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SECURITIES AND EXCHANGE COMMISSION

Form 10-K

Commission File Number: 0-19171

ICOS Corporation

22021-20th Avenue S.E.

Securities registered pursuant to Section 12(b) of the Act:

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

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

      Indicate by check mark whether the registrant is an accelerated filer (as defined by Rule 12b-2 of the Act).     Yes þ          No o

      State the aggregate market value of voting and non-voting stock held by non-affiliates of the registrant as of June 28, 2002.     $954,337,640

      Indicate the number of shares outstanding of each of the registrant’s classes of Common Stock as of January 31, 2003.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant’s definitive Proxy Statement for the annual meeting of stockholders to be held on May 2, 2003, relating to “Security Ownership of Principal Stockholders and Management,” “Election of Directors,” “Continuing Class 2 Directors (until 2004),” “Continuing Class 3 Directors (until 2005),” “Executive Officers,” “Compensation of Directors,” “Executive Compensation,” “2002 Option Grants,” “2002 Aggregate Option Exercises and Year-end Option Values,” “Compensation Committee Interlocks and Insider Participation,” “Report of the Compensation Committee on Executive Compensation,” “Stock Price Performance Graph,” “Related Party Transactions,” “Employment Contracts, Termination of Employment and Change of Control Arrangements” and “Section 16(a) Beneficial Ownership Reporting Compliance” are incorporated by reference in Part III of this Form 10-K.

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ICOS CORPORATION

TABLE OF CONTENTS

*	Not Applicable

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PART I

Item 1.      Business

Overview

      ICOS is a product-driven company that has expertise in both protein-based and small molecule therapeutics. We combine our capabilities in molecular, cellular and structural biology, high throughput drug screening, medicinal chemistry and gene expression profiling to develop highly innovative products expected to have significant commercial potential. We apply our integrated approach to erectile dysfunction and other urologic disorders, sepsis, psoriasis and other inflammatory diseases. We believe our strategy of targeting multiple therapeutic areas with drugs that act through distinct molecular mechanisms increases our chances of successfully developing commercial products.

      We have established collaborations with pharmaceutical and biotechnology companies to enhance our internal development capabilities and to offset a substantial portion of the financial risk of developing our product candidates. At the same time, we maintain substantial rights to the product candidates covered by these collaborations, which provide us the opportunity to participate in a significant portion of the potential economic benefit from successful development and commercialization. Our most significant collaboration partners, for continuing programs, are Eli Lilly and Company (“Lilly”) and Biogen, Inc. (“Biogen”).

      In November 2002, Lilly ICOS LLC (“Lilly ICOS”), a joint venture we established with Lilly in 1998, received approval from the European Commission to market Cialis^TM (tadalafil), for the treatment of erectile dysfunction. Lilly ICOS began shipping Cialis to European wholesalers in January 2003, and Cialis is now available, by prescription, in pharmacies across Europe.

      In June 2001, Lilly ICOS submitted a New Drug Application (“NDA”) to the U.S. Food and Drug Administration (“FDA”) seeking marketing approval of Cialis for the treatment of erectile dysfunction. In April 2002, Lilly ICOS received an “approvable” letter from the FDA. An “approvable” letter indicates that the FDA is prepared to approve an application upon the satisfaction of conditions specified in the letter. The conditions specified by the FDA are the successful completion of clinical pharmacology studies, labeling discussions, and successful resolution of matters related to Lilly’s manufacturing facilities. A U.S. regulatory decision for Cialis is projected to occur in the second half of 2003, with product launch anticipated to occur shortly after approval.

      Lilly is pursuing approval of Cialis for the treatment of erectile dysfunction in markets outside of the European Union and North America under an exclusive license from Lilly ICOS. In those markets, Lilly will sell Cialis and pay a royalty, equal to 20% of net sales, to Lilly ICOS. In addition, Lilly ICOS has initiated a Phase 2 clinical program evaluating tadalafil for the treatment of diabetic gastroparesis.

      We and our collaboration partners have the following additional product candidates in development:

	•	IC747 initiated Phase 2 clinical trials in the third quarter of 2002 for the treatment of psoriasis. IC747 is being developed in a worldwide LFA-1 antagonist collaboration with Biogen.
	•	RTXTM (resiniferatoxin) began a Phase 2 clinical trial in the first quarter of 2003 for the treatment of interstitial cystitis.
	•	IC14 began a Phase 2 clinical trial in the third quarter of 2002 for the treatment of sepsis resulting from community acquired pneumonia (CAP).
	•	IC485 completed Phase 1 clinical trials in the third quarter of 2002. We expect to initiate a Phase 2 clinical trial in 2003 for the treatment of chronic obstructive pulmonary disease.

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Business Strategy

      Our objective is to become a leading biopharmaceutical company focused on the discovery, development and commercialization of innovative drugs. We intend to accomplish this objective by:

      Successfully commercializing Cialis in Europe, the U.S. and in other countries. With the European Commission’s 2002 approval of Cialis for erectile dysfunction, and subsequent Cialis product launch in the European Union, we have succeeded in bringing our first product to the commercial market. We expect to build on this success by obtaining regulatory approval for Cialis in the U.S. and other markets around the world. An NDA seeking approval for Cialis was submitted to the FDA in June 2001, and Lilly ICOS received an “approvable” letter from the FDA in April 2002. A U.S. regulatory decision for Cialis is projected to occur in the second half of 2003. Product launch is anticipated shortly after approval. Through sales and marketing efforts with Lilly, we intend to increase awareness of the unique benefits of Cialis, as we expand our position in the large and growing erectile dysfunction market.

      Diversifying and commercializing our portfolio of product candidates. We have developed, and plan to continue to develop, a broad portfolio of product candidates encompassing a variety of therapeutic approaches to address both chronic and acute diseases and medical conditions. For example, we are currently researching and developing product candidates targeting erectile dysfunction and other urologic disorders, sepsis, psoriasis and other inflammatory diseases. To mitigate some of the risks inherent in clinical development, we plan to continue developing a number of product candidates in parallel. We believe this diversified approach yields the greatest opportunity for long-term commercial success.

      Using our internal capabilities to discover and develop novel product candidates. Using our capabilities in molecular, cellular and structural biology, high throughput drug screening, medicinal chemistry and gene expression profiling, we have successfully identified novel product candidates and obtained patents, or filed patent applications, for protein-based and small molecule product candidates. We plan to continue our discovery and development efforts in these areas, emphasizing diseases and medical conditions for which current therapies are substandard or unavailable, or for which the market opportunities are large.

      Identifying attractive acquisition and in-licensing candidates. We have acquired and in-licensed product candidates and plan to acquire or in-license additional product candidates in the future. For example, our IC14 and RTX product candidates are the result of such acquisition and in-licensing efforts. We believe that we are well positioned to attract additional product candidates as a result of our demonstrated experience and success in completing such acquisitions and in-licensing arrangements.

      Forming strategic collaborations. We have established, and intend to continue to establish, corporate collaborations with large pharmaceutical and other biotechnology companies to enhance the development of product candidates. These collaborations enable us to retain a significant portion of the potential economic benefit, while offsetting a substantial portion of the financial risk, of developing product candidates. For example, we have entered into collaborations with Lilly, Suntory Ltd., Texas Biotechnology Corporation (“Texas Biotechnology”) and Biogen. Collaborations such as these generally enable us to develop a greater number of product candidates than otherwise would be possible and provide us with domestic and international marketing and sales expertise for our partnered product candidates if approved.

      Expanding our intellectual property portfolio. We intend to continue to aggressively pursue protection of our proprietary technology and other intellectual property. We believe that establishing a strong proprietary position could provide an important competitive advantage in our target markets. We have applied, and are applying, for patents for our product candidates and unique aspects of our technologies both in the United States and, when appropriate, in other countries.

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Approved Product

      In November 2002, Lilly ICOS received approval from the European Commission to market Cialis, an oral phosphodiesterase type 5 enzyme (PDE5) inhibitor for the treatment of erectile dysfunction, in all fifteen member states of the European Union. Lilly ICOS began shipping Cialis to wholesalers in January 2003, and Cialis is now available, by prescription, in pharmacies across Europe.

      The European Commission based its decision on the review and evaluation of a comprehensive data package that comprised results of more than 60 studies, in more than 4,000 human subjects. In clinical trials evaluating Cialis for the treatment of erectile dysfunction, efficacy studies demonstrated that Cialis both improved patient’s ability to attain and maintain an erection sufficient for sexual intercourse and significantly increased the percentage of successful sexual attempts. Clinical studies have further demonstrated that Cialis is effective up to twenty-four hours after taking the drug. We believe that the drug’s duration, coupled with a lack of a food effect, should allow men and their partners more freedom to pick the right moment for sexual activity.

      Background. Erectile dysfunction is a condition in which a man is unable to attain or maintain an erection sufficient for sexual intercourse. Erectile dysfunction affects an estimated 30 million men in Europe and 40 million men in North America and is increasingly recognized as a serious and treatable medical condition. Erectile dysfunction is often associated with underlying diseases such as diabetes, cardiovascular disease and depression, or may be a neurological consequence of conditions such as prostate surgery, spinal cord injury or treatment with certain medications.

      Typically, sexual arousal leads to increased blood flow into penile tissue, resulting in an erection. As part of this process, a chemical called cyclic guanosine monophosphate (cGMP) causes penile blood vessels to dilate, allowing blood flow to increase. PDE5, an enzyme present in penile blood vessels, cleaves cGMP, thereby allowing the penile blood vessels to return to their undilated state. Inhibition of PDE5 can enhance blood flow to the penis, contributing to an erection.

      Current Treatment. Until 1998, treatments for erectile dysfunction were primarily limited to the use of injectables, vacuum pumps and prostheses, which are inconvenient and unpleasant options that have limited the size of the treated population. With the introduction in 1998 of Viagra®(sildenafil citrate), which also inhibits PDE5, millions of men were motivated for the first time to acknowledge their affliction and seek treatment. We believe, however, that many men have ceased therapies for erectile dysfunction due to ineffectiveness, unpleasant side effects or inconvenient administration. We believe that as few as 10% of the world’s male population who could benefit from orally administered treatment for erectile dysfunction are currently undergoing treatment. We believe the entry of Cialis into the marketplace may encourage use among the untreated population of erectile dysfunction patients, in addition to encouraging those currently using other therapies to switch to Cialis.

Clinical Development Pipeline

      We are developing several product candidates targeting a variety of serious diseases and medical conditions. We have retained significant marketing rights to each of the product candidates covered by our collaboration arrangements. We have retained co-promotion rights to Cialis in North America, and most of Europe. We expect to co-promote IC747 and other LFA-1 antagonists in our worldwide collaboration with Biogen. The table on the following page summarizes our ongoing product development programs.

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Clinical Development Pipeline

      In the status column of the table: “Phase 1” indicates clinical trials for safety and pharmacology; “Phase 2” indicates clinical trials to determine dosing and efficacy; and FDA “approvable” letter indicates that the FDA is prepared to approve an NDA upon the satisfaction of conditions specified in the letter.

      We are continuing to perform development studies in our evaluation of Cialis (tadalafil), a small molecule compound that inhibits PDE5, for the treatment of erectile dysfunction. We are also evaluating tadalafil for the treatment of diabetic gastroparesis.

      U.S. Development Status. Lilly ICOS submitted an NDA for Cialis to the FDA in June 2001. In April 2002, Lilly ICOS received an “approvable” letter from the FDA. A U.S. regulatory decision for Cialis is projected to occur in the second half of 2003, with product launch anticipated to occur shortly after approval.

      Gastroparesis is a condition that results in delayed emptying of stomach contents. Motility studies have documented the presence of gastroparesis in 30 to 50% of diabetic patients. Many patients suffer from abdominal symptoms such as nausea, vomiting, bloating and abdominal pain. Diabetic gastroparesis can also make glucose control more difficult because the absorption of food is not well coordinated with the administration of medication. Only a subset of patients with diabetic gastroparesis will have symptoms severe enough to seek prescription medication, but with over 11 million Americans suffering from diabetes, it is expected that there would be a substantial market for a drug which proves safe and effective for gastroparesis.

      Inhibition of PDE5 may improve gastric emptying and symptoms in patients with diabetic gastroparesis. Adequate levels of cGMP in the smooth muscle cells of the gastrointestinal tract are necessary for muscle relaxation. The PDE5 found in these smooth muscle cells degrades cGMP, thereby opposing this relaxation. In experimental diabetic mouse models, cGMP levels are low in smooth muscle cells of the pylorus (the muscular valve that allows the stomach to empty) and the pylorus does not relax normally. These diabetic mice develop a condition that mimics diabetic gastroparesis of humans, and treatment with an inhibitor of the PDE5 enzyme restored gastric emptying rates.

      In the United States, agents that improve gastric emptying (e.g., erythromycin and metoclopromide) can only be used intermittently and are of limited efficacy. Tadalafil may improve gastric emptying and provide relief to patients with diabetic gastroparesis by helping normal relaxation of the pylorus.

      In 2003, we began patient enrollment in a Phase 2 study evaluating tadalafil for patients with diabetic gastroparesis.

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      In July 2001, we entered into a collaboration with Biogen to jointly develop and co-promote IC747 and other LFA-1 antagonists as oral therapeutics for autoimmune and inflammatory diseases.

      Background. Psoriasis is a chronic T lymphocyte-driven skin disorder affecting approximately four to five million people in the United States, with over 400,000 of those severely afflicted. The disorder is characterized by frequent episodes of scaly skin plaques which are associated with redness and itching.

      Current Treatment. Approved therapies for psoriasis are focused on treating the symptoms of this disorder and include immunosuppressive medications such as corticosteroids or methotrexate, antifungal medications, antibiotics, cyclosporine, UV light treatment, and vitamin D analogs. Tumor necrosis factor alpha (TNF-alpha) sequestrants and efalizumab are in late-stage development or recently approved for the treatment of psoriasis. In January 2003, Biogen received approval from the FDA for Amevive® (alefacept) for the treatment of adult patients with moderate to severe chronic plaque psoriasis. Amevive will be administered by physicians as an intravenous or intramuscular injection over a 12-week period.

      Potential Treatment by IC747. IC747 is an orally administered, small molecule antagonist of the cell adhesion molecule LFA-1, which is expressed by white blood cells. Many chronic inflammatory diseases are thought to be driven by abnormal activation of T lymphocytes, a type of white blood cell. In our preclinical studies, we have demonstrated that IC747 binds to LFA-1 and inhibits T lymphocyte activation. An effective, well tolerated oral agent could appeal to patients and dermatologists, who currently must contend with toxic and/or injectable drugs, messy topical applications and in-center UV light exposures.

      Development Status. During 2002, in our collaboration with Biogen, we began a Phase 2 clinical trial evaluating IC747 for patients with psoriasis.

      Other chronic diseases for which LFA-1 antagonists may prove useful are asthma and rheumatoid arthritis. In the United States, an estimated 17 million people suffer from asthma and an estimated 2 million are afflicted with rheumatoid arthritis.

      In November 2001, we acquired exclusive worldwide rights to RTX (resiniferatoxin) for the treatment of bladder disease or function.

      Background. Interstitial cystitis is a chronic condition associated with bladder pain, urinary urgency and high frequency of urination, including at night. These symptoms adversely affect quality of life and may cause significant disability. According to the National Institutes of Health, more than 700,000 Americans have interstitial cystitis, of whom 90% are women.

      Current Treatment. Medicines that are prescribed in attempts to control interstitial cystitis symptoms include antihistamines, tricyclic antidepressants and analgesics. The only oral medication that is currently approved for interstitial cystitis is Elmiron® (pentosan polysulfate sodium), which has taken up to six months to provide symptom improvement. Bladder instillation of various agents (including dimethylsulfoxide, heparin-like compounds and others) is also routinely used. Although numerous treatments have been tried for interstitial cystitis, many patients continue to suffer.

      Potential Treatment by RTX. RTX is a small molecule that can be delivered directly into the bladder through a catheter to desensitize afferent nerve fibers termed C-fibers. C-fibers are believed to play a role in many pathological conditions of the bladder, including interstitial cystitis. The clinical objectives of RTX

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      Development Status. In 2003, we began and plan to complete a Phase 2 clinical trial evaluating RTX for patients with interstitial cystitis.

      RTX may also be evaluated for the treatment of detrusor hyperreflexia (overactive bladder) resulting from multiple sclerosis, spinal cord injury, stroke, Parkinson’s disease or benign prostatic hyperplasia.

     IC14

      IC14 is a monoclonal antibody that blocks the function of CD14, a receptor found on the surface of certain white blood cells, which plays an early role in the development of sepsis. IC14 is currently in development as a treatment for sepsis resulting from CAP.

      Background. Sepsis is a serious, potentially life-threatening condition that occurs in some patients with serious infections. The inflammation caused by these infections can, in some cases, systemically spread throughout the body. This process begins when bacteria release toxins into the bloodstream. CD14, present on the surface of myeloid cells and in plasma, recognizes these toxins and triggers a release of inflammatory mediators that drives the systemic inflammatory response.

      In the U.S., approximately 1.1 million patients are hospitalized each year with CAP. Patients with CAP represent the largest subset of patients that develop sepsis. If unattended, sepsis resulting from CAP may progress to severe sepsis and organ failure, which is typically treated using costly and/or invasive medical interventions including intensive care unit admission, dialysis, mechanical ventilation, vasopressor and Xigris® (drotrecogin alfa).

      Current Treatment. We are currently not aware of other therapies in development for the prevention of progression of sepsis as a result of CAP.

      Potential Treatment by IC14. IC14 is unique among sepsis therapies because its early mechanism of action suggests that it may have potential as a broad-based, first line therapy. IC14 inhibits the inflammatory response of sepsis at an early stage by blocking the function of CD14. CD14 is unique in its ability to recognize components from most types of microorganisms. Once activated by the recognition of these microbial components, CD14 triggers a localized inflammatory response that removes microorganisms at the site of infection. However, in some cases CD14 triggers an over-exuberant systemic inflammatory response that may lead to severe sepsis and multiple organ failure. In contrast to other potential targets, CD14 does not appear to be a redundant component of the immune response that leads to sepsis. Not only does CD14 recognize a diverse array of microbial components, but it also is directly involved in activating multiple cell types that promote this immune response, making it an attractive target for the treatment of sepsis. IC14 has been shown to block CD14 in both in vitro and in vivo models in preclinical studies.

      Development Status. We conducted a bacterial toxin challenge study in 16 healthy volunteers, which demonstrated that IC14 inhibited the inflammatory response to specific bacterial toxins by blocking the release of greater than 95% of the cytokine TNF-alpha which is grossly elevated during sepsis, and substantially reduced the development of flu-like symptoms. In 2002, we began enrollment in a Phase 2 clinical trial evaluating IC14 for patients with sepsis resulting from CAP.

      IC485 is an orally administered, small molecule inhibitor of the type 4 cyclic adenosine monophosphate (cAMP) phosphodiesterase enzyme, or PDE4. Inhibition of PDE4 leads to an increase in the second

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      Background. Chronic obstructive pulmonary disease (COPD) is under consideration as the primary clinical application for IC485. According to the U.S. Centers for Disease Control and Prevention, approximately 24 million U.S. adults have evidence of impaired lung function, indicating that COPD is under diagnosed.

      Current Treatment. COPD is currently treated with bronchodilators and anti-inflammatory drugs. However, these drugs have been of limited benefit in treating the disease. Rheumatoid arthritis is currently treated with strong anti-inflammatory medications or biologics that specifically target TNF-alpha.

      Potential Treatment by IC485. Clinical efficacy has been observed with other PDE4 inhibitors in patients with asthma and COPD. Clinical benefits in rheumatoid arthritis and Crohn’s disease have also been observed with approved therapies that target TNF-alpha production. We have demonstrated efficacy in preclinical models of rheumatoid arthritis and a lung injury model related to the pathology of COPD. Historically, drugs that have targeted PDE4 have induced side effects such as nausea, vomiting and sedation, thereby limiting their clinical utility. In preclinical studies of IC485, vomiting and sedation were not observed over a range of doses that inhibited TNF-alpha production, demonstrating the potential utility of this product candidate.

      Development Status. We completed a Phase 1 clinical trial in 2002 and plan to begin a Phase 2 study evaluating IC485 for patients with COPD in 2003.

      IC485 may also be evaluated for the treatment of rheumatoid arthritis.

Preclinical and Research Pipeline

      We continuously evaluate new product candidates as part of our discovery research program. We use an integrated approach in this program that incorporates our capabilities in molecular, cellular and structural biology, high throughput drug screening, medicinal chemistry and gene expression profiling. The table below summarizes our product development programs in which we are engaged in preclinical development or research.

Preclinical and Research Pipeline

      In the status column of this table: “Preclinical” indicates evaluation of lead or preferred compounds for safety, pharmacology and proof of efficacy in non-human animal models; and “Research” indicates the research phase of the product identification process for compounds for which activity in target human biological assay systems has been demonstrated in laboratory tests, but which have not yet been tested in non-human animal models of specific human diseases.

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      Resistance of tumor cells to radiation or chemotherapy is due in part to cellular enzymes collectively termed cell cycle checkpoint/ DNA repair enzymes. These enzymes are proteins that recognize and repair potentially lethal defects in cellular DNA introduced by radiation or chemotherapeutic agents. In preclinical tests, we are currently evaluating and optimizing lead compounds that inhibit key enzymes involved in this process. We are assessing these compounds for their ability to selectively increase the sensitivity of tumors versus normal tissue to radiation or chemotherapeutic agents, thereby enhancing the success and minimizing the toxic effects of conventional treatments for many different types of tumors.

      According to the American Cancer Society, cancer is a major cause of death in the U.S., second only to cardiovascular disease. Because our cell cycle checkpoint/ DNA repair inhibitors potentially sensitize human cancer cells to chemotherapy and radiation therapy, they could potentially treat various forms of cancer, including the most common and lethal forms, such as prostate, breast, lung and colon cancer, as well as less common forms that are very poorly treated, such as pancreatic cancer.

      Certain lipid and protein kinases are enzymes that regulate activation of white blood cell types that participate in inflammatory and degenerative diseases such as autoimmune disorders, chronic obstructive pulmonary disease and osteoporosis. We are currently evaluating, in preclinical studies, small molecule inhibitors of a kinase involved in white blood cell activation. Autoimmune disorders, a large group of clinically important diseases, occur when the immune system confuses normal tissue with invading foreign material and attacks itself, causing tissue destruction. The triggers that cause this process are many, but the net result is that white blood cells are activated and a robust immune response ensues against normal tissue. In preclinical studies, we are testing our kinase inhibitors for their ability to quell an autoimmune response.

      In addition to PDE4 and PDE5, the targets for IC485 and Cialis (tadalafil), respectively, we continue our discovery efforts and are conducting preclinical evaluations of inhibitors that selectively target other distinct members of the phosphodiesterase family of enzymes. These enzymes collectively regulate many bodily functions. Drugs targeted to individual enzymes impact specific bodily functions associated with the cardiovascular, urinary and nervous systems. We are currently evaluating inhibitor compounds in preclinical models of Parkinson’s disease and urinary incontinence.

      Since our inception, we have placed a strong emphasis on generating novel drug candidates from our own internal research activities. Over the past twelve years, we have assembled a highly integrated multidisciplinary research staff which includes:

	•	molecular biologists and biochemists who identify new genes or proteins that are either product candidates or targets for product candidates; and
	•	medicinal and process chemists, robotics experts, and pharmacologists and toxicologists who create, evaluate and optimize new product candidates.

      To use our expertise most effectively, we have concentrated our product discovery efforts on specific gene families, including phosphodiesterases, cell adhesion molecules and cell cycle checkpoint enzymes. In each case, we seek first to identify all the members of the family, understand the distribution of each member within the body and, through multiple functional tests, determine which members are most likely to affect human disease in a manner that can lead to therapeutic treatment. Once a given target is linked to an important biological function, such as activation of white blood cells, it is screened by our robotics group against a complex library of small organic molecules, from which lead compounds are identified. These lead

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      Our current discovery research programs are directed toward the discovery of new product candidates for the treatment of various diseases, including allergic and other inflammatory diseases, cardiovascular diseases, oncologic diseases and infectious diseases.

      Compounds in the research phase of the product identification process are those for which activity in the target human biological assay systems has been demonstrated in laboratory tests. These compounds have not yet been tested in non-human animal models of specific human diseases. These compounds include:

	•	antagonists of a chemokine receptor that promotes the exit of certain white blood cells from the bloodstream to sites of inflammation, which are potentially important in allergic inflammatory diseases such as asthma and skin inflammation;
	•	compounds that block the function of other cell adhesion molecules that are potentially important in diseases such as rheumatoid arthritis, asthma and other degenerative diseases of the kidney, liver and lung;
	•	lead inhibitors of other members of the PDE family of enzymes, including those that may be involved in regulating neurodegenerative diseases such as Parkinson’s disease and urological disorders, such as incontinence; and
	•	molecules that represent lead compounds for new classes of antibiotics.

Collaborations and Licensing Agreements

      We have entered into arrangements with other parties to access technology, and to facilitate and fund the development and marketing of several of our product candidates. Our collaborations and licensing agreements include:

      In October 1998, ICOS and Lilly formed Lilly ICOS, which is 50/50-owned, to develop and commercialize PDE5 inhibitors. In November 2002, Lilly ICOS received approval from the European Commission to market Cialis, for the treatment of erectile dysfunction, in all 15 member states of the European Union. Lilly ICOS began shipping Cialis to European wholesalers in January 2003. Both Lilly and ICOS will market any products resulting from the collaboration.

      Lilly ICOS continues to develop Cialis as an oral therapeutic agent for the treatment of erectile dysfunction in North America and other countries, and is also evaluating tadalafil in diabetic gastroparesis. Lilly ICOS intends to commercialize products approved in North America and Europe through the services of both ICOS and Lilly. For countries outside the European Union and North America, in exchange for royalty payments, Lilly ICOS has granted Lilly an exclusive license to develop, manufacture and commercialize the PDE5 inhibitors developed in the collaboration.

      Under the terms of this arrangement, we received a $75.0 million payment upon formation of the joint venture, a $15.0 million payment in 1999 upon initiation of a Phase 3 clinical trial program for Cialis and an additional $15.0 million payment in 2001 following the filing of the NDA with the FDA. We could receive

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      ICOS acquired the rights to the intellectual property license under an agreement with a third party in association with a previous collaboration. Pursuant to the terms of the third party agreement, ICOS committed to pay the party a royalty equal to 5% of the net sales of products developed utilizing the acquired technology. Lilly ICOS and Lilly have accepted primary responsibility for any royalty obligations resulting from ICOS’ previous arrangement.

      In July 2001, we entered into an agreement with Biogen to jointly develop and globally commercialize orally active, small molecule LFA-1 antagonists for the treatment of inflammatory diseases and conditions, including psoriasis, and other autoimmune diseases. Under the terms of this agreement, we and Biogen will cross-license LFA-1 antagonist technology and patents, including IC747 and other LFA-1 antagonists. We will share costs of ongoing development activities with Biogen, co-promote any products developed under the agreement, and equally share in the profits of the collaboration. We received an $8.0 million upfront fee upon executing the agreement, and received an additional $3.0 million in milestones in 2002, upon the successful completion of Phase 1 clinical trials and the subsequent initiation of a Phase 2 clinical program. We could receive future success-based milestones from Biogen based on the progression of IC747 and other LFA-1 antagonists through development. As of December 31, 2002, we have also received $10.0 million in loans from Biogen to fund part of our share of the related development costs, of which $9.0 million has been forgiven upon the achievement of certain objectives. Some or all future loans, of up to an additional $10.0 million as of December 31, 2002, may also be forgiven upon the achievement of further development milestones.

      In June 2000, ICOS and Texas Biotechnology formed ICOS-Texas Biotechnology L.P. (“ICOS-TBC”), a 50/50-owned limited partnership, to develop and commercialize endothelin receptor antagonists, such as sitaxsentan. Under the terms of this arrangement, ICOS and Texas Biotechnology equally funded the development of endothelin receptor antagonists and are entitled to equally share in the profits of the partnership. We made an initial $2.0 million payment to Texas Biotechnology upon formation of the partnership and made an additional $2.0 million payment in October 2001. Texas Biotechnology made an initial contribution to ICOS-TBC of an exclusive worldwide license to the intellectual property associated with endothelin receptor antagonists, including patent rights and technical information. ICOS-TBC is managed jointly by Texas Biotechnology and ICOS. Both parties provided the partnership with research and development services. In January 2003, we announced our conclusion that joint development of the endothelin receptor antagonist program, through ICOS-TBC, should not continue. We and Texas Biotechnology are currently negotiating the terms pursuant to which Texas Biotechnology might independently continue the endothelin receptor antagonist program.

      In February 1997, ICOS and Suntory Ltd. (the predecessor to Daiichi Suntory Pharma Co., Ltd.) formed Suncos, a 50/50-owned corporation, to develop and commercialize Pafase® (recombinant human platelet-activating factor acetylhydrolase). The joint venture was established with a $30.0 million cash investment, in Suncos, by Suntory Ltd., and ICOS’ contribution of an exclusive license for Pafase technology. Subsequent capital contributions were made by Suntory Ltd. and ICOS in equal amounts. Both Suntory Ltd. and ICOS provided Suncos with research and development services in support of the Pafase program. In December 2002, the Pafase development program was terminated, after an interim analysis did not demonstrate clinical benefit in a Phase 3 study for severe sepsis. There are no current plans for further development activities by Suncos.

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      In April 1995, we formed a collaboration with Abbott Laboratories to discover small molecule drugs that modulate the intracellular signaling connections of certain intercellular adhesion molecules and integrins. In September 1997, we expanded and extended this relationship to include small molecule antagonists of the extracellular domains of certain integrins and intercellular adhesion molecules. The research program under the collaboration, which provided us with research funding from Abbott Laboratories, was completed at the end of its term on April 1, 1999. Under the terms of the arrangement, each company received exclusive development and commercialization rights to drugs relating to specific molecular targets with royalties and milestone obligations to the other party. Each party was responsible for the development, registration and commercialization of its own product candidates. In addition, the collaboration provided us with a library of chemical compounds for use in our own discovery programs. In June 2000, we amended the arrangement by acquiring Abbott Laboratories’ worldwide rights to all compounds developed in connection with the collaboration, including LFA-1 antagonists such as IC747. Abbott Laboratories will receive royalties and milestone payments on any products that we market that incorporate these compounds.

      We have also entered into collaborative arrangements regarding the following product candidates:

	•	IC14. We have entered into a sublicensing arrangement with Johnson & Johnson and The Rockefeller University under which technology relating to IC14, developed by Dr. Richard Ulevitch at The Scripps Clinic and Research Foundation and Dr. Samuel Wright at The Rockefeller University, was sublicensed to us. Under this arrangement, we received a sublicense to the intellectual property relating to IC14 in exchange for royalty and future milestone payments based on development of this product candidate. We have exclusive rights to a portfolio of patents for the production and commercialization of IC14.
	•	RTX. We have entered into a licensing agreement with Afferon Corporation related to RTX. Under the terms of this agreement, we have exclusive worldwide license rights for commercial use of RTX for the treatment of bladder disease or function. We are responsible for the costs of developing and commercializing RTX and related analogues. Afferon receives certain periodic payments and is entitled to future success-based milestone payments and royalties upon sales of marketed products, if any, resulting from this arrangement.
	•	IC485. We have entered into a research and development arrangement with Array BioPharma Inc. relating to IC485. Under this arrangement, we funded the medicinal chemistry performed by Array relating to IC485. We received either an assignment of, or a license to, any and all intellectual property developed by Array relating to IC485 in exchange for future milestone payments based on development of this product candidate. We have exclusive rights to the worldwide production and commercialization of IC485.
	•	Cell cycle checkpoint/ DNA repair inhibitors. We have entered into a research and development arrangement with Array relating to multiple research targets, including cell cycle checkpoint/ DNA repair inhibitors. Under this arrangement, we fund the medicinal chemistry performed by Array relating to the targets. We receive either an assignment of, or a license to, any and all intellectual property developed by Array, in exchange for future milestone payments based on the development of any product candidates that may arise from this arrangement. In addition, we have exclusive rights to the worldwide production and commercialization of any product candidates developed under this arrangement.
	•	IDAS targeted product candidates. We have entered into an additional research and development agreement with Array relating to two research targets which contain an IDAS structural feature related to, but distinct from, that found in the cell adhesion molecule LFA-1, the target of IC747. Under the terms of this agreement, we will provide Array with research funding and both parties will collaborate in all aspects of lead generation and lead optimization. We will be responsible for clinical development

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		and commercialization. We have exclusive rights to market, sell and distribute products that may arise from this arrangement. Array is entitled to receive success-based payments upon reaching certain development milestones and royalties based upon sales of products resulting from the collaboration.
	•	Chemokine receptor 5 (“CCR5”). We have entered into a licensing agreement with Euroscreen S.A. related to CCR5. Under the terms of this agreement, we granted Euroscreen an exclusive license for key patents relating to the human CCR5 receptor and its role in HIV infection. We received an upfront payment in January 2003 and are entitled to future milestone and potential royalty payments upon commercialization of the licensed technology.

      In addition, we have entered, and may continue to enter, into licensing agreements and research collaborations with institutions and scientists to expand our access to new scientific developments, technologies and discoveries in certain areas. We have contracted with several academic and institutional collaborators to conduct research and development activities relating to our product candidates. We have also entered into licensing agreements with respect to specific technologies. These arrangements generally provide that we will fund either the research or development of the technology, or both, and will obtain an exclusive license or option to the technology developed, subject to certain royalty and other obligations.

Patents and Proprietary Rights

      Because of the length of time and expense associated with bringing new products through development and the governmental approval process to the marketplace, pharmaceutical and biotechnology companies have traditionally placed considerable importance on obtaining and maintaining patent protection for significant new technologies, products and processes. We have applied, and are applying, for patents for our product candidates and aspects of our technologies both in the U.S. and, when appropriate, in other countries. Our ability, however, to obtain patents in a timely manner, if at all, in foreign countries may be limited by the laws of some of those countries. For example, many countries, including several European countries, allow for an opposition period, often lasting many months, after a patent is granted, providing third parties with the opportunity to submit arguments that may call for the withdrawal of or limitations on the affected patents.

      Even if we are granted patents by government authorities, the validity and enforceability of patents issued to pharmaceutical and biotechnology companies has proven highly uncertain. For example, legal considerations surrounding the validity of patents in the fields of pharmaceuticals and biotechnology are in transition, and we cannot assure you that the historical legal standards surrounding questions of validity will continue to be applied or that current defenses relating to issued patents in these fields will, in fact, be considered sufficient in the future. In addition, we cannot assure you as to the degree and range of protections any of our patents may afford us, whether patents will be issued or the extent to which we will be successful in avoiding infringement of patents granted to others. For example, patents which have already been issued to us may be subjected to further governmental review that may ultimately result in the reduction of their scope of protection, and pending patent applications may have their requested breadth of protection significantly limited before being issued, if issued at all. Furthermore, since publication of discoveries in scientific or patent literature often lags behind actual discoveries, we cannot assure you that we were the first creator of inventions covered by our patents or pending patent applications, or that we were the first to file patent applications for these inventions. In addition, after seeking advice of counsel, we may undertake research and development with respect to potential products, even when we are aware of third party patents that may be relevant to these potential products, on the basis that such patents may be challenged or licensed by us. If our subsequent challenges to or attempts to license such patents were to prove unsuccessful, we may not be able to commercialize our potential products after having incurred significant expenditures, and may be subject to patent infringement claims. Under U.S. federal law, companies are protected against claims of infringement for using technology patented by others in clinical trials. Accordingly, we cannot assure you that the absence of litigation with respect to our product candidates in clinical development is an indication that our commercially marketed products will not be found to infringe the patent rights of others.

      Many pharmaceutical and biotechnology companies and university and research institutions have filed patent applications or already have received patents in our areas of product development. Many of these

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      In connection with the treatment of erectile dysfunction, our principal competitor, Pfizer Inc., has been granted a number of U.S. and foreign patents. On October 22, 2002, the U.S. Patent and Trademark Office issued to Pfizer a “method of use” patent (US6469012). Later that day, Pfizer filed a lawsuit in the United States District Court for the District of Delaware against ICOS, Lilly, and Lilly ICOS alleging that the proposed marketing of product candidate Cialis would infringe this patent. We believe that Pfizer’s suit lacks merit and intend to vigorously pursue our defenses. If Pfizer were to prevail, however, we might be subject to substantial damages, prohibited from marketing Cialis for the treatment of erectile dysfunction in the United States, or required to enter into a licensing agreement to market Cialis in the United States. We cannot assure you that any required agreement would be available on commercially reasonable terms, if at all.

      On March 11, 1998, the European Patent Office granted Pfizer a similar patent (EP702555). We, Lilly, and eleven other companies successfully opposed this patent before the Opposition Division of the European Patent Office which, on July 18, 2001, revoked all the claims. Pfizer has appealed this decision. Pfizer’s European Patent had been nationalized by Pfizer in most European countries. Lilly ICOS brought suits challenging the patent in a number of these countries. On November 8, 2000, in the United Kingdom, the High Court of Justice, Chancery Division, Patents Court issued a judgment that the Pfizer patent claims are invalid for obviousness. Pfizer appealed and on January 23, 2002, the Supreme Court of Judicature, Court of Appeals affirmed. No further appeal is available to Pfizer in the United Kingdom. In other European Countries, Lilly ICOS’ suits have been stayed pending the appellate decision in the opposition proceeding before the European Patent Office. The resolution of the European Patent Office appeal and pending or subsequent litigation in the various European countries could take years. If Pfizer’s patent were ultimately reinstated by the European Patent Office or the courts in European countries, we might be subject to litigation by Pfizer in Europe, prohibited from marketing Cialis for the treatment of erectile dysfunction in some European countries, or required to enter into licensing agreements to market Cialis in Europe. We cannot assure you that such agreements would be available on commercially reasonable terms, if at all.

      While we pursue patent protection and enforcement of our product candidates and aspects of our technologies when appropriate, we also rely on trade secrets, know-how and continuing technological advancement to develop and maintain our competitive position. To protect this competitive position, we regularly enter into confidentiality and proprietary information agreements with third parties, including employees, suppliers and collaborators. Our Company employment policy requires each new employee to enter into an agreement that contains provisions generally prohibiting the disclosure of confidential information to anyone outside of the Company and providing that any invention conceived by an employee within the scope of his employment duties is the exclusive property of ICOS. Furthermore, our know-how that is accessed by third parties through collaborations and research and development contracts and through our relationships with scientific consultants is generally protected through confidentiality agreements with the appropriate parties. We cannot, however, assure you that these protective arrangements will be honored by third parties, including employees, suppliers and collaborators, or that these arrangements will effectively protect our rights relating to unpatented proprietary information, trade secrets and know-how. In addition, we cannot assure you that other parties will not independently develop substantially equivalent proprietary information and techniques or otherwise gain access to our proprietary information and technologies.

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      To protect our rights to our patents and proprietary information, we may need to litigate against infringing third parties, or avail ourselves of the courts or participate in hearings to determine the scope and validity of our patent rights, such as participation in interference proceedings to determine priority of invention. These types of proceedings are often costly and could be very time-consuming to us, and we cannot assure you that the deciding authorities will rule in our favor. An unfavorable decision could allow third parties to use our technology without being required to pay us licensing fees or may compel us to license needed technologies to avoid infringing third party patent and proprietary rights. In addition, we may be required to defend ourselves in patent suits brought by third parties who seek to enjoin our product development efforts or seek damages for infringement. If we receive an unfavorable judgment on any of these claims, we could be forced to, among other things, alter our operations, pay licensing fees or discontinue developing or marketing one or more of our potential products, as well as incur significant legal expenses.

Government Regulation

      Regulation by government authorities in the United States, Europe, and other countries is a significant consideration in the manufacture and marketing of our products and potential product candidates and in our ongoing research and product development activities. Our product candidates will require regulatory approval by government agencies prior to commercialization. Human therapeutic products are subject to rigorous preclinical and clinical testing and other approval requirements by the FDA and comparable agencies in foreign countries. The time required for completing testing and obtaining approvals of our product candidates is uncertain, but often takes several years. Any delay in the approval of testing or in the evaluation of preclinical or clinical results by governmental authorities may hinder product development. In addition, we may encounter delays in product development or rejections of product applications due to changes in FDA or foreign regulatory policies during the period of product development and testing. Various federal, state and foreign statutes and regulations, including the Federal Food, Drug and Cosmetic Act, as amended, and the regulations promulgated thereunder, also regulate the manufacturing, safety, labeling, storage, record keeping, advertising, promotion and marketing of our product candidates, and failure to comply with these legal requirements may subject us to, among other things, civil penalties, criminal prosecution and restrictions on product development and production. The lengthy process of obtaining regulatory approvals and ensuring compliance with appropriate statutes and regulations requires the expenditure of substantial resources. Any delay or failure by us, our joint ventures or our collaborators to obtain regulatory approvals could adversely affect our ability to commercialize our product candidates, receive product, collaborative research or royalty payments and generate sales revenue.

      In general, the steps ordinarily required before a new therapeutic product candidate may be marketed in the United States include:

	•	preclinical laboratory tests, animal tests and formulation studies;
	•	the submission to the FDA of an Investigational New Drug Application, which must become effective before clinical testing may begin in humans;
	•	adequate and well-controlled clinical trials to establish the safety and efficacy of the product candidate for each indication;
	•	the submission of a New Drug Application or Biologics License Application, as the case may be, to the FDA; and
	•	FDA review and approval of a New Drug Application or Biologics License Application, as the case may be, prior to any commercial sale or shipment of the product candidate.

      Preclinical studies generally are conducted in the laboratory to evaluate the potential safety and efficacy of a therapeutic product candidate and are undertaken in compliance with Good Laboratory Practices regulations. The results of these studies are submitted to the FDA as part of an Investigational New Drug Application, which must be reviewed by the FDA before clinical testing may begin in the United States. Once the FDA is satisfied with or does not comment on the submission of the Investigational New Drug Application, clinical trials on humans may begin, although the FDA may put a hold on these trials at any time.

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      Clinical trials are conducted in accordance with Good Clinical Practices regulations at sponsoring institutions under protocols detailing the objectives of the trial, the parameters to be used in monitoring safety and the efficacy criteria to be evaluated. Typically, clinical evaluation involves three sequential phases, which may overlap. During Phase 1, clinical trials are conducted with a relatively small number of subjects to determine the early safety profile of a drug, as well as the pattern of drug distribution and drug metabolism by the subject. In Phase 2, clinical trials are conducted with groups of patients afflicted by a specific target disease to determine preliminary efficacy, optimal dosages and dosage tolerance, and to gather additional safety data. In Phase 3, large-scale, multicenter comparative clinical trials are conducted with patients afflicted with a specific target disease to provide data for the statistical proof of efficacy and safety as required by the FDA and others. The FDA and a clinical trial sponsor may suspend clinical trials at any time if it is believed that clinical subjects are being exposed to an unacceptable health risk.

      The results of preclinical and clinical testing of a product candidate, as well as data relating to a product candidate’s chemistry, pharmacology and manufacture, are required to be submitted to the FDA, in the form of a New Drug Application for small molecule products or a Biologics License Application for biological products, in order to seek FDA approval. FDA approval of the New Drug Application or Biologics License Application is required before marketing of a product may begin in the United States, and the cost of this process may be substantial. In response to a New Drug Application or Biologics License Application, the FDA may grant marketing approval, request additional information or deny the application if the FDA determines that the application does not satisfy its regulatory approval criteria, including the pre-approval of relevant product manufacturing facilities. No action can be taken to market any new drug or biologic product in the United States until an appropriate marketing application has been approved by the FDA. The failure to obtain timely permission for clinical testing or timely regulatory approval for product marketing could materially affect us. Furthermore, following approval, the FDA may require additional testing and surveillance programs to monitor the side effects or adverse events associated with use of a new product. The FDA may prevent or limit future marketing of a product based on the results of these post-marketing programs. Additional testing is also required to gain approval for the use of a product as a treatment for indications other than those already approved.

      In addition, some of our product candidates may qualify as orphan drugs under the Orphan Drug Act of 1983. This act generally provides incentives to manufacturers to undertake development and marketing of products to treat relatively rare diseases or those diseases that would likely affect fewer than 200,000 persons annually in the United States. A drug that receives orphan drug designation by the FDA, and is the first product to receive FDA marketing approval for its product claim, is entitled to various advantages, including a seven-year exclusive marketing period in the United States for that product claim. However, any drug that is considered by the FDA to be different from a particular orphan drug, including any orphan drug of ours that has been so designated by the FDA, is not precluded from sale in the United States during the seven-year exclusive marketing period. We cannot assure you that any of our product candidates will be designated as an orphan drug by the FDA or, if so designated, will have a positive effect on our revenues.

      In order to manufacture our potential products, a domestic drug manufacturing facility must be registered with the FDA as a domestic drug manufacturing establishment, must submit to periodic inspection by the FDA and must comply with current Good Manufacturing Practices regulations. In addition, to supply products for use in the United States, foreign manufacturing establishments must comply with these regulations and are subject to periodic inspection by the FDA or corresponding regulatory agencies in countries under reciprocal agreements with the FDA.

      Whether or not FDA approval has been obtained, approval of a product by comparable regulatory authorities may be necessary in foreign countries prior to the commencement of marketing of a product in those countries. The approval procedures vary among countries and can involve additional testing. The time required to obtain approval may differ from that required for FDA approval. Although there are some procedures for unified filings in some countries, including some in Europe, in general each country has its own procedures and requirements, many of which may be expensive and time-consuming. Accordingly, there may be substantial delays in obtaining required approvals from foreign regulatory authorities after the relevant applications are filed, if we ultimately receive any approvals at all.

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      In the event that one of our product candidates is approved for sale in the United States, we will also be subject to various federal and state laws pertaining to health care “fraud and abuse,” including anti-kickback laws and false claims laws. Anti-kickback laws make it illegal for a prescription drug manufacturer to solicit, offer, receive, or pay any remuneration in exchange for, or to induce, the referral of business, including the purchase or prescription of a particular drug. The federal government has published regulations that identify exemptions or “safe harbors” for certain payment arrangements that do not violate the anti-kickback statutes. Due to the breadth of the statutory provisions and the absence of guidance in the form of regulations or court decisions addressing certain practices, it is possible that our future practices might be challenged under anti-kickback or similar laws. False claims laws prohibit anyone from knowingly and willingly presenting, or causing to be presented for payment to third party payors (including Medicare and Medicaid) claims for reimbursed drugs or services that are false or fraudulent, claims for items or services not provided as claimed, or claims for medically unnecessary items or services. In the event that one of our product candidates is approved for sale in the United States and is subject to reimbursement by third party payors, our future activities relating to the sale and marketing of our products may be subject to scrutiny under these laws. Violations of fraud and abuse laws may be punishable by criminal and/or civil sanctions, including fines and civil monetary penalties, as well as the possibility of exclusion from federal health care programs (including Medicare and Medicaid). If the government were to allege against or convict ICOS of violating these laws, there could be a material adverse effect on us, including our stock price. Our future activities could be subject to challenge for the reasons discussed above and due to the broad scope of these laws and the increasing attention being given to them by law enforcement authorities.

      Our policy is to conduct our research activities in compliance with the National Institute of Health Guidelines for Research Involving Recombinant DNA Molecules. We are also subject to various federal, state and local laws, regulations and recommendations relating to safe working conditions, laboratory and manufacturing practices, the experimental use of animals, and the use and disposal of hazardous or potentially hazardous substances, including radioactive compounds and infectious disease agents, used in connection with our work. The extent and character of government regulation that might result from future legislation or administrative action, including additions or changes to environmental laws, cannot be accurately predicted and may materially affect our business operations and revenues. Additionally, our present and future business is and will continue to be subject to various other forms of governmental regulation.

Competition

      Competition in the pharmaceutical and biotechnology industries is intense and characterized by rapid technological development. We expect that our product candidates will encounter significant competition. A number of pharmaceutical and biotechnology companies are currently developing products targeting the same diseases and medical conditions that we target, and some of our competitors’ products have entered clinical trials or are already commercially available. For example, Pfizer has already successfully commercialized Viagra, a competitor of our product candidate Cialis. Bayer AG has filed a New Drug Application with the FDA seeking approval for a PDE5 inhibitor, to be marketed in partnership with GlaxoSmithKline, for the treatment of erectile dysfunction. Additionally, Bayer AG recently received marketing approval from the European Commission for that PDE5 inhibitor for the treatment of erectile dysfunction. Genentech, Inc. and XOMA Ltd. have demonstrated the efficacy of an injectable LFA-1 antibody, efalizumab, in Phase 3 clinical trials for psoriasis, with which IC747 would compete. Similarly, Amgen Inc. recently announced positive results in a Phase 3 clinical study for psoriasis with Enbrel® (etanercept), a TNF-alpha inhibitor, for the treatment of moderate to severe plaque psoriasis. RTX, if approved, would compete with both Elmiron, an oral therapy approved for the treatment of interstitial cystitis, and BCG, an intravesical therapy currently in development. Major competitors for IC485 could include cilomilast, roflumilast and other compounds currently under development. In addition, our potential products, if approved and commercialized, will compete against well-established existing therapeutic products that are currently reimbursed by government health administration authorities, private health insurers and health maintenance organizations.

      Our competitors include pharmaceutical companies, biotechnology companies and chemical companies. Furthermore, significant levels of biotechnology research now occur in universities, government agencies and

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      Many of our competitors have substantially more experience, capital, research and development, regulatory, manufacturing, sales, marketing, human and other resources than we do. As a result, they may:

	•	develop products that are safer, more effective or less costly than our products or product candidates, or that render our products or product candidates obsolete;
	•	obtain FDA and other regulatory approvals or reach the market with their products more rapidly than we can, or with labeling claims more favorable than ours, reducing the potential sales of our product candidates;
	•	obtain intellectual property rights that could increase our costs or prevent development or commercialization of our product candidates;
	•	devote greater resources to market or sell their products;
	•	adapt more quickly to new technologies and scientific advances;
	•	initiate or withstand substantial price competition more successfully than we can;
	•	have greater success in recruiting skilled scientific workers from the limited pool of available talent;
	•	more effectively negotiate third party collaborative and licensing arrangements; and
	•	take advantage of acquisition or other opportunities more readily than we can.

      We anticipate that we will face increased competition in the future as new companies enter our markets and as scientific developments surrounding biologic and small molecule therapeutics continue to accelerate. Through research and discoveries, our competitors may render some or all of our product candidates obsolete or unmarketable, and may succeed in developing products that are safer and more effective than our potential products. Furthermore, even if our product candidates prove superior to the products of our competitors, our business could suffer as a result of collaboration partners independently developing competing products through the use of product candidates we licensed to them or developed through our collaborations.

      We believe the principal competitive factors affecting our markets are the timing and scope of regulatory approvals, safety and efficacy of therapeutic products, cost and availability of these products, availability of alternative treatments, third party reimbursement programs and patent and proprietary rights protection. Although we believe that we are well positioned to compete adequately with respect to these factors in the future, our future success is currently difficult to predict because Cialis was only recently made available in Europe and all of our product candidates are still in various stages of development and are subject to substantial regulatory approval and commercialization risks.

Manufacturing

      We have been manufacturing recombinant protein-based clinical materials in our production facilities in Bothell, Washington, a suburb of Seattle, to support our clinical trials since 1993. Our current facilities are capable of utilizing both microbial- and mammalian-based production processes and were designed to meet the FDA requirements for the production of purified recombinant protein bulk product. We currently produce bulk product for our product candidate IC14 at our production facilities. Vialing and other finishing steps in the manufacturing processes of IC14 are completed under contracts with third parties. We also manufacture purified recombinant protein bulk product for third parties pursuant to contractual arrangements and may enter into additional arrangements in the future.

      We currently do not have facilities to produce small molecule drugs. Cialis is currently manufactured under contract by Lilly in the United Kingdom. We have established relationships with third party

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Marketing and Sales

      We have begun the development of a marketing and sales infrastructure by recruiting several individuals experienced in these functions from larger pharmaceutical and biotechnology companies. Currently, we have employees with significant commercial experience in marketing and sales from major pharmaceutical companies who will oversee the development of this infrastructure.

      Our marketing professionals are also focused on other product candidates at earlier stages of development within ICOS. As these products advance in development, the commitment of marketing resources will increase. In this regard, the launch of Cialis will provide opportunities for our marketing professionals to develop further skills and experience prior to assuming marketing responsibilities for future product launches.

      In addition to our own marketing and sales force, we may promote our potential products with marketing partners. We also may rely on relationships with one or more companies with established distribution systems and direct sales forces to distribute and sell our potential products, including our collaboration partners. For example, the marketing of Cialis in the United States and Europe will be managed by teams made up of employees of ICOS and Lilly, our joint venture partner for this product. We plan to build a sales force that, together with Lilly, will co-promote Cialis. Costs of marketing and selling Cialis in Europe and North America will be charged to Lilly ICOS.

Human Resources

      As of December 31, 2002, we employed approximately 525 individuals. Approximately 400 of our employees are engaged in research or development activities and the others are engaged in general, administrative, marketing and sales positions. We consider our employee relations to be good. We have never had a work stoppage, and none of our employees are represented under a collective bargaining agreement. We believe that our future success is dependent in part on our ability to attract, integrate and retain skilled scientific, sales and marketing, and other professional and senior management personnel. Competition in our industry for these skilled workers is intense, and we cannot assure you that we will be able to attract, integrate and retain these personnel.

Important Factors Regarding Forward-Looking Statements

      This report contains forward-looking statements. These statements relate to future events or our future financial performance. In some cases, you can identify forward-looking statements by terminology such as “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “might,” “plan,” “possible,” “potential,” “predict,” “should” or “will” or the negative of such terms or other comparable terminology. Forward-looking statements are only predictions that provide our current expectations or forecasts of future events. In particular, forward-looking statements include:

	•	information concerning possible or assumed future results of operations, trends in financial results and business plans;
	•	statements about our product development schedule;
	•	statements about our expectations for regulatory approvals for any of our product candidates;

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	•	statements about our potential or prospects for future product sales;
	•	statements about the level of our costs and operating expenses relative to our revenues, and about the expected composition of our revenues;
	•	statements about our future capital requirements and the sufficiency of our cash, cash equivalents, investments and other financing proceeds to meet these requirements;
	•	statements about the outcome of contingencies such as legal proceedings;
	•	other statements about our plans, objectives, expectations and intentions; and
	•	other statements that are not historical fact.

      From time to time, we also may provide oral or written forward-looking statements in other materials we release to the public. Any or all of our forward-looking statements in this report and in any other public statements that we make may turn out to be wrong. Inaccurate assumptions we might make and known and unknown risks, uncertainties and other factors may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, performance or achievements. You should not place undue reliance on these forward-looking statements.

      We undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise. You are advised, however, to consult any further disclosures we make on related subjects in our Quarterly Reports on Form 10-Q and Current Reports on Form 8-K. Also note that we provide a cautionary discussion of risks, uncertainties and possibly inaccurate assumptions relevant to our business under the caption Risk Factors in this report. These are risks that we think could cause our actual results to differ materially from expected or historical results.

Risk Factors

      ICOS operates in an environment that involves a number of risks and uncertainties. The risks and uncertainties described below are not the only risks and uncertainties we face. Additional risks and uncertainties not presently known to us or that we currently deem immaterial also may impair our business operations. If any of the following risks actually occur, our business, results of operations and financial condition would suffer. The risks discussed below also include forward-looking statements, and our actual results may differ substantially from those discussed in these forward-looking statements.

      We have incurred significant operating losses since we began operations in September 1990. As of December 31, 2002, we had an accumulated deficit of $464.0 million. Development work for Lilly ICOS’ anticipated U.S. approval of Cialis continues. Sales of Cialis in Europe, which will be reported by Lilly ICOS, did not begin until late January 2003. ICOS has never reported revenues from the sale of approved pharmaceutical products. Our operating losses have been increasing during the past several years and are expected to increase in 2003 and, possibly, thereafter, as we attempt to complete development of our potential products, obtain necessary regulatory approvals and manufacture and market these product candidates. We expect to incur substantial marketing and other costs related to commercializing Cialis in Europe and if we are able to complete development and obtain regulatory approval for this product candidate in the United States. Even if we do successfully develop products that can be marketed, we or our collaboration entities will need to generate significant revenues from those products to achieve and maintain profitability. We currently do not expect to achieve profitability for at least two-to-three years. Even if we do become profitable, we cannot assure you that we would be able to sustain or increase profitability on a quarterly or annual basis.

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      Our operating results have fluctuated in the past and are likely to continue to do so in the future. Our revenue is unpredictable and may fluctuate due to many factors, some of which we cannot control. For example, factors affecting our revenue presently or in the future could include:

	•	the timing of non-recurring licensing fees;
	•	reimbursements earned by us for manufacturing services;
	•	achievement of milestones under new and existing licensing and collaborative agreements;
	•	timing and success of product launches;
	•	lower than expected demand for our products;
	•	changes in wholesaler buying patterns;
	•	changes in reimbursement rates;
	•	government regulation;
	•	changes in physician prescribing habits;
	•	increased competition for new or existing products;
	•	fluctuations in foreign currency exchange rates; and
	•	changes in our product pricing strategies.

      Revenue historically recognized under our prior collaborative agreements may not be an indicator of revenue from any future collaborations. In addition, our expenses are unpredictable and may fluctuate from quarter to quarter due to the timing of expenses, which may include payments owed by us under licensing or collaborative arrangements. We believe that quarter-to-quarter comparisons of our operating results are not a good indicator of our future performance and should not be relied upon to predict the future performance of our stock price.

      It is possible that, in the future, our operating results in a particular quarter or quarters will not meet the expectations of securities analysts or investors, causing the market price of our common stock to decline. In the past, some companies that have experienced decreases in the market price of their stock have been subject to securities class action litigation. A securities class action lawsuit against us could result in substantial damages, costs and a diversion of our management’s attention and resources.

      Successful development of pharmaceutical and biotechnology products is highly uncertain, and very few research and development projects produce a commercial product. Any failure or substantial delay in completing clinical trials for our product candidates may severely harm our business. Before obtaining regulatory approval for the sale of any of our potential products, we must subject these product candidates to extensive preclinical and clinical testing to demonstrate their safety and efficacy for humans. Clinical trials are expensive, time-consuming and may take years to complete. We may not complete clinical trials of product candidates under development, and the results of the trials may fail to demonstrate the safety or efficacy of such product candidates to the extent necessary to obtain regulatory approvals or to make commercialization of the product candidates worthwhile. At any time during these clinical trials, factors such as ineffectiveness of the product candidate, discovery of unacceptable toxicities or side effects, development of disease resistance or other physiological factors, or delays in patient enrollment could cause us to interrupt, limit, delay or abort the development of these product candidates.

      In addition, success in preclinical and early clinical trials does not ensure that late-stage or large-scale trials will be successful. Many companies in the pharmaceutical and biotechnology industries, including us,

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      We may at times elect to use aggressive clinical strategies to advance product candidates through clinical development as rapidly as possible. For example, we may commence clinical trials without conducting preclinical animal efficacy testing, or we may conduct late-stage trials based on limited early-stage data. As a result, we anticipate that only some of our product candidates may show safety and efficacy in clinical trials and many may encounter difficulties or delays during clinical development.

      Any failure to receive the regulatory approvals necessary to commercialize our product candidates, in particular Cialis, could cause our business to fail. Our product candidates are subject to extensive and rigorous government regulation. For example, the United States Food and Drug Administration, or FDA, regulates, among other things, the development, testing, manufacture, safety, efficacy, recordkeeping, labeling, storage, approval, advertising, promotion, sale and distribution of pharmaceutical products. Our products marketed abroad are also subject to extensive regulation by foreign governments. None of our product candidates has been approved for sale in the United States, and only Cialis has been approved outside of the U.S. In addition, we have only limited experience in filing and pursuing applications necessary to gain regulatory approvals, which may impede our ability to obtain such approvals.

      The regulatory review and approval process, which includes preclinical studies and clinical trials of each product candidate, is lengthy, expensive and uncertain. Securing FDA approval requires the submission of extensive preclinical and clinical data and supporting information to the FDA for each indication to establish the product candidate’s safety and efficacy. The approval process may take many years to complete and may involve ongoing requirements for post-marketing studies. Any FDA or other regulatory approval of our product candidates, once obtained, may be withdrawn. The effect of government regulation may be to:

	•	delay marketing of potential products for a considerable period of time;
	•	limit the indicated uses for which potential products may be marketed;
	•	impose costly requirements on our activities; and
	•	provide competitive advantage to other pharmaceutical and biotechnology companies.

      In addition, regulatory compliance may prevent us from introducing new or improved products or may require us to stop marketing potential products. If we fail to comply with the laws and regulations pertaining to our business, we may be subject to sanctions, including the temporary or permanent suspension of operations, product recalls, marketing restrictions and civil and criminal penalties.

      In June 2001, Lilly ICOS submitted a New Drug Application for Cialis for the treatment of erectile dysfunction to the FDA and, in April 2002, received an “approvable” letter from the FDA. The letter indicated that FDA approval for Cialis is conditional upon completion of additional pharmacology studies, labeling discussions and manufacturing inspections. If the FDA finds that the additional required data are insufficient or is unsatisfied with the manufacturing inspections, the FDA could require corrective action or additional data, which could further delay or prevent approval. For example, the FDA could require additional studies for Cialis which could require clinical testing in significantly more patients. These additional studies could take years and require significant resources.

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      We currently have limited direct sales and marketing capabilities. We anticipate relying on others to market and sell some of our primary product candidates. For example, we have entered into an agreement with Lilly to co-promote Cialis in North America and Europe. Lilly ICOS began European promotion of Cialis in late 2002, following receipt of marketing authorization from the European Commission. Lilly is expected to provide the majority of the sales and marketing resources to Lilly ICOS. Because we expect to market or co-market our potential products through a direct sales force, we will need to either hire a sales force with expertise in pharmaceutical sales or contract with a third party to provide a sales force to meet our needs. We may be unable to establish marketing, sales and distribution capabilities necessary to commercialize and gain market acceptance for our potential products. In addition, co-promotion or other marketing arrangements with others to commercialize potential products could significantly limit the revenues we derive from these potential products, and these parties may fail to commercialize our potential products successfully.

      Through Lilly ICOS, we and Lilly have joint responsibility for the promotion, sale and distribution of Cialis in North America and Europe. In addition, Lilly has promotion, sales and distribution rights to Cialis for the other parts of the world with royalties to be paid to Lilly ICOS. As a company, ICOS has no experience in the sale or marketing of pharmaceutical products and has only recently hired an experienced sales and marketing staff. We believe that, for Cialis to be widely adopted, the efforts of a sizeable, experienced pharmaceutical sales force are needed. If Lilly fails to devote appropriate resources to promote, sell and distribute Cialis, sales of Cialis could be reduced. In addition, if Lilly breaches or terminates its agreement with us, or otherwise fails to conduct its Cialis-related activities in a timely manner, sales of Cialis could be delayed, reduced or become substantially more costly for us to achieve.

      We do not have facilities to manufacture small molecule product candidates, such as Cialis, and we do not have sufficient manufacturing capacity to manufacture our biological product candidates in quantities necessary for commercial sale. In addition, our manufacturing capacity may be inadequate to complete all clinical trials contemplated by us over time. We intend to rely significantly on contract manufacturers, including our collaboration partners, to produce large quantities of drug material needed for clinical trials and commercialization of our potential products. We will have to depend on these manufacturers to deliver materials on a timely basis and to comply with regulatory requirements, including Good Manufacturing Practices regulations enforced by the FDA through its facilities inspection program. Contract manufacturers may not be able to meet our needs with respect to timing, quantity or quality of materials, and may fail to satisfy applicable regulatory requirements with respect to the manufacture of these materials. If we are unable to contract for a sufficient supply of needed materials on acceptable terms, or if we should encounter delays or difficulties in our relationships with manufacturers, our revenues and potential profitability may be lower. For example, our ability to satisfy demand for our products could be reduced, which could adversely affect our operating results. Further, our clinical trials may be delayed, thereby delaying the submission of product candidates for regulatory approval and the market introduction and subsequent commercialization of our potential products.

      Manufacturing product candidates in compliance with regulatory requirements is complex, time-consuming and expensive. If we make changes in our manufacturing processes, the FDA and corresponding foreign authorities may require us to demonstrate that the changes have not caused the resulting drug material to differ significantly from the drug material previously produced. Also, we may want to rely on results of prior preclinical studies and clinical trials performed using the previously produced drug material. Depending on the type and degree of differences between the newer and older drug material, we may be required to conduct additional animal studies or human clinical trials to demonstrate that the newly produced drug material is

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      We may develop our manufacturing capacity in part by expanding our current facilities or building new facilities. Either of these activities would require substantial additional funds, and we would need to hire and train significant numbers of employees to staff these facilities. We may not be able to develop manufacturing facilities that are sufficient to produce drug material for clinical trials or commercial use. Moreover, we and any contract manufacturers that we may use must continually adhere to current Good Manufacturing Practices regulations. If our facilities or the facilities of contract manufacturers cannot pass a pre-approval plant inspection, the FDA pre-market approval of our product candidates will not be granted. In complying with these regulations and foreign regulatory requirements, we and any of our contract manufacturers will be obligated to expend time, money and effort in production, recordkeeping and quality control to assure that our potential products meet applicable specifications and other requirements. If we or any of our contract manufacturers fail to comply with these requirements, we may be subject to regulatory sanctions.

      It is expected that Cialis will be manufactured by Lilly for sale in all markets where regulatory approval has been granted. Recently, Lilly has had a number of regulatory issues with its manufacturing facilities. In early 2001, as a result of preapproval plant inspections for certain of its products, the FDA issued a warning letter to Lilly regarding their U.S. manufacturing practices. In November 2001, following a reinspection of their manufacturing facilities, the FDA noted additional observations. In the spring of 2002, the FDA conducted a comprehensive review of eight of Lilly’s global manufacturing sites and a number of observations were noted. Lilly has stated that it has provided the FDA with responses to the observations, and has been meeting with senior FDA officials to discuss the Agency’s priority issues and expectations as well as Lilly’s comprehensive action plan. The FDA has not yet issued its final conclusions and recommendations. Lilly has stated that it continues to work to resolve issues related to their manufacturing operations and expects to be prepared for a reinspection by the FDA during the first half of 2003. Lilly has informed us that the FDA approval of Cialis and availability of Cialis for the U.S. market is not expected to be affected by Lilly’s manufacturing issues. However, we can give no assurances as to what future actions the FDA may take with regard to the manufacturing of Cialis, and we cannot be certain that Lilly’s outstanding manufacturing issues will not impact the anticipated approval or sale of Cialis in the U.S.

      We depend on outside vendors for the timely supply of raw materials used to conduct preclinical testing and clinical trials of product candidates. Once a supplier’s materials have been selected for use in our manufacturing process, the supplier in effect becomes a sole or limited source of that raw material due to regulatory compliance procedures. Presently, Lilly is the sole, authorized provider of the active pharmaceutical ingredient (“API”) utilized in the manufacture of Cialis, and all API production for Cialis is conducted at a single Lilly facility. Lilly relies on a third-party vendor who has the exclusive rights to mill the API to conform the drug substance to specifications used in the manufacturing process. Once milled, the refined API is shipped to a different Lilly location, where the drug substance is manufactured into tablets, packaged, and made ready for sale. At each of these stages in the manufacturing process, Lilly ICOS depends on an exclusive provider (i.e. Lilly or another vendor) for the timely supply and production of raw materials. If any of these suppliers, or production facilities, were to cease production or otherwise fail to supply Lilly ICOS with quality raw materials or manufacturing services in a timely manner, Lilly ICOS and ICOS could be materially impacted. Similar risks exist with respect to raw materials used in the testing and development of our other product candidates.

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      The markets in which we compete are well established, and intensely competitive. We may be unable to compete successfully against our current and future competitors. Our failure to compete successfully may result in pricing reductions, reduced gross margins, failure to achieve market acceptance for our potential products and inability to achieve profitability.

      Our potential products, if approved and commercialized, will compete against well-established existing therapeutic products or treatments, many of which are currently reimbursed by government health administration authorities, private health insurers and health maintenance organizations. In addition, a number of pharmaceutical and biotechnology companies are currently developing products targeting the same diseases and medical conditions that we target. For example, Pfizer has already successfully commercialized Viagra, a competitor of our product candidate Cialis. Also, Bayer AG recently received marketing approval from the European Commission, and has received an “approvable” letter from the FDA, for a PDE5 inhibitor for the treatment of erectile dysfunction.

      Our competitors include pharmaceutical companies, biotechnology companies, chemical companies, academic and research institutions and government agencies. Many of these organizations have substantially more experience and more capital, research and development, regulatory, manufacturing, sales, marketing, human and other resources than we do. Furthermore, large pharmaceutical companies recently have been consolidating, which has increased their resources and concentrated valuable intellectual property assets. As a result, they may:

	•	develop products that are safer, more effective or less costly than any of our current or future products or that render our products obsolete;
	•	obtain FDA and other regulatory approvals or reach the market with their products more rapidly than we can or with labeling claims more favorable than ours, reducing the potential sales of our product candidates;
	•	obtain intellectual property rights that could increase our costs or prevent development or commercialization of our product candidates;
	•	devote greater resources to market or sell their products;
	•	adapt more quickly to new technologies and scientific advances;
	•	initiate or withstand substantial price competition more successfully than we can;
	•	have greater success in recruiting skilled workers from the limited pool of available talent;
	•	more effectively negotiate third party licensing and collaborative arrangements; and
	•	take advantage of acquisition or other opportunities more readily than we can.

      We face, and will continue to face, intense competition from other companies for collaborative arrangements with pharmaceutical and biotechnology companies, for relationships with academic and research institutions, and for licenses to proprietary technology. In addition, we anticipate that we will face increased competition in the future as new companies enter our markets and as scientific developments surrounding protein-based and small molecule therapeutics continue to accelerate.

      Our success is dependent in part on our ability and the ability of our collaboration partners to obtain, maintain and enforce patents and other proprietary rights. Patent law relating to the scope of claims in the biotechnology field in which we operate is still evolving and surrounded by a great deal of uncertainty. Accordingly, we cannot assure you that our pending patent applications will result in issued patents. In addition, we cannot assure you that others have not filed patent applications for technology covered by our

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      In addition, although we own a number of patents, the issuance of a patent is not conclusive as to its validity or enforceability, and third parties may challenge the validity or enforceability of our patents. We cannot assure you how much protection, if any, will be given to our patents if we attempt to enforce them and they are challenged in court or in other proceedings. It is possible that a competitor may successfully challenge our patents or that challenges will result in limitations of their coverage. In addition, the cost of litigation to uphold the validity of patents can be substantial. If we are unsuccessful in such litigation, third parties may be able to use our patented technologies without paying licensing fees or royalties to us.

      Moreover, competitors may infringe our patents or successfully avoid them through design innovation. To prevent infringement or unauthorized use, we may need to file infringement claims, which are expensive and time-consuming. In addition, in an infringement proceeding a court may decide that a patent of ours is not valid or is unenforceable, or may refuse to stop the other party from using the technology at issue on the ground that its technology is not covered by our patents. Policing unauthorized use of our intellectual property is difficult, and we cannot assure you that we will be able to prevent misappropriation of our proprietary rights, particularly in countries where the laws may not protect such rights as fully as in the United States.

      In addition to our patented technology, we also rely on unpatented technology, trade secrets and confidential information. We may not be able to effectively protect our rights to this technology or information. Other parties may independently develop substantially equivalent information and techniques or otherwise gain access to or disclose our technology. We require each of our employees, consultants and corporate partners to execute a confidentiality agreement at the commencement of an employment, consulting or collaborative relationship with us. However, these agreements may not provide effective protection of our technology or information or, in the event of unauthorized use or disclosure, they may not provide adequate remedies.

      Patent litigation is very common in the biopharmaceutical industry. We cannot assure you that third parties will not assert patent or other intellectual property infringement claims against us or our collaboration partners with respect to technologies used in potential products. Any claims that might be brought against us relating to infringement of patents may cause us to incur significant expenses and, if successfully asserted against us, may cause us to pay substantial damages. Even if we were to prevail, any litigation could be costly and time-consuming and could divert the attention of our management and key personnel from our business operations. Furthermore, as a result of a patent infringement suit brought against us or our collaboration partners, we or our collaboration partners may be forced to stop or delay developing, manufacturing or selling potential products that are claimed to infringe a third party’s intellectual property unless that party grants us or our collaboration partners rights to use its intellectual property. We or our collaboration partners may not be able to obtain these rights on commercially reasonable terms, if at all. Even if we or our collaboration partners were able to obtain rights to the third party’s intellectual property, these rights may be non-exclusive, thereby giving our competitors access to the same intellectual property. Ultimately we may be unable to commercialize some of our potential products or may have to cease some of our business operations as a result of patent infringement claims, which could severely harm our business. For example, on October 22, 2002, the U.S. Patent and Trademark Office issued to Pfizer a “method of use” patent (US6469012). Later that day, Pfizer filed a lawsuit in the United States District Court for the District of Delaware against ICOS, Lilly, and Lilly ICOS alleging that the proposed marketing of product candidate Cialis would infringe this patent. We believe that Pfizer’s suit lacks merit and intend to vigorously pursue our defenses. If Pfizer were to prevail, however, we might be subject to substantial damages, prohibited from marketing Cialis for the treatment of erectile dysfunction in the United States, or required to enter into a licensing agreement to market Cialis in the United States. We cannot assure you that any required agreement would be available on commercially reasonable terms, if at all. In the event that we were unable to profitably market Cialis in the U.S., our future

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      Additionally, we may have to resort to costly and time-consuming proceedings and litigation to determine the invalidity or scope of the proprietary rights of others. For example, we, Lilly and eleven other companies were involved in an opposition proceeding in the European Patent Office in which we opposed a patent previously granted by the European Patent Office to Pfizer. This patent (EP702555) is a “method of use” patent similar to the patent (US6469012) subsequently granted to Pfizer in the United States. Although the opposition proceeding was successful before the Opposition Division of the European Patent Office, which on July 18, 2001, revoked all the claims, Pfizer has appealed. Pfizer’s European Patent had been nationalized by Pfizer in most European countries. Lilly ICOS brought suits challenging the patent in a number of these countries. Generally, these cases have been stayed pending the appellate decision in the opposition proceeding before the European Patent Office. The resolution of the European Patent Office appeal and pending or subsequent litigation in the various European countries could take years. If Pfizer’s patent were ultimately reinstated by the European Patent Office or the courts in European countries, we might be subject to litigation by Pfizer in Europe, prohibited from marketing Cialis for the treatment of erectile dysfunction in some European countries, or required to enter into licensing agreements to market Cialis in Europe. We cannot assure you that such agreements would be available on commercially reasonable terms, if at all.

      Furthermore, after seeking advice of counsel, we may undertake research and development with respect to potential products even when we are aware of third-party patents that may be relevant to these potential products, on the basis that such third party patents may be challenged or licensed by us. If our subsequent challenges to such patents were not to prevail, we may be subject to patent infringement claims. In addition, if our subsequent attempts to license such patents were to prove unsuccessful, we may not be able to commercialize these potential products after having incurred significant expenditures.

      Our business does not currently generate the cash needed to finance our operations. We will require substantial financial resources to conduct the time-consuming and costly research, preclinical development, clinical trials, manufacturing, regulatory and marketing activities necessary to commercialize our potential products. We expect to seek additional financing through public or private sources, including equity or debt financings, and through other alternatives, including collaborative arrangements. Poor financial results, unanticipated expenses or unanticipated opportunities that require financial commitments could give rise to additional financing requirements. However, financing may be unavailable when we need it or may not be available on acceptable terms. If we raise additional funds by issuing equity or convertible debt securities, the percentage ownership of our existing stockholders would be reduced, and these securities might have rights superior to those of our common stock. If we are unable to raise additional funds when we need them, we could be required to delay, scale back or eliminate expenditures for some of our development programs or grant rights to third parties to develop and market product candidates that we would prefer to develop and market internally. If we are required to grant such rights, the ultimate value of these product candidates to us may be reduced.

      We have entered into, and we expect to enter into in the future, collaborative arrangements with third parties who provide us with funding and/or who perform research, development, regulatory compliance, manufacturing or marketing activities relating to some or all of our product candidates. If we fail to secure or maintain successful collaborative arrangements, our development and marketing activities may be delayed or reduced. Currently, we have collaborative arrangements with Lilly, Biogen and other companies and research laboratories. We may be unable to negotiate additional collaborative arrangements or, if necessary, modify our existing arrangements on acceptable terms.

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      Our collaborative agreements can be terminated under certain conditions by our partners. In addition, our partners may separately pursue competing products, therapeutic approaches or technologies to develop treatments for the diseases targeted by us or our collaborative efforts. Even if our partners continue their contributions to the collaborative arrangements, they may nevertheless determine not to actively pursue the development or commercialization of any resulting products. Disputes may arise between us and our partners as to a variety of matters, including financing obligations under our agreements and ownership of intellectual property rights. Also, our partners may fail to perform their obligations under the collaborative arrangements or may be slow in performing their obligations. In addition, our partners may experience financial difficulties at any time that could prevent them from having available funds to contribute to these collaborations. In these circumstances, our ability to develop and market potential products could be severely limited.

      We may acquire, merge with or invest in other businesses, products or technologies that are intended to complement our existing business. From time to time, we have had discussions and negotiations with companies regarding business combinations or investing in these companies’ businesses, products or technologies, and we regularly engage in these discussions and negotiations in the ordinary course of our business. Some of our management have limited or no prior experience in assimilating acquired or merged companies. Any acquisitions or investments we complete will likely involve some or all of the following risks:

	•	difficulty of assimilating the new operations and personnel, products or technologies;
	•	commercial failure of the new products;
	•	disruption of our ongoing business;
	•	diversion of resources;
	•	inability of management to maintain uniform standards, controls, procedures and policies;
	•	difficulty of managing our growth and information systems;
	•	reduction in the overall growth rate of the combined organization;
	•	risks of entering markets in which we have little or no prior experience; and
	•	impairment of relationships with employees or customers.

      In addition, future acquisitions, mergers or investments could result in potentially dilutive issuances of equity securities, use of cash or incurrence of debt and assumption of direct and contingent liabilities, any of which could have an adverse effect on our business and operating results or the price of our common stock.

      Provisions of our certificate of incorporation and bylaws will make it more difficult for a third party to acquire us on terms not approved by our board of directors, even if such acquisitions were beneficial to our stockholders, and may have the effect of deterring hostile takeover attempts. For example, our certificate of incorporation currently authorizes our board of directors to issue up to 2,000,000 shares of preferred stock and to fix the price, rights, preferences, privileges and restrictions, including voting rights, of those shares without any further vote or action by the stockholders. The rights of the holders of our common stock will be subject to, and may be harmed by, the rights of the holders of any preferred stock that may be issued in the future. The issuance of preferred stock could reduce the voting power of the holders of our common stock and the likelihood that common stockholders will receive payments upon liquidation. In addition, our certificate of incorporation divides our board of directors into three classes having staggered terms, which would make it more difficult for a potential acquirer to replace our board of directors. We are also subject to provisions of Delaware law that could have the effect of delaying, deferring or preventing a change in control of ICOS. One

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      We are highly dependent on the efforts and abilities of our current management and key technical personnel. Our success will depend in part on retaining the services of our existing management and key personnel and attracting and retaining new highly qualified personnel. Failure to retain our existing key management and technical personnel or to attract additional highly qualified personnel could, among other things:

	•	delay our ongoing discovery research efforts;
	•	delay preclinical or clinical testing of our product candidates;
	•	delay the regulatory approval process;
	•	compromise our ability to negotiate additional collaborative arrangements; or
	•	prevent us from successfully commercializing our product candidates.

      In our field, competition for qualified management and technical personnel is intense. In addition, many of the companies with which we compete for experienced personnel have greater financial and other resources than we do. As a result of these factors, we may be unsuccessful in recruiting and retaining sufficient qualified personnel.

      Our product candidates, even if approved by the FDA or foreign regulatory agencies, may fail to achieve market acceptance, which would impair our ability to become profitable. We believe that market acceptance of our potential products will depend on our ability to provide acceptable evidence of safety, efficacy and limited side effects; our ability to provide these potential products at reasonable prices; and the availability of third party reimbursement for these potential products. In addition, market acceptance depends on the effectiveness of our marketing strategy, and, to date, we have very limited sales and marketing experience or capabilities.

      We are engaged in a field characterized by extensive research efforts and rapid technological development. New drug discoveries and developments in our field and other drug discovery technologies are accelerating. Our competitors may develop technologies and products that are more effective than any we develop or that render our technology and potential products obsolete or noncompetitive. In addition, our potential products could become unmarketable if new industry standards emerge. To be successful, we will need to enhance our product candidates and design, develop and market new product candidates that keep pace with new technological and industry developments.

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      We face an inherent business risk of exposure to product liability claims in the event that the use of our products is alleged to have resulted in harm to others. This risk exists in clinical trials as well as in commercial distribution. In addition, the pharmaceutical and biotechnology industries in general have been subject to significant medical malpractice litigation. We may incur significant liability if product liability or malpractice lawsuits against us are successful. Furthermore, product liability claims, regardless of their merits, could be costly and divert management’s attention from other business concerns, or adversely affect our reputation and the demand for our products. Although we maintain product liability insurance, we cannot be sure that this coverage is adequate or that it will continue to be available to us on acceptable terms.

      Our research and development activities involve the controlled use of chemicals, viruses, radioactive compounds and other hazardous materials. If an accident involving these materials occurs, we could be held liable for any damages that result, and that liability could exceed our resources. We are subject to federal, state and local laws and regulations governing the use, manufacture, storage, handling and disposal of hazardous materials and certain waste products. Although we believe that our operations comply with the standards prescribed by these laws and regulations, we cannot completely eliminate the risk of accidental contamination or injury from these materials.

Available Information

      Our internet address is www.icos.com. We make our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to these reports available free of charge through our internet website. In addition, we will voluntarily provide paper copies of such filings, free of charge, upon request.

Item 2.      Properties

       We lease or own approximately 300,000 square feet of space in seven buildings located in Bothell and Bellevue, Washington. Our leases expire between March 2006 and January 2009, with options to renew for additional four- or five-year periods. Our principal administrative offices, research laboratories and clinical production facility occupy approximately 285,000 square feet. We sublease the remaining 15,000 square feet of space under a lease expiring in 2003. In addition, in December 1992, we purchased approximately 300,000 square feet of undeveloped land adjacent to our main facilities. We believe this property gives us additional flexibility to expand in our current geographic location if our space needs increase in the foreseeable future. Over the next several years, we plan to lease, acquire or build additional facilities to accommodate the activities and personnel necessary to continue the anticipated growth of our business.

Item 3.      Legal Proceedings

       On October 22, 2002, Pfizer Inc., Pfizer Limited, and Pfizer Ireland Pharmaceuticals filed a patent infringement lawsuit against ICOS, Lilly ICOS and Lilly in the United States District Court for the District of Delaware. The complaint alleges that the intended and imminent use, offering for sale, selling, manufacture, or importing into the United States upon FDA approval of Cialis for the treatment of erectile dysfunction by ICOS, Lilly ICOS and Lilly will constitute infringement of plaintiffs’ U.S. Patent No. 6,469,012, which issued on October 22, 2002. The plaintiffs seek a judgment declaring that the defendants’ using, selling, offering for sale, making or importing of Cialis for the treatment of erectile dysfunction will infringe this patent. The plaintiffs also seek a permanent injunction, attorneys’ fees, costs and expenses. On January 6, 2003, we filed an answer denying the central allegations of plaintiffs’ complaint and setting forth various affirmative defenses. Litigation is inherently unpredictable and the eventual outcome in a particular case is impossible to determine in advance. We believe that Pfizer’s suit lacks merit and intend to vigorously pursue

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

       No matters were submitted to a vote of ICOS’ stockholders during the fourth quarter of 2002.

PART II

       Our common stock trades on The Nasdaq National Market under the symbol ICOS. The following table sets forth, for the periods indicated, the high and low sale prices per share of our common stock as reported on The Nasdaq National Market.

As of January 31, 2003, there were approximately 2,183 holders of record of our common stock. Because many of these shares are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of stockholders represented by the record holders.

We have never declared or paid any dividends on our common stock. For the foreseeable future, we intend to retain earnings, if any, for use in the operation and expansion of our business and do not anticipate paying any cash dividends.

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       The following selected consolidated financial data should be read in conjunction with Item 7, Management’s Discussion and Analysis of Results of Operations and Financial Condition, and the consolidated financial statements and related notes included in this Form 10-K for the year ended December 31, 2002.

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Notes to Selected Consolidated Financial Data:

(1)	In the fourth quarter of 2000, we changed our accounting for nonrefundable upfront technology license fees and milestones received, for product candidates where we are providing continuing services related to product development. Upfront technology license fees are deferred and recognized as revenue over the estimated product development periods, based on estimated total future development costs. Milestones are recognized as revenue at the time such payments are due, based on the ratio of cumulative costs incurred to date, to total estimated development costs. Any remaining balance is deferred and recognized as revenue over the estimated remaining product development period. Prior to 2000, milestones were recognized as revenue upon attainment of a specified event, and other nonrefundable technology or licensing fees were recognized as revenue when payment was received. Pro forma amounts give effect to this accounting change as if it occurred prior to January 1, 1998.
(2)	The following tables summarize our revenue from collaborations with related parties and licenses of technology, and equity in losses of affiliates.

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       The following discussion and analysis should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this report. This discussion contains forward-looking statements based on current expectations that are subject to risks and uncertainties, such as statements of our plans, objectives, expectations and intentions. In some cases, you can identify forward-looking statements by terminology such as “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “might,” “plan,” “possible,” “potential,” “predict,” “project,” “should” or “will” or the negative of those terms or comparable terminology. Our actual results and the timing of events could differ materially from those anticipated or implied by the forward-looking statements discussed herein as a result of various factors. Factors that could cause or contribute to such differences include risks associated with clinical development, manufacturing, collaboration arrangements with affiliates and third parties, regulatory approvals, product commercialization, intellectual property claims, litigation and other risks set forth under “Important Factors Regarding Forward-Looking Statements” and “Risk Factors” in Item 1, “Business”, and elsewhere in this Annual Report on Form 10-K. You should not place undue reliance on these forward-looking statements, which speak only as of the date of this report. We undertake no obligation to publicly release the results of any revisions to these forward-looking statements that may be made to reflect events or circumstances after the date of this report or to reflect the occurrence of unanticipated events.

Overview

      ICOS Corporation and subsidiaries, herein collectively referred to as ICOS, is a product-driven company that has expertise in both protein-based and small molecule therapeutics. We combine our capabilities in molecular, cellular and structural biology, high throughput drug screening, medicinal chemistry and gene expression profiling to develop highly innovative products expected to have significant commercial potential. We apply our integrated approach to erectile dysfunction and other urologic disorders, sepsis, psoriasis and other inflammatory diseases. We believe our strategy of targeting multiple therapeutic areas with drugs that act through distinct molecular mechanisms increases our chances of successfully developing commercial products.

      We have established collaborations with pharmaceutical and biotechnology companies to enhance our internal development capabilities and to offset a substantial portion of the financial risk of developing our product candidates. At the same time, we maintain substantial rights to the product candidates covered by

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     Approved Product

     Cialis — European Markets

      In November 2002, Lilly ICOS received approval from the European Commission to market Cialis, for the treatment of erectile dysfunction. Lilly ICOS began shipping Cialis to European wholesalers in January 2003, and Cialis is now available, by prescription, in pharmacies across Europe.

     Product Candidates in Clinical Development

     Cialis

      In June 2001, Lilly ICOS submitted an NDA to the FDA seeking marketing approval of Cialis for the treatment of erectile dysfunction. In April 2002, Lilly ICOS received an “approvable” letter from the FDA indicating the FDA is prepared to approve the application upon the satisfaction of conditions specified in the letter. Those conditions are the successful completion of clinical pharmacology studies, labeling discussions, and successful resolution of matters related to Lilly’s manufacturing facilities. A U.S. regulatory decision for Cialis is projected to occur in the second half of 2003, with product launch anticipated to occur shortly after approval.

      Lilly is pursuing approval of Cialis for the treatment of erectile dysfunction in markets outside of the European Union and North America under an exclusive license from Lilly ICOS. In those countries, Lilly will market Cialis and pay a royalty, equal to 20% of net sales, to Lilly ICOS.

      In addition, Lilly ICOS has initiated a Phase 2 clinical program evaluating tadalafil for the treatment of diabetic gastroparesis.

      In July 2001, we entered into an agreement with Biogen to jointly develop and co-promote IC747 and other LFA-1 antagonists as oral therapeutics for autoimmune and inflammatory diseases. IC747 is an orally administered, small molecule antagonist that we are currently evaluating for the treatment of psoriasis. In the third quarter of 2002, we began a Phase 2 clinical trial evaluating IC747 for patients with psoriasis.

      In November 2001, we acquired exclusive worldwide rights to RTX for the treatment of bladder disease or function. RTX is a small molecule that can be delivered to the bladder to desensitize afferent nerve fibers, which are believed to play a role in many pathological conditions of the bladder. We are initially evaluating RTX as a treatment for interstitial cystitis, a chronic condition often associated with bladder pain, urinary urgency and high frequency of urination, including at night. In January 2003, we began a Phase 2 clinical trial evaluating RTX for patients with interstitial cystitis.

      IC14 is a monoclonal antibody that we are currently evaluating in a Phase 2 clinical trial as a treatment for sepsis resulting from CAP.

      IC485 is an orally administered, small molecule PDE4 inhibitor. We completed Phase 1 clinical trials for IC485 in the third quarter of 2002, and expect to initiate a Phase 2 clinical trial in 2003 for the treatment of chronic obstructive pulmonary disease.

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      Sitaxsentan completed a Phase 2b/3 clinical trial in patients with pulmonary arterial hypertension in the fourth quarter of 2002. In January 2003, we announced our conclusion that joint development of the endothelin receptor antagonist program, through ICOS-TBC, should not continue. We and Texas Biotechnology are currently negotiating the terms pursuant to which Texas Biotechnology might independently continue the endothelin receptor antagonist program.

      In December 2002, the Pafase development program was terminated after an interim analysis did not demonstrate clinical benefit in a Phase 3 study for severe sepsis.

Results of Operations

     Critical Accounting Policies and Estimates

      We recognize revenue from our contracts for research and development services, including those under collaborative agreements (“cost reimbursement revenue”), as the related costs are incurred. Payments received that are related to future performance are deferred and recognized as revenue over the appropriate future performance periods. Nonrefundable upfront technology license fees, for product candidates where we are providing continuing services related to product development, are deferred. We recognize these fees as revenue over the estimated product development periods, based on estimated total future development costs. Milestones earned, in the form of additional license fees, are recognized as revenue at the time such payments are due, based on the ratio of cumulative costs incurred to date, to total estimated development costs. Any remaining balance is deferred and recognized as revenue over the estimated remaining product development period. Contract manufacturing revenue, including fees earned for process development and manufacturing services performed for third parties, is recognized as revenue when services are provided and collectibility is reasonably assured.

      The timing and amount of revenue that we recognize as licenses of technology is dependent upon our estimates of total product development costs as well as the timing of such costs over the estimated development period. As product candidates move through the development process, it is necessary to revise these estimates to consider changes to the products’ development cycle, such as changes in the clinical development plan, regulatory requirements, or various other factors, many of which may be outside of our control. The impact on revenue of changes in our estimates of total product development costs and the timing thereof, is recognized prospectively, over the remaining estimated product development period.

      We recognize our share of the operating results of our unconsolidated affiliates in proportion to our ownership interest in the affiliate and report it as equity in losses of affiliates. Losses relating to our affiliates are recognized only to the extent we have made, or are committed to make, capital contributions to the affiliate. Operating results of our affiliates include expenses related to research, development, marketing and sales services that we provide to them, and that we recognize as cost reimbursement revenue. The amount of our cost reimbursement revenue, and the associated costs, both depend on the continued progression of clinical trial and development activities, the timing and amount of marketing and sales activities, and our level of participation in those activities. A shift of research, development and co-promotional activities among collaboration partners could have a significant impact on our overall operating results to the extent that our negotiated reimbursement rates include indirect and overhead costs that may not vary based on our collaboration activities. Also, a shift of such activities could have a material impact on our costs and expenses and the consequent amount of our cost reimbursement revenue. For example, the shift of development activities from ICOS to our affiliate partner would be expected to result in our reporting lower revenue and lower operating expenses.

      The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial

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      Research and certain clinical trial activities are conducted by various third parties, including contract research organizations, which may also provide contractually defined administration and management services. We recognize expenses for these contracted activities based on a variety of factors, including actual and estimated labor hours, clinical site initiation activities, patient enrollment rates, estimates of external costs, and other activity-based factors. On a regular basis, our estimates of these costs are reconciled to actual invoices from the service providers and adjustments are made accordingly.

     General

      Our results of operations may vary significantly from period to period. Operating results will depend on, among other factors, the timing of expenses, continued funding from our collaboration partners, and the timing and progress of our research, development, marketing and sales activities. We may experience significant fluctuations in cost reimbursement revenue, revenue from licenses of technology and contract manufacturing revenue. Revenue from licenses of technology will vary as a result of the timing of milestone payments and changes in estimated total development costs, which depend on the success of clinical trials and other development efforts. Contract manufacturing revenue may fluctuate depending upon our needs to manufacture our own internal product candidates and our ability to attract third parties to utilize any remaining manufacturing capacity. In addition, significant changes in collaboration activities could cause the amount of affiliate losses to fluctuate from period to period. Our collaboration activities are subject to the oversight of both parties. Accordingly, the clinical, development, marketing and sales activities of our affiliates are not entirely within our control.

      We have incurred significant operating losses since we began operations in September 1990. As of December 31, 2002, we had an accumulated deficit of $464.0 million. Our operating expenses have been increasing during the past several years and are expected to increase during 2003 and, possibly, thereafter, as we attempt to complete development of our potential product candidates, obtain necessary regulatory approvals and manufacture and market these product candidates. Directly and through Lilly ICOS, we expect to incur substantial marketing and other costs related to commercializing Cialis in Europe and, to complete development, obtain expected regulatory approval and launch Cialis in the United States. We also expect to continue to incur substantial costs under our collaborative agreement with Biogen. In the future, we may pursue our internal research, development, marketing and sales activities more aggressively and, when beneficial to do so, establish additional collaborations. As a result of these factors, we currently do not expect to achieve profitability for at least two-to-three years.

      In the fourth quarter of 2000, we adopted the provisions of the Securities and Exchange Commission Staff Accounting Bulletin No. 101, as amended (“SAB 101”), “Revenue Recognition in Financial Statements.” Pursuant to SAB 101, nonrefundable upfront technology license fees, for product candidates where we are providing continuing services related to product development, are deferred. We recognize these fees as revenue over the estimated product development periods, based on estimated total future development costs. Milestones, in the form of additional technology license fees, are recognized as revenue at the time such payments are due, based on the ratio of cumulative costs incurred to date, to total estimated development costs. Any remaining balance is deferred and recognized as revenue over the estimated remaining product development period. Previously, milestones were recognized as revenue upon attainment of a specified event, and nonrefundable upfront technology license fees were recognized as revenue when received. Our results for the year 2000 include a $63.1 million charge ($1.36 per share) representing the cumulative effect of adopting SAB 101 effective January 1, 2000. This charge reflects the aggregate amount of license fees and milestone payments that we reported as revenue in years prior to 2000, to be recognized as revenue in 2000 and future years under SAB 101. During 2002, 2001, and 2000, we recognized, as revenue, $4.5 million, $15.6 million and $42.9 million, respectively, of the $63.1 million deferred in 2000 as a result of a change in accounting for certain revenues.

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      Revenue for the year ended December 31, 2002, was $92.9 million compared to $93.0 million for the year ended December 31, 2001. Cost reimbursement revenue was $77.7 million for the year ended December 31, 2002, compared to $54.8 million for the year ended December 31, 2001. The increase in cost reimbursement revenue primarily reflects manufacturing activities and patient enrollment in the Phase 3 clinical trial with Pafase for severe sepsis, prior to the December 2002 decision to discontinue the Pafase program. The increase also includes the impact of the Phase 2b/3 clinical trial with sitaxsentan for pulmonary arterial hypertension, which was concluded in late 2002. These increases were partially offset by a decline in cost reimbursement revenue related to Cialis, primarily due to the completion, in 2001, of development activities required to file the NDA. Revenue from ICOS Clinical Partners, L.P. (“ICOS Clinical Partners”) also declined, as funding under the related services agreement ended in early 2001.

      Revenue from licenses of technology was $6.6 million in 2002, compared to $30.8 million in 2001. Revenue for the 2001 period included $14.8 million of a $15.0 million license fee payment received from Lilly ICOS following submission of the NDA for Cialis in June 2001. During 2002 and 2001, we recognized, as revenue, $4.5 million and $15.6 million, respectively of the $63.1 million deferred in 2000 as a result of a change in accounting for certain revenues. The decrease in 2002 was primarily due to the completion, in 2001, of development activities required to file the NDA for Cialis, partially offset by $1.7 million of previously deferred, nonrefundable license fees that were recognized as revenue in the fourth quarter of 2002 upon the decision to terminate the Pafase program.

      Contract manufacturing revenue was $8.5 million in 2002, compared to $7.4 million in the prior year. We began our contract manufacturing program in the fourth quarter of 2000.

      Research and development. Research and development expense consists primarily of costs associated with conducting basic research, clinical trials for our product candidates and other costs incurred in support of those activities. Research and development expense was $145.0 million in 2002, compared to $111.7 million in 2001. This increase was primarily due to higher patient enrollment in the Phase 3 clinical trial with Pafase for severe sepsis and costs associated with Pafase manufacturing activities. The increase also reflects development activities related to other clinical product candidates (IC485, IC14, IC747 and sitaxsentan), and increased spending on discovery and preclinical research activities. Research and development costs for Cialis decreased during 2002, primarily due to the completion of certain activities in 2001, prior to the NDA filing.

      General and administrative. General and administrative expense consists primarily of costs associated with corporate support functions, general management and other activities not directly related to research and development efforts. General and administrative expense increased $8.6 million, to $17.6 million in 2002. This increase primarily reflects start-up costs incurred during the first half of 2002 in anticipation of the U.S. commercial launch of Cialis and an increase in market research activities.

      In 2002, we recognized $104.2 million in losses related to our equity interests in affiliates, compared to $64.9 million in 2001. Our share of Lilly ICOS losses increased $27.5 million, to $65.7 million in 2002. This increase reflects higher Lilly ICOS sales and marketing costs, in anticipation of the commercial launch of Cialis in the U.S. and Europe, and higher research and development costs associated with seeking regulatory approval in the U.S. and other countries. Our share of Suncos losses increased $14.7 million, to $29.9 million in 2002, reflecting incremental clinical and manufacturing development activities for Pafase, prior to the decision, in December 2002, to discontinue the Pafase program. Upon discontinuation of the program, Suncos accrued $3.3 million of estimated close-out costs, consisting primarily of expenses associated with the termination of clinical studies and manufacturing activities. Our share of ICOS-TBC losses decreased to

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      Interest and other income totaled $12.3 million in 2002, compared to $12.5 million in 2001. Interest and other income in 2002 reflects the impact of an increase in our average invested funds, due to the net proceeds of our November 2001 equity financing, largely offset by substantially lower interest rates.

      Revenue for the year ended December 31, 2001, was $93.0 million compared to $90.7 million for the year ended December 31, 2000. Cost reimbursement revenue was $54.8 million for the year ended December 31, 2001, compared to $47.4 million for the year ended December 31, 2000. The increase in cost reimbursement revenue primarily related to the Pafase Phase 3 clinical trial for severe sepsis and the sitaxsentan Phase 2b/3 clinical trial for pulmonary arterial hypertension. These increases in revenue were partially offset by a decline in cost reimbursement revenue related to Cialis, as certain clinical activities were completed prior to the submission of the NDA to the FDA in June 2001. Revenue from ICOS Clinical Partners also declined, as funding under the related services agreement ended in the first quarter of 2001.

      Revenue from licenses of technology was $30.8 million in 2001, compared to $42.9 million in 2000. The decrease was primarily due to the completion of Cialis development activities required to file the NDA earlier in 2001 and the substantially greater proportion of estimated total product development costs incurred in 2000. Revenue from licenses of technology for 2001 included $14.8 million of a $15.0 million license fee received from Lilly ICOS following the submission of the Cialis NDA to the FDA in June 2001. During 2001, we also recognized $15.6 million of the $63.1 million deferred in 2000 as a result of a change in accounting for certain revenues.

      During 2001, we recognized $7.4 million in revenue related to the development and manufacture of third party clinical materials, compared to $0.4 million in the prior year. We began offering contract manufacturing services in the fourth quarter of 2000.

      Research and development. Research and development expense was $111.7 million in 2001, compared to $87.4 million in 2000. This increase was primarily due to the progression of development activities for Pafase, sitaxsentan, and early-stage product candidates TBC3711, IC485 and IC747. These increases were partially offset by lower development costs for Cialis.

      General and administrative. General and administrative expense increased to $9.1 million in 2001, compared to $6.6 million in 2000. This increase reflects growth of our corporate marketing and sales functions and other expenditures to support the anticipated commercial launch of Cialis.

      We recognized $64.9 million of affiliate losses in 2001, compared to $37.0 million in 2000. This increase is primarily due to our share of operating losses of Lilly ICOS, which we began recognizing in the third quarter of 2000. The increase also reflects higher operating losses from Suncos and ICOS-TBC due to the progression of development activities for Pafase, sitaxsentan and TBC3711.

      Interest and other income totaled $12.5 million in 2001, compared to $5.5 million for 2000. This increase was primarily due to higher average invested balances in 2001, from the net proceeds of our December 2000 and November 2001 equity financings, offset by the impact of lower interest rates.

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Liquidity and Capital Resources

      At December 31, 2002, we had cash, cash equivalents, investment securities available-for-sale and interest receivable of $354.0 million, compared to $470.7 million at December 31, 2001.

      We used $41.0 million in cash for operating activities during 2002 compared to $8.1 million during 2001. The change in operating cash flow primarily reflects the receipt of a $15.0 million license fee from Lilly ICOS in June 2001, receipt of an $8.0 million upfront payment from Biogen in July 2001, timing of vendor payments and cost reimbursements from our affiliates and an overall increase in research and development and general and administrative spending in 2002.

      We used $210.0 million in cash for investing activities during 2002 compared to $250.3 million in cash for investing activities during 2001. Cash used in investing activities in 2002 included a $106.7 million net increase in our investment portfolio, compared to a $172.5 million net increase in our investment portfolio in 2001. The increase in our investment portfolio in both years primarily reflects our conversion of cash equivalents held at the end of the prior year into investments with slightly longer maturities. Agreements with our affiliates obligate us to fund a portion of the development and commercialization activities of the relevant collaboration. We generally fund these obligations in the form of capital contributions to the affiliate. Investing outflows in 2002 included $97.0 million of affiliate capital contributions, compared to $71.6 million of affiliate capital contributions in 2001. The increase in affiliate capital contributions reflects increased research and development spending by certain of the affiliates and the timing of partner expense reimbursements. None of our affiliates have any third party indebtedness. Each affiliates’ liabilities are principally payable to its owners for reimbursable research, development, sales, marketing or other expenses.

      We generated $30.5 million in cash from financing activities in 2002, compared to $324.6 million in 2001. Proceeds from stock options and warrants totaled $22.9 million in 2002, for 2.3 million shares of our common stock, compared to $25.2 million in 2001, for 1.9 million shares of our common stock. The 2002 and 2001 proceeds included $17.4 million and $7.3 million, respectively, from the exercise of Series A warrants to purchase 1.8 million and 0.8 million shares, respectively, of our common stock. The Series A warrants were issued in 1997, exercisable at $9.13 and $10.35 per share and, if unexercised, expired on May 31, 2002. Financing cash inflows during 2002 also included $7.7 million in borrowings under our line of credit with Biogen, of which $6.7 million was forgiven upon the achievement of a clinical milestone in 2002. Financing cash inflows during 2001 included $2.3 million in borrowings under our line of credit with Biogen, all of which was forgiven in 2001 upon the achievement of a clinical milestone. Some or all future loans from Biogen, of up to an additional $10.0 million as of December 31, 2002, may also be forgiven upon the achievement of development milestones. Cash inflows from financing activities in 2001 also included $297.0 million in net proceeds received from our November 2001 public offering of 5.5 million shares of common stock at $57 per share.

      Our future cash requirements will depend on various factors, many of which are beyond our control, including:

	•	obtaining regulatory approval for Cialis in the U.S., Canada and Mexico, and continued progress in commercializing Cialis in Europe, the U.S. and elsewhere;
	•	funding levels for research and development programs, including continued funding from our collaboration partners;
	•	the results of clinical trials and preclinical studies;
	•	the time and costs involved in filing and prosecuting patents and enforcing and defending patent claims;
	•	the regulatory process in the U.S. and other countries;
	•	acquisitions of products or technologies, if any;
	•	relationships with research and development collaborators;
	•	capital contributions to our affiliates;

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	•	competing technological and market development activities; and
	•	the time and costs of manufacturing, scale-up and commercialization activities.

      We have engaged in collaborations and joint development agreements with other parties where the capabilities and strategies of the other parties complement ours. Although corporate collaborations, partnerships and joint ventures have provided cost reimbursement revenue to us in the past, we cannot assure you that this type of revenue will be available to us in the future. Substantially all of our cost reimbursement revenue to date has been for reimbursement of the cost of research and development services that we provided. In the future, collaborative revenue is also expected to include reimbursement of the cost of marketing and sales services we expect to provide related to product commercialization.

      We intend to expand our operations and hire the additional personnel necessary to commercialize Cialis and continue development of our current portfolio of product candidates in clinical trials, as well as to continue discovery and preclinical research to identify additional product candidates. We also intend to continue to engage in pre-marketing activities necessary to bring our product candidates to market and to establish marketing and selling capabilities for product candidates ready for commercialization. We anticipate that expansion of these activities will increase operating expenses in the future. Furthermore, we will need to make incremental expenditures for additional laboratory, production and office facilities to accommodate the activities and personnel associated with these increased development and commercialization efforts.

      We anticipate that our existing cash and cash equivalents, investment securities, interest income from our investments, cash flow from other operating activities, including anticipated payments from Lilly ICOS, cash flow from potential future collaborations, and the line of credit available to us under an agreement with Biogen, will be sufficient to fund operations for approximately two years. However, given our product development and marketing and sales efforts, including those associated with the recent commercial launch of Cialis in Europe, and the anticipated commercial launch of Cialis in the U.S. and other countries, there is a reasonable likelihood that we will seek additional financing during the next year or so. Additional financing may not be available when we need it or may be unavailable on acceptable terms. If we are unable to raise additional funds when we need them, we may be required to delay, scale back or eliminate expenditures for some of our development programs or grant rights to third parties to develop and market product candidates that we would prefer to develop and market on our own.

      Our operating cash flows include the effect of certain noncancelable obligations. We lease certain property and equipment under operating leases which, in the aggregate, obligate us through 2009. Future minimum payments due under noncancelable operating leases, as of December 31, 2002, are as follows:

      We have entered into various licensing and research and development arrangements under which we may be obligated to make future payments to third parties upon the achievement of certain success-based objectives.

      In connection with our acquisition of technology rights to certain PDE5 inhibitors, including Cialis (tadalafil), we committed to pay a third party a royalty equal to 5% of the net sales of products developed utilizing the acquired technology. Lilly ICOS and Lilly have accepted primary responsibility for any royalty obligations resulting from ICOS’ previous arrangement.

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New Accounting Standard

      In November 2002, the Financial Accounting Standards Board Emerging Issues Task Force issued its consensus concerning Revenue Arrangements with Multiple Deliverables (“EITF 00-21”). EITF 00-21 addresses how to determine whether a revenue arrangement involving multiple deliverables should be divided into separate units of accounting, and, if separation is appropriate, how the arrangement consideration should be measured and allocated to the identified accounting units. The guidance in EITF 00-21 is effective for revenue arrangements entered into in fiscal periods beginning after June 15, 2003. We do not anticipate that adoption of EITF 00-21 will have a material impact on our consolidated financial statements.

Legal Proceedings

      On October 22, 2002, Pfizer Inc., Pfizer Limited, and Pfizer Ireland Pharmaceuticals filed a patent infringement lawsuit against ICOS, Lilly ICOS, and Lilly in the United States District Court for the District of Delaware. The complaint alleges that the intended and imminent use, offering for sale, selling, manufacture, or importing into the United States upon FDA approval of Cialis for the treatment of erectile dysfunction by ICOS, Lilly ICOS and Lilly will constitute infringement of plaintiffs’ U.S. Patent No. 6,469,012, which issued on October 22, 2002. The plaintiffs seek a judgment declaring that the defendants’ using, selling, offering for sale, making or importing of Cialis for the treatment of erectile dysfunction will infringe this patent. The plaintiffs also seek a permanent injunction, attorneys’ fees, costs and expenses. On January 6, 2003, we filed an answer denying the central allegations of plaintiffs’ complaint and setting forth various affirmative defenses. Litigation is inherently unpredictable and the eventual outcome in a particular case is impossible to determine in advance. We believe that Pfizer’s suit lacks merit and intend to vigorously pursue our various defenses. If Pfizer were to prevail, however, we might be subject to substantial damages, prohibited from marketing Cialis for the treatment of erectile dysfunction in the United States, or required to enter into a licensing agreement to market Cialis in the United States. Any such adverse result could have a material adverse effect on our business, financial condition, results of operations and cash flows.

       At December 31, 2002 and 2001, our financial instruments consist principally of cash, cash equivalents and marketable investment securities. We do not use derivative financial instruments in our investment portfolio. Our exposure to market risk for changes in interest rates relates primarily to our marketable investment securities. Because of the relatively short maturities of our investments, we do not expect interest rate fluctuations to materially affect the aggregate value of our financial instruments.

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INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

SUPPLEMENTARY DATA

      Balance sheets of Lilly ICOS LLC as of December 31, 2002 and 2001, and the related statements of operations, comprehensive operations, members’ equity (deficit), and cash flows for each of the years in the three-year period ended December 31, 2002, and the period from October 2, 1998 (inception) through December 31, 2002, are included elsewhere in this report.

      Balance sheets of Suncos Corporation as of December 31, 2002 and 2001, and the related statements of operations, stockholders’ equity (deficit) and comprehensive loss, and cash flows for each of the years in the three-year period ended December 31, 2002, and the period from February 6, 1997 (inception) through December 31, 2002, are included elsewhere in this report.

      All other consolidated financial statement schedules have been omitted as the information is not required or the information required is included in the consolidated financial statements or the notes thereto.

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INDEPENDENT AUDITORS’ REPORT

The Board of Directors and Stockholders

      We have audited the accompanying consolidated balance sheets of ICOS Corporation and subsidiaries as of December 31, 2002 and 2001, and the related consolidated statements of operations, stockholders’ equity and comprehensive loss, and cash flows for each of the years in the three-year period ended December 31, 2002. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

      We conducted our audits in accordance with auditing standards generally accepted in the United States of America. 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of ICOS Corporation and subsidiaries as of December 31, 2002 and 2001, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States of America.

      As discussed in Note 3 to the consolidated financial statements, the Company changed its method of accounting for nonrefundable technology license fees and milestones in 2000.

	/s/ KPMG LLP

Seattle, Washington

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ICOS CORPORATION

CONSOLIDATED BALANCE SHEETS