrictions
under the Securities Act (except for those purchased in the offering by
affiliates of the Company) immediately upon the effectiveness of such
registration. Such sales may have an adverse effect on the market price of the
Common Stock and could impair the Company's ability to raise additional capital.

POSSIBLE STOCK PRICE VOLATILITY

The stock market, including the Nasdaq National Market, on which the
Company's shares are listed, has from time to time experienced significant price
and volume fluctuations that may be unrelated to the operating performance of
particular companies. In addition, the market price of the Company's Common
Stock, like the stock prices of many publicly traded pharmaceutical and
biotechnology companies, has been and may continue to be highly volatile. The
sale by the Company's controlling shareholder or members of the Company's
management of shares of Common Stock, announcements of technological innovations
or new commercial products by the Company or its competitors, developments or
disputes concerning patent or proprietary rights, publicity regarding actual or
potential medical results relating to the NIASPAN product or to products under
development by the Company or its competitors, regulatory developments in either
the United States or foreign countries, public concern as to the safety of
pharmaceutical and biotechnology products and economic and other external
factors, as well as the trend of prescriptions for the NIASPAN product and the
period-to-period fluctuations in sales or other financial results, among other
factors, may have a significant impact on the market price of the Common Stock.
See "Price Range of Common Stock."

CONTROL BY EXISTING SHAREHOLDER

Michael Jaharis, the Chairman of the Board of Directors of the Company and
one of its founders, beneficially owns approximately 49.9% of the outstanding
Common Stock. Accordingly, this shareholder can control the outcome of certain
shareholder votes, including votes concerning the election of directors, the
adoption or amendment of provisions in the Company's Articles of Incorporation,
and the approval of mergers and other significant corporate transactions. This
level of concentrated ownership by one person, along with the factors described
in the next paragraph, "Anti-Takeover Provisions," may have the effect of
delaying or preventing a change in the management or voting control of the
Company.

ANTI-TAKEOVER PROVISIONS

Certain provisions of the Company's Articles of Incorporation and Bylaws, as
well as the Florida Business Corporation Act, could discourage a third party
from attempting to acquire, or make it more difficult for a third party to
acquire, control of the Company without approval of the Company's Board of
Directors. Such provisions could also limit the price that certain investors
might be willing to pay in the future for shares of the Common Stock. Certain of
such provisions allow the Board of Directors to authorize the issuance of
preferred stock with rights superior to those of the Common Stock.

<PAGE>

Moreover, certain provisions of the Company's Articles of Incorporation or
Bylaws generally permit removal of directors only for cause by a 60% vote of the
shareholders of the Company, require a 60% vote of the shareholders to amend the
Company's Articles of Incorporation or Bylaws, require a demand of at least 50%
of the Company's shareholders to call a special meeting of shareholders, and
prohibit shareholder actions by written consent.

<PAGE>

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

None.

ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.

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

PAGE
----
Financial Statements:

Report of Independent Certified Public Accountants............. 28

Consolidated Balance Sheets at December 31, 1996 and 1997...... 29

Consolidated Statements of Operations for the year ended
December 31, 1995, 1996 and 1997............................. 30

Consolidated Statements of Shareholders' Equity (Deficit) for
the period December 31, 1994 to December 31, 1997............ 31

Consolidated Statements of Cash Flows for the year ended
December 31, 1995, 1996 and 1997............................. 32

Notes to Consolidated Financial Statements..................... 33

Financial Statement Schedule:*

Report of Independent Certified Public Accountants
on Schedule.................................................. 44

II. Valuation and Qualifying Accounts........................ 45

- ----------
* All other schedules for which provision is made in the applicable
accounting regulations of the Securities and Exchange Commission are not
required under the related instructions or are inapplicable, and therefore
not included herein.

<PAGE>

REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS

To the Board of Directors of
Kos Pharmaceuticals, Inc.:

We have audited the accompanying consolidated balance sheets of Kos
Pharmaceuticals, Inc. and subsidiary as of December 31, 1996 and 1997, and the
related consolidated statements of operations, shareholders' equity (deficit)
and cash flows for each of the three years in the period ended December 31,
1997. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Kos
Pharmaceuticals, Inc. and subsidiary as of December 31, 1996 and 1997, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1997, in conformity with generally accepted
accounting principles.

ARTHUR ANDERSEN LLP

Miami, Florida,
January 23, 1998 (except with respect
to the matter discussed in Note 12 as
to which the date is February 19, 1998).

<PAGE>
<TABLE>
<CAPTION>
KOS PHARMACEUTICALS, INC. AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

DECEMBER 31,
1996 1997
------------- -------------
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents ......................... $ 357,520 $ 39,502,484
Marketable securities ............................. -- 30,894,009
Trade accounts receivable, net .................... -- 1,820,011
Inventories ....................................... -- 3,382,868
Prepaid expenses and other current assets ......... 233,841 1,872,862
------------- -------------
Total current assets .......................... 591,361 77,472,234
Fixed Assets, net .................................... 2,605,404 6,900,160
Other Assets ......................................... -- 31,036
------------- -------------

Total assets .................................. $ 3,196,765 $ 84,403,430
============= =============

LIABILITIES AND SHAREHOLDERS'
EQUITY (DEFICIT)
Current Liabilities:
Accounts payable .................................. $ 1,055,415 $ 3,159,685
Accrued expenses .................................. 536,409 3,373,887
Loan from Kos Investments, Inc. ................... 8,355,000 --
------------- -------------
Total current liabilities ..................... 9,946,824 6,533,572
------------- -------------
Commitments and Contingencies (Note 9)

Shareholders' Equity (Deficit):
Preferred stock, $.01 par value, 10,000,000 shares
authorized, none issued and outstanding ........... -- --
Common stock, $.01 par value, 50,000,000 shares
authorized, 10,000,000 and 17,165,695 shares issued
and outstanding in 1996 and 1997, respectively .... 100,000 171,657
Additional paid-in capital ........................ 58,472,323 183,650,564
Accumulated deficit ............................... (65,322,382) (105,952,363)
------------- -------------
Total shareholders' equity (deficit) .......... (6,750,059) 77,869,858
------------- -------------
Total liabilities and shareholders' equity
(deficit) .................................. $ 3,196,765 $ 84,403,430
============= =============
</TABLE>

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.

<PAGE>
<TABLE>
<CAPTION>
KOS PHARMACEUTICALS, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF OPERATIONS

FOR THE YEAR ENDED DECEMBER 31,
--------------------------------------------
1995 1996 1997
------------ ------------ ------------
<S> <C> <C> <C>
Net sales .............................. $ 2,600 $ -- $ 2,892,065
Cost of sales .......................... -- -- 792,230
------------ ------------ ------------
Gross profit ....................... 2,600 -- 2,099,835
------------ ------------ ------------
Operating expenses:
Research and development ............ 11,680,714 13,679,009 24,130,216
General, selling and administrative . 1,655,220 2,880,776 20,508,654
Expense recognized on modification of
Stock option grants ............... -- 5,436,000 --
------------ ------------ ------------
Total operating expenses ........... 13,335,934 21,995,785 44,638,870
------------ ------------ ------------

Loss from operations ................... (13,333,334) (21,995,785) (42,539,035)
------------ ------------ ------------
Other income (expense):
Other expense ....................... -- -- (10,240)
Interest income (expense), net ...... 6,520 11,324 2,786,946
Interest expense-related parties .... -- (136,282) (867,652)
------------ ------------ ------------
Total other income (expense) ... 6,520 (124,958) 1,909,054
------------ ------------ ------------
Loss before minority interest ... (13,326,814) (22,120,743) (40,629,981)
Minority interest ..................... 4,143 15,341 --
------------ ------------ ------------
Net loss ........................ $(13,322,671) $(22,105,402) $(40,629,981)
============ ============ ============

Net loss per share, basic and diluted .. $ (1.17) $ (1.95) $ (2.79)
Weighted average shares of common
stock outstanding .................... 11,340,000 11,340,000 14,569,474

</TABLE>

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.

KOS PHARMACEUTICALS, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)

ADDITIONAL
COMMON PAID-IN ACCUMULATED
STOCK CAPITAL DEFICIT TOTAL
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1994 ......... $ 100,000 $ 390,000 $ (29,894,309) $ (29,404,309)

Capital contributions from Kos
Investments, Inc. .................... -- 13,745,000 -- 13,745,000
Assumption of note payable by Kos
Investments, Inc. .................... -- 30,372,000 -- 30,372,000
Net loss ............................. -- -- (13,322,671) (13,322,671)
------------- ------------- ------------- -------------

BALANCE AT DECEMBER 31, 1995 ......... 100,000 44,507,000 (43,216,980) 1,390,020

Capital contributions from Kos
Investments, Inc. .................... -- 8,381,633 -- 8,381,633
Modification of stock options ........ -- 5,436,000 -- 5,436,000

Contribution of minority interest .... -- 147,690 -- 147,690

Net loss ............................. -- -- (22,105,402) (22,105,402)
------------- ------------- ------------- -------------

BALANCE AT DECEMBER 31, 1996 ......... 100,000 58,472,323 (65,322,382) (6,750,059)

Issuance of Common Stock ............. 58,577 109,167,409 -- 109,225,986
Exercise of stock options ............ 3,479 1,226,562 -- 1,230,041
Conversion of Convertible Note to
Common Stock ....................... 9,601 14,391,435 -- 14,401,036

Stock options issued to non-employees -- 392,835 -- 392,835

Net loss ............................. -- -- (40,629,981) (40,629,981)
------------- ------------- ------------- -------------

BALANCE AT DECEMBER 31, 1997 ......... $ 171,657 $ 183,650,564 $(105,952,363) $ 77,869,858
============= ============= ============= =============
</TABLE>

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.

KOS PHARMACEUTICALS, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE YEAR ENDED DECEMBER 31,
-----------------------------------------------
1995 1996 1997
------------- ------------- -------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss ..................................... $(13,322,671) $ (22,105,402) $ (40,629,981)
Adjustments to reconcile net loss to net
cash used in operating activities -
Provision for doubtful accounts ............ -- -- 80,000
Depreciation and amortization .............. 482,409 539,661 921,271
Provision for inventory obsolescence ....... -- -- 246,987
Minority interest .......................... (4,143) (15,341) --
Compensation recognized on modification of
stock option grants ...................... -- 5,436,000 --
Stock options issued to non-employees ...... -- -- 392,835
Changes in operating assets and liabilities:
Trade accounts receivable ................ -- -- (1,900,011)
Prepaid expenses and other current assets (58,275) (81,531) (1,639,021)
Inventories .............................. -- -- (3,629,855)
Other assets ............................. -- -- (31,036)
Accounts payable ......................... 536,324 336,134 2,104,270
Accrued expenses ......................... (272,593) 429,002 3,843,514
------------- ------------- -------------
Net cash used in operating activities ..... (12,638,949) (15,461,477) (40,241,027)
------------- ------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Investment purchases ......................... -- -- (30,894,009)
Capital expenditures ......................... (954,192) (1,147,067) (5,216,027)
------------- ------------- -------------
Net cash used in investing activities ..... (954,192) (1,147,067) (36,110,036)
------------- ------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from issuance of Common Stock ... -- -- 109,225,986
Net proceeds from exercise of stock options .. -- -- 1,230,041
Capital contributions received from Kos
Investments, Inc. ........................... 13,745,000 8,381,633 --
Borrowings under Convertible Note ............ -- 8,355,000 5,040,000
------------- ------------- -------------
Net cash provided by financing activities . 13,745,000 16,736,633 115,496,027
------------- ------------- -------------
Net increase in cash and cash
equivalents ............................. 151,859 128,089 39,144,964

Cash and Cash Equivalents, beginning of period . 77,572 229,431 357,520
------------- ------------- -------------
CASH AND CASH EQUIVALENTS, END OF PERIOD ....... $ 229,431 $ 357,520 $ 39,502,484
============= ============= =============
Supplemental Disclosure of Cash Flow
Information:
Interest paid ................................ $ 26,897 $ -- $ --
Supplemental Disclosure of Non-cash
Information:
Transfer of note payable to Kos Investments,
Inc .......................................... $ 30,372,000 $ -- $ --
Contribution of minority interest to paid-in
capital ...................................... $ -- $ 147,690 $ --
Conversion of Convertible Note and accrued
interest payable to Common Stock ............. $ -- $ -- $ 14,401,036
</TABLE>

THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE FINANCIAL STATEMENTS.

<PAGE>

KOS PHARMACEUTICALS, INC. AND SUBSIDIARY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. GENERAL

The predecessor to Kos Pharmaceuticals, Inc. (the "Company"), Kos Holdings,
Inc. ("Holdings"), was incorporated in Florida on July 1, 1988, to develop
prescription pharmaceutical products principally for the cardiovascular and
respiratory markets. On June 25, 1996, the Company was incorporated in Florida
as the successor to the business of Holdings. On June 30, 1996, all of the
assets and liabilities of Holdings, other than its net operating loss
carryforwards, were transferred to the Company in exchange for shares of Common
Stock of the Company (the "Reorganization"). The Reorganization was accomplished
in order to transfer the assets and operations of Holdings to the Company while
preserving Holdings' net operating losses and related federal tax benefits for
Holdings and its sole shareholder and one of its founders. Kos Investments, Inc.
("Investments") is the sole shareholder of Holdings. As this transaction was
between entities under common control, the transaction was accounted for on a
historical cost basis, in a manner similar to a pooling of interests.

On June 22, 1993, Holdings and Aeropharm Technology, Inc. ("Aeropharm")
entered into a letter of intent for Holdings' purchase of a controlling interest
in Aeropharm. On February 14, 1995, the transaction was completed through a
stock purchase agreement that gave control (80% ownership) of Aeropharm to
Holdings. Holdings accounted for its investment in Aeropharm as a consolidated
subsidiary from June 22, 1993. On June 20, 1996, Holdings acquired the minority
interest in Aeropharm, held by an employee of Aeropharm, in exchange for options
to purchase 50,000 shares of Holdings' common stock at $7.00 per share, the
estimated fair value of the underlying shares at the date of grant. The
acquisition of the minority interest in Aeropharm was accounted for under the
purchase method and the fair value of the options granted approximated the
carrying value ($147,690) of the minority interest.

On July 28, 1997, the Company obtained clearance from the U.S. Food and Drug
Administration ("FDA") to market NIASPAN, its first product (NIASPAN(R) is a
registered trademark of the Company). The Company began sales of the NIASPAN
product during August 1997. NIASPAN is a once-a-day, oral, solid dose
extended-release formulation of niacin for the treatment of hyperlipidemia, a
multiple lipid disorder that is a primary risk factor for coronary heart
disease. Niacin is a water soluble vitamin that has long been recognized as an
effective pharmacological agent for the treatment of multiple lipid disorders
including elevated LDL and low HDL cholesterol.

The Company expects to incur additional losses in the near-term due primarily
to the continued expansion of sales and marketing efforts associated with
NIASPAN and to research and development activities in connection with its
products under development. No assurance can be given that the Company's
products can be successfully marketed, that products under development can be
successfully formulated or manufactured at acceptable cost and with appropriate
quality, or that required regulatory approvals will be obtained. The Company is
subject to a number of other risks including, but not limited to, uncertainties
related to market acceptance, uncertainties related to limited sales and
marketing experience, uncertainties related to patents and trademarks,
interference and risk of infringement, uncertainties related to competition and
technological changes, government regulation, dependence on product development
collaborators, limited manufacturing experience and risk of scale-up, future
capital needs and uncertainty of additional funding, dependence on single
sources of supply, and no assurances of adequate third party reimbursement. The
likelihood of the success of the Company must be considered in light of the
uncertainty caused by problems, expenses, complications and delays frequently
encountered in connection with the development of new business ventures.

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2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

BASIS OF PRESENTATION

The consolidated financial statements include the results of Holdings (prior
to July 1, 1996), the Company and its subsidiary, Aeropharm. All significant
intercompany accounts and transactions have been eliminated in consolidation.

CASH AND CASH EQUIVALENTS

The Company considers all highly liquid investments purchased with an
original maturity of 90 days or less to be cash equivalents.

MARKETABLE SECURITIES

All of the Company's marketable securities are considered available-for-sale
securities. The Company accounts for marketable securities in accordance with
Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for
Certain Investments in Debt and Equity Securities". Available-for-sale
securities represent debt securities that are stated at fair value.
Amortizations of premiums and accretion of discounts are recognized as
adjustments to interest income. Gains or losses on disposition are based on the
net proceeds and the adjusted carrying amount of the securities sold, using the
specific identification method.

LONG-LIVED ASSETS

In March 1995, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed Of". SFAS No. 121 requires that long-lived assets and
certain identifiable intangibles to be disposed of be recorded at the lower of
carrying amount or fair value less cost to sell. The Company adopted the
provisions of this statement, effective in 1996. Such adoption did not have a
material effect on the Company's financial statements.

MINORITY INTEREST

Minority interest represents the minority shareholders' interest in the
shareholders' equity and net loss of Aeropharm. As of December 31, 1996 and
1997, the Company owned 100% of Aeropharm; therefore, no minority interest is
reflected.

FAIR VALUE OF FINANCIAL INSTRUMENTS

As of December 31, 1996 and 1997, the carrying amount of cash and cash
equivalents, trade accounts receivable, and notes payable approximates fair
value due to the short term nature of these accounts. See Note 3. for
information regarding the fair value of marketable securities.

CONCENTRATION OF CREDIT RISK

The Company has no significant off-balance-sheet concentrations of credit
risk.

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DEPRECIATION AND AMORTIZATION

Fixed assets are stated at cost, less accumulated depreciation and
amortization. Depreciation and amortization are provided using the straight-line
method over the estimated useful lives of the assets or lease term as follows:

YEARS
-----

Furniture and equipment................................. 3-7
Computer software and hardware.......................... 3-5
Laboratory and manufacturing equipment.................. 3-5
Leasehold improvements.................................. Life of lease

RESEARCH AND DEVELOPMENT EXPENSES

All research and development expenses are reflected in the Company's
consolidated statements of operations as incurred.

LOSS PER SHARE

Basic loss per share is determined by dividing the net loss attributable to
holders of the Company's Common Stock by the weighted average number of shares
of Common Stock outstanding. Diluted loss per share also includes dilutive
Common Stock equivalents outstanding after applying the treasury stock method.

In February 1997, the FASB issued SFAS No. 128, "Earnings per Share". SFAS
No. 128 simplifies the methodology of computing earnings per share and requires
the presentation of basic and diluted earnings per share. The Company's basic
and diluted earnings per share are the same, because the Company's Common Stock
equivalents are antidilutive.

INCOME TAXES

The Company follows the SFAS No. 109, "Accounting for Income Taxes," which
requires, among other things, recognition of future tax benefits measured at
enacted rates attributable to deductible temporary differences between financial
statement and income tax bases of assets and liabilities and to tax net
operating loss carryforwards to the extent that realization of said benefits is
more likely than not. The net operating loss carryforwards, amounting to
approximately $51 million as of the Reorganization were not transferred to the
Company. As of December 31, 1997, the Company had approximately $18 million of
deferred tax assets resulting from net operating loss carryforwards. Due to the
uncertainty of the Company's ability to generate sufficient taxable income in
the future to utilize such loss carryforwards, the net deferred tax asset has
been fully reserved as of December 31, 1997.

USE OF ESTIMATES

The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities, the disclosure of
contingent assets and liabilities at the date of the financial statements, and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.

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FISCAL-YEAR CHANGE

The Company's Board of Directors changed the end of the Company's fiscal year
from June 30 to December 31 effective with the December 31, 1997, reporting
period. Fiscal years presented and referred to in these consolidated financial
statements and notes thereto are on a December 31 fiscal-year basis.

The following table presents condensed unaudited financial data for the
six-month periods ended December 31, 1995, 1996 and 1997:
<TABLE>
<CAPTION>
SIX-MONTH PERIOD ENDED DECEMBER 31,
--------------------------------------------
1995 1996 1997
------------ ------------ ------------
(in thousands, except per share data)
<S> <C> <C> <C>
Net sales ........................... $ -- $ -- $ 2,892
Cost of sales ....................... -- -- 792
------------ ------------ ------------
Gross profit ................... -- -- 2,100
------------ ------------ ------------
Operating expenses:
Research and development .......... 6,703 6,290 12,306
General, selling and administrative 858 1,898 16,923
------------ ------------ ------------
Total operating expenses ....... 7,561 8,188 29,229
------------ ------------ ------------
Loss from operations ................ (7,561) (8,188) (27,129)
------------ ------------ ------------
Other income (expense):
Other expense ..................... (9) (11)
(10)
Interest income (expense), net .... 41 152 1,867
Interest expense - related parties (24) (271) (361)
------------ ------------ ------------
Total other income (expense) ... 8 (130) 1,496
------------ ------------ ------------
Loss before minority interest .. (7,553) (8,318) (25,633)
Minority interest ................... 1 -- --
------------ ------------ ------------
Net loss ....................... $ (7,552) $ (8,318) $ (25,633)
============ ============ ============
Net loss per share, basic and diluted $ (0.67) $ (0.73) $ (1.60)
Weighted average shares of common
stock outstanding ................ 11,340,000 11,340,000 16,043,018
</TABLE>

RECENT ACCOUNTING PRONOUNCEMENTS

In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income"
which is required to be adopted in 1998. This statement establishes standards to
reporting and display of comprehensive income and its components in a full set
of general-purpose financial statements. This statement requires that an
enterprise (a) classify items of other comprehensive income by their nature in
financial statements and (b) display the accumulated balance of other
comprehensive income separately from retained earnings and additional paid-in
capital in the equity section of statements of financial position. Comprehensive
income is defined as the change in equity during the financial reporting period
of a business enterprise resulting from non-owner sources. The Company currently
does not have other comprehensive income and therefore does not believe the
adoption of SFAS No. 130 will have a significant impact on its financial
statement presentation.

<PAGE>

In June, 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of
an Enterprise and Related Information", which is also required to be adopted in
1998. This statement requires that a public business enterprise report financial
and descriptive information about its reportable operating segments including,
among other things, a measure of segment profit or loss, certain specific
revenue and expense items, and segment assets. The Company currently has one
reporting segment and therefore does not believe the adoption of SFAS No. 131
will have a significant impact on its financial statement presentation.

3. MARKETABLE SECURITIES

As of December 31, 1997, marketable securities consisted of U.S. government
securities for which fair values approximate unamortized cost. The contractual
maturities of these securities are less than one year. Fair values are based on
quoted market prices obtained from an independent broker.

4. ACCOUNTS RECEIVABLE

Accounts receivable as of December 31, 1997, consist of the following:

Trade accounts receivable.................................. $1,900,011
Less allowance for doubtful accounts....................... (80,000)
----------
Accounts receivable, net................................ $1,820,011
==========

5. INVENTORIES

Inventories as of December 31, 1997, consist of the following:

Raw materials............................................... $ 218,363
Work in process............................................. 1,916,865
Finished goods.............................................. 1,247,640
----------
Total inventories......................................... $3,382,868
==========

6. FIXED ASSETS

Fixed assets consist of the following:

DECEMBER 31,
----------------------
1996 1997
----------- ---------

Furniture and equipment......................... $ 310,284 $1,238,853
Computer software and hardware.................. 469,105 1,314,214
Laboratory and manufacturing equipment.......... 2,376,250 5,101,992
Leasehold improvements.......................... 1,318,792 2,035,399
---------- ----------
Fixed assets, gross........................... 4,474,431 9,690,458
Less accumulated depreciation and amortization.. (1,869,027) (2,790,298)
---------- ----------
Fixed assets, net............................. $2,605,404 $6,900,160
========== ==========

<PAGE>

7. ACCRUED EXPENSES

Major components of accrued expenses were as follows:

DECEMBER 31,
---------------------
1996 1997
---------- ----------
License fee..................................... $ - $1,000,000
Employee bonuses................................ 57,250 415,621
Employee vacations.............................. 139,907 370,625
Clinical studies................................ - 335,994
Other various operating expenses................ 339,252 1,251,647
--------- ----------
Total accrued expenses........................ $ 536,409 $3,373,887
========= ==========

8. CONVERSION OF NOTES PAYABLE

Michael Jaharis, the controlling shareholder of Investments, personally
guaranteed the repayment of a loan to Investments from certain financial
institutions. Prior to March 21, 1995, the Company was the primary borrower
under this loan and, therefore, received the benefit of the personal guaranty
extended by Mr. Jaharis. As consideration for Mr. Jaharis' personal guaranty,
the Company agreed to pay Mr. Jaharis an annual fee of 0.25% of the average
amount outstanding under the loan during the Company's fiscal year. In March
1995, the Company was released as a borrower under the loan. The assumption of
the note payable to the bank has been accounted for as a transfer to Investments
and is reflected as an increase in "Additional paid-in capital" in the
accompanying consolidated statements of shareholders' equity (deficit).

On July 1, 1996, the Company executed a loan in favor of Kos Investments,
Inc. (the "Convertible Note") in the aggregate principal amount of up to $15.0
million, the proceeds of which were used to fund the Company's operations until
the consummation of its IPO. Under the terms of the Convertible Note, interest
accrued on the outstanding principal amount at First Union National Bank of
Florida's prime rate commencing July 1, 1996, escalating to a rate of 1% over
such prime rate during calendar year 1997. The Convertible Note was convertible
into Common Stock at a conversion price per share equal to the IPO price per
share ($15.00).

On October 25, 1997, the outstanding principal and interest of the
Convertible Note were converted into 960,069 shares of Common Stock. At the time
of conversion, the Convertible Note accrued interest at a rate of 8.50% per year
and had outstanding principal and interest of $13,395,000 and $1,006,036,
respectively.

9. COMMITMENTS AND CONTINGENCIES

EMPLOYMENT AGREEMENTS

Through December 31, 1997, the Company had employment agreements with three
of its officers. Salary and benefits expense recorded under the agreements
totaled approximately $580,000, $769,000 and $708,000 during the years ended
December 31, 1995, 1996 and 1997, respectively. In addition to salary and
benefits, these agreements entitle certain officers to royalties on sales of the
Company's

<PAGE>

products, the aggregate amounts of which may not exceed $5,500,000. The Company
recorded $29,000 as royalty expense from these agreements during the year ended
December 31, 1997. Future minimum payments under these employment agreements are
as follows:

YEAR ENDING DECEMBER 31, AMOUNT
------------------------ ----------
1998...................................................... $ 465,000
1999...................................................... 465,000
2000...................................................... 300,000
2001...................................................... 300,000
2002...................................................... 150,000
----------
$1,680,000
==========

LEASE COMMITMENTS

The Company has various operating leases that expire through 2002 for the
rental of office space, laboratory facilities, and sales force vehicles. Future
minimum commitments under these agreements are as follows:

YEAR ENDING DECEMBER 31, AMOUNT
------------------------ ----------
1998..................................................... $1,561,157
1999..................................................... 1,434,589
2000..................................................... 940,515
2001..................................................... 510,981
2002..................................................... 20,000
----------
$4,467,242
==========

As of December 31, 1996 and 1997, standby letters of credit of approximately
$65,000 and $960,000, respectively, were issued by a bank on the Company's
behalf in favor of the lessors as collateral for leases provided to the Company.

Rent expense under operating leases during the years ended December 31, 1995,
1996 and 1997 was approximately $525,000, $558,000 and $823,000, respectively.

LICENSING AND JOINT VENTURE AGREEMENTS

The Company has several license agreements (the "License Agreements") with
third parties (the "Licensees") for the development of future products. Under
the License Agreements, the Company is required to make payments to the
Licensees upon completion of various milestones of each project in order to
secure exclusive rights to develop, manufacture, sell and/or sublicense future
products developed through the License Agreements. In connection with the
License Agreements, the Company recorded licensing expense of approximately
$385,000, $1,671,000 and $5,638,000 for the years ended December 31, 1995, 1996
and 1997, respectively, which is reflected in "Research and development" in the
accompanying consolidated statements of operations. In order to maintain its
rights under the License Agreements, the Company is required to pay certain
future milestone payments and licensing fees. In the event that no milestone
event occurs, the Company generally would not be required to

<PAGE>

make any milestone payment. The Company anticipates, based on the development
efforts that have been conducted to date, that it will be required to make
future milestone payments under the License Agreements as follows:

YEAR ENDING DECEMBER 31, AMOUNT
------------------------ --------
1998...................................................... $125,000
1999...................................................... 125,000
2000...................................................... 375,000
--------
$625,000
========

Additionally, assuming FDA approval of a certain other licensed product, the
Company would be obligated to pay up to $1,250,000 to a licensee. Milestone
payments are recorded when the milestone event occurs.

On February 7, 1997, the Company entered into an agreement with an
unaffiliated generic drug manufacturer pursuant to which the parties agreed to
resolve the effects, as between themselves, of a potential interference
proceeding by the United States Patent and Trademark Office by granting cross
licenses under their respective patent applications and patents, regardless of
whether such licenses would be required. In connection with this licensing
agreement, the Company recognized $3,000,000 as a licensing expense; such
expense is included in "Research and development" expenses in the accompanying
consolidated statement of operations for the year ended December 31, 1997. As
further consideration for entering into the agreement, the Company agreed to pay
the generic manufacturer certain royalties on the net sales of NIASPAN subject
to a cap on such royalty payments in the United States and a separate cap on
such payments for sales outside the United States. As a result, the Company
recorded approximately $148,000 of royalty expense, which is included in
"General, selling and administrative" expenses in the accompanying consolidated
statement of operations for the year ended December 31, 1997.

The Company has also entered into a binding letter of intent forming a joint
venture agreement (the "Joint Venture") with a company related to the sale of a
certain product using technology provided by that company. The Company paid
$1,000,000 for the exclusive right to use the technology. Because of the
uncertainties surrounding the use of the technology, as well as the lack of an
existing technologically feasible product with commercial viability, such amount
has been expensed and is included in "Research and development" in the
accompanying 1996 consolidated statement of operations. Within 30 days following
the filing of a New Drug Application ("NDA") to the FDA for a certain product
developed by the Joint Venture, or in the event management determines such NDA
filing to be infeasible, any party to the Joint Venture investing in excess of
the other party shall be entitled to consideration and a transfer to it from the
Joint Venture of an amount not to exceed $1,250,000.