OSI PHARMACEUTICALS INC - 10-K Annual Report

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549
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FORM 10-K
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(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 2002 OR

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

FOR THE TRANSITION PERIOD FROM TO

COMMISSION FILE NUMBER: 0-15190
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OSI PHARMACEUTICALS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

DELAWARE 13-3159796
(STATE OR OTHER JURISDICTION OF INCORPORATION OR (I.R.S. EMPLOYER IDENTIFICATION NO.)
ORGANIZATION)

58 SOUTH SERVICE ROAD, MELVILLE, N.Y. 11747
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)

REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE
(631) 962-2000

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, PAR VALUE $.01 PER SHARE, AND
SERIES SRPA JUNIOR PARTICIPATING PREFERRED STOCK PURCHASE RIGHTS
(TITLE OF CLASS)

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. [X] Yes [ ] No

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. [ ]

As of March 28, 2002, the aggregate market value of the Registrant's voting
stock held by non-affiliates was $1,057,560,516. For purposes of this
calculation, shares of common stock held by directors, officers and stockholders
whose ownership exceeds five percent of the common stock outstanding at March
28, 2002 were excluded. Exclusion of shares held by any person should not be
construed to indicate that the person possesses the power, direct or indirect,
to direct or cause the direction of the management or policies of the
Registrant, or that the person is controlled by or under common control with the
Registrant.

Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Securities Exchange Act of 1934). [X] Yes [
] No

As of November 29, 2002, there were 36,418,319 shares of the Registrant's
common stock, par value $.01 per share, outstanding.

DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's definitive proxy statement for its 2003 annual
meeting of stockholders are incorporated by reference into Part III of this Form
10-K.

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OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

TABLE OF CONTENTS

PART I

ITEM 1. BUSINESS

We are a leading biotechnology company focused on the discovery,
development and commercialization of high-quality oncology products that both
extend life and improve the quality-of-life for cancer patients worldwide. We
have established a balanced pipeline of oncology drug candidates that includes
both next-generation cytotoxic chemotherapy agents and novel mechanism-based,
gene-targeted therapies.

Our most advanced drug candidate, Tarceva(TM) (erlotinib HC1), is a small
molecule inhibitor of the epidermal growth factor receptor, or HER1/EGFR. The
protein product of the HER1/EGFR gene is a receptor tyrosine kinase that is
over-expressed or mutated in many major solid tumors. We believe HER1/ EGFR
inhibitors represent an exciting new class of relatively safe and well tolerated
anti-cancer agents that may have utility in treating a wide range of cancer
patients. Tarceva(TM) is an oral once-a-day small molecule drug designed to
specifically block the activity of the HER1/EGFR protein. Currently, Tarceva(TM)
is being developed in an alliance with Genentech, Inc. and Roche. If the drug
receives regulatory approval, Genentech will lead the marketing effort in the
United States and Roche will market it in the rest of the world. We will receive
milestone payments from both Genentech and Roche, an equal profit share from
U.S. sales, and royalties on sales outside of the United States. Tarceva(TM) has
demonstrated encouraging indications of anti-cancer activity in single-agent,
open label Phase II trials in non-small cell lung cancer, head and neck cancer
and ovarian cancer. Tarceva(TM) is currently in Phase III clinical trials for
non-small cell lung cancer and pancreatic cancer.

Behind Tarceva(TM) we have five additional drug candidates in earlier
stages of clinical development. Three of these (OSI-211, OSI-7904L and OSI-7836)
are next generation cytotoxic chemotherapy agents and the other two (CP-547,632
and CP-724,714) are gene-targeted therapies currently being developed by Pfizer
Inc. We own commercial rights to the first three and will receive royalty
payments on the latter two if they are successfully commercialized.

Our next generation cytotoxic chemotherapy candidates are designed to
improve upon currently marketed products in the same drug class. OSI-211 is a
liposomal formulation of lurtotecan, a topoisomerase-1 inhibitor, that is being
developed to compete with topotecan (Hycamptin(R)). OSI-7904L is a liposomal
formulation of a thymidylate synthase inhibitor, GW1843, that is being developed
as a potential competitor to 5-Fluorouracil (5-FU) and capecitabine (Xeloda(R)),
and OSI-7836 is a nucleoside analog being developed to compete with gemcitabine
(Gemzar(R)). OSI-211 is in Phase II clinical trials, and OSI-7904L and OSI-7836
are in Phase I clinical trials. Like Tarceva(TM), the two gene-targeted
therapies are receptor tyrosine kinase inhibitors. CP-547,632 is a small
molecule targeting the vascular endothelial growth factor receptor, or VEGFR,
and CP-724,714 is a small molecule targeting HER2/erbB2. Both agents are
currently in Phase I clinical trials.

In order to support our clinical pipeline, we have established (through
acquisition and internal investment) a high quality oncology clinical
development and regulatory affairs capability and a pilot scale chemical
manufacturing and process chemistry group. Behind our clinical pipeline we have
an extensive, fully integrated small molecule drug discovery organization
designed to generate a pipeline of high quality oncology drug candidates to move
into clinical development. This research operation has been built upon our
historical strengths in high throughput screening, chemical libraries, medicinal
and combinational chemistry, and automated drug profiling technology platforms.

OUR STRATEGY

We believe that Tarceva(TM) has established a corporate presence for us in
the oncology field. Our strategy over the last several years has been designed
to capitalize upon this presence and to re-orient our business

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towards becoming a world class oncology organization. To this end, we have
raised capital, formed alliances and engaged in merger and acquisition activity
with the strategic intent to:

- maximize our prospects for successful development and commercialization
of Tarceva(TM);

- enhance our skill sets and improve the quality of our organization,
allowing us to establish a comprehensive array of research, development
and business skills necessary for our cancer mission;

- divest or exit from our current non-oncology research activities and
alliances;

- engage in active in-licensing and partnering efforts to add to our cancer
pipeline and complement our internal cancer research programs; and

- continue to invest in opportunities that will lead to successful growth
while aggressively managing the risks inherent in our industry in order
to sustain a strong balance sheet through to profitability.

As we move forward, we intend to follow through on the following core
elements of our strategy:

Execution on Tarceva(TM). Together with our partners, Genentech and
Roche, we have formulated a comprehensive, global development program for
Tarceva(TM). Since the beginning of the alliance, we, with our partners,
have collectively initiated numerous clinical trials, four of which are
Phase III registration-oriented trials in lung and pancreatic cancers. This
registration strategy focuses on the execution of adequate, controlled and
well-designed studies to support a worldwide registration program. All four
Phase III trials are designed as large-scale, placebo controlled,
double-blinded trials with a primary endpoint of survival and several
secondary endpoints which include, among others, symptom relief and quality
of life. Should these studies prove successful, we have established a goal
of achieving profitability within 18 to 24 months of market launch of
Tarceva(TM).

Focus on Oncology. We intend to focus our business entirely on
oncology and continue to build upon our extensive pipeline of oncology
product candidates, our strong core of discovery research, and our top-tier
oncology clinical development and regulatory affairs group. As our pipeline
reaches the commercialization stage, we also intend to establish a full
commercial operation, initially in the U.S. market. Although we intend to
commercialize selected products independently, we will also continue to
engage in marketing partnerships where we believe this will add value to
our ability to effectively and competitively commercialize our products.

We also intend to complete the divestiture of all remaining
non-oncology research programs. In July 2002, we agreed to accelerate the
conclusion of the phase-down period of our funded research alliance with
Anaderm Research Corporation, a wholly-owned subsidiary of Pfizer, focused
on the development of novel treatments for skin and hair conditions. We
expect the transfer of all research related to the collaboration to be
completed by the beginning of 2003. We are in the process of divesting our
diabetes program and certain of our adenosine receptor assets into an
entity with the intent that this entity subsequently will be funded by
third party investors and will be one in which we will maintain a minority
interest. This planned divestiture coupled with steps we took in October
2002 to re-size and re-focus the skill sets of our organization will carry
us into 2003 with approximately 425 research, development and business
personnel focused entirely on oncology.

These steps will allow us to maintain the level of resource commitment
we believe is required to achieve our primary goal of building a
first-class oncology franchise with a pipeline of clinical and research
opportunities anchored around Tarceva(TM).

Licensing and Acquiring Oncology Products and Clinical Candidates. In
order to effectively manage the risks inherent in pharmaceutical research
and development and to complement our internal research efforts, we believe
it is essential that we continue to explore licensing and acquisition
initiatives designed to add oncology products and clinical candidates to
our pipeline in order to further strengthen our growing position in
oncology. In December 2001, we acquired Gilead Sciences, Inc.'s entire
pipeline of clinical candidates in oncology and certain related
intellectual property, as well as Gilead's Boulder, Colorado operations,
including clinical research, regulatory affairs and drug development
personnel,

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infrastructure, and facilities. This transaction accelerated our
development and commercialization capabilities with the addition of an
outstanding and complementary drug development and oncology group, and
augmented our pipeline of gene-targeted small molecule therapeutics with
several promising next-generation cytotoxic chemotherapy agents currently
in clinical development. Under the terms of the transaction, we received
exclusive worldwide development and commercialization rights to Gilead's
three clinical development candidates in oncology. With a full array of
cancer drug discovery and development capabilities and a strong balance
sheet, we expect to be well positioned to compete for premier in-licensing
and acquisition opportunities.

OUR RESEARCH AND DEVELOPMENT PROGRAMS

RESEARCH AND DEVELOPMENT PIPELINE

The following table summarizes the status of our more advanced oncology
product candidates as of November 30, 2002 and identifies any related
collaborator.

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(*) Denotes clinical safety and efficacy tests as follows:
Phase I - Evaluation of safety in humans.
Phase II - Evaluation of safety, dosing, and initial efficacy in humans.
Phase III - Evaluation of safety and efficacy in humans.

OSI'S APPROACH TO CANCER THERAPY

Cancer remains a major unmet healthcare concern with approximately 1.3
million Americans diagnosed with various solid tumors, lymphomas and leukemias
every year. In total, it is estimated that the overall direct medical costs for
cancer in the United States for 2001 were in excess of $56 billion. The
worldwide market for anti-cancer drugs is estimated to be $14 billion in 2002
and is expected to grow as breakthrough products, which offer safer and more
effective treatment options based upon an improved understanding of the genetic
basis of human cancer, begin to enter the market. Traditionally, development of
anti-cancer drugs has resulted in products which generally kill rapidly dividing
cells. Although these products, called cytotoxic drugs, are effective in killing
rapidly dividing cancer cells, they usually interfere directly and
non-selectively with normal processes in the cell associated with DNA
replication and cell division. Since these cell division processes occur
routinely in healthy tissues, the cytotoxic drugs are severely limited in their
utility by their serious side effects, such as disruption of the blood, immune
and gastrointestinal systems. These side effects limit the anti-tumor value of
these cytotoxic drugs because they can be used only in sub-optimal dosing
regimens.

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We have taken two general approaches in an attempt to improve the available
drug treatment options for cancer patients. The first approach involves the
development of next-generation cytotoxic agents which present improvements in
activity over existing drugs or technological innovations, such as liposomal
formulations that are designed to improve targeting of the cytotoxic agent to
the tumor, thus reducing the incidence of the harmful side effects usually
associated with cytotoxic drugs. The second approach involves the exploitation
of our rapidly growing understanding of the genetic basis for cancer in order to
develop drugs that directly target the genetic abnormalities present in human
cancers or treat their consequences. As these new targeted therapies emerge in
clinical testing, they may be used independently, in combination with other
targeted drugs or in combination with cytotoxic chemotherapy drugs, in an
attempt to maximize the anti-cancer benefit by using so-called drug cocktails.
It is our belief that to be a successful oncology franchise, we should be
developing both next-generation or improved cytotoxic drugs and targeted
therapies in order to provide an array of effective treatment options for the
cancer patient. Thus, while our drug discovery research efforts are focused on
next-generation gene-targeted therapies, our acquisition of oncology assets from
Gilead has complemented our research efforts with a portfolio of novel cytotoxic
agents. These assets include OSI-211 and OSI-7904L, which are liposomal
formulations of novel agents belonging to two classes of drug (topoisomerase 1
inhibitors and thymidylate synthase inhibitors, respectively), for which
products are currently marketed. Our belief is that these liposomal formulations
might allow us to achieve improved activity profiles over the existing marketed
products. The third of our cytotoxic agents is OSI-7836, which, in pre-clinical
testing, has clearly demonstrated anti-tumor activity in a variety of refractory
solid tumor xenograft models and is being developed as an alternative to
gemcitabine (Gemzar(R)), which is sold in the United States for the treatment of
pancreatic cancer and non-small cell lung cancer.

Our drug discovery efforts in targeted therapies were for many years
conducted in partnership with Pfizer. Tarceva(TM) was jointly discovered as part
of this alliance. Pfizer is continuing to develop three other targeted therapies
from this alliance (two of which are in clinical development), the funded
discovery phase of which concluded in April 2001. These drugs represent the
vanguard of a substantial research effort directed toward the discovery and
development of these next generation targeted drugs. If Pfizer is successful in
commercializing any of these drug candidates, we will receive a royalty from
Pfizer on the sales of such drugs.

The novel, anti-cancer drugs resulting from our alliance with Pfizer,
including Tarceva(TM), specifically target cancer-causing genes, or oncogenes,
and processes required for tumor growth such as angiogenesis. Oncogenes are
typically growth regulating genes that are either over-expressed or mutated in
cancer cells in such a manner that they confer either a significant growth
advantage on cancer cells in the body or interrupt the normal process of
programmed cell death, or apoptosis, that contributes to the uncontrolled growth
associated with cancer. One of the most important of these oncogenes is HER1 or
EGFR. HER1/EGFR is part of a family of growth factor receptors (the HER family)
that binds to natural protein signals like the epidermal growth factor, or EGF,
and transforming growth factor-(LOGO), or TGF-(LOGO), sending growth signals,
via the receptor's tyrosine kinase enzyme activity, to the nucleus of the cell
controlling growth. In many solid tumors, HER1/EGFR is either over-expressed or
mutated, leading to abnormal signaling which is linked to the development of a
cancerous mass.

HER1/EGFR kinase is over-expressed in a wide range of solid tumors and a
significant number of patients diagnosed with cancer each year in the United
States have solid tumors that over-express HER1/EGFR. In addition, a frequently
occurring mutation of the HER1/EGFR gene called EGFRvIII is found in many
tumors. Thus, there is both an urgent medical need and a substantial potential
market for effective anti-HER1/EGFR agents. Progress in the field has
established HER1/EGFR as a validated target for cancer intervention and small
molecule tyrosine kinase inhibitors as promising drug candidates in this area.
Antibody products are also under development which target the EGF binding region
of the receptor and have demonstrated indications of improved anti-cancer
activity when used in conjunction with existing treatment and chemotherapy
regimens. We believe these agents are unlikely to effectively inhibit mutated
forms of HER1/EGFR. They also require delivery via intravenous infusion and are
sometimes difficult and expensive to produce. In contrast to these agents, small
molecule inhibitors of the tyrosine kinase activity, such as Tarceva(TM), should
be effective against either mutant or over-expressed forms of HER1/EGFR, are
convenient

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once-a-day oral therapies, and are relatively easy and inexpensive to
manufacture. In addition, Tarceva(TM) has demonstrated anti-tumor activity when
used clinically as a single agent in Phase II clinical trials.

TARCEVA(TM)

From 1986-2001, the focus of our cancer collaboration with Pfizer was the
discovery and development of novel classes of orally active, gene-targeted,
small molecule anti-cancer drugs based on oncogenes and tumor suppressor genes
and the fundamental mechanisms underlying tumor growth. Today these approaches
remain at the core of our in-house discovery efforts. The most prominent and
advanced of these programs targets HER1/EGFR. Tarceva(TM), a small molecule
anti-cancer agent, is a potent, selective and orally active inhibitor of the
receptor tyrosine kinase activity of HER1/EGFR. Tarceva(TM) has demonstrated
anti-cancer activity in open-label Phase II trials and is now in Phase III
trials for non-small cell lung cancer and pancreatic cancer. We gained full
development and marketing rights to Tarceva(TM) in June 2000 when the U.S.
Federal Trade Commission ordered Pfizer to divest it to us as a result of an
anti-trust finding upon the FTC's review of Pfizer's merger with Warner-Lambert
Company. In January 2001, we entered into an alliance with Genentech and Roche
for the global co-development and commercialization of Tarceva(TM).

Clinical Data. Phase I and Phase II trials on Tarceva(TM) have
demonstrated the drug to possess activity as a single agent and to be relatively
safe and well-tolerated with manageable side effects, principally, reversible
rash and a generally mild diarrhea. The dose limiting side effect in the Phase I
trials was diarrhea, which was moderate to severe in three of nine patients in
these particular studies involving very sick cancer patients at 200 mg per day.
150 mg per day was established as the maximum tolerated dose in this study. On a
150 mg oral daily dosing regimen, diarrhea is generally mild and is treated
effectively (when necessary) with loperamide (over the counter Imodium(R)).
Clinical investigators have generally considered the rash, which is common to
all anti-HER1/EGFR drugs in development, to be the most common adverse event in
the context of this anti-cancer therapy. Some success in treating rash has been
observed with antibiotic creams as well as with a variety of other agents.
However, we believe that the rash itself may serve to be a useful biomarker of
the effective delivery and potential activity of Tarceva(TM). Indeed, in our
Phase II trials the survival of patients who developed rash during Tarceva(TM)
treatment was significantly higher than those who did not. A subset of patients
in Phase I, Phase II and Phase III trials have now received daily doses of
Tarceva(TM) for extended periods (one year or more) with generally well-managed
side effect profiles.

We have now completed Phase II trials for Tarceva(TM) in non-small cell
lung cancer, head and neck cancer and ovarian cancer. Patients in these trials
had advanced or metastatic cancer and had generally failed standard treatment
regimens. We believe these trials are encouraging because they demonstrate
objective clinical responses and noteworthy survival data for patients treated
with Tarceva(TM) as a single agent. The primary endpoint in these trials was
response rate, with stable disease, survival, time to progression and
quality-of-life being monitored as secondary endpoints. Updated analysis of data
from these Phase II trials showed that rash and rash related disorders were seen
in 162 patients, or 79%, of the patients. Mild to moderate rash was seen in 146
of these patients and 16 patients showed severe rash. Diarrhea was experienced
by 93, or 45%, of the patients. For 86 patients, the diarrhea was mild to
moderate, and seven patients had severe diarrhea.

Non-Small Cell Lung Cancer. This trial consisted of 57 non-small cell lung
cancer, or NSCLC, patients having tumors that were confirmed to be HER1/EGFR
positive and who had failed standard platinum-based chemotherapy. Patients
received a daily dose of 150 mg of Tarceva(TM). The results from this trial
showed that 51% of the patients had either a response or disease stabilization,
22 of whom demonstrated stable disease, five of whom had a partial response, and
two of whom had a complete response. The median survival in this trial was 37
weeks. At 12 months, 40% of the patients were alive, 21% of the patients were
alive at 18 months, and 16% of the patients are still alive, as of the last
follow-up, over 18-24 months. In this trial, a strong correlation between rash
and survival was observed. All seven responders experienced rash, 21 out of 22
patients (95%) with stable disease experienced rash while only 15 out of 28
patients (54%) with progressive disease experienced rash. The median survivals
of patients who experienced no rash, grade 1 rash or grade 2/3 rash were 1.5,
8.5 and 19.6 months, respectively.

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Head and Neck Cancer. This trial had 115 patients with advanced head and
neck cancer receiving 150 mg of Tarceva(TM) per day. The results showed that 43%
of the patients in the study had either a partial response or stable disease.
Five patients had objective partial response while 44 patients demonstrated
stable disease. The median survival in this study was 26 weeks with 21% of the
patients surviving one year or longer.

Ovarian Cancer. The third Phase II trial was in advanced ovarian cancer
and reported a response plus stable disease rate of 53% based on 34 evaluable
patients. Two patients had a partial response, and 16 patients demonstrated
stable disease. The median survival of these patients was 35 weeks with 35% of
the patients surviving one year or longer.

Other Cancers. Genentech has completed an exploratory Phase II study in
advanced metastatic breast cancer. Many of the patients in this study were
resistant to Herceptin(R) which is another inhibitor of the HER family signaling
pathway. Initial results from this study do not indicate broad-based activity
for Tarceva(TM) in this patient population. We anticipate that results from this
study will be presented in the near future.

The data from the NSCLC, head and neck cancer and ovarian cancer Phase II
trials are summarized in the following table:

TARCEVA(TM) PHASE II DATA
(SINGLE-AGENT SALVAGE STUDIES IN PATIENTS WITH ADVANCED REFRACTORY CANCER)

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Data as of November 18, 2002

SIDE EFFECTS
(ALL THREE STUDIES)

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Data as of November 18, 2002

Development. Since the inception of our alliance with Genentech and Roche
in January 2001, we have implemented a global development strategy for
Tarceva(TM) with our partners. This plan was designed to be a broad-based
approach in implementing several Phase III trials to result in a registration
with the U.S. Food and Drug Administration. These trials include a single agent
trial for refractory NSCLC patients as well as combination trials with existing
chemotherapy regimens for front-line use in pancreatic cancer and NSCLC. These
trials are large, placebo-controlled, double-blind studies designed to
demonstrate a survival and symptom improvement/quality-of-life benefit for
Tarceva(TM) in either combination or single agent settings. We are also
conducting several safety trials to review the effect of Tarceva(TM) in
combination with other chemotherapy drugs, and additional Phase II studies are
being conducted both independently and in

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collaboration with the U.S. National Cancer Institute's Cancer Therapy
Evaluation Program, or CTEP, in a wide array of tumor types including head and
neck, ovarian and glioblastoma multiforme. Under the alliance, the following
Phase III trials are being conducted, with the indicated enrollment goals:

- An approximately 700 patient Phase III trial in refractory NSCLC. In this
trial, Tarceva(TM) is being used as a single agent to treat second/third
line NSCLC versus best supportive care of patients as a control group. We
have been given fast track status by the FDA for the indication covered
by this trial, and patient enrollment is expected to be completed by
early 2003.

- An approximately 1,000 patient Phase III front-line NSCLC trial comparing
Tarceva(TM) used in combination with carboplatin (Paraplatin(R)) and
paclitaxel (Taxol(R)), the standard of care in the United States, versus
chemotherapy alone. This indication was given fast track status by the
FDA and patient enrollment was completed in July 2002.

- An approximately 1,200 patient Phase III front-line NSCLC trial comparing
Tarceva(TM) used in combination with gemcitabine (Gemzar(R)) and
cisplatin (Platinol(R)), a commonly used treatment regimen in Europe,
versus chemotherapy alone. Enrollment in this trial was completed in
September 2002.

- A Phase III front-line pancreatic trial comparing Tarceva(TM) used in
combination with gemcitabine (Gemzar(R)) versus chemotherapy alone.
Patient enrollment is expected to be completed by spring 2003.

These Phase III trials are large scale, placebo controlled registration
orientated trials. Improvement in patient survival is the primary endpoint in
all of these studies with symptom improvement and quality-of-life as key
secondary endpoints.

AstraZeneca PLC, a pharmaceutical company developing a direct competitor
drug to Tarceva(TM), announced in August 2002 that its drug candidate, Iressa,
showed no improvement in its front-line NSCLC trials when used in combination
with chemotherapy against chemotherapy alone. These trials are similar to the
Tarceva(TM) trials we are conducting in front-line NSCLC which assess
Tarceva(TM) in combination with chemotherapy versus chemotherapy alone.
AstraZeneca's announcement had a significant impact on our stock price. However,
although both Tarceva(TM) and AstraZeneca's drug candidate belong to the same
class of HER1/EGFR targeted therapies and a positive outcome for our Tarceva(TM)
Phase III combination studies must therefore be considered higher risk, there
are important differences between the two agents and the respective clinical
programs including structure, formulation, pharmacokinetics, Phase III design,
and dosing. The Phase III program for Tarceva(TM) is designed on the basis of
our Phase II data which demonstrated encouraging indications of clinical
activity in three separate single agent Phase II trials in refractory or
advanced cancer patients with NSCLC, ovarian cancer or squamous cell carcinoma
of the head and neck. Our two Phase III front-line studies in NSCLC are designed
to assess the potential of survival benefit of Tarceva(TM) with standard
chemotherapy. These trials contain noteworthy differences in study design as
compared to those of AstraZeneca's trial design. The dose employed in our Phase
III NSCLC program of 150 mg per day is the apparent maximum tolerated dose, or
MTD, whereas the AstraZeneca trials were conducted at relatively lower doses for
this agent versus the MTD determined for Iressa in earlier Phase I studies. The
choice of the MTD as the dose for our Phase III studies is based on our belief
that this dosing strategy may be clinically important in the use of this agent.
In addition, and unlike AstraZeneca, we are conducting a Phase III study in
refractory NSCLC investigating the potential survival benefit of single agent
Tarceva(TM) at 150 mg per day. This is the most advanced single agent controlled
Phase III study of an HER1/EGFR targeted agent designed to detect a survival
advantage in refractory NSCLC. We believe this second/third line NSCLC trial is
our highest priority and a key registration study for Tarceva(TM). We have,
therefore, increased the patient size of this trial from 330 to approximately
700. We have also shifted emphasis from our pancreatic trial to our refractory
NSCLC trial. In doing so, we intend to reduce the target patient enrollment in
the pancreatic trial after consultation with the National Cancer Institute of
Canada's Clinical Trial Group with whom we are collaborating on this study. This
reduction will not affect the endpoints but will extend the timeline for filing
a new drug application, or NDA, for this indication. Initial results indicated
that the combination of 100 mg per day of Tarceva(TM) with gemcitabine appeared
to be the appropriate dose for this patient population.

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During fiscal 2001, we agreed to collaborate with the U.S. National Cancer
Institute in its CTEP program to conduct over 20 clinical trials with
Tarceva(TM) in multiple tumor types, including epithelial malignancies of the
gastrointestinal and genitourinary tracts, gynecological malignancies and brain
tumors. The trials are being funded and managed by NCI, and we are providing
Tarceva(TM) for these trials. These investigations generate useful clinical data
in addition to maintaining awareness of Tarceva(TM) in the oncology community.

OTHER PROPRIETARY CANCER PROGRAMS

OSI-211. OSI-211 is a proprietary liposomal formulation of the active
topoisomerase-1 inhibitor lurtotecan, a drug candidate that was originally
licensed by Gilead from GlaxoSmithKline and subsequently acquired by us from
Gilead. It is a member of the camptothecin class of cytotoxics that act as
topoisomerase-1 inhibitors. This class of drugs has established activity in
cancers. Two members of this class of drugs that are currently marketed are
irinotecan (Camptosar(R) by Pharmacia Corporation in the United States and by
Aventis in Europe) which is indicated primarily for colorectal cancer, and
topotecan (Hycamtin(R) by GlaxoSmithKline) which is used to treat relapsed
ovarian cancer and relapsed small cell lung cancer. Lurtotecan had been active
in Phase II clinical trials. The liposome formulation was designed to enhance
efficacy and improve the drug's therapeutic index. OSI-211 has been demonstrated
to be active in a d,1,2,3 schedule (intravenous doses of OSI-211 on three
consecutive days) for the treatment of relapsed ovarian cancer. However, in
order to develop this agent, we believe it is essential that we clearly
differentiate it from topotecan in terms of activity, safety and convenience. We
have, therefore, initiated a head-to-head Phase II trial versus topotecan in
relapsed ovarian cancer and a Phase II trial in advanced small cell lung cancer
using the d,1,2,3 schedule.

As part of the acquisition of the Gilead oncology assets, we have agreed to
make a milestone payment to Gilead of $20 million, payable in cash or shares of
our common stock or a combination of cash and shares of our common stock, at our
option, upon our commencement of Phase III clinical trials for OSI-211. We have
also agreed to pay to Gilead $10 million in cash upon our filing of an NDA with
respect to OSI-211. Additional milestone payments are due to GlaxoSmithKline
upon successful development of this product.

OSI-7904L. OSI-7904L is a member of the thymidylate synthase inhibitor, or
TSI, class of cytotoxic chemotherapies. This drug candidate was also originally
licensed by Gilead from GlaxoSmithKline and subsequently acquired by us from
Gilead. Milestone and royalty payments are due to GlaxoSmithKline upon
successful development of this product. It is formulated in liposomes with a
goal of extending its pharmacokinetic (or drug exposure) profile and thereby
improving its therapeutic ratio. It is in Phase I clinical trials, having
demonstrated promising activity in pre-clinical testing for the potential
treatment of various solid tumors. The leading TSI used today is 5-Fluorouracil,
or 5-FU, a generically available TSI which is extensively used in many tumor
types, notably colorectal cancer. A recently marketed entrant from this class is
capecitabine (Xeloda(R) by Roche), which is indicated in second line treatment
of metastatic breast cancer and colon cancer. We believe that there is a need
for better therapies than 5-FU or Xeloda(R) in relapsed colorectal cancer and
metastatic breast cancer. Initial data from the Phase I study has indicated that
the liposomal formulation has extended the drug exposure profile in patients'
blood.

OSI-7836. OSI-7836 was originally licensed by Gilead from the Southern
Research Institute and subsequently acquired by us from Gilead. Milestone and
royalty payments are due to Southern Research Institute upon successful
development of this product. OSI-7836 is a member of the nucleoside class of
cytotoxic drugs of which gemcitabine (Gemzar(R) marketed by Eli Lilly and
Company) is the market leader. Gemzar(R) is approved in the United States for
pancreatic cancer and non-small cell lung cancer. OSI-7836 is being developed as
an alternative gemcitabine and has clearly demonstrated anti-tumor activity in a
variety of refractory solid tumor xenograft models.

PFIZER COLLABORATIVE CANCER PROGRAMS

In April 1986, we entered into a collaborative research agreement and a
license agreement with Pfizer which was focused on the discovery and development
of cancer therapeutic products. On April 1, 2001, the

8

funded phase of the collaborative research agreement expired and was not
renewed. We have three drug discovery programs in targeted therapies for cancer
with Pfizer, two of which are in clinical trials and one is in advanced
pre-clinical development. These programs are focused on developing drugs which
are orally available, potent inhibitors of key protein tyrosine kinase receptors
involved in signal transduction and angiogenesis. Angiogenesis is the process of
blood vessel growth and is induced by solid tumors which require nutrients that
enable growth. We believe that the ability to safely and effectively inhibit
this process represents one of the most intriguing opportunities in cancer drug
development. Under our alliance with Pfizer, we discovered two compounds in this
area. CP-547,632 targets VEGFR and is in Phase I trials. A second drug candidate
in this area, CP-673,451, targets the platelet derived growth factor receptor,
or PDGFR, and is in advanced pre-clinical development.

In September 2002, an additional candidate from the Pfizer program,
CP-724,714, a potent, selective small molecule inhibitor of the HER2/erbB2
receptor tyrosine kinase, advanced to Phase I clinical trials. Overexpression of
HER2/erbB2 oncogenes has been demonstrated to correlate with aggressive cancer
growth, particularly in metastatic breast cancer. Approximately 25-30% of all
women with metastatic breast cancer over express HER2/erbB2.

OSI-754. On November 21, 2001, Pfizer chose to discontinue development of
OSI-754, a farnesyl transferase inhibitor that was undergoing Phase I trials,
and returned to us full commercial rights pursuant to the terms of the original
license agreement between the parties. In November 2002, we suspended Phase I
clinical development of OSI-754, allowing prioritization of clinical development
resources to the Tarceva(TM) program. We will continue to conduct further
internal, pre-clinical experiments with OSI-754 in order to gain a better
understanding of the possible interactions and synergies of this class with our
other research compounds.

CONTINUOUS ENRICHMENT OF OUR PRODUCT PIPELINE

We intend, through a combination of in-house research and aggressive
technology acquisition, candidate in-licensing and partnering efforts, to add to
our oncology pipeline of drug candidates. Since drug development is by its
nature a high-risk venture, a philosophy of combining internal research and
business development activities is important to our ability to sustain a high
quality pipeline of clinical candidates. With the acquisition of the Gilead
oncology assets in December 2001, as well as assets acquired from British
Biotech plc in September 2001, we now have the skill sets necessary to conduct
the entire process of drug discovery and development from the inception of the
drug discovery process through to registration. These skill sets also enable us
to absorb external opportunities at any stage of the drug discovery or
development process.

LICENSING AND ACQUISITIONS

We have set ourselves a goal of continuing to enrich our pipeline beyond
Tarceva(TM) by employing a strategy to identify and acquire products, clinical
and pre-clinical development candidates and technology pertinent to our cancer
mission. The acquisition of the oncology assets of Gilead is a successful
example of this effort. This acquisition not only provided us with world class
oncology development capabilities, but also three clinical stage drug
candidates. The sourcing for these opportunities will range from academia to
large pharmaceutical companies.

INTERNAL DRUG DISCOVERY

The core of our company has historically been built around a base of high
quality scientific research focused on gene targeted, small molecule drug
discovery. We have focused our internal discovery organization on oncology while
continuing to collaborate extensively with high quality academic and technical
groups. We believe this scientific base coupled with a platform of discovery
technologies and capabilities will provide a stream of high quality product
opportunities for our future growth. The mission of our drug discovery research
teams is to generate a flow of product candidates to create a valuable pipeline
which will contribute significant revenues in the five-to ten-year time frame.

9

OUR DRUG DISCOVERY AND DEVELOPMENT CAPABILITIES

BACKGROUND

Our approach is focused on the discovery and development of small molecule
pharmaceutical products which, typically, would be taken either orally by a
patient as a pill, capsule or suspension or intravenously as is common for many
cancer products. Our drug discovery platform constitutes an integrated set of
technologies and capabilities covering every major aspect of pre-clinical and
clinical development. The process begins with a lead seeking phase. In this
phase, which generally takes one to two years, a combination of modern molecular
biology, robotics and computational science is used to build assay or test
systems in which large libraries of diverse small molecules are tested to
determine if any of these molecules possess activity against a drug target. In
order to enhance our capabilities in this area, we have recently entered into a
research collaboration with Cold Spring Harbor Laboratories to rapidly identify
and validate new targets for cancer drug discovery. This collaboration will
focus on identifying specific targets that we consider to be important in the
progression of a variety of cancer types, thus allowing us the opportunity to
take advantage of the wealth of genetic information that is rapidly being
generated within the field of oncology. Our goal is to identify and validate a
number of targets that will be proprietary to us and which can enter our
automated screening tests. After this initial testing, active compounds are
tested in a variety of secondary assays designed to determine their potency and
selectivity, and to obtain early information on their potential metabolism,
toxicity and mechanism of action. Active compounds surviving this selection
process are considered leads and progress into lead optimization.

During lead optimization, medicinal chemists synthesize new molecules and
combinatorial libraries which are structurally related to the lead compound.
These are tested extensively in order to produce a drug candidate which has
greatly improved drug-like qualities, is active and well-tolerated in animal
models and can be patented as a novel pharmaceutical. Having identified a
suitable drug candidate, the molecule is advanced toward clinical trials and
enters the IND-track phase, in which toxicological, scale-up synthesis and
clinical trial design issues are addressed. This phase usually takes nine to 12
months.

Upon entering clinical trials (with an investigational new drug, or IND,
approval from the FDA or its foreign equivalent), a drug is first assessed for
its safety. After these Phase I trials, drugs are tested in efficacy, or Phase
II, trials to demonstrate initial activity in humans prior to extensive Phase
III trials designed to collect the data necessary to support an NDA filing with
the FDA. The entire drug discovery and development process typically takes over
a decade and is subject to significant risk and attrition. A significant number
of drug candidates which enter clinical trials fail to result in a successful
product. We have, therefore, adopted a research strategy that manages a
portfolio of product opportunities, adding, through in-licensing, lead compounds
at various stages of the process in order to help mitigate the risks inherent in
these efforts. We have integrated a platform of technologies designed to rapidly
and cost-effectively enhance the overall process.

OUR TECHNOLOGY PLATFORM

We have built a fully-integrated drug discovery platform in order to
accelerate the process of identifying and optimizing high-quality, small
molecule drug candidates. Our core discovery technologies and capabilities
include (i) gene transcription, signal transduction, protein kinases and other
assay systems, (ii) automated high throughput screening, (iii) a library of over
350,000 proprietary small molecule compounds, (iv) medicinal and automated
combinatorial chemistry, (v) in vivo pharmacology, pharmacokinetics and
pharmaceutical development capabilities, and (vi) core clinical project
management and regulatory affairs units.

BIOLOGY AND LEAD SEEKING

We are able to conduct high throughput screening on a wide variety of assay
platforms, including enzyme, immuno and receptor assays. We have developed
proprietary hardware and software systems to automate the entire drug screening
process, from the addition of the test substances to assay systems to the
analysis of the data generated from the tests.

10

Part of our assay technology includes the use of genetically engineered
human cells to identify compounds that affect transcription of target genes.
These assay systems, which employ reporter gene technology, represent a broadly
enabling technology that is the subject of an extensive patent estate which we
have successfully licensed to third parties.

Access to large libraries of diverse, small molecule compounds is a key
asset in our drug discovery efforts. Leads discovered from these libraries
become the starting materials from which drugs are optimized. Our proprietary
libraries include focused libraries of small molecule compounds derived from our
high-speed combinatorial analoging, and libraries of diverse, high quality small
molecule compounds that we have acquired.

CHEMISTRY AND LEAD OPTIMIZATION

The pharmaceutical properties of a lead compound generally must be
optimized before clinical development of that compound begins. We have assembled
a high quality medicinal chemistry team of combinatorial, computational and
pharmaceutical development chemists, which are critical elements of the lead
optimization process. A pilot manufacturing plant provides us the ability to
rapidly scale up the production of small molecules for pre-clinical toxicology
testing and early clinical trials and will further enable us to move
competitively into clinical development. We also have a high quality group of
professionals engaged in the in vivo testing of our lead compounds, including
the use of so-called xenograft models. These models allow us to test potential
anti-cancer drugs against human tumors grown in genetically modified mice.

PRE-CLINICAL DEVELOPMENT

We have expertise in pharmacokinetics, toxicology, drug metabolism and
pharmaceutical chemistry to support the development of pre-clinical drug
candidates. In addition, we have expertise in the management and generation of
good laboratory practices and accredited data, which are required for regulatory
dossier submissions to agencies such as the FDA. We are, therefore, able to
independently support the development of a drug candidate for clinical testing.
We have invested significant resources in expanding this capability and in
technological enhancements in this area.

CLINICAL DEVELOPMENT

We have established an oncology development team with considerable
expertise in clinical development, data management and analysis and regulatory
approval. We also engage third-party clinical research organizations, or CROs,
under the management and supervision of our clinical development team, to
conduct large scale clinical studies. We have entered into agreements with CROs
with expertise in oncology to monitor our ongoing clinical trials for
Tarceva(TM). Our Tarceva(TM) development team works to integrate externally
contracted clinical development support activities with contract research,
manufacturing and inventory control organizations. Under our tripartite
development agreement with Genentech and Roche, while the costs are shared
equally, each party is responsible for managing certain trials. Genentech and
Roche are each managing one of the Phase III trials in NSCLC testing Tarceva(TM)
in combination with cytotoxic chemotherapy. We are managing the Tarceva(TM)
Phase III trials in second/third line NSCLC and the combination chemotherapy
trial in pancreatic cancer.

MANUFACTURING AND SUPPLY

We currently rely on third-party manufacturers to manufacture our late
stage product candidates. Under our collaboration agreement with Genentech, we
are responsible for the manufacture and supply of Tarceva(TM) for pre-clinical
and clinical trials and to supply commercial quantities for sales within the
United States. Under our collaboration agreement with Roche, Roche has elected
to manufacture and supply Tarceva(TM) tablets for sale outside of the United
States.

Erlotinib HCl (Tarceva(TM)), a small molecule, is manufactured in a
three-step process with high yield. We currently engage multiple third-party
manufacturers to supply starting materials and active pharmaceutical ingredient,
or API, used for the preparation of Tarceva(TM) tablets. We expect to enter into
long-term

11

manufacturing and supply agreements with several of these manufacturers. In
April 2001, we entered into a contract with a third party manufacturer to
formulate erlotinib HC1 into tablets. Additionally, we are in the process of
identifying an additional source for the tablet manufacture. All manufacturers
are required to comply with current Good Manufacturing Practices, or cGMP. We
have sufficient quantities of Tarceva(TM) tablets to conduct our ongoing
clinical trials. We currently use third parties to label, inventory and
distribute the drug product. In addition, we are using third-party manufacturers
in connection with the development of alternative formulations of drug product
consisting of an IV formulation and an oral solution.

In connection with our acquisition of certain of the pre-clinical research
operations of British Biotech in September 2001, we acquired a fully-integrated
cGMP chemical pilot plant in Oxford, England. This plant is capable of producing
clinical grade non-cytotoxic compounds on a scale sufficient to support our
proprietary development activities generally through the completion of Phase II
clinical trials. We plan to use this facility to manufacture products to support
our current and future pre-clinical and clinical development programs.

In connection with our purchase of certain oncology assets from Gilead in
December 2001, we entered into a manufacturing agreement covering products
acquired from Gilead. During a one-year transition period, Gilead has continued
to manufacture and supply to us the API for preparation of OSI-7836 and
OSI-7904L drug products. We are currently in the process of transitioning the
manufacture of the API to new manufacturers as soon as practicable. Starting
materials for OSI-7904L are manufactured by other third-party manufacturers.
Starting materials for OSI-7836 are manufactured in our chemical pilot plant in
our Oxford, England facility. The entire synthesis of OSI-211 API (including
starting materials) is manufactured by a third party. Gilead will produce for us
liposomal formulations of OSI-211 and OSI-7904L at its manufacturing facility in
San Dimas, California to support our ongoing clinical trial activities and, upon
FDA approval, commercial manufacturing needs for these two liposomal products.
OSI-7836 drug product, which is a conventional IV formulation, will be prepared
by a third party manufacturer that is yet to be determined.

ROCHE AND GENENTECH COLLABORATION

On January 8, 2001, we entered into an alliance with Genentech and Roche
for the global co-development and commercialization of Tarceva(TM). We received
upfront fees of $25 million related to this alliance, and Genentech and Roche
each purchased $35 million of our common stock at $75.66 per share. We are also
entitled to up to $92 million upon the achievement of certain milestones under
the terms of the alliance.

Under the Tripartite Agreement, we agreed with Genentech and Roche to
optimize the use of each party's resources to develop Tarceva(TM) in certain
countries around the world, and share certain global development costs on an
equal basis; to share information generated under a global development plan; to
facilitate attainment of necessary regulatory approval of Tarceva(TM) products
for commercial marketing and sale in the world; and to work together on such
matters as the parties agree from time to time during the development of
Tarceva(TM). We, as well as Genentech and Roche, may conduct clinical and
pre-clinical activities for additional indications for Tarceva(TM) not called
for under the global development plan, subject to certain conditions. The
Tripartite Agreement will terminate when either the OSI/Genentech agreement or
the OSI/Roche agreement terminates.

Under the OSI/Genentech agreement, we agreed to collaborate in the product
development of Tarceva(TM) with the goal of obtaining regulatory approval for
commercial marketing and sale in the United States of products resulting from
the collaboration. Consistent with the development plan and with the approval of
a joint steering committee, we will agree with Genentech as to who will own and
be responsible for the filing of drug approval applications with the FDA other
than the first NDA which we will own and be responsible for filing and the first
supplemental NDA which we will have the option to own and be responsible for
filing. Genentech has primary responsibility for the design and implementation
of all product launch activities and the promotion, marketing and sales of all
products resulting from the collaboration in the United States, its territories
and Puerto Rico. We have certain co-promotion rights that may be enacted by
mutual agreement at any time provided that we have established a commercial
operation independent of Tarceva(TM). Genentech will pay us certain milestone
payments and we will share equally in the operating profits or losses on
products

12

resulting from the collaboration. Under the OSI/Genentech agreement, we granted
to Genentech a royalty-free non-transferable (except under certain
circumstances), non-sublicensable (except under certain circumstances),
co-exclusive license under our patents and know-how related to Tarceva(TM) to
use, sell, offer for sale and import products resulting from the collaboration
in the United States, its territories and Puerto Rico. In addition, Genentech
granted to us a royalty-free non-transferable (except under certain
circumstances), non-sublicensable (except under certain circumstances),
co-exclusive license to certain patents and know-how held by Genentech to use,
make, have made, sell, offer for sale and import products resulting from the
collaboration in the United States, its territories and Puerto Rico. We have
primary responsibility for patent filings for the base patents protecting
Tarceva(TM) and, in addition, we have the right, but not the obligation, to
institute, prosecute and control patent infringement claims relating to the base
patents. The term of the OSI/ Genentech agreement continues until the date on
which neither we nor Genentech are entitled to receive a share of the operating
profits or losses on any products resulting from the collaboration. The
OSI/Genentech agreement is subject to early termination in the event of certain
defaults. The agreement is also subject to early termination under certain
circumstances.

Under the OSI/Roche agreement, we granted to Roche a license under our
intellectual property rights with respect to Tarceva(TM). Roche is collaborating
with us and Genentech in the product development of Tarceva(TM) and is
responsible for future marketing and commercialization of Tarceva(TM) outside of
the United States in certain territories as defined in the agreement. The grant
is a royalty-bearing, non-transferable (except under certain circumstances),
non-sublicensable (except under certain circumstances), sole and exclusive
license to use, sell, offer for sale and import products resulting from the
development of Tarceva(TM) in the world, other than the territories covered by
the OSI/Genentech agreement. In addition, Roche has the right, which it has
exercised, to manufacture commercial supplies of Tarceva(TM) for its territory,
subject to certain exceptions. Roche will pay us certain milestone payments and
royalty payments on sales of products resulting from the collaboration. We have
primary responsibility for patent filings for the base patents protecting
Tarceva(TM) and, in addition, we have the right, but not the obligation, to
institute, prosecute and control patent infringement claims relating to the base
patents. The term of the OSI/Roche agreement continues until the date on which
we are no longer entitled to receive a royalty on products resulting from the
development of Tarceva(TM). The OSI/Roche agreement is subject to early
termination in the event of certain defaults. In addition, after two and one
half years from the effective date, Roche may terminate the agreement on a
country-by-country basis. We may also have the right to terminate the agreement
on a country-by-country basis if Roche has not launched or marketed a product in
such country under certain circumstances.

OTHER COLLABORATIONS

ANADERM RESEARCH CORPORATION

On April 23, 1996, we formed Anaderm with Pfizer and New York University
for the discovery and development of novel compounds to treat conditions such as
baldness, wrinkles and pigmentation disorders. In April 1999, we amended a prior
research agreement with Pfizer and Anaderm to expand our collaborative program.
On September 23, 1999 we sold our interest in Anaderm to Pfizer. The amended
research agreement expired in April 2002, followed by a three-year phase-down
period. Anaderm or Pfizer will pay royalties to us on the sales of products
resulting from the collaboration. In July 2002, we announced our agreement with
Anaderm to accelerate the conclusion of the phase-down period of this
collaboration. We will receive an $8 million wind-down fee in consideration for
transferring all research being performed by us to Anaderm. The transfer is
expected to be completed by the beginning of 2003.

DIABETES COLLABORATIONS

We have collaborations with Tanabe Seiyaku Co., Ltd and the Vanderbilt
University Diabetes Center in the area of diabetes. As a result of our strategy
to focus on oncology, we intend to divest our diabetes program into an
externally funded entity in which we will maintain a minority equity interest by
the end of the second quarter of fiscal 2003. We believe that our high quality
discovery research programs in this area can be more effectively capitalized
through an externally-funded entity. We expect that the Tanabe and Vanderbilt
collaborations will be transferred along with the diabetes program. In addition
to our alliances with Tanabe

13

and Vanderbilt, our discovery research program in diabetes includes six
proprietary gene-targeted discovery programs in the lead seeking and lead
optimization phases, primarily focused in the glucose regulation and obesity
fields. We intend to also transfer to this new entity these programs and the
existing diabetes teams comprising approximately 24 employees from our existing
work force. If external funding for this entity does not materialize, we will
consider other alternatives to discontinue the diabetes program, including the
outlicensing of the diabetes assets and employee headcount reductions.

Our collaboration with Tanabe is focused on discovering and developing
novel pharmaceutical products to treat diabetes. We are responsible for
identification of targets, assay development, screening of compounds,
identification of seed compounds, optimization of these seed compounds and
identification of lead compounds meeting certain criteria specified in the
agreement. Tanabe maintains responsibility for further development and marketing
of a lead compound in exchange for milestone and royalty payments to us. The
OSI/Vanderbilt research program, which commenced on April 28, 1998 and will end
upon termination of the contract period under the Tanabe agreement unless
mutually extended, is comprised of both research directed toward the targets
identified, as well as those not identified, in the Tanabe agreement. Vanderbilt
is assisting us in fulfilling our obligations under the OSI/Tanabe collaboration
by providing access to Vanderbilt's drug discovery resources, including
laboratories and assays. We provide funding to Vanderbilt to conduct the OSI/
Vanderbilt research program. A portion of this funding comes from Tanabe's
funding of the OSI/Tanabe research program. We will also pay to Vanderbilt a
percentage of the revenues we receive from Tanabe and any other third party
which commercializes products resulting from the OSI/Tanabe research program,
based on the extent to which Vanderbilt technology and patents contributed to
the product generating the revenue.

OTHER COLLABORATIVE RESEARCH PROGRAMS

We have several other product candidates outside of cancer from our past
collaborations which are being developed by our former partners. Should these
candidates become commercialized drugs, we will receive royalties, and in one
instance milestones, from sales of such products. These candidates are in
various stages of early clinical and advanced pre-clinical development and
include disease areas such as respiratory/asthma, heart disease and
cosmeceuticals. The table below summarizes these agents.

- ---------------

(*) Denotes clinical safety and efficacy tests as follows:

IND Track-Final stage of pre-clinical development which focuses on meeting
formal FDA requirements for an IND. This phase typically takes nine months
to one year to complete.

Phase I-Evaluation of safety in humans.

OUR INTELLECTUAL PROPERTY

Patents and other proprietary rights are vital to our business. Our policy
is to protect our intellectual property rights in technology developed by our
scientific staff through a variety of means, including applying for patents in
the United States and other major industrialized countries. We also rely upon
trade secrets and improvements, unpatented proprietary know-how and continuing
technological innovations to develop and maintain our competitive position. In
this regard, we seek restrictions in our agreements with third parties,
including research institutions, with respect to the use and disclosure of our
proprietary technology. We also enter into confidentiality agreements with our
employees, consultants and scientific advisors.

14

Patents issued in the United States, the European Patent Office, Japan, and
20 other countries, cover composition of matter for the Tarceva(TM) compound
itself, processes for its preparation, and pharmaceutical compositions
containing Tarceva(TM). Patent applications are being pursued, seeking
protection in and outside the United States, for polymorphic, anhydrous,
hydrate, and certain salt forms of Tarceva(TM), as well as for processes and
important intermediate chemicals in the manufacture of Tarceva(TM). Further,
patent protection for methods of use of Tarceva(TM) are being sought.

As of September 30, 2002, we own 26 U.S. patents, 93 foreign patents, 32
pending applications for U.S. patents, two of which have been allowed, and 165
applications for foreign patents, two of which have been allowed. Moreover, we
jointly own with Pfizer rights to numerous issued U.S. and foreign patents and
pending U.S. and foreign patent applications and we jointly own, with North
Carolina State University, two issued U.S. patent and certain U.S. and foreign
pending patent applications. Further, other institutions have granted us
exclusive rights under their U.S. and foreign patents and patent applications.

More specifically, we co-own with Pfizer about 600 U.S. and foreign patents
and patent applications in about 50 patent families. The majority are patent
applications that cover novel compounds discovered during our cancer
collaboration with Pfizer. These include two families of patents covering
composition of matter for Tarceva(TM). They also include several families
covering farnesyl transferase inhibitors (e.g., OSI-754), an OSI program, and
other development compounds being pursued by Pfizer (i.e., VEGFR, PDGFR and
erbB2 inhibitors). Several of the compounds in which we have an interest in
certain of our research programs are also generically covered by some of these
patents.

We have assembled a strong gene transcription patent portfolio. We
currently have 10 issued U.S. patents, one allowed European Patent Office
patent, and two additional issued foreign patents in this patent estate. These
include U.S. Patent Nos. 5,863,733, 5,665,543, 5,976,793 and 6,376,175, which
cover the use of reporter genes in many cell-based transcription assays used for
drug discovery; U.S. Patents Nos. 5,776,502 and 6,136,779, which cover methods
of modulating gene transcription in vivo using low molecular weight compounds;
U.S. Patent Nos. 5,580,722 and 5,846,720, which cover modulation of genes
associated with cardiovascular disease, and U.S. Patent No. 6,165,712, which
covers modulation of viral genes. We have additional patent applications
pending, one of which has been allowed in the United States, that should further
enhance our patent position in the area of gene transcription.

We have a non-exclusive out-licensing program for our gene transcription
patent estate. Currently, we have licensed this technology to Aurora Biosciences
Corporation, Pharmacia, the R.W. Johnson Pharmaceutical Research Institute,
Wyeth Corporation, BASF and Merck & Co., Inc. Helicon Therapeutics, Inc. also
has an exclusive license for a narrow use. Under these agreements, we receive
reciprocal license rights to other technology or annual fees together with
milestone and royalty payments with respect to small-molecule gene transcription
modulators developed and marketed as pharmaceutical products. We are seeking to
expand our transcriptional licensing program to include additional users of the
screening aspects of this technology. Financial return from this patent estate
could accrue from licensing revenues in the event a compound, whose use is
covered by our claims to methods of modulating gene transcription in vivo,
becomes an approved drug.

We have an exclusive license to patent applications filed by Southern
Research Institute in the United States, European Patent Office, Japan, Canada,
New Zealand and Australia to methods of use of OSI-7836 for the treatment of
cancer, method of manufacture, and methods of inhibiting DNA synthesis. Patents
directed to the OSI-211 and OSI-7904 compounds have issued in the United States,
Japan, the European Patent Office, and, in the case of OSI-211, certain other
countries. Patent protection is being sought for liposomal formulations of
OSI-211 and OSI-7904.

We also have non-exclusive licenses from Cadus Pharmaceutical Corporation
(to seven U.S. patents, and additional U.S. and foreign applications) and Wyeth
(to four U.S. patents, and additional foreign applications) to a portfolio of
patents and applications covering yeast cells engineered to express heterologous
gene-protein coupled receptors, or GPCR, and G-protein polypeptides, methods of
use thereof in screening assays, and DNAs encoding biologically active
yeast-mammalian hybrid GPCRs.

15

OUR COMPETITION

The pharmaceutical and biotechnology industries are intensely competitive.
We face, and will continue to face, intense competition from organizations such
as large pharmaceutical companies, biotechnology companies and academic and
research institutions. We face significant competition from industry
participants which are pursuing the same or similar technologies as those that
comprise our technology platform and are pursuing pharmaceutical products or
therapies that are competitive with our potential products. Most of the major
pharmaceutical organizations competing with us have greater capital resources,
larger overall research and development staffs and facilities and greater
experience in drug development, obtaining regulatory approval and pharmaceutical
product manufacturing and marketing. Our major competitors include
fully-integrated pharmaceutical companies that conduct extensive drug discovery
efforts and are developing novel small molecule pharmaceuticals, as well as
numerous smaller companies.

With respect to our small molecule drug discovery programs, other companies
have potential drugs in clinical trials to treat disease areas for which we are
seeking to discover and develop drug candidates. These competing drug candidates
may be further advanced in clinical development than our potential products in
our small molecule programs and may result in effective, commercially successful
products. In the cancer field, our lead drug candidate, Tarceva(TM), is
currently in Phase III trials. At least three competitors, AstraZeneca PLC,
ImClone Systems Incorporated/Bristol Myers Squibb, and Abgenix, Inc./Amgen,
Inc., also have substantial clinical development programs for this target.
AstraZeneca has recently received approval for Iressa, its anti-EGFR drug, in
Japan and has an NDA before the FDA.

We also face competition with respect to our next-generation cytotoxic drug
candidates. The most advanced of these products, OSI-211, a topoisomerase-1
inhibitor, is currently in Phase II trials for refractory ovarian and small cell
lung cancer. Hycamtin(R) is already marketed for this target by GlaxoSmithKline.
The two other products, OSI-7836 and OSI-7904L, are both in Phase I trials.
OSI-7836 is a nucleoside analog; Eli Lilly currently markets Gemzar(R) for this
target. OSI-7904L is a thymidylate synthase inhibitor; this target faces generic
competition, as well as competition from Xeloda(R) which is marketed by Roche.

Companies with related research and development activities also present
significant competition for us. For example, research efforts with respect to
gene sequencing and mapping are identifying new and possibly superior target
genes than our target genes. In addition, alternative drug discovery strategies,
such as monoclonal antibodies, may prove more effective than those pursued by
us. Furthermore, competitors may have access to more diverse compounds than we
do for testing by virtue of larger compound libraries or through combinatorial
chemistry skills or other means.

We believe that our ability to compete successfully will be based upon,
among other things, our ability to create and maintain scientifically advanced
technology, attract and retain scientific and clinical personnel possessing a
broad range of expertise, obtain patent protection or otherwise develop and
protect proprietary products or processes, compete for premium in-licensing
products, conduct clinical trials, obtain required government approvals on a
timely basis and commercialize our products.

GOVERNMENT REGULATION

We and our collaborative partners are subject to, and any potential
products discovered and developed by us must comply with, comprehensive
regulation by the FDA in the United States and by comparable authorities in
other countries. These national agencies and other federal, state, and local
entities regulate, among other things, the pre-clinical and clinical testing,
safety, effectiveness, approval, manufacture, labeling, marketing, export,
storage, record keeping, advertising and promotion of pharmaceutical and
diagnostic products.

16

THE FDA PROCESS

The process required by the FDA before pharmaceutical products may be
approved for marketing in the United States generally involves:

- pre-clinical laboratory and animal tests;

- submission to the FDA of an IND application, which must be in effect
before clinical trials may begin;

- adequate and well controlled human clinical trials to establish the
safety and efficacy of the drug for its intended indication;

- submission to the FDA of an NDA; and

- FDA review of the NDA or product license application in order to
determine, among other things, whether the drug is safe and effective for
its intended uses.

Pre-clinical tests include laboratory evaluation of product chemistry and
formulation, as well as animal studies, to assess the potential safety and
efficacy of the product. Certain pre-clinical tests must comply with FDA
regulations regarding current good laboratory practices. The results of the
pre-clinical tests are submitted to the FDA as part of an investigational new
drug application to support human clinical trials and are reviewed by the FDA,
with patient safety as the primary objective, prior to the commencement of human
clinical trials.

Clinical trials are conducted according to protocols that detail matters
such as a description of the condition to be treated, the objectives of the
study, a description of the patient population eligible for the study and the
parameters to be used to monitor safety and efficacy. Each protocol must be
submitted to the FDA as part of the investigational new drug application.
Protocols must be conducted in accordance with FDA regulations concerning good
clinical practices to ensure the quality and integrity of clinical trial results
and data. Failure to adhere to good clinical practices and the protocols may
result in FDA rejection of clinical trial results and data, and may delay or
prevent the FDA from approving the drug for commercial use.

Clinical trials are typically conducted in three sequential phases, which
may overlap. During Phase I, when the drug is initially given to human subjects,
the product is tested for safety, dosage tolerance, absorption, distribution,
metabolism, and excretion. Phase I studies are often conducted with healthy
volunteers depending on the drug being tested. Phase II involves studies in a
limited patient population (typically patients with the conditions needing
treatment) to:

- evaluate preliminarily the efficacy of the product for specific, targeted
indications;

- determine dosage tolerance and optimal dosage; and

- identify possible adverse effects and safety risks.

Pivotal or Phase III adequate and well-controlled trials are undertaken in
order to evaluate efficacy and safety in a comprehensive fashion within an
expanded patient population for the purpose of registering the new drug. The FDA
may suspend or terminate clinical trials at any point in this process if it
concludes that patients are being exposed to an unacceptable health risk.
Results of pre-clinical and clinical trials must be summarized in comprehensive
reports for the FDA. In addition, the results of Phase III studies are often
subject to vigorous statistical analysis. This data may be presented in
accordance with the guidelines for the International Committee of Harmonization
that can facilitate registration in Europe and Japan.

FDA approval of our own and our collaborators' products is required before
the products may be commercialized in the United States. FDA approval of the NDA
will be based, among other factors, on our comprehensive reporting of clinical
data, risk/benefit analysis, animal studies, and manufacturing processes and
facilities. The process of obtaining NDA approvals from the FDA can be costly
and time consuming and may be affected by unanticipated delays.

Among the conditions for NDA approval is the requirement that the
prospective manufacturer's procedures conform to good manufacturing practices,
or cGMP, which must be followed at all times. In

17

complying with this requirement, manufacturers, including a drug sponsor's
third-party contract manufacturers, must continue to expend time, money and
effort in the area of production quality assurance, and quality control to
ensure compliance. Domestic manufacturing establishments are subject to periodic
inspections by the FDA in order to assess, among other things, compliance with
cGMP. To supply products for use in the United States, foreign manufacturing
establishments also must comply with cGMP and are subject to periodic inspection
by the FDA or by regulatory authorities in certain countries under reciprocal
agreements with the FDA.

Both before and after market approval is obtained, a product, its
manufacturer and the holder of the NDA for the product are subject to
comprehensive regulatory oversight. Violations of regulatory requirements at any
stage, including after approval, may result in various adverse consequences,
including the FDA's delay in approving or refusal to approve a product,
withdrawal of an approved product from the market and the imposition of criminal
penalties against the manufacturer and NDA holder. In addition, later discovery
of previously unknown problems may result in restrictions on the product,
manufacturer or NDA holder, including withdrawal of the product from the market.
Furthermore, new government requirements may be established that could delay or
prevent regulatory approval of our products under development.

OTHER REGULATORY PROCESSES

For marketing of a drug outside the United States, we and our
collaborators, and the drugs developed by us, if any, will be subject to foreign
regulatory requirements governing human clinical trials and marketing approval
for drugs. The requirements governing the conduct of clinical trials, product
licensing, pricing and reimbursement vary widely from country to country. Before
a new drug may be exported from the United States, it must either be approved
for marketing in the United States or meet the requirements of exportation of an
unapproved drug under Section 802 of the Export Reform and Enhancement Act or
comply with FDA regulations pertaining to INDs.

In addition to regulations enforced by the FDA, we must also comply with
regulations under the Occupational Safety and Health Act, the Environmental
Protection Act, the Toxic Substances Control Act, the Resource Conservation and
Recovery Act and other federal, state and local regulations. Our research and
development activities involve the controlled use of hazardous materials,
chemicals and various radioactive compounds. Although we believe that our safety
procedures for handling and disposing of hazardous materials comply with the
standards prescribed by state and federal regulations, the risk of accidental
contamination or injury from these materials cannot be completely eliminated.

OUR EMPLOYEES

In October 2002, reflecting the refocusing of our business on oncology and
away from the screening services that we had historically provided to our former
collaborative partners, we reduced our headcount by 42 employees, most of whom
had been involved in early research activities. Following this reduction, as of
October 31, 2002, we employed 429 persons worldwide (277 in the United States),
of whom 173 were primarily involved in research activities and 140 in
development activities, with the remainder engaged in executive and
administrative capacities. Although we believe that we are now more
appropriately sized to focus on our mission in oncology, we intend to add
personnel with specialized oncology expertise, as needed.

We believe that we have been successful to date in attracting skilled and
experienced scientific and business professionals. We consider our employee
relations to be good. However, competition for personnel is intense and we
cannot assure that we will continue to be able to attract and retain personnel
of high caliber. Further, we believe that our success is largely dependent upon
our ability to attract and retain such qualified personnel.

18

CAUTIONARY FACTORS THAT MAY AFFECT FUTURE RESULTS

(Cautionary Statement under the Private Securities Litigation Reform Act of
1995, as amended)

This report contains forward-looking statements that do not convey
historical information, but relate to predicted or potential future events, such
as statements of our plans, strategies and intentions, or our future performance
or goals for our product development programs. These statements can often be
identified by the use of forward-looking terminology such as "believe,"
"expect," "intend," "may," "will," "should," or "anticipate" or similar
terminology. The statements involve risks and uncertainties and are based on
various assumptions. Stockholders and prospective stockholders are cautioned
that these statements are only projections. In addition, any forward-looking
statement that we make is intended to speak only as of the date on which we made
the statement. We will not update any forward-looking statement to reflect
events or circumstances that occur after the date on which the statement is
made. The following risks and uncertainties, among others, may cause our actual
results to differ materially from those described in forward-looking statements
made in this report or presented elsewhere by management from time to time.

ALTHOUGH WE HAVE POTENTIAL ONCOLOGY PRODUCTS THAT APPEAR TO BE PROMISING AT
EARLY STAGES OF DEVELOPMENT AND IN CLINICAL TRIALS, NONE OF OUR POTENTIAL
ONCOLOGY PRODUCTS MAY REACH THE MARKET FOR A NUMBER OF REASONS.

Successful research and development of pharmaceutical products is high
risk. Most projects and development candidates fail to reach the market. Our
success depends on the discovery of new drugs that we can commercialize. It is
possible that none of our potential oncology products, including Tarceva(TM),
may ever reach the market for a number of reasons. They may be found ineffective
or cause harmful side effects during pre-clinical testing or clinical trials or
fail to receive necessary regulatory approvals. We may find that certain
products cannot be manufactured on a commercial scale basis and, therefore, they
may not be economical to produce. Our products could also fail to achieve market
acceptance or be precluded from commercialization by proprietary rights of third
parties.

We have a number of oncology product candidates in early stages of
development and we do not expect them to be commercially available for several
years, if at all. All but six of our product candidates are in the pre-clinical
development phase. The six candidates that are in clinical trials will still
require significant research and development and regulatory approvals before we
or our collaborative partners will be able to market them.

IF WE HAVE A SETBACK IN OUR TARCEVA(TM) PROGRAM, OUR STOCK PRICE WOULD ALMOST
CERTAINLY DECLINE.

We are currently conducting four Phase III clinical trials for Tarceva(TM).
If we do not receive any positive results from these trials, we would need to
conduct additional clinical trials or abandon our Tarceva(TM) program. Since
Tarceva(TM) is our most advanced product candidate, a setback of this nature
would almost certainly cause a decline in our stock price. Recently, AstraZeneca
announced unfavorable results from its clinical trials which were testing its
drug candidate, Iressa, which is in the same class of targeted therapies as
Tarceva(TM), in combination with traditional chemotherapy agents for the front
line treatment of non small cell lung cancer. While there are important
differences between Iressa and Tarceva(TM) and AstraZeneca's clinical program
and our clinical program, including structure, formulation, pharmacokinetics and
Phase III trial design and dosing, two of our four Phase III trials are designed
to test Tarceva(TM) in combination with chemotherapy agents for NSCLC in studies
similar to those of AstraZeneca. A positive outcome from these two trials must
now be considered higher risk.

SET-BACKS ON THE PART OF OUR COMPETITORS WHO ARE DEVELOPING DRUGS IN THE
HER1/EGFR FIELD WHICH ARE SIMILAR TO TARCEVA(TM) COULD RESULT IN DECREASES IN
OUR STOCK PRICE.

Our major competitors who are developing drugs in the HER1/EGFR field which
are similar to our most advanced clinical candidate, Tarceva(TM), have suffered
setbacks with respect to their drug candidates during the last 12 months which
have impacted our stock price by raising concerns regarding the HER1/EGFR class
of targeted therapies. Both AstraZeneca and ImClone, who are each developing
drug candidates in the same

19

class of HER1/EGFR targeted therapies as Tarceva(TM), suffered setbacks in their
programs during the last year. These setbacks have resulted in casting doubt
amongst some investors on all drug candidates targeting the HER1/EGFR gene,
including Tarceva(TM), which has led to declining stock prices for us and others
developing drugs in this class. Additional set-backs on the part of our
competitors could result in a further decrease in our stock price.

IF WE ARE UNABLE TO DEMONSTRATE ACCEPTABLE SAFETY AND EFFICACY OF TARCEVA(TM)
DURING CLINICAL TRIALS, WE WILL NOT BE ABLE TO OBTAIN REGULATORY APPROVAL AND
THUS WILL NOT BE ABLE TO COMMERCIALIZE AND GENERATE REVENUES FROM TARCEVA(TM).

We must continue to demonstrate, through pre-clinical testing and clinical
trials, that Tarceva(TM) is safe and effective. The results from pre-clinical
testing and early clinical trials may not be predictive of results obtained in
subsequent clinical trials, and we cannot be sure that our clinical trials will
demonstrate the safety and efficacy necessary to obtain regulatory approval for
Tarceva(TM). A number of companies in the biotechnology and pharmaceutical
industries have suffered significant setbacks in advanced clinical trials, even
after obtaining promising results in earlier trials. In addition, certain
clinical trials are conducted with patients having the most advanced stages of
disease. During the course of treatment, these patients often die or suffer
other adverse medical effects for reasons that may not be related to the
pharmaceutical agent being tested. These events can complicate our statistical
analysis of clinical trial results and may lead to misinterpretation of clinical
trial results.

Any significant delays in, or termination of, clinical trials for
Tarceva(TM) may hinder our ability to obtain regulatory approval of Tarceva(TM).
Any delays in obtaining or failure to obtain regulatory approval will hinder or
prevent us from commercializing and generating revenues from Tarceva(TM).

IF WE DO NOT MAINTAIN OUR CO-DEVELOPMENT AND MARKETING ALLIANCE WITH GENENTECH
AND ROCHE FOR TARCEVA(TM), OUR ABILITY TO PROCEED WITH THE TIMELY AND PROFITABLE
MANUFACTURE AND SALE OF TARCEVA(TM) MAY BE COMPROMISED OR DELAYED.

If we do not maintain a successful collaborative partnership with Genentech
and Roche for the co-development and commercialization of Tarceva(TM), we may be
forced to focus our efforts internally to commercialize Tarceva(TM) which would
require a greater expenditure of financial resources and may cause a delay in
launch and market penetration while we build our own commercial operation or
seek alternative partners. Although we manage the manufacturing of Tarceva(TM)
for the U.S. market through third party providers, there may be a delay in our
ability to scale up if we were requested to replace Roche's manufacturing role
in markets outside of the United States.

IF OUR COMPETITORS WHO ARE DEVELOPING DRUGS IN THE HER1/EGFR FIELD RECEIVE FDA
APPROVAL FOR THEIR DRUG CANDIDATES AND COMMENCE MARKETING SUCH PRODUCTS
SIGNIFICANTLY IN ADVANCE OF OUR LAUNCH OF TARCEVA(TM), THEN OUR ABILITY TO
COMPETE FOR SALES IN THIS MARKET MAY BE A GREATER CHALLENGE.

If our competitors, some of whom have greater resources than we do, receive
FDA approval for their drugs and begin marketing those products significantly in
advance of our launch of Tarceva(TM), it may be more difficult for us to
penetrate the market and our sales may be less than projected. This could
negatively impact our potential future profitability and the scope of our
operations including research and development of our other oncology drug
candidates.

IF OUR COMPETITORS SUCCEED IN DEVELOPING PRODUCTS AND TECHNOLOGIES THAT ARE MORE
EFFECTIVE THAN OUR OWN, OUR PRODUCTS AND TECHNOLOGIES MAY BE RENDERED LESS
COMPETITIVE.

We face significant competition from industry participants that are
pursuing similar products and technologies as we are and are developing
pharmaceutical products that are competitive with our potential products. Where
we are developing products independently, some of the organizations competing
with us have greater capital resources, larger overall research and development
staffs and facilities, and more extensive experience in drug discovery and
development, obtaining regulatory approval and pharmaceutical product

20

manufacturing and marketing. With these additional resources, our competitors
may be able to respond to the rapid and significant technological changes in the
biotechnology and pharmaceutical industries faster than we can. Our future
success will depend in large part on our ability to maintain a competitive
position with respect to these technologies. Rapid technological development may
result in our compounds, products or processes becoming obsolete before we
recover any of the expenses incurred to develop them.

In particular, we face significant competition from other biotechnology and
pharmaceutical companies which are currently developing drugs similar to
Tarceva(TM) that could dilute our potential for sales from Tarceva(TM). We are
aware of at least three companies, some of which have resources substantially
greater than we do, which currently have drugs similar to Tarceva(TM) in
substantial clinical development programs. In addition to AstraZeneca's Iressa,
ImClone/Bristol Myers Squibb and Abgenix/Amgen are developing a different kind
of product, humanized antibodies, against the HER1/EGFR target. The ImClone
product is currently in Phase III trials, and the Abgenix product is in Phase II
trials. If our competitors succeed in developing drugs similar to Tarceva(TM)
that are more effective than our own, our product may not gain widespread market
acceptance.

IF WE ARE UNABLE TO ESTABLISH A COMMERCIAL INFRASTRUCTURE FOR THE MARKETING OF
OUR POTENTIAL ONCOLOGY PRODUCTS OTHER THAN TARCEVA(TM), WE WILL NEED TO ENTER
INTO AND MAINTAIN ARRANGEMENTS WITH THIRD PARTIES FOR COMMERCIALIZATION OF SUCH
PRODUCTS WHICH COULD SUBSTANTIALLY DIMINISH OUR SHARE OF THE REVENUES FROM THE
SALES OF SUCH PRODUCTS.

In order to successfully commercialize our other product candidates, we
must be able to:

- manufacture our products in commercial quantities at reasonable costs;

- obtain reimbursement coverage for our products;

- compete favorably against other products; and

- market our products successfully.

We may not be successful in establishing a commercial infrastructure to
enable us to accomplish the above with respect to our products other than
Tarceva(TM). If we are unsuccessful or delayed in establishing this
infrastructure, we would need to enter into and successfully maintain additional
co-development and commercialization agreements. This would result in our
receipt of a decreased share of the revenues generated from the sale of such
products.

IF OUR COLLABORATIVE PARTNERS OR OTHER THIRD PARTY CONTRACTORS GIVE OTHER
PRODUCTS GREATER PRIORITY THAN OUR PRODUCTS, OUR PRODUCTS MAY BE SUBJECT TO
DELAYS IN RESEARCH AND DEVELOPMENT, MANUFACTURE AND COMMERCIALIZATION THAT MAY
IMPEDE OUR ABILITY TO TAKE THEM TO MARKET BEFORE OUR COMPETITORS. THIS MAY
RENDER OUR PRODUCTS OBSOLETE OR MAY RESULT IN LOWER THAN ANTICIPATED REVENUES
FOR US.

We rely on some of our collaborative partners and certain third party
contractors to assist with research and development as well as the manufacture
of our potential products in their FDA-approved manufacturing facilities. Some
of our collaborative agreements allow these parties significant discretion in
electing whether or not to pursue the activities that they have agreed to pursue
for us. We cannot control the amount and timing of resources these parties
devote to our programs or potential products. Our potential products may be in
competition with other products for priority of access to these parties'
research and development and manufacturing facilities. If these parties do not
give significant priority to the research and development or manufacture of our
potential products in an effective or timely manner, the clinical development of
our product candidates or their submission for regulatory approval could be
delayed, and our ability to deliver products to the market on a timely basis
could be impaired. Furthermore, we may not be able to enter into any necessary
third-party research and development or manufacturing arrangements on acceptable
terms, if at all.

21

IF GOVERNMENT AGENCIES DO NOT GRANT US OR OUR COLLABORATIVE PARTNERS REQUIRED
APPROVALS FOR ANY OF OUR POTENTIAL PRODUCTS, WE OR OUR COLLABORATIVE PARTNERS
WILL NOT BE ABLE TO MANUFACTURE AND SELL OUR PRODUCTS.

All of our newly discovered potential products must undergo an extensive
regulatory approval process in the United States and other countries. This
regulatory process, which includes pre-clinical testing and clinical trials of
each compound to establish its safety and efficacy, can take many years and
requires the expenditure of substantial resources. Moreover, data obtained from
pre-clinical and clinical activities are susceptible to varying interpretations
that could delay, limit or prevent regulatory approval. The FDA and other
regulatory agencies may delay or deny the approval of our proposed products.
None of our products has yet received governmental approval, and none may ever
do so. If we do not receive the required regulatory approvals, we or our
collaborative partners will not be able to manufacture and sell our products.

Even if we obtain regulatory approval, a marketed product and its
manufacturer are subject to continuing review, including post-marketing
surveillance. We may be required to withdraw our product from the market if
previously unknown problems are discovered. Violations of regulatory
requirements at any stage may result in various unfavorable consequences to us,
including the FDA's imposition of criminal penalties against the manufacturer
and the holder of the NDA.

OUR RELIANCE ON THIRD PARTIES SUCH AS CLINICAL DISTRIBUTORS, MANUFACTURERS AND
CLINICAL RESEARCH ORGANIZATIONS, OR CROS, MAY RESULT IN DELAYS IN COMPLETING, OR
A FAILURE TO COMPLETE, CLINICAL TRIALS IF THEY FAIL TO PERFORM UNDER OUR
AGREEMENTS WITH THEM.

From time to time in the course of product development, we may engage
clinical distributors, manufacturers and/or CROs to manufacture and distribute
the product candidate and to conduct and manage clinical studies and to assist
us in guiding products through the FDA review and approval process. Because we
have engaged and intend to engage clinical distributors, manufacturers and CROs
to help us obtain market approval for our drug candidates, many important
aspects of this process have been and will be out of our direct control. If the
clinical distributors, manufacturers and CROs fail to perform their obligations
under our agreements with them or fail to manufacture and distribute the product
candidate and to perform clinical trials in a satisfactory manner, we may face
delays in completing our clinical trials, as well as commercialization of any
drug candidate. Furthermore, any loss or delay in obtaining contracts with such
entities may also delay the completion of our clinical trials and the market
approval of drug candidates.

WE HAVE INCURRED LOSSES SINCE OUR INCEPTION, AND WE EXPECT TO INCUR LOSSES OVER
THE NEXT SEVERAL YEARS, WHICH MAY CAUSE THE VALUE OF OUR COMMON STOCK TO
DECREASE.

We have had net operating losses since our inception in 1983. At September
30, 2002, our accumulated deficit was approximately $324.2 million. Our losses
have resulted principally from costs incurred in research and development,
acquired in-process research and development and from general and administrative
costs associated with our operations. These costs have exceeded our revenues,
and we expect them to continue to do so until we generate significant sales from
marketed products.

We expect to continue to incur operating losses over the next few years as
a result of our expenses for the development of Tarceva(TM) and our other
clinical products and our research programs. These expenses include enhancements
in our drug discovery technologies and increases in the resources we will devote
to our internally funded proprietary projects. We do not expect to generate
revenues from the sale of our potential products for a number of years, and we
expect to continue to incur operating losses during this period.

IF WE CANNOT PROTECT OUR INTELLECTUAL PROPERTY RIGHTS, OUR ABILITY TO DEVELOP
AND COMMERCIALIZE OUR PRODUCTS WILL BE SEVERELY LIMITED.

As of September 30, 2002, we held 26 U.S. patents, 93 foreign patents, 32
pending applications for U.S. patents, two of which have been allowed, and 165
applications for foreign patents, two of which have been allowed. Moreover, we
jointly hold with Pfizer rights to numerous issued U.S. and foreign patents and
pending U.S. and foreign patent applications. We also jointly hold, with North
Carolina State University, two issued

22

U.S. patents and certain U.S. and foreign pending patent applications. We intend
to continue to aggressively seek patent protection for all of the product
candidates that we have discovered, developed or acquired.

Our success depends, in part, on our ability and our collaborative
partners' ability to obtain patent protection for new product candidates,
maintain trade secret protection and operate without infringing the proprietary
rights of third parties. As with most biotechnology and pharmaceutical
companies, our patent position is highly uncertain and involves complex legal
and factual questions. Without patent and other similar protection, other
companies could offer substantially identical products for sale without
incurring the sizable discovery and development costs that we have incurred. Our
ability to recover these expenditures and realize profits upon the sale of
products could be diminished.

The process of obtaining patents can be time consuming and expensive with
no certainty of success. Even if we spend the necessary time and money, a patent
may not issue or it may insufficiently protect the technology it was intended to
protect. We can never be certain that we were the first to develop the
technology or that we were the first to file a patent application for the
particular technology because most U.S. patent applications are confidential
until a patent issues, and publications in the scientific or patent literature
lag behind actual discoveries.

The degree of future protection for our proprietary rights will remain
uncertain if our pending patent applications are not approved for any reason or
if we are unable to develop additional proprietary technologies that are
patentable. Furthermore, third parties may independently develop similar or
alternative technologies, duplicate some or all of our technologies, design
around our patented technologies or challenge our issued patents.

IF OTHER COMPANIES CLAIM THAT WE INFRINGE ON THEIR INTELLECTUAL PROPERTY RIGHTS,
WE MAY BE SUBJECT TO COSTLY AND TIME-CONSUMING LITIGATION AND DELAYS IN PRODUCT
INTRODUCTION.

Our processes and potential products may conflict with patents which have
been or may be granted to competitors, academic institutions or others. As the
biotechnology and pharmaceutical industries expand and more patents are filed
and issued, the risk increases that our product candidates may give rise to a
declaration of interference by the Patent and Trademark Office, or to claims of
patent infringement by other companies, institutions or individuals. These
entities or persons could bring legal proceedings against us seeking substantial
damages or seeking to enjoin us from testing, manufacturing or marketing our
products. If any of these actions were successful, we may also be required to
cease the infringing activity or obtain the requisite licenses or rights to use
the technology which may not be available to us on acceptable terms, if at all.
Any litigation, regardless of the outcome, could be extremely costly to us.

IF OTHER BIOTECHNOLOGY AND PHARMACEUTICAL COMPANIES ARE NOT WILLING TO PAY
APPROPRIATE ROYALTIES FOR THE USE OF OUR PATENTED "GENE TRANSCRIPTION ESTATE,"
WE MAY NEED TO EXPEND SUBSTANTIAL AMOUNTS OF FUNDS AND RESOURCES IF WE CHOOSE TO
ENFORCE THE PATENTS.

We license to other companies rights to use our patented "gene
transcription estate" which consists of drug discovery assays that provide a way
to identify novel product candidates that can control the activity of genes. We
believe technology and practices covered by these patents are in widespread use
in the pharmaceutical and biotechnology industries. To date, we have granted
seven licenses to use our gene transcription patents. If other pharmaceutical
and biotechnology companies which we believe are using our patented technology
are not willing to negotiate license arrangements with us on reasonable terms,
we may have to choose between abandoning our licensing strategy or initiating
legal proceedings against those companies. Legal action, particularly patent
infringement litigation, is extremely costly.

IF WE OR OUR COLLABORATIVE PARTNERS ARE REQUIRED TO OBTAIN LICENSES FROM THIRD
PARTIES, OUR REVENUES AND ROYALTIES ON ANY COMMERCIALIZED PRODUCTS COULD BE
REDUCED.

The development of some of our products may require the use of technology
developed by third parties. The extent to which efforts by other researchers
have resulted or will result in patents and the extent to which we or our
collaborative partners are forced to obtain licenses from others, if available,
is currently unknown. If

23

we or our collaborative partners must obtain licenses from third parties, fees
must be paid for such licenses. These fees would reduce the revenues and
royalties we may receive on commercialized products.

THE USE OF ANY OF OUR POTENTIAL PRODUCTS IN CLINICAL TRIALS AND THE SALE OF ANY
APPROVED PRODUCTS MAY EXPOSE US TO LIABILITY CLAIMS RESULTING FROM THE USE OF
PRODUCTS OR PRODUCT CANDIDATES.

The nature of our business exposes us to potential liability risks inherent
in the testing, manufacturing and marketing of drug discovery candidates and
products. Using our drug candidates in clinical trials may expose us to product
liability claims. These risks will expand with respect to drugs, if any, that
receive regulatory approval for commercial sale. While we currently maintain
product liability insurance that we believe is adequate, such insurance may not
be available at reasonable rates, if at all, in the future. If we do not or
cannot maintain adequate insurance coverage, we may incur significant liability
if a product liability claim arises.

IF WE CANNOT OBTAIN ADEQUATE FUNDING FOR OUR RESEARCH AND DEVELOPMENT EFFORTS OR
OUR PROJECTED FUTURE SALES ARE DELAYED OR DIMINISHED, WE MAY HAVE TO LIMIT THE
SCOPE OF OUR PROPRIETARY PRODUCT DEVELOPMENT IN FUTURE YEARS OR ENTER INTO MORE
RESTRICTIVE ARRANGEMENTS WITH COLLABORATIVE PARTNERS.

Our future capital requirements will depend on many factors, including the
size and complexity of our research and development programs, the progress of
pre-clinical testing and early stage clinical trials, the time and costs
involved in obtaining regulatory approvals for our product candidates, the costs
of manufacturing arrangements and the costs of commercialization activities.

Although we believe our current cash reserves are sufficient for our
near-term operating needs, we may choose to raise additional funds through
public or private sales of our securities, including equity securities, as well
as from collaborative partners in order to further our growth. We may not be
able to obtain adequate funding from equity financings on reasonable or
acceptable terms, if at all. Furthermore, any additional equity financings may
dilute the value of the common stock held by our stockholders. If adequate funds
are not available, we may be required to significantly curtail one or more of
our research and development programs or obtain funds through arrangements with
collaborative partners or others that may require us to relinquish certain of
our rights to a number of our technologies or product candidates.

IF THE MARKET PRICE OF OUR COMMON STOCK, SIMILAR TO OTHER BIOTECHNOLOGY
COMPANIES, REMAINS HIGHLY VOLATILE, THEN OUR STOCKHOLDERS MAY NOT BE ABLE TO
SELL THEIR STOCK WHEN DESIRED OR AT DESIRABLE PRICES.

When the stock prices of companies in the Nasdaq Biotechnology Index fall,
our stock price will most likely fall as well. The market price of the common
stock of biotechnology and pharmaceutical companies and our common stock has
been volatile and may remain volatile for the foreseeable future. If our stock
price falls, our stockholders may not be able to sell their stock when desired
or at desirable prices.

The following factors, among others, some of which are beyond our control,
may also cause our stock price to decline:

- fluctuations in operating results;

- announcements of technological innovations or new therapeutic products by
others;

- negative or neutral clinical trial results;

- developments concerning strategic alliance agreements;

- negative clinical or safety results from our competitors' products;

- changes in government regulation including pricing controls;

- delays with the FDA in the approval process for Tarceva(TM) and other
clinical candidates;

- developments in patent or other proprietary rights;

- public concern as to the safety of our products;

24

- future sales of substantial amounts of our common stock by existing
stockholders; and

- comments by securities analysts and general market conditions.

OUR OUTSTANDING INDEBTEDNESS HAS INCREASED SUBSTANTIALLY WITH THE ISSUANCE OF
CONVERTIBLE SENIOR SUBORDINATED NOTES IN FEBRUARY 2002, AND WE MAY NOT BE ABLE
TO PAY THESE NOTES AND OUR OTHER OBLIGATIONS.

As a result of the sale of the Convertible Senior Subordinated Notes in
February 2002 and the subsequent repurchase of a portion of these notes in
August and September 2002, our long-term debt relating to these notes was $160
million as of September 30, 2002. This may:

- make it more difficult for us to obtain any necessary financing in the
future for working capital, capital expenditures, debt service
requirements or other purposes;

- significantly increase our interest expense and related debt service
costs; and

- make us more vulnerable in the event of a downturn in our business.

Currently, we do not have any product sales and we are not generating
sufficient cash flow to satisfy the annual debt service payments that will be
required as a result of the consummation of the sale of the notes. This may
require us to use a portion of the proceeds from the sale of the notes to pay
interest or borrow additional funds or sell additional equity to meet our debt
service obligations after the first three years when the payment of interest on
the notes is no longer secured. If we are unable to satisfy our debt service
requirements, or do not have the funds to repay the notes upon maturity in 2009,
we will default on the notes and liquidity problems could result.

OUR CORPORATE GOVERNANCE DOCUMENTS AND STATE LAW PROVIDE CERTAIN ANTI-TAKEOVER
MEASURES WHICH WILL DISCOURAGE CERTAIN TYPES OF TRANSACTIONS INVOLVING AN ACTUAL
OR POTENTIAL CHANGE IN CONTROL OF OUR COMPANY.

Under our certificate of incorporation, our Board of Directors has the
authority, without further action by the stockholders, to fix the rights and
preferences, and issue shares of, preferred stock. Since January 1999, we have
had a shareholders rights plan, which was subsequently replaced with a new plan,
commonly referred to as a "poison pill." Further, we are subject to Section 203
of the Delaware General Corporation Law which, subject to certain exceptions,
restricts certain transactions and business combinations between a corporation
and a stockholder owning 15% or more of the corporation's outstanding voting
stock for a period of three years from the date the stockholder becomes an
interested stockholder.

25

ITEM 2. PROPERTIES

We currently lease three facilities in New York, one located at 58 South
Service Road, Melville, New York, consisting of approximately 37,000 square
feet, one located at 106 Charles Lindbergh Boulevard, Uniondale, New York,
consisting of 30,000 square feet, and one located at 1 Bioscience Park Drive,
Farmingdale, New York, consisting of approximately 53,000 square feet. The
Melville facility houses our principal executive, finance, legal and
administrative offices. The Uniondale and Farmingdale facilities house our drug
discovery and pre-clinical laboratories.

In August 2002, we entered into a Termination and Surrender Agreement with
our landlord at our Tarrytown, New York facility whereby we were released from
our obligations under the lease. Our Tarrytown research operations were
consolidated primarily into our Farmingdale facility.

In December 2001, in connection with our acquisition of Gilead's pipeline
of clinical candidates in oncology, we acquired the leases to three facilities,
one located at 2860 Wilderness Place, Boulder, Colorado, consisting of 60,000
square feet, one located at 2900 Center Green Court South, Boulder, Colorado,
consisting of approximately 10,000 square feet, and one located at 2970
Wilderness Place, Boulder, Colorado, consisting of approximately 26,000 square
feet. The Boulder facilities house our clinical research, regulatory affairs and
drug development personnel.

Our subsidiary, OSI Pharmaceuticals (UK) Limited, leases three facilities,
one located at 10 Holt Court South, Aston Science Park, Birmingham, England,
consisting of approximately 26,000 square feet, one located at Windrush Court,
Watlington Road, Oxford, England, consisting of approximately 88,000 square
feet, and another located at Isis House, Watlington Road, Oxford, England,
consisting of approximately 34,000 square feet. We ceased operations at our
Aston Science Park, Birmingham, England facility in March 2002 and have
consolidated the Birmingham operations into the Oxford facilities. Our leases at
the Birmingham facility expire at dates through January 2006. The Oxford
facilities house our research and development laboratories and administrative
offices.

ITEM 3. LEGAL PROCEEDINGS

There are no material legal proceedings pending against us.

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

There were no matters submitted to a vote of our security holders during
the fourth quarter of fiscal 2002.

26

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

MARKET INFORMATION

Our common stock is traded in the over-the-counter market and is included
for quotation on the NASDAQ National Market under the symbol OSIP. The following
is the range of high and low sales prices by quarter for our common stock from
October 1, 2000 through September 30, 2002 as reported on the NASDAQ National
Market:

HOLDERS AND DIVIDENDS

As of November 29, 2002, there were approximately 436 holders of record of
our common stock. We have not paid any cash dividends since inception and we do
not intend to pay any cash dividends in the foreseeable future. Declaration of
dividends will depend, among other things, upon future earnings, our operating
and financial condition, our capital requirements and general business
conditions.

SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS

EQUITY COMPENSATION PLAN INFORMATION AS OF SEPTEMBER 30, 2002

- ---------------

(a) Consists of six plans: 1985 Stock Option Plan, 1989 Incentive and
Non-Qualified Stock Option Plan, 1993 Incentive and Non-Qualified Stock
Option Plan, 1997 Incentive and Non-Qualified Stock Option Plan, 1999
Incentive and Non-Qualified Stock Option Plan and 2001 Incentive and
Non-Qualified Stock Option Plan.

(b) In connection with the acquisition of certain oncology assets from Gilead
Sciences, Inc. on December 21, 2001, we adopted a Non-Qualified Stock Option
Plan for Former Employees of Gilead Sciences, Inc. We granted ten-year
options to purchase an aggregate of 693,582 shares of our common stock at a
purchase

27

price of $45.01 per share, which represents the fair value of our stock at the
date granted. The options vest one-third in a year from the date of grant and
monthly thereafter for twenty-four months.

In connection with the acquisition of Cadus Pharmaceutical Corporation, we
adopted a Non-Qualified Stock Option Plan for Former Employees of Cadus
Pharmaceutical Corporation. We granted ten-year options to purchase an
aggregate of 415,000 shares of our common stock at a purchase price of $5.00
per share, which represents the fair value of our stock at the date granted.
These options became exercisable on July 30, 2000, one year from the date of
the grant.

(c) Includes options established for certain outside consultants related to
clinical trial operations, options granted to employees of our subsidiary
OSI-UK and options granted to outside directors.

(d) Includes 675,624 shares reserved for issuance under the 1993 Employee Stock
Purchase Plan, 1995 Employee Stock Purchase Plan and a stock purchase plan
for employees of OSI-UK. (See note 10(d) to the accompanying consolidated
financial statements.)

We have a policy of rewarding employees who achieve ten, fifteen, and
twenty years of continued service with the Company with 100, 150, and 200
shares, respectively, of our common stock. We grant such shares of common stock
on an annual basis to those individuals who meet the stated requirements.

28

29

ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

The following table sets forth our selected consolidated financial data as
of and for each of the years in the five-year period ended September 30, 2002.
The information below should be read in conjunction with the consolidated
financial statements and notes thereto included elsewhere in this report.

- ---------------

(a) The fiscal 2002 consolidated financial statements include the acquisition of
certain assets from Gilead Sciences, Inc. for approximately $175.7 million
in cash and common stock; the issuance of $200.0 million of convertible
senior subordinated notes for net proceeds of approximately $193.0 million;
the receipt of $4.5 million from the phase-down of our collaboration with
Anaderm Research Corporation, of which $1.8 million was recognized as
revenue in accordance with SAB No. 101, and the early retirement of

29

$40.0 million aggregate principal amount of convertible senior subordinated
notes resulting in a net gain of approximately $12.6 million. (See notes
3(a), 5(b) and 9 to the accompanying consolidated financial statements.)

(b) The fiscal 2001 consolidated financial statements include a cumulative
effect of the change in accounting principle of $2.6 million relating to the
adoption of SAB No. 101; the acquisition of certain assets from British
Biotech plc for $13.9 million; $25 million in upfront fees received upon the
execution of collaboration agreements with Genentech, Inc. and Roche; net
proceeds of approximately $404 million from a public offering of common
stock in November 2000; the sale of newly-issued shares of common stock to
Genentech and Roche for an aggregate purchase price of $35 million each; and
a charge to operations of $5.1 million for the estimated cost of closing our
Tarrytown, New York and Birmingham, England facilities. (See notes 1(b),
3(b), 5(a), 10(f), 10(g), 16(a) and 16(b) to the accompanying consolidated
financial statements.)

(c) The fiscal 2000 consolidated financial statements include a charge to
operations of $700,000 representing the cost of a license to use and
practice certain of Cadus Pharmaceutical Corporation's technology and
patents; a $3.5 million technology access fee received upon the execution of
a collaborative research and license agreement with Tanabe Seiyaku Co.,
Ltd.; non-cash compensation charges of approximately $6.8 million and
deferred compensation of approximately $8.8 million associated with options
issued to an employee and consultants; net proceeds of approximately $53
million from a private placement of common stock; and a $3.7 million gain
resulting from the sale of our diagnostics business, including the assets of
our wholly-owned subsidiary, OSDI, Inc., to The Bayer Corporation. (See
notes 5(c), 10(a), 10(e), and 17 to the accompanying consolidated financial
statements.)

(d) The fiscal 1999 consolidated financial statements include the acquisition of
Cadus Pharmaceutical Corporation's research business for $2.2 million in
cash, including a $806,000 charge to operations for in-process R&D acquired;
a gain of $3.3 million on the sale of our Anaderm stock to Pfizer Inc.; and
a $535,000 charge to operations for the estimated costs of closing our
facilities in North Carolina. (See note 16(c) to the accompanying
consolidated financial statements.)

(e) The fiscal 1998 consolidated financial statements include approximately
$702,000 of license revenue received upon execution of a license agreement
with Aurora Biosciences Corporation.

30

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

OVERVIEW

We are a leading biotechnology company focused on the discovery,
development and commercialization of high-quality oncology products that both
extend life and improve the quality-of-life for cancer patients worldwide. We
have established a balanced pipeline of oncology drug candidates that includes
both next-generation cytotoxic chemotherapy agents and novel mechanism-based,
gene-targeted therapies. We currently have four proprietary candidates in
clinical trials and two additional candidates in clinical trials with Pfizer.

Our most advanced drug candidate, Tarceva(TM) (erlotinib HC1), is a small
molecule inhibitor of the epidermal growth factor receptor, or HER1/EGFR. The
protein product of the HER1/EGFR gene is a receptor tyrosine kinase that is
over-expressed or mutated in many major solid tumors. We believe HER1/EGFR
inhibitors represent an exciting new class of relatively safe and well tolerated
anti-cancer agents that may have utility in treating a wide range of cancer
patients. Tarceva(TM) is an oral once-a-day small molecule drug designed to
specifically block the activity of the HER1/EGFR protein. Currently, Tarceva(TM)
is being developed in an alliance with Genentech, Inc. and Roche. If the drug
receives regulatory approval, Genentech will lead the marketing effort in the
United States and Roche will market it in the rest of the world. We will receive
milestone payments from both Genentech and Roche, an equal profit share from
U.S. sales, and royalties on sales outside of the United States. Tarceva(TM) has
demonstrated encouraging indications of anti-cancer activity in single-agent,
open label Phase II trials in non-small cell lung cancer, head and neck cancer
and ovarian cancer. Tarceva(TM) is currently in Phase III clinical trials for
non-small cell lung cancer and pancreatic cancer.

Behind Tarceva(TM) we have five additional drug candidates in earlier
stages of clinical development. Three of these (OSI-211, OSI-7904L and OSI-7836)
are next generation cytotoxic chemotherapy agents and the other two (CP-547,632
and CP-724,714) are gene-targeted therapies currently being developed by Pfizer
Inc. We own commercial rights to the first three and will receive royalty
payments on the latter two if they are successfully commercialized.

Our next generation cytotoxic chemotherapy candidates are designed to
improve upon currently marketed products in the same drug class. OSI-211 is a
liposomal formulation of lurtotecan, a topoisomerase-1 inhibitor, that is being
developed to compete with topotecan (Hycamptin(R)). OSI-7904L is a liposomal
formulation of a thymidylate synthase inhibitor, GW1843, that is being developed
as a potential competitor to 5-Fluorouracil (5-FU) and capecitabine (Xeloda(R)),
and OSI-7836 is a nucleoside analog being developed to compete with gemcitabine
(Gemzar(R)). OSI-211 is in Phase II clinical trials, and OSI-7904L and OSI-7836
are in Phase I clinical trials. Like Tarceva(TM), the two gene-targeted
therapies are receptor tyrosine kinase inhibitors. CP-547,632 is a small
molecule targeting the vascular endothelial growth factor receptor, or VEGFR,
and CP-724,714 is a small molecule targeting HER2/erbB2. Both agents are
currently in Phase I clinical trials.

In order to support our clinical pipeline, we have established (through
acquisition and internal investment) a high quality oncology clinical
development and regulatory affairs capability and a pilot scale chemical
manufacturing and process chemistry group. Behind our clinical pipeline we have
an extensive, fully integrated small molecule drug discovery organization
designed to generate a pipeline of high quality oncology drug candidates to move
into clinical development. This research operation has been built upon our
historical strengths in high throughput screening, chemical libraries, medicinal
and combinational chemistry, and automated drug profiling technology platforms.

Key Business Transactions During Fiscal 2002

We believe that Tarceva(TM) has established a corporate presence for us in
the oncology field. Our strategy over the last several years has been designed
to capitalize upon this presence and to re-orient our business toward becoming a
world class oncology organization. To this end, we have raised capital, formed
alliances and engaged in merger and acquisition activity as set forth below.

31

On December 21, 2001, we acquired certain oncology assets from Gilead
Sciences, Inc., which included a pipeline of three clinical oncology candidates
and certain related intellectual property, as well as Gilead's Boulder, Colorado
operations, including clinical research and drug development personnel,
infrastructure and facilities. The Gilead employees retained by us provide us
with extensive expertise in clinical development, regulatory affairs, toxicology
and in vivo pharmacology. The acquisition forms a key part of our strategy to
build a completely integrated and high quality drug discovery, development and
commercial organization in oncology. The acquisition has complemented and
enhanced our ability to successfully execute key components of our business
strategy, including carrying out our obligations for the development and
registration of Tarceva(TM) in our alliance with Genentech and Roche. In
consideration for these assets, we paid Gilead $130 million in cash and issued
to Gilead 924,984 shares of common stock valued at $40 million. We will also be
obligated to pay up to an additional $30 million in either cash, stock or a
combination of cash and common stock upon the achievement of certain milestones
related to the development of OSI-211 (formerly NX211). We also assumed certain
royalty and milestone obligations to third parties in connection with these
oncology products.

At the conclusion of fiscal 2001, we completed a transaction with British
Biotech plc whereby we assumed the leases for two state-of-the-art research and
development facilities in Oxford, England and acquired 58 employees, of whom 42
were engaged in research and development activities with the remainder in
administrative positions. During fiscal 2002, we ceased operations at our
Birmingham, England facility and relocated those operations and certain
personnel to our new Oxford facility and integrated the assets acquired from
British Biotech into our existing operations.

On February 1, 2002, we issued $200.0 million aggregate principal amount of
convertible senior subordinated notes in a private placement for net proceeds to
us of approximately $193.0 million. The notes are convertible into shares of our
common stock at a conversion price of $50 per share and mature on February 1,
2009. We are planning to use the proceeds from the sale of the notes for
continued development of our product pipeline, licensing and acquisition
opportunities that add oncology products and drug candidates, and general
corporate purposes. In August and September 2002, taking advantage of a market
opportunity, we retired a total of $40.0 million in principal amount of the
notes for an aggregate purchase price of $26.2 million, including accrued
interest of $133,000.

With oncology as our focus, we have made the strategic decision to divest
all non-oncology research programs by the end of our second quarter in fiscal
2003, and realign our internal resources toward an oncology strategy. In July
2002, we agreed to accelerate the conclusion of the phase-down period of our
funded research alliance with Anaderm Research Corporation, a wholly-owned
subsidiary of Pfizer focused on the development of novel treatments for skin and
hair conditions. As of September 30, 2002, we received $4.5 million of a total
$8.0 million phase-down fee for transferring to Anaderm all of our research
related to this collaboration. We will also receive royalties on the sale of
products for these treatments which may arise from compounds that we have
identified. We expect the transfer to be completed by January 2003. We also plan
to divest our diabetes program and certain of our adenosine receptor assets into
a newly formed and externally funded entity in which we will maintain a minority
interest. Our diabetes program includes a partnership with the Vanderbilt
University Diabetes Center, a funded alliance with Tanabe Seiyaku Co. Ltd., and
six proprietary gene-targeted discovery programs in the lead seeking and lead
optimization phases, primarily focused in the glucose regulation and obesity
fields. We also intend to transfer to this entity our existing diabetes teams
comprised of approximately 24 employees. If we are unable to obtain external
funding for this newly formed entity, we will consider other alternatives to
discontinue the diabetes program, including the out-licensing of diabetes assets
and employee headcount reductions.

Historically, our research organization had been established to provide
early stage discovery research services to our pharmaceutical industry partners
who funded these activities. Since some of our employee skill sets were from
this multi-disease drug discovery service focus of our past collaborations and
not ideally suited to an oncology-only strategy, in October 2002, we made the
decision to reduce our employee headcount by approximately 9% as we strive to
better balance our staff and skill sets to focus on oncology while maintaining
strict fiscal control of the business. This action left us with 429 employees
and will now allow us to hire additional oncology expertise, as needed.

32

To date, none of our proprietary or collaborative programs have resulted in
commercial products; therefore, we have not received any revenues or royalties
from the sale of products by us or by our collaborators. Since our inception, we
have funded our operations primarily through public and private placements of
common stock, the private placement of convertible debt securities and payments
under collaborative research agreements with major pharmaceutical companies.

CRITICAL ACCOUNTING POLICIES

We prepare our consolidated financial statements in accordance with
accounting principles generally accepted in the United States. As such, we are
required to make certain estimates, judgments and assumptions that we believe
are reasonable based upon the information available. These estimates and
assumptions affect the reported amounts of assets and liabilities as of the date
of the consolidated financial statements and the reported amounts of revenue and
expenses during the periods presented. Actual results could differ significantly
from those estimates under different assumptions and conditions. We believe that
the following discussion addresses our most critical accounting policies which
are those that are most important to the portrayal of our financial condition
and results of operations and which require our most difficult and subjective
judgments, often as a result of the need to make estimates about the effect of
matters that are inherently uncertain. Note 1 to the accompanying consolidated
financial statements includes a summary of the significant accounting policies
used in the preparation of the consolidated financial statements.

Revenue Recognition

We recognize all nonrefundable upfront license fees, including upfront
technology access fees, as revenue over the term of the related research
collaboration period in accordance with the guidance provided in the Securities
and Exchange Commission's Staff Accounting Bulletin No. 101 -- "Revenue
Recognition in Financial Statements," as amended, or SAB No. 101. Our most
significant application of this policy, to date, is the $25 million in upfront
fees received from Genentech and Roche in January 2001 which was originally
being recognized evenly over the expected three-year term of our required
research and development efforts under the terms of the agreement. The expected
term is subject to change based upon the parties' continuous monitoring of
current research data and their projections for the remaining development
period. A change in this expected term impacts the period over which the
remaining deferred revenue would be recognized. In the fourth quarter of fiscal
2002, the expected term was changed to four years to reflect the revised
estimated timing of our research and development commitment for Tarceva(TM)
under the alliance. The revision was a result of the review of the current
research data available, current developments in the HER1/EGFR targeted therapy
market and the involved parties' revised projections for the clinical
development plan. As a result of this revision, we recorded revenues of $1.3
million in the fourth quarter compared to $2.1 million had the upfront fees
continued to be recognized over a three-year period. Collaborative program
revenues represent funding arrangements for research and development in the
field of biotechnology and are recognized when earned in accordance with the
terms of the contracts and the related development activities undertaken. Other
revenues are recognized pursuant to the terms of grants which provide
reimbursement of certain expenses related to our other research and development
activities. Collaborative and other revenues are accrued for expenses incurred
in advance of the reimbursement and deferred for cash payments received in
advance of expenditures. Such deferred revenues are recorded as revenue when
earned.

Accruals for Clinical Research Organization and Clinical Site Costs

We make estimates of costs incurred to date but not yet invoiced in
relation to external clinical research organizations, or CROs, and clinical site
costs. We analyze the progress of clinical trials, including levels of patient
enrollment, invoices received and contracted costs when evaluating the adequacy
of the accrued liabilities. Significant judgments and estimates must be made and
used in determining the accrued balance in any accounting period. Actual results
could differ significantly from those estimates under different assumptions.

33

Intangible and Long-Lived Assets

Intangible and other long-lived assets are reviewed for impairment whenever
events or changes in circumstances indicate that the carrying value of an asset
may not be recoverable. Our judgments regarding the existence of impairment
indicators are based on historical and projected future operating results,
changes in the manner of our use of the acquired assets or our overall business
strategy, and market and economic trends. In the future, events could cause us
to conclude that impairment indicators exist and that certain intangible assets
are impaired which might result in an adverse impact on our financial condition
and results of operations.

COMPARISON OF FISCAL 2002 AND FISCAL 2001

Results of Operations

Our fiscal 2002 net loss of $218.5 million increased $194.7 million
compared to our fiscal 2001 net loss of $23.8 million. The increase in the net
loss was primarily related to the one-time in-process research and development,
or in-process R&D, charge of $130.2 million in connection with the acquisition
of Gilead's oncology assets. Excluding the non-recurring charge of $130.2
million related to the in-process R&D acquired, the net loss for fiscal 2002
would have been $88.3 million or $2.45 per share, an increase of $64.5 million
compared to fiscal 2001. This increase in the net loss is primarily due to an
increase in development costs associated with Tarceva(TM) and the three clinical
candidates acquired from Gilead. Included in the net loss for fiscal 2001 was a
non-cash charge of $2.6 million related to the cumulative effect of a change in
accounting principle for the recognition of upfront fees upon the adoption of
SAB No. 101 (see note 1(b)) to the accompanying consolidated financial
statements). Excluding the effect of this change in accounting principle, the
net loss for fiscal 2001 would have been $21.1 million or $0.62 per share.

Revenues

Total revenues of $21.8 million in fiscal 2002 decreased $4.2 million or
16% compared to fiscal 2001. Total collaborative program revenues of $12.0
million in fiscal 2002 decreased $6.0 million or 33% compared to fiscal 2001.
These decreases were primarily due to the phase-down of our collaboration with
Anaderm commencing in April 2002 and the conclusions of our funded
collaborations with Pfizer in April 2001, Sankyo Co., Ltd. in December 2001 and
Solvay Pharmaceuticals, Inc. in December 2000. In July 2002, we entered into an
agreement with Pfizer to accelerate the phase-down period of the collaboration
with Anaderm so that it will terminate no later than April 23, 2003. In
consideration for the work to be performed by us during the accelerated
phase-down period, we received $4.5 million in September 2002 and will receive
$3.5 million upon the successful completion of the transition period. The $4.5
million will be recognized as revenue ratably over the expected term of the
transition period and the $3.5 million will be recognized upon the successful
completion of the transition. We expect this transition to be completed by
January 2003. For fiscal 2002, we recognized $1.8 million of revenue related to
the phase-down. As we continue to focus our business away from
collaborative-based to independent drug discovery and development, we expect
collaborative revenue to continue to decrease.

License and related revenues of $8.7 million in fiscal 2002 increased $1.3
million or 17% compared to fiscal 2001. This increase was due primarily to the
recognition of the pro rata portion of the $25 million upfront fees received
from Genentech and Roche for 12 months in fiscal 2002 compared to only nine
months in fiscal 2001 (see note 5(a) to the accompanying consolidated financial
statements). In accordance with the provisions of SAB No. 101, we were
recognizing the $25 million received from Genentech and Roche evenly over the
expected three-year development phase of our agreement. In the fourth quarter of
fiscal 2002, we changed the expected term of the agreement to four years to
reflect the revised estimated timing of our research and development commitment
for Tarceva(TM) under the alliance. The revision was a result of the review of
the current research data available, current developments in the HER1/EGFR
targeted therapy market and the involved parties' revised projections for the
clinical development plan. In accordance with Accounting Principles Board
Opinion No. 20, "Accounting Change," the remaining deferred revenue will be
recognized prospectively over the revised term. As a result, we recorded
revenues of $1.3 million in the fourth

34

quarter of fiscal 2002 compared to $2.1 million had we continued to recognize
the upfront fees over a three-year period.

Other revenues of $1.2 million in fiscal 2002 were primarily related to
transition assistance services provided to Gilead and certain administrative
services provided to British Biotech during the transition periods under our
respective agreements with each of them.

Expenses

Operating expenses of $261.8 million increased $189.0 million or 260% in
fiscal 2002 compared to fiscal 2001. Operating expenses primarily included (i)
research and development, or R&D, expenses, which include expenses related to
the development of our lead clinical candidate, Tarceva(TM), and proprietary and
collaborative-based research; (ii) the $130.2 million charge related to the
acquired in-process R&D related to the oncology assets acquired from Gilead;
(iii) selling, general and administrative expenses; and (iv) amortization of
intangibles. We intend to hold our core operating costs, including expenses
related to Tarceva(TM) development, to approximately $140-145 million over the
next year.

Research and development expenses increased $46.2 million or 82% in fiscal
2002 compared to fiscal 2001. The increase was related primarily to increased
costs associated with (i) the clinical development of Tarceva(TM) under our
Tripartite Agreement with Genentech and Roche, (ii) increased investments in our
proprietary cancer programs, including oncology candidates acquired from Gilead
in December 2001; and (iii) increased investments in our core proprietary
research programs and facilities. These increases were slightly offset by a
decrease in collaborative-based research expenses, a reduction in certain stock
option based compensation charges in comparison to the prior year, and a
restructuring charge included in fiscal 2001 of approximately $4.4 million. This
restructuring charge related to the closing of our Tarrytown, New York and
Birmingham, England facilities, as further discussed below.

On August 17, 2000, the Board of Directors granted non-qualified stock
options to purchase up to 250,000 common shares to our then new President and
Head of Research and Development. The terms of this grant provided for an option
to purchase 100,000 shares of common stock with an exercise price equal to 50%
of the fair market value on the grant date vesting immediately upon his
employment date on September 28, 2000 (i.e., the measurement date), and an
option to purchase 150,000 shares of common stock with an exercise price equal
to the fair market value on the grant date vesting one-third in a year from the
measurement date and monthly thereafter for twenty-four months. The granting of
the options at 50% of fair market value resulted in a compensation charge of
$5.0 million in fiscal 2000. The granting of the other options resulted in
deferred compensation of $4.4 million as of September 30, 2000, which was to be
recognized as compensation expense over the vesting period. A significant
portion of this compensation expense was due to the high volatility of our
common stock price between the grant date and the measurement date. In fiscal
2002, $485,000 of compensation expense was included in R&D expenses compared to
$1.5 million in fiscal 2001. As a result of his resignation as an employee
effective February 1, 2002, no additional compensation expense has been recorded
subsequent to February 1, 2002 and the remaining deferred compensation of $2.4
million was reversed. In addition, other stock options granted to non-employees
in connection with their consulting arrangements resulted in the recognition of
$503,000 and $1.5 million in fiscal 2002 and fiscal 2001, respectively, and
deferred compensation of $49,000 and $1.0 million as of September 30, 2002 and
2001, respectively. In accordance with EITF Issue 96-18, "Accounting for Equity
Instruments that Are Issued to Other Than Employees for Acquiring, or In
Conjunction with Selling, Goods or Services," the amount of compensation expense
to be recorded in future periods related to the non-employee grants is subject
to change each reporting period based upon the then fair value of these options,
using a Black-Scholes option pricing model, until expiration of the vesting
period.

In connection with the acquisition of certain assets from Gilead in fiscal
2002, we recorded an in-process R&D charge of $130.2 million representing the
estimated fair value of the acquired in-process technology that had not yet
reached technological feasibility and had no alternative future use (see note
3(a) to the accompanying consolidated financial statements). We obtained a third
party valuation to assist us in determining the fair value of certain assets.
The value was determined by estimating the costs to develop the

35

purchased in-process technology into commercially viable products, estimating
the resulting net cash flow from such projects and discounting the net cash
flows back to their present value. These cash flows were probability-adjusted to
take into account the uncertainty surrounding the successful development and
commercialization of the acquired in-process technology. The resulting net cash
flows were based on estimated revenue, cost of sales, R&D costs, selling,
general and administrative costs, and the net cash flow reflects the assumptions
that would be used by market participants. In determining the value of the
in-process R&D, the assumed commercialization dates for these products ranged
from 2004 to 2008. We believe that the assumptions used in the valuation of
purchased in-process technology represented a reasonable estimate of the future
benefits attributable to the purchased in-process technology at the time of the
acquisition. No assurance can be given that actual results will not deviate from
those assumptions in future periods. The cumulative value of the R&D projects we
acquired from Gilead was divided between the three principal projects, OSI-211
(Phase II), OSI-7836 (Phase I), and OSI-7904L (Phase I). Value was assigned to
each program ($19.9 million to OSI-211; $96.9 million to OSI-7836; $13.4 million
to OSI-7904L) based on the assessment of estimated value at the date of
acquisition.

As of September 30, 2002, the technological feasibility of these three
projects had not yet been reached. For each project, we need to successfully
complete a series of clinical trials and to receive FDA or other regulatory
approvals prior to commercialization. Our current estimates of the required
investments for the overall development and registration for these next
generation cytotoxic drugs range from $80 to $120 million per drug. There can be
no assurances that any of these projects will ever reach feasibility or develop
into products that can be marketed profitably, nor can there be assurance we
will be able to develop and commercialize these products prior to the
development of comparable products by our competitors. If it is determined that
it is not cost beneficial to pursue the further development of any of these
projects, we may discontinue such further development of certain or all of these
projects.

Selling, general and administrative expenses increased $12.3 million or 78%
in fiscal 2002 compared to fiscal 2001. The increase was primarily attributable
to the increased expenses for additional management and administrative personnel
and consultants, as well as an increase in facility and information technology
expenses and other professional fees associated with our expansion, corporate
development and governance activities. The increase was also due to increased
commercialization and marketing costs relating to Tarceva(TM) which are shared
with Genentech in accordance with the OSI/Genentech Agreement. Consulting
expenses include stock options granted to non-R&D consultants in connection with
their consulting arrangements which resulted in $109,000 in compensation
expenses in fiscal 2002 compared to $324,000 in fiscal 2001. We anticipate that
general and administrative expenses will remain relatively steady during fiscal
2003 with an increase in commercialization and marketing cost as we expand our
commercial operations in preparation for the launch of Tarceva(TM) and other
development programs.

During fiscal 2001, we made the strategic decision to (i) close our
Birmingham, England facility and relocate our Birmingham personnel to our new
Oxford, England facilities as a result of the acquisition of assets from British
Biotech, and (ii) close our Tarrytown, New York facility and relocate the
Tarrytown, New York personnel to our new research facility in Farmingdale, New
York. The estimated cost of closing these facilities of $5.1 million was accrued
as of September 30, 2001, of which $4.4 million was included in R&D expenses and
$613,000 in selling, general and administrative expenses in fiscal 2001.
Included in the closing costs were amounts associated with severance for
employees who would not be relocated, the lease cost from the anticipated
closing date through the lease termination date and the value of related
leasehold improvements and other capital items which were not being relocated.

Amortization of intangibles of $1.3 million were primarily related to the
amortization of the capitalized workforce and library license acquired from
British Biotech in September 2001.

Other Income and Expense

Net investment income decreased $11.2 million or 43% in fiscal 2002
compared to fiscal 2001. The decrease was primarily attributable to a decrease
in the average rate of return on our investments and to less funds available for
investment. Interest expense increased $5.2 million in fiscal 2002 compared to
fiscal 2001,

36

primarily due to the interest expense incurred on the convertible senior
subordinated notes issued in February 2002 (see note 9 to the accompanying
consolidated financial statements), a portion of which were retired in August
and September 2002. The convertible senior subordinated notes bear interest at
4% per annum, payable semi-annually, and mature on February 1, 2009. For fiscal
2002 and 2001, other expenses-net were approximately $1.6 million and $228,000,
respectively. Included in fiscal 2002 was the amortization of debt issuance
costs of $642,000 and a charge of $500,000 related to the writedown of our
investment in a privately-owned healthcare information company (see note 4(b) to
the accompanying consolidated financial statements). With respect to the early
retirement of these notes, we recognized a net gain of $12.6 million in fiscal
2002 representing the difference between the purchase price of $26.2 million and
the aggregate principal of $40.0 million and related accrued interest less the
writedown of $1.3 million of related debt issuance costs (see note 9 to the
accompanying consolidated financial statements). Also in fiscal 2002, we
recognized the $1.0 million contingent payment received from The Bayer
Corporation in December 2001, in connection with the sale of the diagnostic
business in November 1999 (see note 17 to the accompanying consolidated
financial statements).

COMPARISON OF FISCAL 2001 AND FISCAL 2000

Results of Operations

Our fiscal 2001 net loss of $23.8 million increased $7.4 million or 45%
compared to our fiscal 2000 net loss of $16.3 million. This increase was
primarily related to the launch of the development program associated with
Tarceva(TM), an increased focus on our proprietary research and the closing and
consolidation of certain facilities. The increase in net loss was partially
offset by the recognition of $6.3 million of the upfront fees from Genentech and
Roche (see note 5(a) to the accompanying consolidated financial statements), and
higher interest income resulting from increased funds available for investment
as more fully discussed in "Other Income and Expense" below. Included in the
fiscal 2001 net loss was a non-cash charge of $2.6 million related to the
cumulative effect of a change in accounting principle for the recognition of
upfront fees upon the adoption of SAB. No. 101 (see note 1(b) to the
accompanying consolidated financial statements). Excluding the net effect of
this change in accounting principle, the fiscal 2001 net loss would have been
$22.0 million, or $.65 per share.

Revenues

Total revenues of $26.0 million in fiscal 2001 decreased $2.6 million or 9%
compared to fiscal 2000 due to the focus of our business away from
collaborative-based to independent drug discovery and development. Total
collaborative program revenues of $18.0 million in fiscal 2001 decreased
approximately $5.7 million or 24% compared to fiscal 2000. This decrease was
primarily due to the conclusion of our funded collaborations with Aventis in
September 2000, Solvay in December 2000, and Pfizer in April 2001. These
decreases were partially offset by increased revenues from the Tanabe
collaboration.

License and related revenues of $7.4 million in fiscal 2001 increased $3.7
million or 99% compared to fiscal 2000. This increase was due to the recognition
of upfront fees received from Genentech and Roche of $6.3 million (see note 5(a)
to the accompanying consolidated financial statements). In accordance with the
provisions of SAB No. 101, we were recognizing the $25 million received from
Genentech and Roche evenly over the expected three-year development phase of our
agreement. In the fourth quarter of fiscal 2002, the expected term was changed
to four years to reflect our revised estimate of the term of the continued
involvement in the research and development efforts under the alliance. The
revision was a result of the review of the current research data available,
current developments in the HER1/EGFR targeted therapy market and the involved
parties' revised projections for the development involvement. The fiscal 2001
increase was offset by a one-time technology access fee of $3.5 million from
Tanabe recognized in fiscal 2000. In connection with a change in accounting
principle effective October 1, 2000 (see note 1(b) to the accompanying
consolidated financial statements) to comply with the provisions of SAB No. 101,
we will recognize this previously recognized technology access fee over the
expected term of the agreement, resulting in approximately $875,000 in revenue
recognition in fiscal 2001. Assuming the technology access fee received from
Tanabe had

37

been recognized over the term of the agreement in fiscal 2000, total revenues
would have been $26 million in fiscal 2000.

Other revenues of $613,000 in fiscal 2001 decreased $656,000 or 52%
compared to fiscal 2000. This decrease related to a decrease in sales of
products and services derived from pharmaceutical services of OSI
Pharmaceuticals (UK) Ltd., our UK subsidiary, as we shifted in focus from
external programs to internal programs. This decrease was also due to a decrease
in our revenues from research relating to governmental and private research
grants.

Expenses

Operating expenses increased $20.5 million or 39% in fiscal 2001 compared
to fiscal 2000. Operating expenses primarily included (i) research and
development expenses, which include expenses related to the development of our
lead clinical candidate Tarceva(TM), and proprietary and collaborative-based
research expenses; (ii) selling, general and administrative expenses; and (iii)
amortization of intangibles.

Research and development expenses increased $16.4 million or 41% in fiscal
2001 compared to fiscal 2000. The increase was related primarily to increased
costs associated with (i) the clinical development of Tarceva(TM) under our
Tripartite Agreement with Genentech and Roche; (ii) increased investments in our
proprietary drug discovery programs, including cancer, diabetes, and other new
opportunities arising from our existing research and development programs; and
(iii) consolidating laboratory facilities. These increases were offset by a
shift of collaborative-based research expenses from Aventis, Solvay, and Pfizer
to independent based drug discovery efforts and a reduction in certain stock
option based compensation charges in comparison to the prior year.

As discussed in the "Comparison of Fiscal 2002 to Fiscal 2001 Expenses"
section above, on August 17, 2000, the Board of Directors granted non-qualified
stock options to purchase up to 250,000 common shares to our then new President
and Head of Research and Development. The granting of these options resulted in
a compensation charge of $5.0 million in fiscal 2000 and deferred compensation
of $4.4 million as of September 30, 2000, which was to be recognized as
compensation expense over the vesting period. In fiscal 2001, $1.5 million of
this deferred compensation was recognized as compensation expense. A significant
portion of this compensation expense was due to the high volatility of the price
of our common stock between the grant date and the measurement date. In
addition, in accordance with EITF Issue 96-18, other stock options granted to
non-employees in connection with their consulting arrangements resulted in the
recognition of $1.5 million and $971,000 in fiscal 2001 and fiscal 2000,
respectively, and deferred compensation of $1.0 million and $4.4 million as of
September 30, 2001 and 2000, respectively.

Also included in R&D expenses in fiscal 2001 was $4.4 million relating to
the closing of the Birmingham, England and Tarrytown, New York facilities, as
discussed in the "Comparison of Fiscal 2002 to Fiscal 2001" section above.

Selling, general and administrative expenses increased $4.8 million or 44%
in fiscal 2001 compared to fiscal 2000. The increase was primarily attributable
to the increased expenses for additional management and administrative personnel
and consultants, as well as an increase in facility expenses and other
professional fees associated with our expansion and corporate development
activities. Consulting expenses included stock options granted to non-R&D
consultants in connection with their consulting arrangements which resulted in
$324,000 in compensation expense in fiscal 2001 compared to $812,000 in
compensation expenses in fiscal 2000. Also included in selling, general and
administrative expenses in fiscal 2001 was $612,000 relating to the closing of
the Birmingham, England and Tarrytown, New York facilities, as discussed in the
"Comparison of Fiscal 2002 to Fiscal 2001 Expenses" section above.

Amortization of intangibles in fiscal 2001 primarily represented
amortization of goodwill from the acquisition of Aston, which was fully
amortized as of September 30, 2001.

38

Other Income and Expense

Net investment income increased $22.2 million to $25.9 million in fiscal
2001 compared to $3.7 million in fiscal 2000. The increase in fiscal 2001 was
largely due to investment of funds generated from: (i) a private sale of common
stock to Genentech and Roche in January 2001; and (ii) the underwritten public
offering of our common stock in November 2000. In fiscal 2000, we recorded a
gain of $3.7 million relating to the sale of our diagnostics business unit to
Bayer in November 1999.

LIQUIDITY AND CAPITAL RESOURCES

At September 30, 2002, working capital, representing primarily cash, cash
equivalents, and restricted and unrestricted short-term investments, aggregated
$444.6 million compared to $533.4 million at September 30, 2001. This decrease
of $88.9 million resulted primarily from the net cash paid for the acquisition
of Gilead's oncology assets in December 2001 and our net operating cash burn for
the year. This decrease was offset by the net proceeds from the issuance of the
convertible senior subordinated notes in February 2002, (less the early
retirement of a portion of the notes in August and September 2002) and cash
proceeds from the exercise of stock options.

On December 21, 2001, we acquired certain assets from Gilead pursuant to
the terms of an Asset Purchase Agreement dated as of November 26, 2001. The
assets purchased include: (a) a pipeline of three clinical oncology candidates,
(b) related intellectual property, and (c) rights to Gilead's leased facilities
located in Boulder, Colorado, as well as leasehold improvements and certain
fixed assets. In connection with the acquisition, we retained 117 Gilead
employees. The results of operations of the acquired Gilead oncology assets have
been included in the consolidated statement of operations since the date of
closing. In consideration for the assets, we paid $135.7 million in cash, which
includes professional fees and the assumption of certain liabilities, and issued
924,984 shares of common stock, valued at $40.0 million. We are obligated to pay
contingent consideration of up to an additional $30.0 million in either cash or
a combination of cash and common stock, at our option, upon the achievement of
certain milestones related to the development of OSI-211. Additionally, we
assumed certain royalty and milestone obligations to third parties in connection
with the oncology candidates acquired as part of the acquisition.

On February 1, 2002, we issued $200.0 million aggregate principal amount of
convertible senior subordinated notes in a private placement for net proceeds to
us of approximately $193.0 million. The notes bear interest at 4% per annum,
payable semi-annually, and mature on February 1, 2009. We pledged $22.9 million
of U.S. government securities which will be sufficient to provide for the
payment in full of the first six scheduled interest payments on the notes when
due. The notes are convertible into shares of our common stock at a conversion
price of $50 per share, subject to adjustment in certain circumstances. We may
redeem the notes, in whole or in part, at any time before February 1, 2005 if
the closing price of our common stock has exceeded 150% of the conversion price
then in effect for a specified period of time. Upon any such early redemption,
we are required to pay interest that would have been due through February 1,
2005. We may also redeem some or all of the notes at any time on or after
February 1, 2005 if the closing price of our common stock has exceeded 140% of
the conversion price then in effect for a specified period of time. Upon a
change in control, as defined in the indenture governing the notes, the holders
of the notes will have the right to require us to repurchase all of the notes,
or a portion thereof, not previously called for redemption at a purchase price
equal to 100% of the principal amount of the notes purchased, plus accrued and
unpaid interest. We may elect to pay the purchase price in common stock instead
of cash. Accordingly, our liquidity position would not be affected by such a
call by the holders of the notes if we elect to pay the purchase price in stock.
The number of shares of common stock a holder would receive would equal the
repurchase price divided by 95% of the average of the closing prices of our
common stock for the five-trading day period ending on the third business day
prior to the repurchase date. If all or any portion of the notes have not been
converted into common stock prior to their maturity date of February 1, 2009, we
will be required to pay, in cash, the outstanding principal amount of the notes
plus any accrued but unpaid interest. This could have a significant impact on
our liquidity depending on our cash position at the time of maturity. If we do
not have sufficient cash to repay the debt, we may need to borrow additional
funds or sell additional equity in order to meet our debt obligations. In August
and September 2002, we retired a total of $40.0 million in principal amount of
the

39

notes for an aggregate purchase price of approximately $26.2 million, including
accrued interest of $133,000. The difference between the purchase price and the
principal amount of the notes retired and accrued interest resulted in a net
gain on the early retirement of the notes in the fourth quarter of fiscal 2002
of approximately $12.6 million net of the write off of related debt issuance
cost. Should conditions warrant, we may from time-to-time continue to enter the
market to repurchase additional notes.

We expect to incur continued losses over the next several years as we
continue our investment in Tarceva(TM) and other product candidates in our
pipeline. The major expenses associated with the broad-based Phase III
development program for Tarceva(TM) are expected to occur in 2003 and, as a
result, we expect our operating expenses and cash burn to increase in fiscal
2003. Beyond fiscal 2003, as the Tarceva(TM) development expenses begin to wind
down, we expect a lower operating expense and cash burn base which we will
maintain until a successful Tarceva(TM) market launch. We have established a
goal of achieving profitability and positive cash flow within 18 to 24 months of
a successful market launch of Tarceva(TM). Although we believe that we have
sufficient cash for operations for the next few years, if the market launch of
Tarceva(TM) is delayed or if Tarceva(TM) does not receive FDA approval or if the
approval process is delayed or takes longer than expected, such events could
have a negative impact on our liquidity position, assuming our current cash
burn.

To achieve profitability, we, alone or with others, must successfully
develop and commercialize our technologies and products, conduct pre-clinical
studies and clinical trials, secure required regulatory approvals and obtain
adequate assistance to successfully manufacture, introduce and market such
technologies and products. The ability and time required to reach profitability
is uncertain. We believe that our existing cash resources provide a strong
financial base from which to fund our operations and capital requirements for at
least the next several years.

COMMITMENTS AND CONTINGENCIES

Our major outstanding contractual obligations relate to our senior
subordinated convertible debt and our facility leases. The following table
summarizes our significant contractual obligations at September 30, 2002 and the
effect such obligations are expected to have on our liquidity and cash flow in
future periods (in thousands):

- ---------------

(a) Includes interest payments at a rate of 4% per annum.

(b) Includes interest payments

Other significant commitments and contingencies include the following:

- We are committed to share equally with Genentech and Roche certain global
development costs of Tarceva(TM).

- In connection with the acquisition of certain of Gilead's oncology assets
in December 2001, we are obligated to pay up to an additional $30.0
million in either cash, common stock or a combination of cash and common
stock upon the achievement of certain milestones related to the
development of OSI-211, the most advanced of Gilead's oncology product
candidates acquired by us.

- Under agreements with external clinical research organizations, or CROs,
over the next 12 to 24 months we will continue to incur expenses relating
to the progress of Tarceva(TM) clinical trials. These

40

disbursements can be based upon the achievement of certain milestones,
patient enrollment, services rendered or as expenses are incurred by the
CROs.

- In connection with our strategic decision to close down our Birmingham,
England facility, we expect to pay approximately $662,000 in
non-cancelable lease exit costs.

- We have a retirement plan which provides postretirement medical and life
insurance benefits to eligible employees, board members and qualified
dependents. Eligibility is determined based on age and years of service.
We have accrued postretirement benefit costs of approximately $2.5
million at September 30, 2002.

- Under certain collaboration agreements with pharmaceutical companies and
educational institutions, we are required to pay royalties and/or
milestones upon the successful development and commercialization of
products.

- Under certain license agreements, we are required to pay license fees for
the use of technologies and products in our research and development
activities.

- We entered into a letter of credit with a commercial bank in relation to
one of our facilities. The irrevocable letter of credit expires annually
with a final expiration date of September 27, 2007. The amount under this
letter of credit is $2.1 million of which the full amount was available
on September 30, 2002.

RECENT ACCOUNTING PRONOUNCEMENTS

In July 2001, the Financial Accounting Standards Board issued SFAS No. 141,
"Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible
Assets." SFAS No. 141 requires that the purchase method of accounting be used
for all future business combinations. It specifies the criteria which intangible
assets acquired in a business combination must meet in order to be recognized
and reported apart from goodwill. SFAS No. 142 requires that goodwill and
intangible assets with indefinite useful lives no longer be amortized, but
instead tested for impairment at least annually in accordance with the
provisions of SFAS No. 142. SFAS No. 142 also requires that intangible assets
with estimable useful lives be amortized over their respective estimated useful
lives, and reviewed for impairment in accordance with SFAS No. 121, "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of." SFAS No. 141 and No. 142 are effective for fiscal years beginning on or
after December 15, 2001; however, both of these statements were effective for
acquisitions and other intangibles acquired on or after July 1, 2001. We adopted
the applicable provisions of these statements for the accounting of the Gilead
and the British Biotech acquisitions, which both occurred after July 1, 2001.

Upon full adoption of these standards in fiscal 2003, we will evaluate our
existing intangible assets that were acquired in prior purchase business
combinations and make any necessary reclassifications in order to conform with
the new criteria in SFAS No. 141 for recognition apart from goodwill. We will be
required to reassess the useful lives and residual values of all intangible
assets acquired and make any necessary amortization period adjustments. In
addition, we will be required to test goodwill and, to the extent an intangible
asset is identified as having an indefinite useful life, the intangible asset
for impairment in accordance with SFAS No. 142. Any impairment loss will be
measured as of the date of adoption and recognized as the cumulative effect of a
change in accounting principle. As a result of the acquisition of certain assets
from Gilead on December 21, 2001, we have $36.5 million in goodwill as of
September 30, 2002 which, in accordance with SFAS No. 142, is not amortized and
identifiable intangible assets in the amount of $2.6 million. As of September
30, 2001, we had goodwill which was fully amortized and unamortized identifiable
intangible assets in the amount of $3.7 million.

In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets" which supercedes SFAS No. 121. SFAS
No. 144 requires, among other things, that long-lived assets be measured at the
lower of carrying amount or fair value, less cost to sell, whether reported in
continuing operations or in discontinued operations. SFAS No. 144 is effective
for fiscal years beginning after December 15, 2001 and interim periods within
those fiscal years.
41

In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." SFAS No. 145, among other things, rescinds SFAS No. 4, which
required all gains and losses from the extinguishment of debt to be classified
as an extraordinary item and amends SFAS No. 13 to require that certain lease
modifications that have economic effects similar to sale-leaseback transactions
be accounted for in the same manner as sale-leaseback transactions. We adopted
SFAS No. 145 effective April 1, 2002, which was the beginning of the fiscal
quarter in which this statement was issued. As a result, we did not classify the
net gain of $12.6 million realized in the fourth quarter of fiscal year 2002
from the early retirement of a portion of the our notes as an extraordinary item
in the accompanying consolidated statements of operations.

In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities", effective for exit or disposal
activities that are initiated after December 31, 2002. Under SAFS No. 146, a
liability for a cost associated with an exit or disposal activity must only be
recognized when the liability is incurred. Under the previous guidance of EITF
94-3, "Liability Recognition for Certain Employee Termination Benefits and Other
Costs to Exit an Activity including Certain Costs Incurred in a Restructuring",
we recognized a liability for an exit or disposal activity cost at the date of
our commitment. If we were to commit to further exit or disposal activities
subsequent to the effective date, we would be subject to the new rules regarding
expense recognition.

FORWARD LOOKING STATEMENTS

A number of the matters and subject areas discussed in this Item 7
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," in Item 1 "Business" and elsewhere in this report that are not
historical or current facts deal with potential future circumstances and
developments. The discussion of these matters and subject areas is qualified by
the inherent risks and uncertainties surrounding future expectations generally,
and these discussions may materially differ from our actual future experience
involving any one or more of these matters and subject areas. These forward
looking statements are also subject generally to the other risks and
uncertainties that are described in this report in Item 1 "Business--Cautionary
Factors that May Affect Future Results."

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS

Our cash flow and earnings are subject to fluctuations due to changes in
interest rates in our investment portfolio of debt securities, to the fair value
of equity instruments held and to foreign currency exchange rates. We maintain
an investment portfolio of various issuers, types and maturities. These
securities are generally classified as available-for-sale and, consequently, are
recorded on the balance sheet at fair value with unrealized gains or losses
reported as a component of accumulated other comprehensive income (loss)
included in stockholders' equity. With respect to the convertible senior
subordinated notes, we pledged $22.9 million of U.S. government securities
(restricted investment securities) with maturities at various dates through
November 2004. Upon maturity, the proceeds of the restricted investment
securities will be sufficient to pay the first six scheduled interest payments
on the convertible senior subordinated notes when due (see note 9 to the
accompanying consolidated financial statements). We consider our restricted
investment securities to be "held-to-maturity," as defined by SFAS No. 115,
"Accounting for Certain Investments in Debt and Equity Securities." These
securities are reported at their amortized cost, which includes the direct costs
to acquire the securities, plus the amortization of any discount or premium, and
accrued interest earned on the securities. Our limited investments in certain
biotechnology companies are carried on the equity method or cost method of
accounting using the guidance of applicable accounting literature. Other-than-
temporary losses are recorded against earnings in the same period the loss was
deemed to have occurred. It is uncertain whether other-than-temporary losses
will be material to our results of operations in the future. We do not currently
hedge these exposures. We at times minimize risk by hedging the foreign currency
exchange rates exposure through forward contracts as more fully described in
note 12(d) to the accompanying consolidated financial statements. We did not
have any forward foreign exchange contracts as of September 30, 2002.

42

At September 30, 2002, we maintained a portion of our cash and cash
equivalents in financial instruments with original maturities of three months or
less. We also maintained an investment portfolio containing financial
instruments of which approximately 13% have original maturities of less than 12
months. These financial instruments, principally comprised of government and
government agency obligations and corporate obligations, are subject to interest
rate risk and will decline in value if interest rates increase. A hypothetical
10% change in interest rates during the year ended September 30, 2002 would have
resulted in approximately a $1.5 million change in our net loss. We have not
used or held derivative financial instruments in our investment portfolio.

Our long-term debt totaled approximately $160.0 million at September 30,
2002 and was primarily comprised of the convertible senior subordinated notes.
The convertible senior subordinated notes bear interest at a fixed rate of 4%.

Underlying market risk exists related to an increase in our stock price or
an increase in interest rates which may make the conversion of the convertible
senior subordinated notes to common stock beneficial to the convertible senior
subordinated notes holders. Conversion of the convertible senior subordinated
notes would have a dilutive effect on any future earnings and book value per
common share.

43

ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Index to Consolidated Financial Statements:

44

INDEPENDENT AUDITORS' REPORT

The Stockholders and Board of Directors
OSI Pharmaceuticals, Inc.:

We have audited the accompanying consolidated balance sheets of OSI
Pharmaceuticals, Inc. and subsidiaries (the "Company") as of September 30, 2002
and 2001, and the related consolidated statements of operations, stockholders'
equity, and cash flows for each of the years in the three-year period ended
September 30, 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 OSI
Pharmaceuticals, Inc. and subsidiaries as of September 30, 2002 and 2001, and
the results of their operations and their cash flows for each of the years in
the three-year period ended September 30, 2002, in conformity with accounting
principles generally accepted in the United States of America.

As discussed in note 1(b) to the consolidated financial statements, the
Company changed its method of revenue recognition for certain upfront
non-refundable fees in 2001.

As discussed in notes 1(d) and 19 to the consolidated financial statements,
the Company adopted provisions of Statement of Financial Accounting Standards
No. 141, "Business Combinations" and No. 142, "Goodwill and Other Intangible
Assets", for acquisitions consummated on or after July 1, 2001.

As discussed in notes 9 and 19 to the consolidated financial statements,
the Company adopted provisions of Statement of Financial Accounting Standards
No. 145 "Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB
Statement No. 13, and Technical Corrections" relating to the classification of
the effect of early debt extinguishments in 2002.

/s/ KPMG LLP

Melville, New York
November 22, 2002

45

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, 2002 AND 2001
(IN THOUSANDS EXCEPT PER SHARE DATA)

See accompanying notes to consolidated financial statements.

46

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS EXCEPT PER SHARE DATA)

See accompanying notes to consolidated financial statements.
47

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED SEPTEMBER 30, 2002, 2001 AND 2000
(IN THOUSANDS)

See accompanying notes to consolidated financial statements.
48

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)

See accompanying notes to consolidated financial statements.
49

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2002, 2001 AND 2000

(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

(a) Principles of Consolidation

The consolidated financial statements of the Company include the accounts
of OSI Pharmaceuticals, Inc., and its wholly-owned subsidiaries, OSI
Pharmaceuticals (UK) Limited (OSI-UK), MYCOsearch, Inc., OSDI, Inc., and Applied
bioTechnology, Inc. All intercompany balances and transactions have been
eliminated in consolidation. The Company operates in one segment. The Company is
primarily focused on the discovery, development and commercialization of
high-quality oncology products that both extend life and improve the
quality-of-life for cancer patients worldwide.

(b) Revenue Recognition

Included in license and related revenues are patent license fees,
maintenance fees, and technology access and other upfront fees. Prior to October
1, 2000, the Company recognized all nonrefundable license fees, including
upfront and technology access fees, as revenue when received and when all
contractual obligations of the Company relating to such fees had been fulfilled.
Effective October 1, 2000, the Company changed its method of accounting for
upfront nonrefundable technology access and other upfront fees to recognize such
fees over the term of the related research collaboration period in accordance
with the guidance provided in the Securities and Exchange Commission's Staff
Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements," as
amended. The Company received a total of $25.0 million in upfront fees from
Genentech, Inc. and Roche in January 2001 which was being recognized on a
straight-line basis evenly over the expected three-year term of the Company's
required research and development efforts under the terms of the agreement. In
the fourth quarter of fiscal 2002, the expected term was changed to four years
to reflect the Company's revised estimate of the term of the continued
involvement in the research and development efforts under the Tripartite
Agreement (see note 5(a)). The revision was a result of the review of the
current research data available, current developments in the HER1/EGFR targeted
therapy market and the involved parties' revised projections for the development
involvement. In accordance with Accounting Principle Board Opinion No. 20
"Accounting Change," the remaining deferred revenue will be recognized
prospectively over the revised term. As a result, the Company recorded revenues
of $1.3 million in the fourth quarter of fiscal 2002 compared to $2.1 million
had the upfront fees continued to be recognized over a three-year period. This
change in estimate increased the basic and diluted loss by $.02 per share for
fiscal 2002.

For the year ended September 30, 2000, the Company recognized as revenue
the full $3.5 million technology access fee received from Tanabe Seiyaku Co.,
Ltd. related to a four-year term collaboration. The Company's adoption of SAB
No. 101 effective October 1, 2000 resulted in a $2.6 million cumulative effect
of a change in accounting principle related to the Tanabe fee which was reported
as a charge in the quarter ended December 31, 2000. The cumulative effect was
initially recorded as unearned revenue and is being recognized as revenue over
the remaining term of the collaboration agreement. During the year ended
September 30, 2001, the impact of the change in accounting principle increased
the net loss by approximately $1.8 million, or $.05 per share, comprised of the
$2.6 million cumulative effect of the change as described above ($.08 per
share), net of the $0.9 million of related deferred revenue that was recognized
as revenue during the year ended September 30, 2001 ($.03 per share). Had the
change in accounting principle been applied retroactively, the net loss for the
year ended September 30, 2000 would have increased by $2.6 million, or $.11 per
basic and diluted shares.

Collaborative program revenues represent funding arrangements for research
and development, (R&D), in the field of biotechnology and are recognized when
earned in accordance with the terms of the contracts and the related development
activities undertaken. Collaborative revenues are accrued for expenses incurred
in advance of the reimbursement and deferred for cash payments received in
advance of expenditures. Such deferred revenues are recorded as revenue when
earned.
50

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2002, 2001 AND 2000

Other revenues are recognized pursuant to the terms of arrangements, which
provide reimbursement of certain expenses related to the Company's other
research and development activities. Other revenues are accrued for expenses
incurred in advance of the reimbursement and deferred for cash payments received
in advance of expenditures

(c) Accrual for clinical research organization and clinical site costs

The Company records accruals for estimated clinical study costs. Clinical
study costs represent costs incurred by clinical research organizations (CROs)
and clinical sites. These costs are recorded as a component of R&D expenses.
Management accrues costs for these clinical studies based on the progress of the
clinical trials, including levels of patient enrollment, invoices received and
contracted costs when evaluating the adequacy of the accrued liabilities.
Significant judgments and estimates must be made and used in determining the
accrued balance in any accounting period. Actual costs incurred may or may not
match the estimated costs for a given accounting period. Actual results could
differ from those estimates under different assumptions. The accrued CRO and
site costs as of September 30, 2002 and 2001 were $3.1 million and $1.3 million,
respectively.

(d) Goodwill and Intangible Assets

In July 2001, the Financial Accounting Standards Board issued SFAS No. 141,
"Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible
Assets." SFAS No. 141 requires that the purchase method of accounting be used
for all future business combinations. It specifies the criteria which intangible
assets acquired in a business combination must meet in order to be recognized
and reported apart from goodwill. SFAS No. 142 requires that goodwill and
intangible assets with indefinite useful lives no longer be amortized, but
instead tested for impairment at least annually in accordance with the
provisions of SFAS No. 142. SFAS No. 142 also requires that intangible assets
with estimable useful lives be amortized over their respective estimated useful
lives and reviewed for impairment in accordance with SFAS No. 121, "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of."

SFAS No. 142 is effective for fiscal years beginning on or after December
15, 2001; however this statement was effective for acquisitions and other
intangibles acquired on or after July 1, 2001. For the Company's two
acquisitions consummated after June 30, 2001, goodwill was not amortized during
2002 in accordance with SFAS No. 142. All intangible assets acquired prior to
July 1, 2001 and intangible assets with finite lives acquired after June 30,
2001 were amortized on a straight-line basis over their estimated periods to be
benefited. Goodwill that was acquired prior to July 1, 2001 was amortized on a
straight-line basis over five years and was fully amortized as of September 30,
2001. Upon full adoption of these standards in fiscal 2003, the Company will
evaluate its existing intangible assets that were acquired in prior business
combinations, and make any necessary reclassifications in order to conform with
the new criteria in SFAS No. 141 for recognition apart from goodwill. The
Company will be required to reassess the useful lives and residual values of all
intangible assets acquired and make any necessary amortization period
adjustments. In addition, the Company will be required to test goodwill and, to
the extent an intangible asset is identified as having an indefinite useful
life, the intangible asset for impairment in accordance with SFAS No. 142. Any
impairment loss will be measured as of the date of adoption and recognized as
the cumulative effect of a change in accounting principle. As of September 30,
2002, the carrying amount of goodwill was $36.5 million and the carrying amount
of identifiable intangible assets was $2.6 million. The Company is currently
assessing the impact of the adoption of these accounting standards.

As a result of the Company's R&D programs, including programs funded
pursuant to R&D funding agreements (see note 5), the Company has applied for a
number of patents in the United States and abroad.

51

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2002, 2001 AND 2000

Costs incurred in connection with patent applications for the Company's R&D
programs have been expensed as incurred.

(e) Deferred Acquisition Costs

Deferred acquisition costs represent common stock purchase rights issued in
connection with the Company's acquisition of OSI-UK on September 19, 1996. The
Company issued rights exercisable at the end of three and five years following
the closing date which was September 19, 1996 (for an aggregate exercise price
of $7,500) to obtain a number of shares of the Company's common stock having an
aggregate value of $750,000 (based on the current market value on the date of
exercise). In December 1999, one half of these rights were exercised in exchange
for 74,255 shares of the Company's common stock. Following this exercise, the
Company purchased these shares at the fair market value for $375,000. These
shares are currently held in treasury stock. The present value of such remaining
rights amounted to $375,000 as of September 30, 2001. In December 2001, the
remaining rights were exercised in exchange for 10,543 shares of the Company's
common stock.

(f) Research and Development Costs

Research and development costs are charged to operations as incurred and
include direct costs of R&D scientists and equipment, contracted costs, and an
allocation of laboratory facility and other core scientific services. In fiscal
years 2002, 2001 and 2000, R&D activities included $95.1 million, $44.6 million
and $20.7 million respectively, of independent R&D. Independent R&D includes the
Company's proportionate share of development expenses related to the Tripartite
Agreement (see note 5(a)), and R&D activities funded by government research
grants and other proprietary R&D programs. The balance of R&D represents
expenses under the collaborative agreements and co-ventures with Pfizer Inc.,
Anaderm Research Corporation, Tanabe, Vanderbilt University, Sankyo Co., Ltd.,
Aventis Pharmaceuticals, Inc., Solvay Pharmaceuticals, Inc., Helicon
Therapeutics, Inc., and The Bayer Corporation. Included in R&D expense is the
impact of stock options granted to non-employees over the past three years that
have resulted in approximately $503,000, $1.5 million and $971,000 of
compensation expense in fiscal 2002, 2001 and 2000, respectively (see note
10(a)). Also included in R&D expense in fiscal 2002 and 2001 is approximately
$534,000 and $4.4 million, respectively, related to the closing of the
Tarrytown, New York and Birmingham, England facilities (see notes 16(a) and
16(b)). Included in R&D expenses in fiscal 2002, 2001 and 2000 is $485,000, $1.5
million and $5.0 million, respectively of compensation expense related to the
issuing of an option to purchase shares of common stock to the Company's then
President and Head of Research and Development (see note 10(a)).

(g) Depreciation and Amortization

Depreciation of equipment is recognized over the estimated useful lives of
the respective asset groups on a straight-line basis utilizing the half-year
convention. Leasehold improvements are amortized on a straight-line basis over
the lesser of the estimated useful lives or the remainder of the lease term.

Amortization of the fungal cultures and compounds acquired in connection
with the acquisition of the research business of Cadus Pharmaceutical
Corporation in fiscal 1999, the acquisition of a compound library license from
The Dow Chemical Company in fiscal 1997, and the acquisition of MYCOsearch, Inc.
in fiscal 1996 are on a straight-line basis over five years.

(h) Income Taxes

Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
52

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2002, 2001 AND 2000

carrying amounts of existing assets and liabilities and their respective tax
bases and operating loss and tax credit carryforwards. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date.

(i) Investments

Investment securities at September 30, 2002 and 2001 consist of U.S.
Treasury obligations, municipal obligations and corporate debt and equity
securities. The Company classifies its investments as available-for-sale. These
securities are recorded at their fair value. Unrealized holding gains and
losses, net of the related tax effect, if any, on available-for-sale securities
are excluded from earnings and are reported in accumulated other comprehensive
income (loss), a separate component of stockholders' equity, until realized. The
specific identification basis is utilized to calculate the cost to determine
realized gains and losses from the sale of available-for-sale securities.

A decline in the market value of any available-for-sale security below cost
that is deemed to be other than temporary results in a reduction in carrying
amount to fair value. The impairment is charged to earnings and a new cost basis
for the security is established. Dividend and interest income are recognized
when earned.

In February 2002, in connection with the issuance of convertible senior
subordinated notes (see note 9), the Company pledged $22.9 million of U.S.
government securities (restricted investment securities) with maturities at
various dates through November 2004. Upon maturity, the proceeds of the
restricted investment securities will be sufficient to pay the first six
scheduled interest payments on the convertible senior subordinated notes when
due. The Company considers its restricted investment securities to be held-to-
maturity, as defined by SFAS No. 115, "Accounting for Certain Investments in
Debt and Equity Securities." These securities are reported at their amortized
cost, which includes the direct costs to acquire the securities, plus the
amortization of any discount or premium, and accrued interest earned on the
securities.

As further discussed in note 5(f), the Company received an equity interest
in a research and development company in exchange for research services
provided. The Company has recorded its investment in the company based on the
cost of services rendered. The Company recognized its share of the operating
losses of this company based on its percentage ownership interest under the
equity method of accounting.

The Company has certain investments in privately-owned companies that are
carried on the cost method of accounting. Other than temporary losses are
recorded against earnings in the period the decrease in value of the investment
is deemed to have occurred.

(j) Net Loss Per Share

Basic and diluted net loss per share is computed by dividing the net loss
by the weighted average number of common shares outstanding during the period.
The diluted loss per share presented excludes the effect of common share
equivalents (stock options, warrants and convertible debt), since such inclusion
in the computation would be anti-dilutive. Such common share equivalents
(options and convertible debt) amounted to 4,894,588 for fiscal 2002. Such
common share equivalents (options and warrants) amounted to 2,105,676 and
1,511,821 for fiscal 2001 and 2000, respectively.

(k) Accounting for Stock-Based Compensation

The Company follows the provisions of SFAS No. 123, "Accounting for
Stock-Based Compensation". The provisions of SFAS No. 123 allow the Company to
either expense the estimated fair value of stock options or to continue to
follow the intrinsic value method set forth in Accounting Principles Board (APB)
53

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2002, 2001 AND 2000

Opinion No. 25 "Accounting for Stock Issued to Employees", but disclose the pro
forma effect on net income (loss) had the fair value of the options been
expensed. The Company has elected to continue to apply APB No. 25 in accounting
for stock options issued to employees.

(l) Cash and Cash Equivalents

The Company includes as cash equivalents reverse repurchase agreements,
treasury bills and time deposits with original maturities of three months or
less. Such cash equivalents amounted to $142.8 million and $220.4 million as of
September 30, 2002 and 2001, respectively.

(m) Use of Estimates

The Company has made a number of estimates and assumptions related to the
reporting of assets and liabilities and the disclosure of contingent assets and
liabilities to prepare these consolidated financial statements in conformity
with accounting principles generally accepted in the United States. Actual
results could differ from those estimates.

(n) Foreign Currency Translation

The assets and liabilities of the Company's non-U.S. subsidiary, OSI-UK,
which operates in its local currency is translated to U.S. dollars at exchange
rates in effect at the balance sheet date with resulting translation adjustments
directly recorded as a separate component of accumulated other comprehensive
income (loss). Income and expense accounts are translated at the average
exchange rates during the year.

(o) Comprehensive Income (Loss)

Comprehensive income includes foreign currency translation adjustments and
unrealized gains or losses on the Company's available-for-sale securities.

As of September 30, the components of accumulated other comprehensive
income were as follows (in thousands):

(p) Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed of

The Company accounts for its long-lived assets in accordance with the
provisions of SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets to be Disposed of." SFAS No. 121 requires that
long-lived assets and certain identifiable intangibles be reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. Recoverability of assets to
be held and used is measured by comparison of the carrying amount of an asset to
the future net cash flows expected to be generated by the asset. If such assets
are considered to be impaired, the impairment to be recognized is measured by
the amount by which the carrying amount of the assets exceed the fair value of
assets. Assets to be disposed of are reported at the lower of the carrying
amount or fair value less cost to sell.

54

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2002, 2001 AND 2000

(q) Computer Software Costs

The Company records the costs of computer software in accordance with AICPA
Statement of Position 98-1, "Accounting for the Costs of Computer Software
Development or Obtained for Internal Use." SOP 98-1 requires that certain
internal-use computer software costs be capitalized and amortized over the
useful life of the asset.

(r) Derivatives

The Company accounts for its derivative instruments and hedging activities
in accordance with SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities," as amended. SFAS No. 133 establishes accounting and
reporting standards for derivative instruments as either assets or liabilities
in the statement of financial position based on their fair values. Changes in
the fair values are reported in earnings or other comprehensive income depending
on the use of the derivative and whether it qualifies for hedge accounting.
Derivative instruments are designated and accounted for as either a hedge of a
recognized asset or liability (fair value hedge) or a hedge of a forecasted
transaction (cash flow hedge). For derivatives designated as effective cash flow
hedges, changes in fair values are recognized in other comprehensive income.
Changes in fair values related to fair value hedges as well as the ineffective
portion of cash flow hedges are recognized in earnings. Changes in the fair
value of the underlying hedged item of a fair value hedge are also recognized in
earnings.

(s) Basis of Presentation

Certain reclassifications have been made to the prior period consolidated
financial statements to conform them to current presentations.

(2) LICENSE AGREEMENTS

The Company has entered into various license agreements with third parties
to grant the use of the Company's proprietary assets. These licenses include the
use of the Company's patented gene transcription estate which consists of drug
discovery assays that provide a way to identify novel product candidates that
can control the activity of genes. Licensees may be obligated to pay the Company
license fees, annual fees, and milestones and royalties based on the development
and sale of products derived from the licensed patents. Generally, the duration
of each license is to be coextensive with the life of the last to expire of the
underlying patents. To date, the Company has granted seven licenses to use our
gene transcription patent. In fiscal 2002, 2001, and 2000, total license
revenues were $308,000, $300,000, and $225,000 respectively.

(3) ACQUISITIONS

(a) Gilead's Oncology Assets

On December 21, 2001, the Company acquired certain assets from Gilead
Sciences, Inc. pursuant to the terms of an Asset Purchase Agreement dated as of
November 26, 2001. Gilead is a biopharmaceutical company that discovers,
develops, manufactures and commercializes proprietary therapeutics for
infectious diseases. The assets purchased by the Company included: (a) a
pipeline of three clinical oncology candidates, (b) certain related intellectual
property, and (c) rights to Gilead's leased facilities located in Boulder,
Colorado, as well as leasehold improvements and certain fixed assets. In
connection with the acquisition, the Company retained 117 Gilead employees in
clinical operations, regulatory affairs, toxicology and in vivo pharmacology.
The results of operations of Gilead's oncology assets have been included in the
consolidated statement of operations commencing as of the date of the closing.
In consideration for the assets, the Company paid approximately $135.7 million,
which includes professional fees and the assumption of

55

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2002, 2001 AND 2000

certain liabilities, and issued 924,984 shares of common stock, valued at $40.0
million. The value of the 924,984 common shares issued was based on the average
closing price of the Company's stock for the five days prior to the date of
closing. The Company would also be obligated to pay contingent consideration of
up to an additional $30.0 million in either cash or a combination of cash and
common stock, upon the achievement of certain milestones related to the
development of OSI-211 (formerly NX211), the most advanced of Gilead's oncology
product candidates acquired by the Company. Additionally, the Company assumed
certain royalty and milestone obligations to third parties in connection with
the oncology candidates, acquired as part of the acquisition.

Included in the assets acquired were certain employee home purchase loans
and a home bridge loan in connection with the acquisition. The total amount of
the loans acquired amounted to $623,000. Under the terms of the home purchase
loan agreements, 50% of the original principal is forgiven over years six to ten
of the loan provided the employees are continuously employed during the term of
the loan. If the employee is terminated, the loan is due within 90 days from
date of termination. The loans are non-interest bearing unless the employee
terminates. During fiscal 2002, the home bridge loan in the amount of $250,000
was repaid in full. The carrying amount of the remaining loans outstanding was
$344,000 and is included in other assets, on the accompanying consolidated
balance sheet as of September 30, 2002.

The acquisition was accounted for under the purchase method of accounting.
The purchase price was allocated to the acquired assets and liabilities assumed
based on the fair values as of the date of the acquisition. The Company obtained
a third-party valuation to assist management in determining the fair value of
certain assets. The excess of the purchase price paid over the fair value of the
net identifiable assets acquired representing goodwill was $35.7 million. During
fiscal 2002, the Company recorded an increase of $800,000 to the goodwill for
additional payments to Gilead for acquisition-related costs. In accordance with
SFAS No. 142, "Goodwill and Other Intangible Assets," which is applicable to
acquisitions occurring after July 1, 2001, such goodwill will not be amortized.
The value assigned to the acquired in-process R&D was determined by identifying
those acquired in-process research projects for which: (a) technological
feasibility had not been established at the acquisition date, (b) there was no
alternative future use, and (c) the fair value was estimable based on reasonable
assumptions. The acquired in-process R&D was valued at $130.2 million and
expensed at the acquisition date and is included in the accompanying
consolidated statement of operations for fiscal 2002. The portion of the
purchase price assigned to the acquired in-process R&D was allocated to the
following three clinical oncology candidates: OSI-211 (formerly NX211), a
liposomal lurtotecan ($19.9 million), OSI-7904L (formerly GS7904L), a liposomal
thymidylate ($13.4 million) and OSI-7836 (formerly GS7836), a nucleoside analog
($96.9 million).

The purchase price was allocated as follows (in thousands):

In-process R&D acquired..................................... $130,200
Fixed assets................................................ 10,529
Goodwill.................................................... 36,528
Prepaid expenses and other assets........................... 663
--------
Total assets and in-process R&D acquired.................... 177,920
Less liabilities assumed.................................... (2,178)
--------
Cash and common stock paid.................................. $175,742
========

The value of the acquired in-process R&D was determined by estimating the
projected net cash flows related to products under development, based upon the
future revenues to be earned upon commercialization of such products. In
determining the value of the in-process R&D, the assumed commercialization dates
for

56

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2002, 2001 AND 2000

these products ranged from 2004 to 2008. Given the risks associated with the
development of new drugs, the revenue and expense forecasts were
probability-adjusted to reflect the risk of advancement through the approval
process. The risk adjustments applied were based on each compound's stage of
development at the time of assessment and the historical probability of
successful advancement for compounds at that stage. These modeled cash flows
were discounted back to their net present value. The projected net cash flows
from such projects were based on management's estimates of revenues and
operating profits related to such projects. The in-process R&D was valued based
on the income approach that focuses on the income-producing capability of the
assets. The underlying premise of this approach is that the value of an asset
can be measured by the present worth of the net economic benefit (cash receipts
less cash outlays) to be received over the life of the asset. Significant
assumptions and estimates used in the valuation of in-process R&D included: the
stage of development for each of the three projects; future revenues; growth
rates for each product; product sales cycles; the estimated life of a product's
underlying technology; future operating expenses; probability adjustments to
reflect the risk of developing the acquired technology into commercially viable
products; and a discount rate of 18% to reflect present value.

In connection with the acquisition, the Company adopted a Non-Qualified
Stock Option Plan for Former Employees of Gilead Sciences, Inc. The Company
granted ten-year options to purchase an aggregate of 693,582 shares of common
stock of the Company at a purchase price of $45.01 per share, which represents
the fair value of the Company's stock at the date granted. The options vest
one-third in a year from the date of grant and monthly thereafter for 24 months.

The following unaudited pro forma financial information presents a summary
of the consolidated results of operations of the Company for the years ended
September 30, 2002 and 2001 assuming the acquisition had taken place as of
October 1, 2001 and 2000, respectively (in thousands, except per share
information):

The unaudited pro forma financial information has been prepared for
comparative purposes only. The pro forma information includes the historical
unaudited results of Gilead's oncology assets for the respective periods. The
pro forma financial information includes adjustments to the Company's historical
results to reflect incremental depreciation expense related to the mark-up of
fixed assets to fair value, reduced interest income generated from cash that was
used for the acquisition, additional interest expense and the issuance of
924,984 shares of common stock and excludes the nonrecurring charge of $130.2
million related to the acquired in-process R&D. The pro forma information does
not purport to be indicative of operating results that would have been achieved
had the acquisition taken place on the dates indicated or the results that may
be obtained in the future.

57

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2002, 2001 AND 2000

(b) British Biotech

On September 28, 2001, the Company acquired certain assets from British
Biotech plc for $13.9 million in cash, which includes professional fees and
other related costs. Accordingly, the acquisition was accounted for as an asset
acquisition and the purchase price was allocated to the tangible and intangible
assets based on the relative fair values at the date of acquisition. The
purchase price was allocated as follows (in thousands):

Equipment and leasehold improvements........................ $ 9,537
Work force intangible....................................... 3,040
License to compound libraries............................... 657
Prepaid expenses............................................ 635
-------
Total assets acquired....................................... $13,869
=======

The Company also assumed two British Biotech facility leases in Oxford,
England as of September 28, 2001. The leases for these two facilities expire in
August 2009 and April 2021. In connection with the acquisition, the Company
acquired a non-exclusive license to compound libraries and the Company agreed to
pay royalties of 2.5% on the sales of products arising out of the use of these
libraries. The cost of the license is being amortized on a straight-line basis
over three years, which represents the estimated period over which the compound
will be used. Also in connection with the acquisition, the Company acquired 58
employees of which 42 were in research and development, two were in information
technology and the remainder were in administrative positions.

In relation to one of the facility leases, the Company entered into a
letter of credit with a commercial bank. The irrevocable letter of credit
expires annually on September 27th, with a final expiration date of September
27, 2007. The amount under this letter of credit is $2.1 million of which the
full amount was available on September 30, 2002. The Company maintains a
collateralized investment account with the same commercial bank for securities
held as collateral against the letter of credit. Included in the accompanying
consolidated balance sheet as of September 30, 2002 in cash and cash equivalents
and investment securities is $1.0 and $2.0 million, respectively, relating to
these collateralized securities.

(4) INVESTMENTS

(a) Investment Securities

The Company invests its excess cash in U.S. Government securities,
municipal obligations and debt and equity instruments of financial institutions
and corporations with strong credit ratings. The Company has established
guidelines relative to diversification of its investments and their maturities
with the objective of maintaining safety and liquidity. These guidelines are
periodically reviewed and modified to take advantage of trends in yields and
interest rates.

The following is a summary of available-for-sale securities as of September
30 (in thousands):

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OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2002, 2001 AND 2000

Government and corporate debt securities include $15.7 million and $20.0
million as of September 30, 2002 and 2001, respectively, of interests in mutual
funds which are invested principally in government and corporate debt
securities. Net realized gains (losses) on sales of investments during fiscal
2002, 2001 and 2000 were $(143,000), $278,000, and $488,000, respectively.

Maturities of debt securities classified as available-for-sale were as
follows at September 30, 2002 (in thousands):

(b) Other Investments

As further discussed in notes 5(b) and 5(f), the Company has collaborative
research agreements with Anaderm and Helicon, and the Company's investments in
such companies were carried based on the equity method of accounting. On
September 23, 1999, the Company exercised its right to require Pfizer to
purchase all of its shares of Anaderm common stock at a sale price of $3.6
million. As of September 30, 1999, the Company recognized a gain of $3.3 million
on the sale of the Anaderm common stock and recorded a receivable of $3.6
million. On November 10, 1999, the Company received a cash payment of this
receivable from Pfizer. As of September 30, 2002 and 2001, the Company fully
reserved its investment in Helicon as more fully discussed in note 5(f).

The Company has an investment in and a license and technology development
agreement with a privately-owned healthcare information company that develops
and provides web-based products and services for the clinical trial process,
including facilitation of patient accrual. During fiscal 2002, the Company
determined that there was an other than temporary decline in fair value for this
investment and recorded a charge of $500,000 in other expense-net, on the
accompanying consolidated statement of operations. The investment was fully
reserved as of September 30, 2002. In addition, in fiscal 2002 the Company
wrote-off a portion of the prepaid balance pertaining to the license agreement
in order to reflect the remaining expected future benefit of this asset. The
write-off resulted in a charge of $700,000, which is reflected in R&D in the
accompanying consolidated statement of operations.

As of September 30, 1999, the Company had an investment in Tularik, Inc.
amounting to $250,000 which was carried at cost and approximated fair market
value (see note 13). In December 1999, the Company sold

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OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2002, 2001 AND 2000

its investment in Tularik resulting in a gain of approximately $488,000 which is
included in net investment income in the accompanying consolidated statement of
operations for fiscal 2000.

(5) PRODUCT DEVELOPMENT CONTRACTS

(a) Roche and Genentech

On January 8, 2001, the Company entered into certain agreements with
Genentech and Roche for the global co-development and commercialization of the
Company's lead anti-cancer drug, Tarceva(TM). The Company received upfront fees
of $25.0 million related to these agreements, which was being recognized evenly
over the expected three-year term of the Company's required R&D efforts under
these agreements. In the fourth quarter of fiscal 2002, the expected term was
revised to four years to more accurately reflect the Company's continued
involvement in the R&D efforts under the alliance. The revision was a result of
the review of the current research data available, current developments in the
HER1/EGFR targeted therapy market and the involved parties' revised projections
for the development involvement. In accordance with Accounting Principle Board
Opinion No. 20 "Accounting Change," the remaining deferred revenue will be
recognized prospectively over the revised term. For the years ended September
30, 2002 and 2001, the Company recognized $7.5 and $6.3 million, respectively,
of the upfront fees which is included in license and related revenues in the
accompanying consolidated statements of operations.

Under the OSI/Genentech Agreement, the Company and Genentech agreed to
collaborate in the product development of Tarceva(TM) with the goal of obtaining
regulatory approval for commercial marketing and sale in the United States, its
territories and Puerto Rico, of products resulting from the collaboration. The
parties are conducting clinical trials of indications for licensed products as
defined in the OSI/Genentech Agreement in accordance with such agreement.
Consistent with the parties' development plan under the OSI/ Genentech
Agreement, and with the approval of the joint steering committee, the parties
will agree as to who will own and be responsible for the filing of drug approval
applications with the U.S. Food and Drug Administration other than the first new
drug application which the Company will own and be responsible for filing and
the first supplemental new drug application which the Company will have the
option to own and be responsible for filing. Genentech has primary
responsibility for the design and implementation of all product launch
activities and the promotion, marketing and sales of all products resulting from
the collaboration in the United States, its territories and Puerto Rico. The
Company has certain co-promotion rights that may be enacted by mutual agreement
at any time provided that the Company has established a commercial operation
independent of Tarceva(TM). Genentech will pay the Company certain milestone
payments and the Company will share equally in the operating profits or losses
on products resulting from the collaboration.

Under the OSI/Genentech Agreement, the Company granted to Genentech a
non-transferable (except under certain circumstances), non-sublicensable (except
under certain circumstances), co-exclusive license under the Company's patents
and know-how related to Tarceva(TM) to use, sell, offer for sale and import
products resulting from the collaboration in the United States, its territories
and Puerto Rico. In addition, Genentech granted to the Company a royalty-free
non-transferable (except under certain circumstances), non-sublicensable (except
under certain circumstances), co-exclusive license to certain patents and
know-how held by Genentech to use, make, have made, sell, offer for sale and
import products resulting from the collaboration in the United States, its
territories and Puerto Rico. The Company has primary responsibility for patent
filings for the base patents protecting Tarceva(TM) and, in addition, has the
right, but not the obligation, to institute, prosecute and control patent
infringement claims relating to the base patents. The term of the OSI/ Genentech
Agreement continues until the date on which both the Company and Genentech are
no longer entitled to receive a share of the operating profits or losses on any
products resulting from the collaboration. The OSI/Genentech Agreement is
subject to early termination in the event of certain defaults. The agreement is
also subject to early termination under certain circumstances.

60

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2002, 2001 AND 2000

Under the OSI/Roche Agreement, the Company granted to Roche a license under
the Company's intellectual property rights with respect to Tarceva(TM). Roche is
collaborating with the Company and Genentech in the product development of
Tarceva(TM) and is responsible for future marketing and commercialization of
Tarceva(TM) outside of the United States in certain territories as defined in
the agreement. The grant is a royalty-bearing, non-transferable (except under
certain circumstances), non-sublicensable (except under certain circumstances),
sole and exclusive license to use, sell, offer for sale and import products
resulting from the development of Tarceva(TM) in the world, other than the
territories covered by the OSI/Genentech Agreement. In addition, Roche has the
right, which it has exercised, to manufacture commercial supplies of Tarceva(TM)
for its territory, subject to certain exceptions. Roche will pay milestone and
royalty payments to the Company on sales of products resulting from the
collaboration. The Company has primary responsibility for patent filings for the
base patents protecting Tarceva(TM) and, in addition, has the right, but not the
obligation, to institute, prosecute and control patent infringement claims
relating to the base patents. The term of the OSI/ Roche Agreement continues
until the date on which the Company is no longer entitled to receive a royalty
on products resulting from the development of Tarceva(TM). The OSI/Roche
Agreement is subject to early termination in the event of certain defaults. In
addition, after two and one half years from the effective date, Roche may
terminate the agreement on a country-by-country basis. The Company may also have
the right to terminate the agreement on a country-by-country basis if Roche has
not launched or marketed a product in such country under certain circumstances.

Under the Tripartite Agreement, the Company, Genentech and Roche agreed to
optimize the use of each party's resources to develop Tarceva(TM) in certain
countries around the world, and share certain global development costs on an
equal basis; to share information generated under a global development plan, to
facilitate attainment of necessary regulatory approvals of Tarceva(TM) products
for commercial marketing and sale in the world; and to work together on such
matters as the parties agree from time to time during the development of
Tarceva(TM). The Tripartite Agreement requires each party to spend equally up to
a specified amount for the further development of Tarceva(TM). Each party may
conduct clinical and pre-clinical activities for additional indications for
Tarceva(TM) not called for under the global development plan, subject to certain
conditions. The Tripartite Agreement will terminate when either the
OSI/Genentech Agreement or the OSI/ Roche Agreement terminates. Any
reimbursement from or additional payments to Genentech or Roche for R&D costs
under the cost sharing arrangement of the Tripartite Agreement are recorded as
an increase or decrease to R&D expenses in the accompanying consolidated
statements of operations.

As discussed in note 10(g), concurrent with the execution of these
agreements, the Company entered into separate Stock Purchase Agreements on
January 8, 2001 with each of Genentech and Roche Holdings, Inc. for the sale to
each of 462,570 newly-issued shares of the Company's common stock for $35.0
million each.

(b) Anaderm

On April 23, 1996, the Company formed Anaderm with Pfizer and New York
University for the discovery and development of novel compounds to treat
conditions such as baldness, wrinkles and pigmentation disorders. In April 1999,
the Company amended a prior research agreement with Pfizer and Anaderm to expand
the collaborative program. On September 23, 1999 the Company sold its interest
in Anaderm to Pfizer. The amended research agreement expired in April 2002,
followed by a three-year phase-down period. On April 24, 2002, pursuant to the
terms of the Collaborative Research Agreement, the Company entered into the
phase-down period of the collaboration. In July 2002, the Company entered into
an agreement with Pfizer to accelerate such phase-down period so that it will
terminate no later than April 23, 2003. During the phase-down period, the
Company will transfer to Anaderm all of the research related to the
collaboration. In consideration for the work to be performed by the Company
during the accelerated phase-down period, the Company received $4.5 million in
September 2002 and will receive $3.5 million upon the successful
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OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2002, 2001 AND 2000

completion of the transition period. The Company will retain its rights to
receive royalties on the sales of products resulting from the collaboration. The
$4.5 million will be recognized as revenue ratably over the expected term of the
transition period and the $3.5 million will be recognized upon the successful
completion of the transition. For the year ended September 30, 2002, the Company
recognized approximately $1.8 million of collaborative program revenues relating
to the phase-down.

(c) Tanabe

Effective as of October 1, 1999, the Company entered into a Collaborative
Research and License Agreement with Tanabe focused on discovering and developing
novel pharmaceutical products to treat diabetes. Under the agreement, the
Company is responsible for identification of targets (subject to Tanabe's
approval), assay development, screening of compounds from the Company's library
and Tanabe's library against identified targets, identification of seed
compounds meeting certain criteria specified in the agreement, optimization of
these seed compounds and identification of lead compounds meeting certain
criteria specified in the agreement. Tanabe maintains responsibility for further
development and marketing of a lead compound in exchange for milestone and
royalty payments to the Company. If Tanabe determines not to initiate further
development of a lead compound or if Tanabe discontinues development of
candidate compounds, the Company will have the sole and exclusive right to
develop, use, manufacture and sell all products resulting from the
collaboration, and it will pay royalties to Tanabe.

The agreement is for a term of four years, with the option to extend for an
additional two-year period. On September 28, 1999, the Company received
approximately $4.3 million from Tanabe, which represented advanced funding of
the technology access fee of $3.5 million and research funding of $812,500 for
the first quarter of fiscal 2000. During the first quarter ended December 31,
1999, the Company recognized as revenue the technology access fee of $3.5
million in accordance with its accounting policy at that time. As a result of
the adoption of SAB No. 101 on October 1, 2000, the Company changed its method
of accounting for such non-refundable upfront fees to recognize such fees over
the term of the related research agreement. This change resulted in a cumulative
effect of an accounting change of $2.6 million recorded in the accompanying
consolidated statement of operations for fiscal 2001 (see note 1(b)).

(d) Vanderbilt

Effective as of April 28, 1998, the Company entered into a Collaborative
Research, Option and Alliance Agreement with Vanderbilt University to conduct a
collaborative research program and seek a corporate partner to fund a technology
collaboration for the discovery and development of drugs to treat diabetes. The
agreement was for a term of one year, and was extended until the Company
executed a third-party research collaboration agreement, which the Company
entered into with Tanabe.

Concurrently with the execution of the Tanabe agreement, the Company
entered into an Amended and Restated Collaborative Research, License and
Alliance Agreement with Vanderbilt and Tanabe with an effective date of August
31, 1999. The term of the research program conducted by the Company and
Vanderbilt commenced on April 28, 1998 and will end upon termination of the
contract period under the Tanabe agreement unless mutually extended by the
Company and Vanderbilt.

The Company is providing funding to Vanderbilt to conduct the
OSI/Vanderbilt research program. A portion of this funding comes from Tanabe's
funding of the OSI/Tanabe research program. The Company will also pay to
Vanderbilt a percentage of the revenues it receives from Tanabe and any other
third party which commercializes products resulting from the OSI/Tanabe research
program based on the extent to which Vanderbilt technology and patents
contributed to the product generating the revenue.

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OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2002, 2001 AND 2000

(e) Pfizer

In April 1986, the Company entered into a collaborative research agreement
and a license agreement with Pfizer. The Company renewed the collaboration for
additional five-year terms in 1991 and 1996, respectively. On April 1, 2001, the
funded phase of the collaborative research agreement expired and was not
renewed. Following the expiration of the collaborative research agreement,
Pfizer is continuing to develop certain specified drug candidates which emanated
from the collaborative research agreement and for which Pfizer will owe the
Company a royalty if ultimately commercialized. The Company continues to have
rights in joint technology developed during the collaboration.

In June 2000, the Company gained full development and marketing rights to
Tarceva(TM) in order to allow Pfizer to meet certain requirements of the U.S.
Federal Trade Commission arising from the FTC's review of Pfizer's merger with
Warner-Lambert Company. Under terms of the agreement with Pfizer, which became
effective upon issuance and publication of the FTC's order on June 19, 2000, the
Company received a royalty-free license to all rights for the further
development and commercialization of Tarceva(TM). The terms of the agreement did
not require the Company to make any payments to Pfizer for the license. In
January 2001, the Company entered into a co-development and marketing
partnership with Genentech and Roche for Tarceva(TM) (see note 5(a)).

(f) Helicon

In July 1997, the Company, Cold Spring Harbor Laboratory and Roche formed
Helicon Therapeutics, Inc., a Delaware corporation. In exchange for
approximately 30% of Helicon's outstanding capital stock, the Company
contributed to Helicon molecular screening services which were completed in
fiscal 1998 and a nonexclusive license with respect to certain screening
technology. As of September 30, 2002 and 2001, the Company's investment in
Helicon was fully reserved.

Effective as of August 15, 2001, the Company entered into a new compound
screening and technology license agreement to provide molecular screening
services to Helicon. Under the terms of the agreement, Helicon retains the right
to use the screening data solely for its own internal research purposes. Helicon
maintains the right for further development of the selected compound in exchange
for royalties and milestone payments to the Company. If Helicon determines to
further develop the selected compounds identified by the Company, the Company
will grant to Helicon a worldwide exclusive license to, among other things, use,
manufacture and sell these compounds in exchange for milestones and royalties on
product sales. If Helicon determines not to further develop any of the
identified selected compounds, the selected compounds and all related data shall
be returned to the Company.

(g) Bayer

Effective January 1, 1997, the Company and Bayer entered into an agreement
to develop serum-based cancer diagnostic products. Upon the sale of the
Company's diagnostic business to Bayer, the agreement terminated. See note 17
for sale of the Company's diagnostic business to Bayer on November 30, 1999.

(h) Other

Under the terms of the aforementioned and other collaborative research
agreements, with terms similar to the aforementioned agreements, certain
collaborative partners will pay the Company royalties on net sales of products
resulting from these research programs in addition to the research revenues
described below. To date, the Company has not received any royalties pursuant to
these agreements. The Company or its collaborative partners may terminate each
of the collaborative research programs upon the occurrence of certain events.

63

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2002, 2001 AND 2000

Total collaborative program revenues under the Company's collaborative
research agreements are as follows (in thousands):

(6) PROPERTY, EQUIPMENT AND LEASEHOLD IMPROVEMENTS

Property, equipment and leasehold improvements are recorded at cost and
consist of the following (in thousands):

The Company capitalized $2.7 and $1.6 million of computer software cost as
of September 30, 2002 and 2001, respectively, of which $980,000 and $263,000 was
amortized as of September 30, 2002 and 2001, respectively.

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OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2002, 2001 AND 2000

(7) INTANGIBLE ASSETS

The components of intangible assets, net are as follows (in thousands):

The above amounts reflect accumulated amortization for license to compound
libraries and acquired work forces of $1.4 million and $105,000 as of September
30, 2002 and 2001, respectively. The goodwill acquired in connection with the
acquisition of certain oncology assets from Gilead, which occurred after July 1,
2001 is not being amortized, in accordance with the provisions of SFAS No. 142.
Goodwill acquired prior to July 1, 2001 was fully amortized as of September 30,
2002 and 2001.

(8) ACCOUNTS PAYABLE AND ACCRUED EXPENSES

Accounts payable and accrued expenses at September 30, 2002 and 2001 are
comprised of (in thousands):

(9) CONVERTIBLE SENIOR SUBORDINATED NOTES

On February 1, 2002, the Company issued $200.0 million aggregate principal
amount of convertible senior subordinated notes (Notes) in a private placement
for net proceeds to the Company of $192.9 million. The Notes bear interest at 4%
per annum, payable semi-annually, and mature on February 1, 2009. The Notes are
convertible into shares of the Company's common stock at a conversion price of
$50 per share, subject to normal and customary adjustments such as stock
dividends or other dilutive transactions. The Company may redeem the Notes, in
whole or in part, at any time before February 1, 2005 if the closing price of
the Company's common stock has exceeded 150% of the conversion price then in
effect for a specified period of time (Provisional Redemption). Upon any such
Provisional Redemption, the Company is required to pay interest that would have
been due through February 1, 2005. The Company may also redeem some or all of
the Notes at any time on or after February 1, 2005 if the closing price of the
Company's common stock has exceeded 140% of the conversion price then in effect
for a specified period of time. Upon a change in control, as defined in the
indenture governing the Notes, the holders of the Notes will have the right to
require the

65

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2002, 2001 AND 2000

Company to repurchase all of the Notes, or a portion thereof, not previously
called for redemption at a purchase price equal to 100% of the principal amount
of the Notes purchased, plus accrued and unpaid interest. The Company may elect
to pay the purchase price in common stock instead of cash. The number of shares
of common stock a holder will receive will equal the repurchase price divided by
95% of the average of the closing prices of the Company's common stock for the
five-trading day period ending on the third business day prior to the repurchase
date. The related debt issuance costs of $7.1 million were deferred and are
being amortized on a straight-line basis over the term of the Notes.

With respect to the Notes, the Company pledged $22.9 million of U.S.
government securities (Restricted Investment Securities) with maturities at
various dates through November 2004. Upon maturity, the proceeds of the
Restricted Investment Securities will be sufficient to pay the first six
scheduled interest payments on the Notes when due. The Company considers its
Restricted Investment Securities to be held-to-maturity, as defined by SFAS No.
115, "Accounting for Certain Investments in Debt and Equity Securities." These
securities are reported at their amortized cost, which includes the direct costs
to acquire the securities, plus the amortization of any discount or premium, and
accrued interest earned on the securities. The aggregate fair value and
amortized cost of the Restricted Investment Securities at September 30, 2002
were $19.6 million and $19.3 million, respectively.

In August and September 2002, the Company retired a total of $40.0 million
in principal amount of the Notes for an aggregate purchase price of $26.2
million, including accrued interest of $133,000. The difference between the
purchase price and the principal amount of the Notes retired and accrued
interest, resulted in a net gain on the early retirement of the Notes in the
fourth quarter of fiscal 2002 of $12.6 million, including the write off of
approximately $1.3 million of the related debt issuance costs. The Company
adopted SFAS No. 145, "Recission of FASB Statements No. 4, 44 and 64, Amendment
of FABB Statement No. 13, and Technical Corrections," effective April 1, 2002
and as a result, the Company did not classify the net gain of $12.6 million
realized in the fourth quarter of fiscal 2002 as an extraordinary item in the
accompanying consolidated statements of operations.

At September 30, 2002, the fair value of the outstanding Notes was
approximately $105.9 million based on quoted market value.

(10) STOCKHOLDERS EQUITY

(a) Stock Option Plans

The Company has established eight stock option plans for its employees,
officers, directors and consultants, including the 2001 Incentive and
Non-Qualified Stock Option Plan and two stock option plans adopted upon the
acquisitions of Gilead's oncology assets in December 2001 (see note 3(a)) and
certain assets from Cadus in July 1999. The plans are administered by the
Compensation Committee of the Board of Directors, which may grant either
non-qualified or incentive stock options. The Committee determines the exercise
price and vesting schedule at the time the option is granted. Options vest over
various periods and expire no later than 10 years from date of grant. The total
authorized shares under these plans is 12,565,249.

The Board of Directors adopted the 2001 Incentive and Non-Qualified Stock
Option Plan, effective June 13, 2001, which was approved by the stockholders at
the annual meeting of stockholders on March 13, 2002. Under the plan the Company
may grant incentive stock options and non-qualified stock options to purchase up
to 4,000,000 shares. Participation in the plan is limited to directors,
officers, employees and consultants of the Company or a parent or subsidiary of
the Company. The plan also continues the automatic, formula-based grants of
non-qualified stock options to directors who are not employees of the Company.
Persons elected to the board after June 13, 2001 are entitled to an initial
grant of a non-qualified option to purchase 30,000 shares of common stock upon
their initial election with annual grants of options to purchase

66

OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2002, 2001 AND 2000

7,500 shares thereafter upon re-election to the board. Persons elected to the
board prior to June 13, 2001 will continue to be eligible for annual grants of
options to purchase shares of common stock in an amount which depends upon the
number of years of service as a director (20,000 shares reducing to 7,500
shares).

The following table summarizes changes in the number of common shares
subject to options in the eight stock option plans, options established for
certain outside consultants related to clinical trial operations, options
granted to employees of OSI-UK, and options granted to outside directors:

At September 30, 2002, the Company has reserved 8,160,807 shares of its
authorized common stock for all shares issuable under options. At September 30,
2002, 2001 and 2000 the number of options exercisable were 2,291,689, 2,147,374,
and 1,752,084, respectively.

Information regarding stock options outstanding as of September 30, 2002,
is as follows:

Stock option grants are generally set at the closing price of the Company's
common stock on the date of grant and the related number of shares granted are
fixed at that point in time, except for one grant as noted below. Therefore
under the principles of APB Opinion No. 25, the Company does not recognize
compensation

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OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2002, 2001 AND 2000

expense associated with the grant of stock options. SFAS No. 123, "Accounting
for Stock-Based Compensation," requires the use of option valuation models to
determine the fair value of options granted after 1995. Pro forma information
regarding net loss and loss per share shown below was determined as if the
Company had accounted for its employee stock options and shares sold under its
stock purchase plan under the fair value method of SFAS No. 123.

The fair value of the options was estimated at the date of grant using a
Black-Scholes option pricing model with the following weighted-average
assumptions for fiscal 2002, 2001 and 2000, respectively: risk-free interest
rates of 3.86 %, 3.28% and 5.95%, dividend yields of 0%; volatility factors of
the expected market price of the Company's common stock of 77.19%, 81.9% and
84.0%; expected life of the employees' options of 3.0 years, 3.0 years, and 4.2
years; and expected life of the consultants' options equal to the remaining
contractual life of the options. These assumptions resulted in weighted-average
fair values of $17.19, $25.29 and $23.08 per share for stock options granted in
fiscal 2002, 2001 and 2000, respectively.

For purposes of pro forma disclosures, the estimated fair value of the
options is amortized over the options' vesting periods. The pro forma effect on
net loss for the periods presented is not representative of the pro forma effect
on net income or loss in future years because it does not take into
consideration pro forma compensation expense related to grants made prior to
fiscal 1996. The Company's pro forma information is as follows (in thousands,
except per share information):

On August 17, 2000, the Board of Directors granted non-qualified options to
purchase up to 250,000 shares of common stock to the Company's then new
President and Head of Research and Development. The terms of this grant provided
for an option to purchase 100,000 shares of common stock with an exercise price
equal to 50% of the fair market value on the grant date, vesting immediately
upon his employment on September 28, 2000 and an option to purchase 150,000
shares of common stock with an exercise price equal to the fair market value on
the grant date, vesting one-third in a year from the effective date of his
employment and monthly thereafter for twenty-four months. Compensation expense
resulting from these awards was measured as of September 28, 2000, the effective
date of employment. The granting of the options at 50% of fair market value
resulted in a compensation charge of $5.0 million, which is included in R&D
expense in the accompanying consolidated statement of operations for fiscal
2000. The granting of the other options resulted in deferred compensation of
$4.4 million which was to be recognized as compensation expense on a
straight-line basis over the vesting period. In fiscal 2002 and 2001, $485,000
and $1.5 million was recognized as compensation expense. As a result of his
resignation as an employee effective February 1, 2002, no additional
compensation expense has been recorded subsequent to February 1, 2002 and the
remaining deferred compensation of $2.4 million was reversed.

On August 17, 2000, one member of the Company's Board of Directors retired
as a director but continues to provide consulting services to the Company under
an existing consulting arrangement. In connection with his retirement, the Board
of Directors declared the then outstanding unvested options held by this
director as immediately vested. Absent this acceleration in vesting, the
unvested options would have continued to vest pursuant to the original terms of
the option award. The modification to the vesting schedule caused a new
measurement date for the unvested options which resulted in an incremental
intrinsic value of $1.6 million. The incremental intrinsic value was not
reflected as compensation in the accompanying consolidated statements of
operations as the individual continued to provide services to the Company
through the original vesting period of such options. In fiscal 2002, 2001 and
2000, the Company granted options to certain non-

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OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2002, 2001 AND 2000

employees to purchase 8,500, 127,000 and 80,000 shares of common stock,
respectively. Such options vest over a three year period, based upon future
service requirements. The Company recorded net deferred compensation of $49,000
and $1.0 million based on the fair value of such options as of September 30,
2002 and 2001, respectively, as determined using a Black-Scholes option pricing
model (see above for weighted average assumptions used). Such compensation cost
is amortized to expense using the methodology prescribed in FASB Interpretation
No. 28 over the respective vesting periods. In accordance with EITF Issue 96-18,
"Accounting For Equity Instruments that Are Issued to Other Than Employees for
Acquiring, or In Conjunction with Selling, Goods or Services," the amount of
compensation expense to be recorded in future periods related to the
non-employee grants is subject to change each reporting period based upon the
then fair value of these options, using a Black-Scholes option pricing model,
until expiration of the grant vesting period. The Company recorded compensation
expense in fiscal 2002 of $612,000 for shares granted in fiscal 2002, 2001 and
2000. The Company recorded compensation expense in fiscal 2001 of $1.8 million
for shares granted in fiscal 2001, 2000 and 1999. The Company recorded
compensation expense in fiscal 2000 of $1.8 million for shares granted in fiscal
2000, 1999 and 1998.

In April 1999, new tax regulations became effective in the UK requiring
employers to remit a national insurance contribution (NIC) tax on gains on the
exercise of stock options by employees. This NIC tax applies to the Company's
grants of options to its UK employees in 1999, 2000 and 2001. On June 12, 2001,
the Company obtained Inland Revenue approval to statutorily transfer the
employer NIC liability to the employee.

(b) Shareholder Rights Plan

On September 27, 2000, the Board of Directors adopted a shareholder rights
plan, declared a dividend distribution of one Series SRPA Junior Participating
Preferred Stock Purchase Right on each outstanding share of its common stock,
and authorized the redemption of the rights issued pursuant to the Company's
then current shareholder rights plan. The Company distributed rights to all
shareholders of record at the close of business on September 27, 2000, the
record date. These rights entitle the holder to buy one one-thousandth of a
share of Series SRPA Junior Participating Preferred Stock upon a triggering
event as discussed below.

Upon the actual acquisition of 17.5% or more of the outstanding common
stock of the Company by a person or group, the rights held by all holders other
than the acquiring person or group will be modified automatically to be rights
to purchase shares of common stock (instead of rights to purchase preferred
stock) at 50% of the then market value of such common stock. Furthermore, such
rightholders will have the further right to purchase shares of common stock at
the same discount if the Company merges with, or sells 50% or more of its assets
or earning power to, the acquiring person or group or any person acting for or
with the acquiring person or group. If the transaction takes the form of a
merger of the Company into another corporation, these rightholders will have the
right to acquire at the same percentage discount shares of common stock of the
acquiring person or other ultimate parent of such merger party.

The Company can redeem the rights at any time before (but not after) a
person has acquired 17.5% or more of the Company's common stock, with certain
exceptions. The rights will expire on August 31, 2010 if not redeemed prior to
such date.

(c) Authorized Common and Preferred Stock

The Company has 200,000,000 shares of authorized common stock, with a par
value of $.01 and 5,000,000 shares of preferred stock with a par value of $.01
per share with such designations, preferences, privileges, and restrictions as
may be determined from time to time by the Company's Board of Directors.

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OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2002, 2001 AND 2000

(d) Employee Stock Purchase Plan

The Company has an Employee Stock Purchase Plan under which eligible
employees may contribute up to 10% of their base earnings toward the quarterly
purchase of the Company's common stock. The employee's purchase price is derived
from a formula based on the fair market value of the common stock. No
compensation expense is recorded in connection with the plan. During fiscal
2002, 2001 and 2000, 19,046, 3,350 and 6,811 shares were issued with 163, 57 and
48 employees participating in the plan, respectively. At September 30, 2002, the
Company has reserved 608,704 shares of its authorized common stock in connection
with this plan.

The Company sponsors a stock purchase plan for employees of OSI-UK, its
wholly-owned subsidiary. Under the terms of the plan, eligible employees may
contribute between L5 and L250 of their base earnings, in 36 monthly
installments towards the purchase of the Company's common stock. The employee's
purchase price is determined at the beginning of the 36-month period and
compensation expense is recorded over the 36-month period. A maximum of 100,000
shares may be issued under the plan. As of September 30, 2002, there were 94
employees, eight employees and 17 employees participating in the 2002, 2001 and
2000 stock purchase plans, respectively. At September 30, 2002, the Company has
reserved 66,920 shares of its common stock in connection with this plan.

(e) Private Placement

On February 28, 2000, the Company sold 3.325 million newly-issued shares of
its common stock to a select group of institutional investors for net proceeds
of approximately $53 million.

(f) Public Offering

On November 6, 2000, the Company concluded a public offering of 5.35
million shares of common stock at a price of $70.00 per share. Gross proceeds
totaled $374.5 million with net proceeds of approximately $351.4 million after
all underwriting and other related fees were deducted. In addition, on November
21, 2000, the underwriters associated with this offering exercised their
over-allotment option to purchase an additional 802,500 shares of common stock
at a price of $70.00 per share. Gross proceeds from the exercise of the over-
allotment option totaled $56.2 million with net proceeds of $52.8 million.

(g) Stock Purchase Agreements

Concurrently with the execution of the collaboration agreements described
in note 5(a), the Company entered into separate Stock Purchase Agreements on
January 8, 2001 with each of Genentech and Roche Holdings for the sale to each
of 462,570 newly-issued shares of the Company's common stock. The purchase price
was $75.664 per share, or an aggregate purchase price of $35 million each. No
underwriters or placement agents were involved in the purchase and sale of the
securities. The transactions contemplated under the collaboration agreements and
Stock Purchase Agreements closed on January 30, 2001.

(h) Issuance of Common Stock to Gilead

On December 21, 2001, in connection with the acquisition of certain
oncology assets from Gilead, the Company issued 924,984 shares of common stock
valued at $40.0 million (see note 3(a)).

(i) Convertible Notes

On February 1, 2002, the Company issued $200.0 million aggregate principal
amount of the notes in a private placement. In August and September 2002, the
Company retired a total of $40.0 million in principal amount of the Notes for an
aggregate purchase price of approximately $26.2 million. The Notes are
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2002, 2001 AND 2000

convertible into shares of the Company's common stock at a conversion price of
$50 per share, subject to normal and customary adjustments such as stock
dividends or other dilutive transactions (see note 9).

(11) INCOME TAXES

There is no provision (benefit) for federal or state income taxes, since
the Company has incurred operating losses since inception and has established a
valuation allowance equal to the net deferred tax assets.

The tax effect of temporary differences, net operating loss carry forwards
and research and development tax credit carry forwards as of September 30 are as
follows (in thousands):

As of September 30, 2002, the Company has available federal net operating
loss carry forwards of approximately $241 million which will expire in various
years from 2003 to 2022, and may be subject to certain annual limitations. The
Company's research and development tax credit carry forwards expire in various
years from 2005 to 2022.

Of the $168 million valuation allowance at September 30, 2002, $88 million
relates to deductions for employee stock options for which the tax benefit will
be credited to additional paid in capital if realized.

(12) COMMITMENTS AND CONTINGENCIES

(a) Lease Commitments

The Company leases office, operating and laboratory space under various
lease agreements.

Rent expense was approximately $6.2, $2.1 and $2.0 million for fiscal 2002,
2001 and 2000, respectively. The rent expense for fiscal 2002 includes the
Oxford, England facility leases (acquired in September 2001), the Boulder,
Colorado facility leases (acquired in December 2001), the Farmingdale, New York
lease (commenced in June 2002) and the expansion of the Melville, New York
facility (commenced June 2002). This was offset by the termination of the
Tarrytown, New York lease (August 2002). Beginning in April 2002, rental
payments for the Birmingham, England facility were charged against the closing
cost accrual (see note 16(b)).

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2002, 2001 AND 2000

The following is a schedule of future minimum rental payments for the next
five fiscal years and thereafter required as of September 30, 2002, assuming
expiration of the leases for the Birmingham, England facility by January 4,
2006, the Uniondale facility on June 30, 2006, the Melville, New York facility
on December 31, 2009, the two Oxford, England facilities on August 24, 2009 and
March 31, 2021, respectively, the Farmingdale facility on May 31, 2022, and the
Boulder facilities by October 16, 2006. Also included in the amounts below are
commitments for equipment under various operating leases (in thousands).

2003........................................................ $ 6,952
2004........................................................ 7,047
2005........................................................ 6,982
2006........................................................ 5,567
2007........................................................ 4,232
2008 and thereafter......................................... 55,443
-------
$86,223
=======

As of September 30, 2002, the Company has entered into capital commitments
of approximately $510,000 relating to the refurbishment and upgrading of the two
Oxford facilities and one of the Boulder facilities.

(b) Contingencies

From time to time, the Company has received several letters from other
companies and universities advising the Company that various products under
research and development by the Company may be infringing on existing patents of
such entities. These matters are reviewed by management and outside counsel for
the Company. Where valid patents of other parties are found by the Company to be
in place, management will consider entering into licensing arrangements with the
universities and/or other companies or modify the conduct of its research. The
Company's future royalties, if any, may be reduced by up to 50% if its licensees
or collaborative partners are required to obtain licenses from third parties
whose patent rights are infringed by the Company's products, technology or
operations. In addition, should any infringement claims result in a patent
infringement lawsuit, the Company could incur substantial costs in defense of
such a suit, which could have a material adverse effect on the Company's
business, financial condition and results of operations, regardless of whether
the Company were successful in the defense.

(c) Borrowings

As of September 30, 2002, the Company had a line of credit with a
commercial bank in the amount of $10.0 million. This line expires annually on
March 31st, and its current rate of interest is prime plus 3/4. There were no
amounts outstanding under the line of credit as of September 30, 2002. In
addition, in 1999, the Company obtained a secured loan of $500,000 from the same
bank. The loan was payable over a three-year period, with monthly principal
payments of $13,888, plus interest at 8.12%. The loan balance as of September
30, 2001 was $111,000 and was fully repaid as of September 30, 2002.

In connection with the acquisition of certain assets from Gilead in
December 2001 (see note 3(a)), the Company assumed certain liabilities from
Gilead including loans utilized to finance equipment. The loans have fixed
interest rates ranging from 11.50% to 11.90% and are due in full by June 2003.
The loan balance as of September 30, 2002 was $275,000. The Company's
wholly-owned subsidiary, OSI-UK, also maintains certain loans to finance
equipment. The loans have interest rates ranging from 10.98% to 16.30% and are
due in full by October 2003. The loan balance as of September 30, 2002 was
$265,000.

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OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2002, 2001 AND 2000

(d) Derivative Financial Instruments

The Company, at times, minimizes risk by hedging the foreign currency
exposure of the Company's net investment in foreign operations through the
purchase of forward foreign exchange contracts. At September 30, 2000, the
Company had $1.0 million in such contracts, with remaining terms not exceeding
six months. The difference between the foreign currency rate in the contract and
such rate as of September 30, 2000 was immaterial to the results of operations
for fiscal 2000.

During fiscal 2002 and 2001, the Company did not have any forward foreign
currency exchange contracts or other derivative instruments. The Company does
not enter into derivative instruments for any purpose other than cash flow
hedging; the Company does not speculate using derivatives.

(13) RELATED PARTY TRANSACTIONS

One director is a partner in a law firm which represents the Company on its
patent and license matters. Fees paid to this firm in fiscal 2002, 2001 and 2000
were approximately $504,000, $546,000 and $482,000, respectively. One director
is a controlling member of Mehta Partners LLC with which the Company has a
strategic and financial services arrangement. In fiscal 2002, 2001 and 2000, the
Company paid Mehta approximately $175,000, $175,000 and $490,000 for consulting
services received. In addition, the Company has compensated other directors for
services performed pursuant to consultant arrangements. In fiscal 2002, 2001 and
2000, consulting fees in the amounts of approximately $153,000, $151,000 and
$292,000, respectively, were paid by the Company pursuant to these arrangements.
A director is an officer of Cold Spring Harbor Laboratory which was a founder of
Helicon and Amplicon (which was acquired by Tularik). The Company's former
chairman was a member of the board of directors of Anaderm through September
1999 and is on the board of directors of Helicon. An executive officer of the
Company was vice president of Helicon through November 2002 and vice president
of Anaderm through November 2001. A director was the chief executive officer of
Helicon through December 1999. The Company has a fully reserved investment in
Helicon and sold its investment in Tularik in December 1999 (note 4). A director
is on the faculty of Vanderbilt with which the Company has a collaborative
research agreement, and also has a consulting agreement with the Company. A
director is a non-executive director of Genentech and is an advisor to Roche,
both entities with which the Company has collaboration agreements.

An officer and a vice president of the Company have outstanding loans with
the Company aggregating $200,000 with a carrying amount of $184,000 as of
September 30, 2002. The Company assumed these loans in connection with the
acquisition of certain assets from Gilead on December 21, 2001 (see note 3(a)).

(14) EMPLOYEE SAVINGS AND INVESTMENT PLAN

The Company sponsors an Employee Savings and Investment Plan under Section
401(k) of the Internal Revenue Code. The plan allows employees to defer from 2%
to 20% of their income on a pre-tax basis through contributions into designated
investment funds. For each dollar the employee invests, up to 6% of his or her
earnings, the Company will contribute an additional 50 cents into the funds. For
fiscal 2002, 2001 and 2000, the Company's expenses related to the plan were
approximately $502,000, $350,000 and $277,000, respectively.

The Company also sponsors four pension plans covering the employees of
OSI-UK, its wholly-owned subsidiary. The Group Personal Pension Plan allows
employees to contribute up to 31% (depending on their age) of their income on a
post-tax basis into designated investment funds. The tax paid on the
contribution is then recovered from the Inland Revenue. The Company will
contribute from 4% to 9% depending on the employees' contributions. The British
Biotech Pension Scheme covers employees retained from the acquisition of certain
assets from British Biotech (see note 3(b)), as well as certain former employees
of British

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OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2002, 2001 AND 2000

Biotech hired by the Company subsequent to the acquisition. The plan allows the
employees to defer up to 15% of their income on a pre-tax basis through
contributions into designated pension funds. For each pound the employee
invests, the Company will contribute up to 9% into the funds. The Company also
sponsors a personal pension plan for one employee and a Flexible Executive
Pension Plan covering two senior employees. The Flexible Executive Pension Plan
allows the employees to defer up to 15% of their income on a pre-tax basis
through contributions into designated pension funds. For each pound the employee
invests, the Company will contribute up to 9% into the funds. For fiscal 2002,
2001, and 2000, the Company's expenses related to the plans were approximately
$602,000, $186,000 and $190,000, respectively.

(15) EMPLOYEE RETIREMENT PLAN

On November 10, 1992, the Company adopted a plan which provides
postretirement medical and life insurance benefits to eligible employees, board
members and qualified dependents. Eligibility is determined based on age and
service requirements. These benefits are subject to deductibles, co-payment
provisions and other limitations.

The Company follows SFAS No. 106, "Employer's Accounting for Postretirement
Benefits Other Than Pensions" to account for the benefits to be provided by the
plan. Under SFAS No. 106 the cost of postretirement medical and life insurance
benefits is accrued over the active service periods of employees to the date
they attain full eligibility for such benefits.

Net postretirement benefit cost for fiscal 2002, 2001 and 2000 includes the
following components (in thousands):

The accrued postretirement benefit cost at September 30, 2002 and 2001 was
as follows (in thousands):

The changes in the accumulated postretirement benefit obligation during
fiscals 2002 and 2001 were as follows (in thousands):

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OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2002, 2001 AND 2000

The accumulated postretirement benefit obligation was determined using a
discount rate of 6.75% and 7.5% in 2002 and 2001, respectively. In fiscal 2002,
the health care cost trend was increased to an initial level of 8%, decreasing
to an ultimate rate of 5% by 2016. The health care cost trend rate used in 2001
was a fixed 5%. Increasing the assumed health care cost trend rates by one
percentage point in each year and holding all other assumptions constant would
increase the accumulated postretirement benefit obligation as of September 30,
2002 by approximately $736,000 and the fiscal 2003 net postretirement service
and interest cost by approximately $191,000. Benefits paid during fiscal 2002,
2001 and 2000 were $60,000, $127,000 and $119,000, respectively.

(16) CONSOLIDATION OF FACILITIES

(a) Tarrytown

During the fourth quarter of fiscal 2001, the Company announced its
strategic decision to close down its Tarrytown, New York facility and
consolidate its operations into its Farmingdale, New York facility. The
operations at the facility ceased on June 30, 2002 and the Company closed the
facility in August 2002. The fungal extract libraries and certain furniture and
equipment from the Tarrytown, New York facility were relocated to the other
company facilities. Twenty-eight research and administrative employees relocated
to the Farmingdale and Uniondale facilities. Under the plan for consolidating
this facility, we had anticipated that 28 research and administrative employees
would not relocate and would receive a severance package, which included two
weeks salary for each year of service. As of the closing of the facility, 35
employees did not relocate and received a severance package and two employees
relocated to our Oxford, England facility. In August 2002, the Company entered
into a Termination and Surrender Agreement with the landlord of the Tarrytown
facility whereby it was released from its obligations under the lease.

The estimated cost of closing this facility as of September 30, 2001 was
$775,000, and has been included in the accompanying consolidated balance sheet
in accrued expenses as of September 30, 2001, and in R&D expense ($673,000) and
in selling, general and administrative expenses ($102,000) in the accompanying
consolidated statement of operations for fiscal 2001. The charge consists of
write down of equipment and leaseholds, which were not relocated, of $384,000,
and severance costs of $391,000.

During fiscal 2002, the Company paid $418,000 in severance costs, of which
$391,000 was charged against the closing costs accrual, and $19,000 has been
included in R&D and $8,000 has been included in selling, general and
administrative costs in the accompanying consolidated statement of operations
for fiscal 2002. The Company also wrote-off $511,000 of leasehold improvements
and furniture and equipment which were not relocated to the other facilities,
net of cash proceeds received from the sale of furniture and equipment. The
Company charged $384,000 of this write-off against the closing costs accrual and
$126,000 is included in the accompanying consolidated statement of operations
for fiscal 2002. As of September 30, 2002, there are no accrued closing costs in
the accompanying consolidated balance sheet relating to the Tarrytown facility.
The consolidation activity for the fiscal year ended September 30, 2002 was as
follows (in thousands):

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OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2002, 2001 AND 2000

(b) Birmingham

During the fourth quarter of fiscal 2001, the Company announced the
decision to consolidate its Birmingham, England facility with the newly acquired
Oxford, England facility as a result of the acquisition of the British Biotech
assets (see note 3(b)). The operations at the facility ceased on March 31, 2002;
however, the Company is still in the process of closing down the facility. Fifty
research and administrative employees relocated to the Oxford facilities. Under
the plan for consolidating this facility, we had anticipated that 28 research
and administrative employees would not relocate but would receive a severance
package based on the number of years of service. As of the cessation of
operations, 32 employees did not relocate and received the severance package.

The estimated cost of closing this facility as of September 30, 2001 was
$4.3 million and has been included in the accompanying consolidated balance
sheet in accrued expenses as of September 30, 2001, in R&D expense ($3.8
million) and selling, general and administrative expenses ($511,000) in the
accompanying consolidated statement of operations for fiscal 2001. The charge
consists of non-cancelable lease exit costs for the period April 2002 through
February 2004 of $2.0 million, write down of equipment and leaseholds which are
not being relocated of $2.1 million, and severance costs of $190,000.

During fiscal 2002, the Company paid $244,000 in severance costs, of which
$185,000 was charged against the closing costs accrual, $28,000 and $31,000 have
been included in R&D expense and selling, general and administrative costs,
respectively, in the accompanying consolidated statement of operations for
fiscal 2002. During fiscal 2002, the Company has also paid rental expense and
costs to restore the facility to its original condition in the amount of
$932,000, which have been charged against the closing costs accrual. The Company
adjusted the accrual for lease exit costs based on a revised estimate of costs
to restore the facility to its original condition. As a result, a credit of
$69,000 is included in selling, general and administrative costs in the
accompanying consolidated statement of operations for fiscal 2002. An adjustment
of $537,000 was also made to the accrual to reflect a longer-than expected lease
term relating to one of the leases at the Aston facility. As a result, a charge
of $486,000 and $51,000 is included in R&D expense and selling, general and
administrative costs, respectively, in the accompanying consolidated statement
of operations for fiscal 2002. The Company also wrote-off approximately $2.3
million of leasehold improvements and furniture and equipment which were not
relocated to the Oxford facility. The Company charged $2.2 million of this
write-off against the closing costs accrual and $97,000 is included in the
accompanying consolidated statement of operations for fiscal 2002. As of
September 30, 2002, the remaining restructuring reserve relating to the
consolidation of this facility was $1.6 million relating to non-cancelable lease
exit costs. The consolidation activity for the fiscal year ended September 30,
2002 was as follows (in thousands):

(c) North Carolina

During fiscal 1999, the Company made the strategic decision to close down
its facilities in North Carolina and consolidate its natural products operations
into its Tarrytown, New York facility. This close-down occurred on March 31,
2000. The fungal extract libraries and certain equipment were relocated to the

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OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2002, 2001 AND 2000

Tarrytown facility. None of the employees at the North Carolina facility were
relocated. Under the plan for relocating this facility, 16 research and
administrative employees received a severance package, which included continued
payments of four months salary, plus four months of continuous health insurance.
The leases in North Carolina were scheduled to expire in 2004. The Company
accrued an estimate of a reserve for an expected delay in finalizing a new
tenant and its assumption of the Company's existing lease.

The estimated cost of closing this facility was $535,000, and was included
in the consolidated balance sheet in accrued expenses as of September 30, 1999,
in R&D expense ($395,000) and in selling, general and administrative expenses
($140,000) in the consolidated statement of operations for fiscal 1999. During
fiscal 2000, the Company incurred approximately $432,000 principally in
severance and subleasing-related costs, including a $61,000 loss resulting from
the assumption of a lease and related leasehold improvements by a third party.
At September 30, 2001, the plan was completed and no liability remains.

(17) SALE OF DIAGNOSTICS BUSINESS

On November 30, 1999, the Company sold assets of its diagnostics business
to Bayer including the assets of the Company's wholly-owned diagnostics
subsidiary, OSDI, based in Cambridge, Massachusetts. The assets sold included
certain contracts, equipment and machinery, files and records, intangible
assets, intellectual property, inventory, prepaid expenses and other assets
primarily related to the operations of the diagnostics business. In connection
with the sale, the Company and OSDI entered into certain agreements with Bayer
including an Assignment and Assumption of Lease with respect to the OSDI
facility located in Cambridge. Under the terms of the agreement, the Company
received $9.2 million up-front from Bayer with additional contingent payments of
$1.0 million made to the Company in December 2001.

The Company recorded a gain on the sale of approximately $3.7 million
during fiscal 2000. The net gain was calculated as follows (in thousands):

Cash received from Bayer.................................... $ 9,151
Accrued expenses assumed by Bayer........................... 599
Net book value of fixed assets sold......................... (611)
Net book value of patent costs (intangibles)................ (4,748)
Professional and legal fees incurred........................ (172)
Commission costs paid....................................... (315)
Other related costs......................................... (158)
-------
Gain on sale of diagnostics business........................ $ 3,746
=======

The Company also recorded a gain on the sale of $1.0 million during fiscal
2002 upon receipt of the additional contingent payment.

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OSI PHARMACEUTICALS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2002, 2001 AND 2000

(18) QUARTERLY FINANCIAL DATA (UNAUDITED)

The tables below summarize the Company's unaudited quarterly operating
results for fiscal 2002 and 2001.

The basic and diluted net (loss) income per common share calculation for
each of the quarters are based on the weighted average number of shares
outstanding in each period. Therefore, the sum of the quarters in a fiscal year
does not necessarily equal the basic and diluted net (loss) income per common
share for the fiscal year.

(19) NEW ACCOUNTING PRONOUNCEMENTS

In July 2001, the Financial Accounting Standards Board issued SFAS No. 141,
"Business Combinations," and SFAS No. 142, "Goodwill and Other Intangible
Assets." SFAS No. 141 requires that the purchase method of accounting be used
for all future business combinations. It specifies the criteria which intangible
assets acquired in a business combination must meet in order to be recognized
and reported apart from goodwill. SFAS No. 142 requires that goodwill and
intangible assets with indefinite useful lives no longer be amortized, but
instead tested for impairment at least annually in accordance with the
provisions of SFAS No. 142. Amortization expense relating to goodwill was $0,
$694,000 and $694,000 for the years ended September 30, 2002, 2001 and 2000,
respectively. SFAS No. 142 also requires that intangible assets with estimable
useful lives be amortized over their respective estimated useful lives, and
reviewed for impairment in accordance with SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of."
SFAS No. 141 and No. 142 are effective for fiscal years beginning on or after
December 15, 2001; however, both of these statements are effective for
acquisitions and other intangibles acquired on or after July 1, 2001. The
Company adopted the applicable provisions of these statements for the accounting
of the acquisition of certain oncology assets from Gilead and the British
Biotech asset acquisition,

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED SEPTEMBER 30, 2002, 2001 AND 2000

which occurred after July 1, 2001 (see notes 3(a) and 3(b) to the consolidated
financial statements, respectively).

Upon full adoption of these standards in fiscal 2003, the Company will
evaluate its existing intangible assets that were acquired in prior purchase
business combinations, and make any necessary reclassifications in order to
conform with the new criteria in SFAS No. 141 for recognition apart from
goodwill. The Company will be required to reassess the useful lives and residual
values of all intangible assets acquired, and make any necessary amortization
period adjustments. In addition, the Company will be required to test goodwill
and, to the extent an intangible asset is identified as having an indefinite
useful life, the intangible asset for impairment in accordance with SFAS No.
142. Any impairment loss will be measured as of the date of adoption and
recognized as the cumulative effect of a change in accounting principle. As of
September 30, 2002, the Company had goodwill in the amount of $36.5 million and
identifiable intangible assets in the amount of $2.6 million. The Company is
currently assessing the impact of the full adoption of these accounting
standards.

In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets" which supercedes SFAS No. 121. SFAS
No. 144 requires, among other things, that long-lived assets be measured at the
lower of carrying amount or fair value, less cost to sell, whether reported in
continuing operations or in discontinued operations. SFAS No. 144 is effective
for fiscal years beginning after December 15, 2001 and interim periods within
those fiscal years. The Company is currently assessing the impact of adoption of
SFAS No. 144.

In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements
No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." SFAS No. 145, among other things, rescinds SFAS No. 4, which
required all gains and losses from the extinguishment of debt to be classified
as an extraordinary item and amends SFAS No. 13 to require that certain lease
modifications that have economic effects similar to sale-leaseback transactions
be accounted for in the same manner as sale-leaseback transactions. The Company
adopted SFAS No. 145 effective April 1, 2002, which was the beginning of the
fiscal quarter in which this statement was issued. As a result, the Company did
not classify the net gain of $12.6 million realized in the fourth quarter of
fiscal year 2002 from the early retirement of a portion of the Company's notes
as an extraordinary item in the accompanying consolidated statements of
operations.

In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities", effective for exit or disposal
activities initiated after December 31, 2002. Under SFAS No. 146, a liability
for a cost associated with an exit or disposal activity must only be recognized
when the liability is incurred. Under the previous guidance of EITF 94-3,
"Liability Recognition for Certain Employee Termination Benefits and Other Costs
to Exit an Activity including Certain Costs Incurred in a Restructuring", the
Company recognized a liability for an exit or disposal activity cost at the date
of its commitment. If the Company were to commit to further exit or disposal
activities subsequent to the effective date, it would be subject to the new
rules regarding expense recognition.

(20) SUBSEQUENT EVENT

On October 24, 2002, the Company announced certain staffing adjustments,
management alignments and business initiatives designed to continue the
Company's efforts to refocus its entire business and research development
activities into the oncology area. The Company reduced its overall headcount by
approximately 40 employees, primarily in the research discovery area, and
announced its intention to divest its non-oncology research assets.

79

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

Not Applicable.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The information required by this item is incorporated by reference to the
similarly named section of our Proxy Statement for our 2003 Annual Meeting to be
filed with the Securities and Exchange Commission not later than 120 days after
September 30, 2002.

ITEM 11. EXECUTIVE COMPENSATION

The information required by this item is incorporated by reference to the
similarly named section of our Proxy Statement for our 2003 Annual Meeting to be
filed with the Securities and Exchange Commission not later than 120 days after
September 30, 2002.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The information required by this item is incorporated by reference to the
similarly named section of our Proxy Statement for our 2003 Annual Meeting to be
filed with the Securities and Exchange Commission not later than 120 days after
September 30, 2002.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information required by this item is incorporated by reference to the
similarly named section of our Proxy Statement for our 2003 Annual Meeting to be
filed with the Securities and Exchange Commission not later than 120 days after
September 30, 2002.

ITEM 14. CONTROLS AND PROCEDURES

CEO and CFO Certifications. Appearing immediately following the Signatures
section of this Annual Report there are two certifications, or the Section 302
Certifications, one by each of our Chief Executive Officer, or CEO, and Chief
Financial Officer, or CFO. This section of the Annual Report which you are
currently reading contains information concerning the evaluation of our
disclosure controls and procedures and internal controls that is referred to in
the Section 302 Certifications and this information should be read in
conjunction with the Section 302 Certifications for a more complete
understanding of the topics presented.

Evaluation of our Disclosure Controls and Procedures. The Securities and
Exchange Commission requires that within 90 days prior to the filing of this
Annual Report on Form 10-K, the CEO and the CFO evaluate the effectiveness of
the design and operation of our disclosure controls and procedures (as defined
in Rule 13(a)-14(c) and Rule 15(d)-19(c) under the Securities Exchange Act of
1934 (the Exchange Act) and report on the effectiveness of the design and
operation of our disclosure controls and procedures. Within 90 days prior to the
filing of this Annual Report on Form 10-K, under the supervision and with the
participation of our management, including our CEO and CFO, we evaluated the
effectiveness of the design and operation of our disclosure controls and
procedures.

Limitations on the Effectiveness of Controls. Our management, including
the CEO and CFO, does not expect that our disclosure controls and procedures or
our internal controls will prevent all error and all fraud. A control system, no
matter how well conceived and operated, can provide only reasonable, not
absolute, assurance that the objectives of the control system are met. Further,
the design of a control system must reflect the fact that there are resource
constraints, and the benefits of controls must be considered relative to their
costs. Because of the inherent limitations in all control systems, no evaluation
of controls can provide

80

absolute assurance that all control issues and instances of fraud, if any,
within the company have been detected. These inherent limitations include the
realities that judgments in decision-making can be faulty, and that breakdowns
can occur because of simple error or mistake. Additionally, controls can be
circumvented by the individual acts of some persons, by collusion of two or more
people, or by management override of the control. The design of any system of
controls also is based in part upon certain assumptions about the likelihood of
future events, and there can be no assurance that any design will succeed in
achieving its stated goals under all potential future conditions; over time,
control may become inadequate because of changes in conditions, or the degree of
compliance with the policies or procedures may deteriorate. Because of the
inherent limitations in a cost-effective control system, misstatements due to
error or fraud may occur and not be detected. While we believe that our
disclosure controls and procedures have been effective, in light of the
foregoing we intend to continue to examine and refine our disclosure controls
and procedures and to monitor ongoing developments in this area.

CEO/CFO Conclusions about the Effectiveness of the Disclosure Controls and
Procedures. Based upon their evaluation of the disclosure controls and
procedures, our CEO and CFO have concluded that, subject to the limitations
noted above, our disclosure controls and procedures are effective to provide
reasonable assurance that material information relating to the Company and its
consolidated subsidiaries is made known to management, including the CEO and
CFO, on a timely basis and particularly during the period in which this Annual
Report on Form 10-K was being prepared.

Changes in Internal Controls. There were no significant changes to our
internal controls or in other factors that could significantly affect our
internal controls, subsequent to the date of our last evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.

PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

The following consolidated financial statements are included
(a)(1) in Part II, Item 8 of this report:
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statements of Stockholders' Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
All schedules are omitted as the required information is
(2) inapplicable or the information is presented in the
financial statements or related notes.
The exhibits listed in the Index to Exhibits are attached or
(3) incorporated herein by reference and filed as a part of this
report.
(b) Reports on Form 8-K
None

81

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, as amended, the Registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized.

OSI PHARMACEUTICALS, INC.

By: /s/ COLIN GODDARD, PH.D.

------------------------------------
Colin Goddard, Ph.D.
Chairman and Chief Executive Officer

Date: December 11, 2002

Pursuant to the requirements of the Securities and Exchange Act of 1934, as
amended, this report has been signed below by the following persons on behalf of
the Registrant and in the capacities and on the days indicated.

83

CERTIFICATION

I, Colin Goddard, certify that:

1. I have reviewed this annual report on Form 10-K of OSI Pharmaceuticals,
Inc.;

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

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

4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

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

(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing
date of this annual report (the "Evaluation Date"); and

(c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):

(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified
for the registrant's auditors any material weaknesses in internal controls;
and

(b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and

6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.

Date: December 11, 2002

/s/ COLIN GODDARD
--------------------------------------
Colin Goddard
Chairman of the Board and Chief
Executive Officer

84

CERTIFICATION

I, Robert L. Van Nostrand, certify that:

1. I have reviewed this annual report on Form 10-K of OSI Pharmaceuticals,
Inc.;

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

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

4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

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

(b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing
date of this annual report (the "Evaluation Date"); and

(c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

5. The registrant's other certifying officers and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):

(a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified
for the registrant's auditors any material weaknesses in internal controls;
and

(b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and

6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.

Date: December 11, 2002

/s/ ROBERT L. VAN NOSTRAND
--------------------------------------
Robert L. Van Nostrand
Vice President and Chief Financial
Officer

85

INDEX TO EXHIBITS

- ---------------

* Filed herewith.

+ Portions of this exhibit have been redacted and are subject to a confidential
treatment request filed with the Secretary of the Securities and Exchange
Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934,
as amended.